Michael Livermore 0:11
Hi, this is Mike Livermore. And with me today is Madison Condon, a professor at Boston University School of Law whose work focuses at the intersection of the environment and corporate governance. And this is an increasingly hot topic these days. Madison, thanks for joining me.
Madison Condon 0:27
Thanks so much for having me, Mike.
Michael Livermore 0:28
So in the environmental community, I feel like there are two camps right, there are on the one hand pessimists who think that corporations are like these rapacious institutions that put profits above all other interests and, you know, kind of destroy the planet in the process. That’s one group. And then there’s another group for a more optimistic, and they look to corporations for leadership. And they’re enthusiastic about things like environmental, social governance, ESG, or sustainability commitments. And that’s kind of like the other camp and you hear from those folks as well. So maybe just to kind of get us, get the conversation started. If you had to pick between one of these two camps, as someone who’s an expert in this area, which camp would you? Where would you pitch your tent?
Madison Condon 1:13
You know, I just think that’s a really well, I mean, by my heart genuinely is an environmental professor and not a corporate professor, even though my scholarship is all corporate. So I think that in general, we have designed policies and laws that make corporations in general bad. I think that right now is really interesting. And lots of corporations are doing lots of different things for lots of different reasons. And there’s, some of them are moving in, like a good direction for their own reasons. But yeah, maybe if you forced me to pick a camp, I would be in the corporations are bad.
Michael Livermore 1:53
And of course, right, we all have our nuanced positions, and everything else. But so so you know, in the US, but you have written about some ways in which maybe there are reasons to be optimistic. I mean, we can explore some of that, and then you have reasons to think we should be pessimistic, right. So so it does kind of go both ways. But one argument that’s been circulated, and you’ve argued and others have as well, in different contexts is, we have something kind of new in the world of corporate governance in the world of investing in investor relations these days, which are these kind of mega funds, like Vanguard and other funds like that, that kind of own the market in some very broad sense. And they’ve become pretty active, at least my that’s my understanding as an outsider, is it’s at least some of these funds have become fairly active in kind of promoting particular types of agendas for corporate governance. And, and the idea is, at least partially that these funds can kind of stand in for environmental interests, because they own so much of the market, you know, they kind of internalize some of the costs. So, so what is the role of these big funds these days? Are they playing an active role on corporate boards? What are the kinds of things that they tend to care about? And is environment in the mix? You know, especially with respect to climate change? Or is that kind of a second tier priority? You know, what is the landscape with these with these big entities now?
Madison Condon 3:23
Yeah, so I would say in the world of large investor, shareholder activism, climate is, in fact, the number one priority. The thing that they spend the most resources, um, I think genuinely both sort of PR out facing and also inside trying to figure out like, what exactly their plan is in the climate and ESG space. So I mean, so what you’re talking about is this universal owner theory, which is, you know, it’s an old theory, actually, it’s sort of a sort of that as we notice, these institutional investors accumulating more and more capital, the first idea, the first sort of concept of the universal owner arose around pension funds that were became sort of enormous in the 80s. The idea was like, well, they own the whole market, they own a very large chunk of every publicly traded company. Therefore, it doesn’t really help them if Exxon pollutes a bunch of carbon into the air, because the climate damages that will result from that pollution will actually like really hurt the other portfolio, the rest of their income portfolio, you know, they’re invested in real estate, they’re invested in agribusiness, they’re, you know, the whole economy will suffer from climate change. So it’s not in these large diversified owners interests, theoretically, to continue to allow the large oil and gas producers that they’re invested in to go about their normal business. So there was this theoretical idea that’s been around for a while. And so the paper that you’re referencing that I wrote about was sort of like this theoretical idea is actually happening in some ways right now the big the biggest institutional investors BlackRock, Vanguard and State Street in America. And a bunch of very large institutional investors in Europe have become very organized on the climate front, and have started to vote for and press for a bunch of different measures that actually have emissions-reducing impacts. And so I sort of theorized that their motivation for this was the externality internalizing motivation that they are, in fact, behaving like universal owners.
