How can beliefs shape corporate climate policies?

By Dr Guosong Xu, Assistant Professor of Finance at Rotterdam School of Management, Erasmus University (RSM)

The latest major UN scientific report reminds us that some devastating effects of global warming are inevitable. In tandem with the mounting concerns issued by various institutions and environmentalists, news about extreme weather events such as icebergs melting, avalanches, freak storms and damaging wildfires is now commonplace in the media. As are the calls from all segments of society that humanity needs to be doing more to decrease the damage we are doing to the natural world.

Reflecting growing investor demand for corporate accountability on climate issues, corporate proposals on climate change-related initiatives have increased steadily in recent years. However, puzzlingly, these environmental proposals rarely receive wide support: From 2006 to 2020, only 2.8% of such proposals were passed during shareholder meetings.

Why is shareholder support for environmental proposals so low? What are the implications for companies and investors? These questions inspired my recent research project, undertaken in partnership with Dr Eliezer Fich at Drexel University. Through our work, we discovered that shareholders’ perceptions about climate risks plays a key role in their willingness to support environmentally focused proposals.

Do beliefs matter for climate policies?

The research explores the impact of natural disasters (major hurricanes and tornadoes) that struck the headquarter locations of institutional shareholders (e.g., pension or mutual funds) in the US between 2006 and 2020. We investigated not the physical impact of these events, but rather how their occurrence might influence the beliefs and priorities of shareholders, under the premise that extreme weather events increase the shareholders’ awareness of climate risks and lead them to be more supportive towards environmental policies.

In total, 12,232 unique funds were analysed. We examined the shareholders’ voting records of their portfolio firms according to the Institutional Shareholder Services (ISS) Voting Analytics database.

By doing this, we made several key discoveries:

Firstly, funds in areas hit by a hurricane, were significantly more likely to vote for an environmental proposal in the immediate aftermath of the event. The difference in investor support was as much as 38% higher in such locations. This is a substantial increase when compared to the average support rate of 25% for such proposals.

Moreover, an institution’s reaction to perceived climate risks increased with its ownership stake in the portfolio company. The sensitivity towards perceived climate risk was also higher for portfolio firms in high pollution sectors, such as petroleum and natural gas, construction, and chemicals, and for firms closer to a hurricane disaster area.

However, this more environmentally conscious outlook was, for many, temporary. Most investors returned to their previous stances and reversing their support for such schemes within just three years – something which will do little to encourage long-term change.

Interestingly, fund characteristics such as size, performance, flows, general attitudes towards environmental, social, and corporate governance (ESG) issues seemed to have very little impact on our research findings. The experiment captures investors’ pure beliefs about climate risk rather than investors’ portfolio firm’s actual risk, because hurricane strikes only affected institutional shareholders’ locations, not the firms.

What are the implications for firms and investors?

There were positives to be gained from our investigations. Increased support from hurricane-affected institutions was seen to have crucial implications for corporate environmental policies. Foremost, it raises the overall approval rates during a shareholder meeting – an important result as this improves the odds that the proposal will receive enough votes to pass during the shareholder meeting.

However, our study finds that, once climate-related proposals were passed, firm profitability typically weakens. For example, abnormal stock returns on the voting date were lower for firms that passed a climate proposal than for firms for which a similar proposal failed. Companies that approved environmental proposals also exhibit long-term accounting underperformance. The high costs of implementing climate-related policies can explain the negative financial market reactions and accounting returns.

While the study indicates corporate climate-related initiatives are costly for the firm, their impact on the welfare of society should be carefully evaluated by other research. One key takeaway from our findings is that investors’ psychology, and their beliefs about the climate change in particular, could shape the future of corporate environmental policies. Going forward, if governments want to encourage environmentally responsible behaviours from the corporate world, and if investors demand more sustainable investment opportunities, it is time to raise the awareness of climate issues. The upcoming UN Climate Change Conference of the Parties (COP26) brings a unique opportunity to accelerate the climate actions, including those from corporations and investors – but for such actions to succeed, more efforts should probably be spent on changing people’s beliefs about their importance.

