Oil and gas giant Exxon Mobil has funded climate-change deniers and campaigned against the Kyoto Protocol, which aimed to reduce global warming. But the company is now committed to investing $15 billion in low-carbon solutions, hit 2025 greenhouse gas emission–reduction targets four years early, and has a new business-solutions unit initially focused on carbon capture and storage.

These actions come on the heels of a push by one small activist investment firm. In December 2020, hedge fund Engine No. 1 launched a campaign to challenge Exxon to reduce its carbon footprint. In June 2021, the firm made headlines when it helped install three independent directors to Exxon’s board.

Engine No. 1, with $275 million in assets under management, held just 0.02 percent of Exxon’s shares. But it had the support of the energy behemoth’s three largest shareholders: BlackRock, State Street, and Vanguard, which together held close to 20 percent of the company. With climate change a public issue that corporations cannot ignore, Engine No. 1 convinced the large investors to vote against management, something institutional shareholders have rarely done.

Investors and consumers are increasingly eager to push companies to be more responsible. Close to $97 billion in net new money flowed to global sustainable funds in the first quarter of 2022, according to a report by Morningstar. While that was down 36 percent from the previous quarter, environmental, social, and governance (ESG)–focused funds received inflows above the broader market, which saw a slump of 73 percent over the same period, per Morningstar.

A growing number of institutions and mutual funds have begun to take a more active stand on ESG. In 2016, only 3 percent of ESG-related shareholder proposals received a majority of votes, notes research by University of Trento’s Eleonora Broccardo, Harvard’s Oliver Hart (a Nobel laureate), and Chicago Booth’s Luigi Zingales, citing a report by EY Center for Board Matters. In 2020, 12 percent of proposals achieved more than 50 percent of the votes. For shareholder meetings through June 30, 2021, 20 percent of ESG proposals received greater than 50 percent support.

Consumers also appear eager to shun companies whose actions run counter to their values; a 2022 survey from LendingTree finds that 25 percent of Americans were boycotting a product or company they had spent money on in the past. All of this illustrates the intensified pressure companies are under by investors and consumers to focus on changing their environmental, political, and social policies—and, by extension, the opportunities investors have to drive that change.

How best to do that? Broccardo, Hart, and Zingales examined the effectiveness of two popular shareholder options, “voice” and “exit,” in bringing about corporate social change. Voice essentially means taking a stand through voting or communicating with corporate management, while exit refers to investors leading with their feet, hoping to punish a company by hurting its bottom line.

For Engine No. 1 founder Chris James, there was no question about how to proceed. Even with a minuscule amount of total assets, Engine No. 1 raised its voice, and bigger investors amplified it. “The idea that by divesting and giving up your vote, that is going to effect change, I think is insane,” James said last year when discussing his win with Zingales on the Capitalisn’t podcast. (Listen to the full episode, “Capitalisn’t: David versus Goliath.”)

Zingales says he agrees that divesting fails to accomplish what most activists want, but he notes that James’s position was that, as he puts it, “investing in renewable sources is both very profitable and good for the planet. If it is both, great, but what happens when it is not? How do we resolve this trade-off?” This is where his research with Broccardo and Hart could be useful, as the results not only demonstrate why voice tends to be more effective in bringing about better social outcomes, but also help investors weighing their own personal costs.

Shareholder activism is on the rise

In the US, investors are putting more pressure on companies to address environmental and social concerns.

Social good versus personal cost

It is possible to be socially responsible and financially successful. Research by University of Chicago PhD student Daniel Hedblom (now at the Trade Desk), UChicago’s John A. List, and Washington University in St. Louis’s Brent R. Hickman finds that corporate responsibility “should not be viewed as a necessary distraction from a profit motive, but rather as an important part of profit maximization.”

However, there are times when those goals can be at odds, or responsibility can involve some short-term costs. “It is important to be clear about your motive for holding companies to account for ESG issues,” says London Business School’s Alex Edmans. “Some shareholders claim that ESG always improves financial performance, but the evidence shows that this isn’t the case.”