Michael Livermore 5:22
So, what are some of the- like, if you happen to know, off the top of your head, like, what are some of the practices that they want to promote from a climate perspective in terms of, you know, when they’re in their role as shareholders,
Madison Condon 5:37
So they have like a few tools at their disposal. So at a very macro level, this way, in corporate governance, you talk about exit versus voice, you know, do you sell the asset that you are displeased? And that the way that direction like the directors of the corporation are running the company? Or do you intervene and use your shareholder presser to either change the leadership or at least like make it very clear, like what your preferences would be? And this stake, this choice actually has sort of a big it really matters and has particular relevance in the climate space. Because there’s a lot of debate over okay, well, if you just divest from an oil and gas company, because you’re upset about its emissions plan, it’s, you know, lack of plan to be compliant with the Paris Agreement. Are you really helping to reduce emissions in any way? Are you really reducing their cost of capital, and like relatedly, if you just press oil and gas companies to sell off their assets, to private equity, or to state-owned oil and gas companies, you’re not really reducing emissions in the overall market, you’re just getting it off of your own books. So I think that just institutional investors are really beginning to recognize this sort of I would call it in the environmental space leakage affects the corporate governance, people haven’t totally caught up with the lingo, I would say, I think, from the climate, regulatory sphere, but um, and so instead, they are sort of starting to push for just sitting on assets, and Glencore a coal company has, has a climate rundown plan where they, you know, climate activists don’t think it’s sufficient, but they are sort of stated position is that they’re not going to sell their assets off, because they would be bought by private equity, that would just pump them for emissions more in the short term.
Michael Livermore 7:18
So, I mean, one of the things that strikes me is, I mean, there’s so many, so many ways to kind of take this to so many different nuances to this, but maybe just to, to the universal owner kind of side of this, does that create, has that created conflicts with other shareholders, so I’m imagining say I own Exxon, or, or, you know, a coal company that you’re mentioning, or whatever. And what I want to do is, you know, what, most people want to do most of the time with most of their investments, which is make money. And I don’t, you know, I’m not a universal owner. I’m the opposite of universal owner. I’m a micro owner, right? I own you know, one little tiny piece of the of the world. And, and so when Blackrock or Vanguard or whoever, you know, wants to take steps, wants Exxon to take steps, so it actually reduces Exxon’s profitability, but would increase the yield on other parts of Vanguard or Blackrock holdings. That strikes me as from, from, from my perspective, as an individual shareholder, that doesn’t just own the whole economy as a bad thing. And are those the kind of conflicts that it has that conflict come up? And how has that been resolved or not resolved?
Madison Condon 8:40
Well, it’s definitely a super interesting question in corporate law that a bunch of different people are thinking about from a lot of different angles right now. I mean, so to be clear, BlackRock, Vanguard and State Street are never explicitly say, we are doing this thing at Chevron, for example, because we are motivated by portfolio impacts you know, so for many corporate law reasons, you a lot of these measures are cloaked in sort of like firm specific impacts so I think one really good example to think through because it just happened and caught a lot of people’s attention is the engine number one battle against Exxon that happened this spring so engine number one is a super tiny as well, it is a small hedge fund. It owned a very tiny interest in Exxon just I think, point zero 2% of the company. And its strategy was sort of a firm-specific strategy. It was like Exxon has a bad business model. It’s never its returns have been consistently failing. It’s overspending on capital, has totally refused to acknowledge that there could be a climate-regulated future. It’s like, basically its risk preparedness is terrible. We want to take over the company, and they successfully replaced three directors on the board of Exxon and they were only able to do that with their .0% ownership share, buy persuading the very large institutions to support them BlackRock, Vanguard and State Street. So there’s a really interesting paper that just got posted SSRN. Actually, it’s by Ed Rock and Marcel Kahan at NYU. And they sort of, and they actually analyze the vote of who supported engine number one at the proxy fight and who didn’t, and who supported management. And it turns out that if you were overweighted, an exxon relative to the market, so you were more concentrated in exon, you were much less likely to support the engine number one sort of attack. And then if you were underweight, and Exxon, but you know, overweight and the rest of the market, you are much more likely to support engine number one. So I think that that is a super interesting finding and consistent, frankly, with the universe, universal ownership theory.
