Climate change risks and shareholder activism
It isn’t mandatory for U.S. firms to report potential environmental risks, but shareholders increasingly seek the information.
Photograph by Westend61
Companies in all industries face exposure to the effects of climate change, regardless of their own emissions levels or efforts to reduce them. These effects include physical risks (such as severe weather), regulatory changes (such as energy efficiency standards and carbon trading programs), and shifts in suppliers’ operations and consumers’ purchasing habits.
In 2019, investors submitted a record number of climate change–related proposals to U.S. firms at annual shareholder meetings, highlighting the growing concern among investors about the potential effects of global warming on firms’ operations, supply chains, and bottom lines.
But climate change remains a complicated and disputed topic in business circles. In the U.S., where the disclosure of potential environmental risks isn’t mandatory, shareholder activism is one of the few mechanisms through which investors can glean information on how companies are bracing for the direct and indirect impacts of climate change. Historically, however, proposals have garnered little support from fellow shareholders.
As environmental concerns grow, shouldn’t more shareholder proposals gain traction? The authors of a new study explore the conditions under which shareholder activism regarding climate change is successful, which types of shareholders are most successful at getting firms to divulge information, and how communicating climate change risks to investors affects a company’s stock price.
The authors analyzed a pair of databases, one of firms’ disclosures of climate-related risks and one that tracks information on shareholder proposals. They obtained data for 2010–16 on 265 public U.S. firms.
The study found that firms facing increased shareholder activism — as assessed by the number of proposals concerning climate change submitted by a firm’s shareholders — disclosed more information about environmental risks and the steps taken to mitigate them. For example, companies might tell shareholders they’re securing suppliers from more geographic locations to minimize the impact of region-specific storms. Or they could report a new focus on energy-efficient products to appeal to changing consumer preferences, burnish their reputation, or meet government guidelines. Shareholder activism was most effective when it was spearheaded by long-term institutional shareholders such as public pension funds, mutual funds, and hedge funds rather than individual investors.
As environmental concerns grow, shouldn’t more shareholder proposals gain traction?
Given the uncertain nature of climate change and its effects, management is more likely to respond positively to requests from institutional investors, the authors posit, because those investors are conceivably interested in the value of the firm over the long haul. As a result of their large ownership stake, they have considerable sway, and also a lot to lose if climate change risks aren’t mitigated.
Individual investors, on the other hand, are apt to be in it for short-term gains, and could be more easily scared away by negative information and withdraw (pdf) their investment, the authors suggest. As a result, their proposals aren’t treated as seriously.
Companies that report climate change risks in the wake of shareholder activism see an uptick of about 4.8 percent in their stock price over the next year, the authors found, implying that investors reward transparency. Indeed, in a 2019 survey of 439 institutional investors, the majority said they thought climate change disclosures were just as important as financial reporting; about a third said they thought environmental information was even more important.
As the authors of the current study note, evidence suggests environmental shareholder activism can alert managers to their firms’ potential climate change risks and increase awareness of vulnerabilities. It can also force them to conduct a formal assessment of the firm’s exposure and outline how they plan to manage it — valuable information for investors.
Still, the authors stress, shareholder activism isn’t a substitute for public governance initiatives. “Long-term institutional investors may therefore find it worthwhile to both pursue shareholder activism and engage with the government to mandate climate change risk disclosure,” the authors write.
Source: “Shareholder Activism and Firms’ Voluntary Disclosure of Climate Change Risks,” by Caroline Flammer (Boston University), Michael W. Toffel (Harvard Business School), and Kala Viswanathan (Harvard Business School), Social Science Research Network, Oct. 2019