To weigh the relative advantages of voice and exit, Broccardo, Hart, and Zingales constructed a theoretical model in which polluting companies cause harm globally, and used it to examine how shareholders using either exit or voice affect corporate policy. They focused on two main types of investors—those who are strictly selfish, caring only about their own self-interest, and those who care, to varying degrees, about the overall welfare of the broad population. (At the level of institutions, the model applies to the person making investment decisions.)

The researchers note that this form of caring about the social good differs from a selfish approach but neither is it “based on purely deontological considerations.” A deontological (or moral) investor will choose not to put money into a company because she finds the business repugnant, not because she wants to effect change. A strict teetotaler, for example, may not want to support a company that produces alcoholic beverages, regardless of the impact her decision may have on the overall consumption of alcohol.

“The reason a lot of people are boycotting oil companies is not because they think it’s morally wrong to extract oil,” Zingales says. “It’s because they’re concerned about global warming.”

The model makes several assumptions, first that shareholders are somewhat socially responsible, meaning they care at least a little bit about the greater good. It also assumes companies can choose to be either “clean” or “dirty,” and if a dirty polluter decides to clean up, it will incur costs that will push down the value of its shares. Lastly, the model presumes that all shareholders vote their preferences.

The results imply that voice often wins out: when shareholders are at least somewhat socially responsible, voice is the most effective means of promoting social change at the corporate level. Particularly, shareholders with a well-diversified investment portfolio are willing to accept the lower share price that could result from the costs of implementing environmentally desirable policies, as long as the social benefit outweighs the loss.

And in fact, these investors are committed to the cause, in that they will continue to make this same decision even if they vote for all the companies they own to become clean, the researchers note. While the financial hit would be bigger, the social benefit would increase too. Thus, the researchers find, smaller, diversified shareholders tend to have the best overall incentives, and naturally, their voice is particularly effective if they comprise a majority of shareholders.

Selfish investors stymie voice

On the other hand, the researchers say, selfish shareholders will vote only in their own interests, and large shareholders may also benefit from a company remaining dirty if its clean-up costs would significantly decrease their own net worth.

The researchers cite a well-known case to illustrate this concept (one that Reichman University’s Roy Shapira and Zingales analyzed in previous research). In 1984, chemical company DuPont had a choice: either pollute the Ohio River with the toxic substance perfluorooctanoic acid or invest in incineration techniques that would mitigate the environmental damage. While the right environmental choice would have been to incinerate, DuPont chose not to.

At the time, the billionaire Bronfman family, who owned the distilled spirits producer and distributor the Seagram Company, held around 20 percent of DuPont as part of its business portfolio. Given the high costs of incineration, it’s logical that the family, as a unified shareholder, may have chosen to pollute, the researchers say. A New York Times article from 1985 noted that the DuPont stake provided close to 75 percent of Seagram’s earnings and was seen as vital to the company’s future.

The researchers stress that they do not have direct evidence that the Bronfmans were actually involved in this decision, so while this is a real-life case, the analysis is hypothetical. Still, says Zingales, it would make sense for these major DuPont shareholders, “thinking in a purely selfish way,” to dump the pollution in the river, “creating a damage that is many, many times the cost of avoiding the damage—because one of the things about pollution is that it is much more expensive to clean up.”

The best exit strategy may not be a blanket divestment but instead what the researchers call tilting.

Calculating the present value of the financial cost and social worth of incineration, the researchers find that the Bronfmans, assuming they were involved in the decision to pollute, chose not to give up almost $4 million (as a capital loss to the family) for a social gain of $335 million. (For more, read “When it makes sense to pollute—and how to change the equation.”)

However, per the researchers’ model, the calculation would have been quite different for smaller, diversified individual investors who owned, say, an index fund in which DuPont was a fraction of its holdings. Broccardo, Hart, and Zingales consider what the equivalent decision would be for a diversified shareholder today with holdings spanning the US stock market. Someone with $500,000 invested proportionally across the market owns one-hundred-millionth of each company, including DuPont, Hart explains. “It follows that if DuPont spends $19 million,” which is the present value of the incineration choice the company rejected, “such a person’s wealth will go down by $19 million divided by 100 million—or 19 cents. Who would not be willing to give up 19 cents for a $331 million social gain?” (In this calculation, the social gain is slightly less because other shareholders bear more of the cost of incineration.)