Michael Livermore 10:47
Right? And then and then and also with this tension between-
Madison Condon 10:51
Exactly, exactly to bring it back home that, you know, yes, maybe a conflict. Certainly, if you only own exon, you’re probably not interested in a measure that reduces exxons profits.
Michael Livermore 11:02
Right? That right, that makes sense. And so, you know, what do we think normatively about this then? And on the one hand, we think, you know, as environmental types, we like the idea that you know, that a company like Exxon would start to shift its emphasis from fossil fuel extraction to other things, I guess, I mean, I’m not even sure what the business model looks like, for these big fossil fuel companies, but that it would be somehow consistent with reducing greenhouse gases over the long term. But on the other hand, it does seem vaguely weird, that, that big actors, like you know, the, you know, these major shareholders like BlackRock, and Vanguard could kind of force one company, Exxon to do things that are bad for it. Because that are those things are good for other parts of the portfolio. So for example, we wouldn’t allow this in other contexts, right? Where, let’s just say there were two companies that were competitors with each other, and company A and B, and then a shareholder held both A and B, and said, Okay, well, we actually want a to just We want a&b to divide the market. So A is going to get the East Coast, B is going to get the West Coast, and that’s going to increase our profits overall, rather than letting them compete with each other. That would clearly be impermissible. We wouldn’t want that.
Madison Condon 12:25
Definitely. And that’s sort of the crux of the problem is, you know, if we’re going to allow this kind of activity as a, as a regulatory matter, as a policy matter, we think it’s good that Blackrock is pressing for emissions reductions. How do you distinguish that from anti-competitive behavior is one question. Because they can look pretty similar. How do you know that United Airlines and American Airlines and Delta haven’t all gotten together and say, we’re going to reduce- We’re going to, you know, reduce our options and hike our rates, try to really reduce our, you know, that’s one way to reduce emissions, reduce supply, but it’s the exact same thing, you know, how do you know they’re doing it for the right reasons, when they sort of the exact same thing? That’s a really hard question, right? And then in a separate arena is this question in corporate law, where it’s sort of like corporate law and embraces this idea of shareholder primacy. And, you know, while I agree with you, that in some ways, it’s weird that shareholders would press a company that they are invested in to hurt the company to actually reduce its profits. It’s also weird that we could envision a future in which most if not all, of Chevron’s owners, for example, are diversified owners, like basically everyone, this is the directory, the market is headed. It sort of also strange that just a single shareholder, who owns what .0001% of this company, can force that company to, like, impose harm on the other 99.9% of shareholders, like, that is also weird.
Michael Livermore 13:52
There’s something weird about that, too. Yeah. It’s a, I don’t know if it’s a paradox, but it’s a kind of a dilemma of that’s, that’s created by this new model, and it places you know, corporate law, and even just our ideas, including our ethical and normative ideas about, you know, within the realm of business, that business ethics kind of grew up in the era of, you know, kind of prior to these big diversified funds, you know, where you, you might be diversified, but you’re in the governance of any particular firm wasn’t really affected by the fact that the some of the shareholders were diversified and cared about the effects on Firm B’s performance of Firm A’s decisions in their capacity as firm as shareholders. Right. And so it really does raise a lot of interesting questions that it seems like we’re really just getting started thinking about these things in the corporate governance area.
