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Centre for Commercial Law Studies

The Agency Costs of Sustainable Capitalism

Date: 4 April 2022

This was the first event in a new CCLS seminar series 'Sustainability and the Law'. The event was chaired and introduced by David Whyte, Professor in Climate Justice at Queen Mary School of Law. Dr Anna Christie presented her paper on 'The Agency Costs of Sustainable Capitalism'.

Anna Christie is an Assistant Professor of Banking, Corporate and Financial Law at the University of Edinburgh Law School and a Research Associate at the University of Cambridge Centre for Business Research. She has broad research interests in comparative corporate governance and law and finance, with a particular focus on sustainability and climate change, ESG investing, and shareholder activism.

Anna read for a joint LLB degree in Law with Accounting and Finance at the University of Aberdeen, followed by an LLM at Harvard Law School and a BCL at Balliol College, Oxford. She later pursued an MBA at Stanford Graduate School of Business and a PhD in Law and Finance at Trinity College, Cambridge. Anna is qualified as a lawyer in New York, England and Wales and Scotland. Prior to entering academia, she worked in legal practice in energy and climate change at a UK law firm and in cross-border mergers and acquisitions at a US law firm. She also spent several years in-house at a FTSE 100 energy company as chief of staff to the CEO and senior legal counsel.

Abstract of Paper

The Agency Costs of Sustainable Capitalism

(Available on SSRN or UC Davis)

The passive index investing revolution and the demand for bespoke environmental, social, and governance (“ESG”) investment products are the most monumental changes to shape the investor landscape for many years. These developments have been accompanied by an unprecedented concentration of power among BlackRock, Vanguard, and State Street (the “Big Three” asset managers). Inevitably, the Big Three are among the most powerful shareholders of the companies that have been identified as major contributors to the climate crisis. Due to the failure of governments to take effective action in the global effort to combat climate change, there has been intense pressure directed at the Big Three to provide investor driven solutions. The Big Three have increasingly purported to assume what I call the role of “sustainable capitalists.”

In this Article, I build upon Gilson and Gordon’s “agency capitalism” framework to put forward a new agency costs theory of sustainable capitalism. In this “sustainable capitalism” framework, I show that the Big Three still exhibit some form of “rational reticence,” especially with respect to firm-specific sustainability activism. There is also a risk that the Big Three may engage in “rational hypocrisy,” similar to corporate greenwashing. The combination of “rational reticence” and “rational hypocrisy” could result in a dual-monitoring shortfall — the “agency costs of sustainable capitalism.”

In the agency capitalism framework, the best solution that emerged was for specialist activist hedge funds to fill the monitoring shortfall by initiating firm-specific activism as “governance arbitrageurs.” In this context, activist hedge funds adapted their strategies to gain crucial support from longer-term institutional investors. Analogously, in the sustainable capitalism framework, ESG hedge funds have the potential to initiate firm-specific ESG activism as “ESG arbitrageurs” in a manner that appeals to, and mobilizes, the sustainable capitalism of the Big Three. Most prominently, ESG hedge funds can play a unique role in nominating specialist climate directors to corporate boards, with the Big Three lending their support to credible nominees. Activist hedge funds already have significant expertise in board representation campaigns and the Big Three have shown willingness to support board changes.

Other “responsible activists,” focusing more on portfolio-wide ESG issues, are also candidates for the role of “ESG arbitrageurs”. However, implementing meaningful strategic changes or board reform using the shareholder proposal mechanism has proven to be much more challenging. Therefore, a valuable role that other responsible activists can play in the ESG investor ecosystem is to focus on the problem of rational hypocrisy and target their activism at the Big Three themselves.

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