He notes that many people would likely be happy to give up much more than 19 cents—which makes it even more striking that DuPont instead chose to pollute.

Granted, the researchers’ model assumes that the social benefit for individual investors would be measured and calculated, which it’s often not. Yet ValueEdge Advisors vice chair Nell Minow points out that widely diversified large institutional investors would also likely not find it in their best interests to choose the pollution option, “especially if you factor in regulatory risk.”

What about divestment?

Investors trying to change DuPont’s decision could have also dumped their shares to dent the stock price and attract attention. But that isn’t necessarily how divestment plays out. Say investors sell shares they hold in a dirty oil and gas company, with the hopes that the resulting loss in shareholder value will encourage the polluter to implement cleaner policies. The advocacy organization Stand reports that 1,485 institutions holding $39 trillion of assets have publicly committed to divesting from fossil fuels.

But their action may be more public relations than anything, and risks being undone by a corresponding set of selfish investors. “One of these groups may come in and say, ‘I don’t care about the mission, and I see that the stock is down 5 percent,’” Zingales says. If enough selfish investors take advantage of this opportunity, they could drive the share price back up again, and then the company has no real financial incentive to clean up.

The effect of exit isn’t proportional to the number of socially conscious shareholders, according to the model. Even if 20 percent of somewhat socially conscious investors divest from companies, far fewer than 20 percent of companies will comply with their demands. And the same forces can make a boycott less effective. Any negative impact on the price of a company’s goods will be temporary, as other buyers go bargain shopping.

Additionally, Broccardo says, “in the real world, it has to be considered that exit changes the population of investors that in the future will vote. Through divestment, socially responsible investors are replaced with less socially responsible ones, who are more likely to vote against clean technologies.”

Stanford’s Jonathan Berk and University of Pennsylvania’s Jules H. van Binsbergen find in their research that divestment strategies have a negligible effect on the price or cost of capital for publicly traded companies. “Our results suggest that to have impact, instead of divesting, socially conscious investors should invest and exercise their rights of control to change corporate policy,” they write.

That said, investors or customers boycotting a company can be effective if their action leads to a strong social movement that may cause a company real reputational harm. “With time, they can change the social preferences of the people, pushing selfish investors to act in a socially responsible way,” says Broccardo. “This is something that voice does not stimulate.”

In a presentation given to the Economist’s Society at University College London, Hart cited the fur industry as an example. Boycotts and activism have made it socially unacceptable in many circles to be seen wearing real animal fur in public. In such a case, even people who don’t care about the movement might stop buying the product to avoid public shame, and companies might stop selling fur. Indeed, after years of boycotts and protests by animal activists including PETA, clothing retailer and manufacturer Canada Goose announced in 2021 that it would stop using fur by the end of 2022.

Why not voice and exit?

Broccardo, Hart, and Zingales present voice and exit as separate actions. But Edmans argues that while this is typical of the debate, both options can be useful in different circumstances. “Moreover, it’s not either-or, but you can use both together, and one might be more powerful with the other,” he says.

Research by Tilburg University’s Joseph McCahery, Frankfort School of Finance & Management’s Zacharias Sautner, and University of Texas’s Laura T. Starks supports this view, at least for larger investors. A survey of institutional investors reveals that they used voice—including discussions with management and boards—most often when they were unhappy with a company’s direction.

Recommended Reading

At the same time, over 40 percent of respondents said they thought their threat of exit (distinct from the actions associated with voice) helped to discipline management, although survey results indicated that the effectiveness of such a threat depended on factors including the size of the investors’ equity stake and whether company managers themselves had a large stake. Overall, the researchers find, “exit and voice are related, as the surveyed investors believe that both governance mechanisms are complementary strategies.” Essentially, they say, shareholders’ threat of exit helps back up voice.

