Sustainability is currently one of the highest-ranking issues on the social and political agenda. As corporations have imposed important externalities on the environment, proposals to rein in their contribution to environmental risks such as climate change abound. In terms of corporate and capital markets law, these include, among other things, reforms of directors’ duties and channelling institutional investors’ stewardship to push companies to reduce their externalities. The European Union, for example, is in preparation to modify directors’ duties (deviating from considering only shareholders’ interests) (see the Sustainable Corporate Governance Initiative) after having put forward a comprehensive framework for sustainable finance and institutional investor stewardship (see the Sustainable Finance measures). However, as far as continental Europe is concerned, these measures overlook the core feature of listed and unlisted companies: the existence of controlling shareholders. This post argues that, in the face of a controlling shareholder, it is difficult to accomplish the aim of creating more sustainable companies through these measures. This, in turn, highlights the role of the direct regulation of the externalities imposed by these companies.
European jurisdictions are characterized by controlled companies. In other words, rather than the dispersion of share-ownership, publicly-traded companies have a majority shareholder who controls and directs the operations of the company (see, eg, Aminadav & Papaioannou 2020). Although these shareholders can be long-term value-maximisers, they are also likely to impose negative externalities if profitable.
In the presence of such a shareholder, the attempt to modify directors’ duties may fail to achieve more sustainability. For example, the European Commission wants to empower directors to ‘take into account all stakeholders’ interests which are relevant for the long-term sustainability of the firm’ (as part of their duty of care) (see Inception Impact Assessment, p 3). Although such a duty may prod directors to consider and mitigate externalities the company imposes, they will be ultimately beholden to the controlling shareholder who can unilaterally elect and remove the directors. Combined with little enforcement of directors’ duties and hurdles to a substantial liability of directors in the Continental European jurisdictions (see, eg, Gelter 2012; Black, Cheffins & Klausner 2006), directors may still prioritize the interests of the controlling shareholder, which might not be aligned with the environmental interests if there are profits to be made.
A second consideration concerns the stewardship role institutional investors may play in listed companies. Although the incentives of institutional investors and asset managers to engage with the management and governance of investee companies are limited and rather controversial (see, eg, Christie 2021), a recent view points to the potential of such investors to prevent companies from creating externalities that have systemic implications and thus generate portfolio-wide consequences (see, eg, Gordon 2021; Enriques & Romano 2021). Climate change is such a systemic risk, so, the argument goes, institutional investors such as index funds may assume stewardship roles to prevent such systemic risks (to protect their portfolio value) and thus push investee companies not to impose externalities that create these risks (even if it depresses firm value). To encourage and facilitate institutional investors’ engagement, for example, in the EU, the Shareholders’ Rights Directive II requires institutional investors and asset managers (on a comply or explain basis) to develop, implement, and disclose an engagement policy which, among other things, encompasses monitoring investee companies in terms of their social and environmental impact (Article 3g). To prevent ‘greenwashing’ by companies and provide more information for capital market participants who then can make better decisions on where and when to allocate capital, the Taxonomy Regulation and the upcoming Corporate Sustainability Reporting Directive require more concrete disclosure by companies such as their green asset ratio (Article 8) or net zero strategies (Article 19a), respectively.
Although institutional investors and asset managers may indeed assume the stewardship role and push managers of investee companies not to impose externalities (in line with their aim of portfolio value maximisation rather than firm value maximisation), the likelihood of their success for the same against the controlling shareholders in controlled companies is evidently not high. Granted, there are examples of hedge funds’ successful activist campaigns against controlling shareholders (see, eg, Kastiel 2016). But especially institutional investors and, most prominently, large index funds are neither willing to pick up such a fight nor have the tools and chance to prevail over controlling shareholders who put profit first in the controlled company.
Another important factor to consider is the identity of the controlling shareholder. Most importantly, state-owned companies present a noticeable case. When the state is the controlling shareholder in a company, it doubles as the regulator and controlling shareholder, which creates a double-edge sword (see, eg, Lim 2021). On the one hand, a state which strives to reduce greenhouse gas emissions in its jurisdiction would also be expected to put companies it controls on a more sustainable path. On the other hand, when states that are currently unwilling or uncommitted to participate in the efforts of climate change mitigation are controlling shareholders, achieving sustainability in companies controlled by these states becomes more difficult. This is significant because most companies that are reported to have so far contributed to 71% of emissions in the world (‘carbon majors’) are owned by states that remain unambitious in terms of curbing emissions for various reasons.
This sobering account underscores, first, the importance of directly regulating the negative externalities the companies impose on the environment. Surely, reforming directors’ duties and channelling institutional investors’ stewardship for sustainability are laudable and virtuous goals. However, in an environment of controlled companies where a profit-minded shareholder calls the shots, the effects of such measures will be limited. In fighting against a crisis as serious as climate change, we will need more effective tools. Secondly, where companies with a major carbon footprint are owned by states that are currently unwilling to curb their carbon externalities, we have even more limited tools in business law. International coordination, regulation and enforcement will then be the key.
This essay is the runner-up in the 2021 Oxford Business Law Blog Essay Competition on ‘Business Law and the Transition to a Net Zero Carbon Economy’ and is part of the homonymous series. The competition was open to graduate students of the Faculties of Law of Oxford University, Hamburg University, Freie Universität Berlin and the National University of Singapore.
Alperen Afşin Gözlügöl is a PhD student at the University of Hamburg, Germany.