About author:

Dr Guosong Xu is an Assistant Professor of Finance at Rotterdam School of Management, Erasmus University (RSM) and co-author of “Do Salient Climatic Risks Affect Shareholder Voting?” alongside Eliezer M. Fich of Drexel University. The paper is available at SSRN: https://ssrn.com/abstract=3895071  

By Dr Guosong Xu, Assistant Professor of Finance at Rotterdam School of Management, Erasmus University (RSM)

The latest major UN scientific report reminds us that some devastating effects of global warming are inevitable. In tandem with the mounting concerns issued by various institutions and environmentalists, news about extreme weather events such as icebergs melting, avalanches, freak storms and damaging wildfires is now commonplace in the media. As are the calls from all segments of society that humanity needs to be doing more to decrease the damage we are doing to the natural world.

Reflecting growing investor demand for corporate accountability on climate issues, corporate proposals on climate change-related initiatives have increased steadily in recent years. However, puzzlingly, these environmental proposals rarely receive wide support: From 2006 to 2020, only 2.8% of such proposals were passed during shareholder meetings.

Why is shareholder support for environmental proposals so low? What are the implications for companies and investors? These questions inspired my recent research project, undertaken in partnership with Dr Eliezer Fich at Drexel University. Through our work, we discovered that shareholders’ perceptions about climate risks plays a key role in their willingness to support environmentally focused proposals.

Do beliefs matter for climate policies?

The research explores the impact of natural disasters (major hurricanes and tornadoes) that struck the headquarter locations of institutional shareholders (e.g., pension or mutual funds) in the US between 2006 and 2020. We investigated not the physical impact of these events, but rather how their occurrence might influence the beliefs and priorities of shareholders, under the premise that extreme weather events increase the shareholders’ awareness of climate risks and lead them to be more supportive towards environmental policies.

In total, 12,232 unique funds were analysed. We examined the shareholders’ voting records of their portfolio firms according to the Institutional Shareholder Services (ISS) Voting Analytics database.

By doing this, we made several key discoveries:

Firstly, funds in areas hit by a hurricane, were significantly more likely to vote for an environmental proposal in the immediate aftermath of the event. The difference in investor support was as much as 38% higher in such locations. This is a substantial increase when compared to the average support rate of 25% for such proposals.

Moreover, an institution’s reaction to perceived climate risks increased with its ownership stake in the portfolio company. The sensitivity towards perceived climate risk was also higher for portfolio firms in high pollution sectors, such as petroleum and natural gas, construction, and chemicals, and for firms closer to a hurricane disaster area.

However, this more environmentally conscious outlook was, for many, temporary. Most investors returned to their previous stances and reversing their support for such schemes within just three years – something which will do little to encourage long-term change.

Interestingly, fund characteristics such as size, performance, flows, general attitudes towards environmental, social, and corporate governance (ESG) issues seemed to have very little impact on our research findings. The experiment captures investors’ pure beliefs about climate risk rather than investors’ portfolio firm’s actual risk, because hurricane strikes only affected institutional shareholders’ locations, not the firms.

What are the implications for firms and investors?

There were positives to be gained from our investigations. Increased support from hurricane-affected institutions was seen to have crucial implications for corporate environmental policies. Foremost, it raises the overall approval rates during a shareholder meeting – an important result as this improves the odds that the proposal will receive enough votes to pass during the shareholder meeting.

However, our study finds that, once climate-related proposals were passed, firm profitability typically weakens. For example, abnormal stock returns on the voting date were lower for firms that passed a climate proposal than for firms for which a similar proposal failed. Companies that approved environmental proposals also exhibit long-term accounting underperformance. The high costs of implementing climate-related policies can explain the negative financial market reactions and accounting returns.

While the study indicates corporate climate-related initiatives are costly for the firm, their impact on the welfare of society should be carefully evaluated by other research. One key takeaway from our findings is that investors’ psychology, and their beliefs about the climate change in particular, could shape the future of corporate environmental policies. Going forward, if governments want to encourage environmentally responsible behaviours from the corporate world, and if investors demand more sustainable investment opportunities, it is time to raise the awareness of climate issues. The upcoming UN Climate Change Conference of the Parties (COP26) brings a unique opportunity to accelerate the climate actions, including those from corporations and investors – but for such actions to succeed, more efforts should probably be spent on changing people’s beliefs about their importance.

About author:

Dr Guosong Xu is an Assistant Professor of Finance at Rotterdam School of Management, Erasmus University (RSM) and co-author of “Do Salient Climatic Risks Affect Shareholder Voting?” alongside Eliezer M. Fich of Drexel University. The paper is available at SSRN: https://ssrn.com/abstract=3895071