This post comes out of the early career workshop ‘Law and Political Economy in Europe’, which took place at the Centre for Socio-Legal Studies, at the University of Oxford, on the 7th of October 2019. For all the posts this series, click here.
Federico Fornasari –
The impending climate crisis, the widespread social tensions and the burgeoning level of wealth and income inequalities have led to diffused discontent, both in the “global north and south” with the current neoliberal order. The role that the financialized corporation plays into this picture has taken a center stage in this discussion. The keyword of the debate has been “sustainability”: the exact meaning of the term remains fuzzy, whilst the legal strategies to enhance it are debated. One of the fundamental ingredients of sustainability is the disclosure of environmental, social and governance (henceforth, ESG) factors.
From a law and political economy perspective, we might ask: what is the role that corporate law and financial market regulation can play in transitioning to a greener economy and a fairer society? And specifically, can (and how to design) ESG factors disclosure to promote such a transition? Finally, how do specific conceptions of the corporation and its boundaries resurface through the designing of ESG indicators?
ESG disclosure has received critiques both from the left and the right. On the one side, there is ample evidence that “responsible” practices are not reported correctly, and that there is a race to the bottom to cherry-pick ESG indicators. Greenwashing – the aura of legitimacy brought by the rhetoric of sustainability hiding the substance of environmental and social exploitation – also abounds. On the other side, it is almost impossible to devise a successful trading strategy based on ESG factors, and the scant evidence of the positive stock returns of corporations that perform better on ESG matters is firm-specific. Of course, the two critiques embed a different worldview and a different conception of the functions of the corporation.
Unsustainability as market failure
Proposals about ESG factors disclosure informed by a “neo-classical” understanding of the corporation are underpinned by the idea that the reason for promoting and regulating non-financial information depends on market failures, and that the role of regulation is to solve this specific market failure, in order to steer the market.
“Neo-classical” approaches to disclosure of ESG factors share these features:
- Shareholders are interested in specific sustainability factors for two main reasons: first, certain factors represent risks that should be taken into account; secondly, the sustainability domain represents in some cases business opportunities that could enhance profits.
- This is the main problem that should be addressed by ESG disclosure is improving information for investors. Once the information is produced it can be adequately priced and optimal sustainable outcomes will emerge spontaneously from the market forces’ operations.
The regulatory hallmarks of these approaches are that shareholders are the main (if not exclusive) addressees of ESG information, that the relevant factors to disclose are those that can impact a company’s operations or its ability to create value, that the reasons to report are connected or linked to the creation of value for the corporation and the choice of information to disclose should be guided by the principle of materiality.
Of course, this curtails the wide range of information that could be of interest to society at large. Moreover, while different frameworks are produced by different entities, shareholders are entrusted with the role to use the information (generally wrapped into indicators), acting as the stewards of the system.
An LPE view on ESG factors disclosure
This theoretical framework suffers from several shortcomings: it downplays the role that corporate law and financial regulation can play in modifying and altering the micro-level decision making by single corporations, to attain macroeconomic results and broader policy objectives. Secondly, an LPE view on ESG factors disclosure is embedded in a different analysis of the causes of unsustainability, which entails that information should serve a broader purpose, rather than solving information asymmetries.
ESG factors disclosure has two faces. On one side, it could help investors to better price risk (even if environmental factors are uncertain, rather than risky). On the other, disclosure could create or at least make more likely those very same risks. Disclosed information could be used to mount a political campaign, to start litigation, to launch consumers’ strikes, or sometimes, to foster tactical activism by specific shareholders. Therefore, fully accurate and complete information could be damaging. Moreover, the collection of precise and accurate information could serve as a precondition to impose duties on directors and institutional investors.
From an LPE perspective, we might understand the mandatory production of ESG information as an important part of democratizing and making corporate activities socially accountable. There are at least two strong rationales for making corporate law part of the regulatory mix, with and besides other forms of regulation. First, the transnational nature of the contemporary corporation, where production and distribution are dispersed along value chains. Given the transnational nature of production and sustainability issues, it would be futile to regulate corporations in core countries as if their production activities were constrained by geography. The productive process is developed along value chains, where relationships of control often depends on contracts and it is difficult to impose strict environmental or social standards. For example, we cannot hold corporations to account for environmental pollution if it is simply shifted in a different country and is accounted as pertaining to a different entity. Mandating disclosure by the leader of the chain is a viable option to extend regulatory pressure to extra-territorial activities. Secondly, a deeper concept of sustainability necessarily pushes towards a “socialization” of investment decisions. ESG disclosure is a necessary precondition and could serve as an instrument to provide countervailing powers with tools to fight corporate conduct and alter the pay-offs structure of management and investment decisions.
Because of the inherent conflict between value maximization and sustainability, the impossibility of adequately forecasting ESG factors’ impact on share prices and the double face of ESG matter disclosure, shareholders cannot be good stewards to foster sustainability. Disclosure should instead be addressed to different actors. As it is vastly recognized in the literature, climate change risk is almost impossible to forecast and largely dependent on governmental actions. It is even more complicated to assess the impact of social issues on shares prices, and very often, a worsening of these conditions, i.e. wages, entails their rise. Rather than solving an information asymmetry, ESG disclosure should be designed to radically alter investment decisions and to be useful for implementing other pieces of legislation.
Corporations have had a long history of countervailing powers imposing limits on managerial strategies for the sake of capital holders. ESG factors disclosure should be designed to feed them. Rather than focusing on shareholders as unlikely stewards, a different theory about the causes of unsustainability, the potentials of corporate law and the users of the indicators produced with this information should bring a different design for disclosure.
Federico Fornasari is a Ph.D. student in legal studies (company law and financial market regulation) at Università di Bologna.