Abstract
The U.S. securities markets have recently undergone (or are undergoing) three fundamental transitions: (1) institutionalization (with the result that institutional investors now dominate both trading and stock ownership); (2) extraordinary ownership concentration (with the consequence that the three largest U.S. institutional investors now hold 20% and vote 25% of the shares in SP and (3) the introduction of ESG disclosures (which process has been driven in the U.S. by pressure from large institutional investors). In light of these transitions, how should disclosure policy change? Do institutions and retail investors have the same or different disclosure needs? Why are large institutions pressing for increased ESG disclosures? This article will focus on the desire of institutions for greater ESG disclosures and suggest that two reasons underlie this demand for more information: (1) ESG disclosures overlap substantially with systematic risk, which is the primary concern of diversified investors; and (2) high common ownership enables institutions to take collective action to curb externalities caused by portfolio firms, so long as the gains to their portfolio from such action exceed the losses caused to the externality-creating firms. This transition to a portfolio-wide perspective (both in voting and investment decisions) has significant implications but also is likely to provoke political controversy. In its final hours, the Trump Administration adopted new rules that discourage voting based on ESG criteria and thus by extension chill ESG investing. This controversy will continue. As more institutions shift to portfolio-wide decision making, there is an optimistic upside: externalities may be curbed by collective shareholder action. For entirely rational reasons, the new “universal” shareholders who now dominate the market will resist even large public companies who might seek to impose externalities on other companies. Owning the market, the “universal” shareholder will protect the market. Still, this process of resistance may produce frictions, and the disclosure needs of individual investors and institutional investors will increasingly diverge. Of course, not all institutional investors are indexed or even diversified, but those that remain undiversified (for example, hedge funds) logically have the perspective of an option-holder and favor greater risk-taking. Across the board, retail investors have different perspectives and preferences than do institutional investors. Above all, the combination of high common ownership and institutional sensitivity to systematic risk makes disclosure a far more powerful force. Once a very good disinfectant, it may now be developing a laser-like power to effect significant social change.
Highlights
How should the norms of corporate governance and disclosure policy change in light of new market conditions and a changing population of shareholders? So framed, this may seem a fairly narrow question, which assumes that one accepts the need for a mandatory disclosure system.[1]
Diversified institutional investors are beginning to make voting and investment decisions on a portfolio-wide basis instead of on a stock-by-stock basis. This is a product of the growth in indexed investing and the high level of common ownership among such indexed investors, but it implies in turn that we may be moving from a system of corporate governance that is premised on a “shareholder primacy model” to a system that is premised on a “portfolio primacy model.”[2]. In the future, our largest institutions may knowingly accept, and even cause, losses at some firms in their portfolios if they
Activist hedge funds have played this role and the passive giant investors have followed, but in the context of a systematic risk campaign, hedge funds are unlikely to be able to play the same role.[123]. This Article has offered five initial conclusions: (1) Institutional investors logically have a greater interest in systematic risk than do undiversified investors, and much of what ESG disclosures would provide relates primarily to systematic risk
Summary
How should the norms of corporate governance and disclosure policy change (at the SEC and elsewhere) in light of new market conditions and a changing population of shareholders? So framed, this may seem a fairly narrow question, which assumes that one accepts the need for a mandatory disclosure system.[1]. No precise metric exists that proves that the same quantum of information is present in both exempt and registered offerings, institutional investors as a group appear to want (and implicitly demand) at least the same information as other investors, and they prefer it presented in the same standardized format As they come to make decisions on a portfolio-wide basis, diversified institutions will increasingly want to know and compare the likely impact of ESG-related policy changes on all firms in their portfolio. Explain the strong interest of diversified institutions in ESG disclosures and the obstacles that exist under current law to the use of such information by certain fiduciaries This leads to a final question: How should the SEC assist, encourage, or otherwise influence this process?
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