Edmans, with University of Washington’s Doron Levit and Indiana University’s Jan Schneemeier, argues that the best exit strategy may not be a blanket divestment but instead what the researchers call tilting—that is, underweighting unsustainable industries overall, but being willing to hold on to “best-in-class” companies (meaning those that have taken at least some corrective actions). This could be, say, a company such as Shell, which a 2020 Morningstar report identified as having one of the best plans for greenhouse gas reduction of all the world’s integrated oil companies.

The idea is that if a company in a specific industry knows its shares will be dumped because investors are broadly excluding the sector from their portfolios, reform will seem less necessary, at least financially. But if management knows that investors will buy up their shares if the company can work to implement more sustainable policies than its industry peers, executives may move toward sustainability to attract investment.

Voting in the real world

The theoretical model is, of course, just that. In reality, a variety of factors can blunt the influence of shareholder voice.

For one thing, 99 percent of US companies are private, and the typical retail investor has limited opportunity to own shares in these. At public companies, voices can be muted when one shareholder holds a majority of the votes. This is the case with Meta’s Mark Zuckerberg, who controls approximately 85 percent of the company’s Class B shares, each of which represents 10 votes. This affords Zuckerberg effectively total veto control over shareholder proposals with which he disagrees.

Getting a resolution for an ESG issue onto a ballot for a vote can also be expensive and challenging in the United States. Per the Securities and Exchange Commission, in order to file a proposal, an investor must have continuously held at least $2,000 of the company’s stock for three years, $15,000 for two years, or $25,000 for one year. The process also takes time and effort: the shareholder must provide a written statement arranging a meeting with the company in person or by teleconference no fewer than 10 days and no more than 30 days after the shareholder submission.

And, as noted by the SEC, a proposal can be rejected for various reasons, including if it appears to be a “personal grievance,” if it relates to less than 5 percent of a company’s operations, or if the company believes it would lack the power and authority to implement it.

If a proposal gets onto a ballot and has the support of a majority of shareholders, the vote is typically advisory rather than binding, meaning the company’s board may ultimately ignore it. Even mandated votes are generally purely advisory, including “say on pay,” a component of the 2010 Dodd–Frank Wall Street Reform and Consumer Protection Act that requires shareholders to take a vote on the compensation of top executives at least every three years.

That said, nonbinding votes can still spur change, especially if companies are forced to take a public stance on a controversial topic. And activists are making progress: the SEC in 2021 moved to reverse Trump-era policies that featured more restrictions on proxy voting (and in keeping with the trend of increased ESG interest, the SEC has proposed a rule that would require companies to include climate-related information in their financial reports). For the 2022 proxy season, investors had filed close to 600 ESG proposals as of the third week of May—100 more than last year, according to the nonprofit Sustainable Investments Institute (Si2). A report by the institute and shareholder advocates As You Sow and Proxy Impact noted that, as of July 1, there had been 282 votes and 34 majority votes favoring ESG shareholder resolutions. “There was a precipitous drop in the number of proposals blocked by company challenges at the US Securities and Exchange Commission,” said Heidi Welsh, executive director of Si2, in a statement.

While many retail investors—for example, the vast majority of those holding index funds in their 401(k)s—can’t currently vote to influence an individual company’s policies, they may find some influence through other methods.

There is likely a market for this. A 2022 Deloitte survey of millennials and members of Generation Z finds that one of their top priorities is “using social impact pension providers or retirement funds focused on sustainable investments.” Nearly a quarter of participants listed climate change as a top concern, just under “cost of living.” And 64 percent of Gen Z respondents said they would be willing to pay a premium to purchase an environmentally sustainable product.

According to the Broccardo, Hart, and Zingales model, such a socially conscious group would be optimal for effecting change at corporations through voice—and if current trends persist, they may get more opportunity to do so.

More from Chicago Booth Review

More from Chicago Booth

Your Privacy
We want to demonstrate our commitment to your privacy. Please review Chicago Booth's privacy notice, which provides information explaining how and why we collect particular information when you visit our website.