Madison Condon 14:55
I think that’s totally right. I think that’s really right. And you know, the other thing that I point out in the paper is given that we acknowledge that they have these incentives, these portfolio-based incentives. You know, what theory are we using to support our embrace of shareholder primacy? Like, you know, why do we then continue to say, corporations have to maximize profits, because part of the theory is the academic theories. And then the theories that courts have embraced, all underlie things that are sort of no longer true if you acknowledge that universal ownership is true. So like, one of the basic theories for why we have shareholder primacy is this residual claimant idea, this sort of idea that like after bankruptcy has happened and all the different stakeholders are paid out, the shareholders are the ones who ever get, like whatever’s left over in the corporation, and therefore they have like the best incentive to maximize the corporation’s profits and to like, oversee, the management of the corporation is like doing a good job to maximize profits. That’s, and that’s, that’s a pretty foundational idea in terms of like, why we should have shareholder primacy. That’s just not true, if all shareholders are universal owners. And so, you know, I think we need to I would, I would like, the field in general to think about which theories we’re gonna use to, you know, to move forward.
Michael Livermore 16:12
Yeah, no, it’s really, it’s really interesting. So here’s, so let me offer a hype bomb, just to try to understand, it makes sense of this whole new, brave new world that we’re in. So let’s imagine that, you know, the three big universal owner type funds or some group, you know, let’s say some consortium of these big entities got together and said, you know, what, there’s a company out there XYZ. And XYZ is terrible for a portfolio, right? We don’t own any XYZ right now, let’s just say, or we own some small, you know, we own up just a tiny bit of it, you know, in our bigger portfolios, because, you know, it’s just a small part of the market, we hold diversified portfolios, so we have a little XYZ, and XYZ creates way more loss for the rest of our portfolio than it creates benefit for us, in our capacity as owners of XYZ. Yeah, let’s just, you know, you can imagine this, there’s, XYZ generates some unregulated toxin that is terrible for agriculture, industry, and real estate or whatever else, right? It’s just a bad actor out there, that’s doing bad stuff, it’s making money, but it’s causing a lot of so many externalities, that they overwhelm the positive benefit that XYZ generates, it’s unregulated for some reason, you know, they’ve got, you know, they’re blackmailing the President or something, somehow they’ve escaped from, you know, the regulatory regime, and tort law isn’t going to work for whatever reason, okay. So our more standard ways, you know, in the legal system of addressing a problem like that are off the table,
Madison Condon 17:46
not a completely unrealistic-
Michael Livermore 17:50
real-world analogies, and, and, and then so that, so the company is gonna say, Alright, let’s do this, let’s, you know, buy up 51% of the shares of the company kind of hostile takeover style, and shut it down. Yeah, that’s what we’re gonna do, we’re just going to buy and we’re not going to, we’re going to shut it down, like, we’re not going to liquidate it, we’re not going to sell it and we’re literally just going to, you know, whatever, just not run it anymore. Right? Not run the factory, just close the factory, stop the pollution, walk away, and carry it as a loss and not even, you know, it’s on our balance sheet. We still own it, but it’s not running. Again, that strikes me as a perfectly logical kind of thing for them to think to do in this hypo, but also strikes me as deeply weird that we would have funds going out there and doing this kind of thing.
Madison Condon 18:42
I mean, so what you’re describing right is like not it’s basically the same mechanism as like a government buyout, except the government is like broken. And somehow for some reason, in this hypo that institutional investors are doing it. I mean, I guess it makes me want to clarify like one point that I think is sort of important when thinking about all this stuff is that a lot of these, all of these large institutional investors, basically their main product, and where most of their money is housed is in these big, quote-unquote, passive funds. So they, they are really limited in their ability to do sort of what you just described, which is, you know, target a specific company and buy it all up. Like, if they were to do stuff like that they would be regulated in a very different way and they live their whole product stuff would be a very different way. It just makes me want to mention that. You know, so, a lot of the reason this is generally like a post-2008 phenomenon that the fact that Vanguard State Street and BlackRock are like so enormous this embrace of index funds and investing index investing and ESG investing has you know, there’s been a massive outflow from actively managed funds into passively managed funds which are quite concentrated so that’s part of the explanation for why they’re so huge, but like a deeper and like, more far away ago historical explanation why this happened, is happening is like a bunch of policy reasons, decisions that we made in the 80s. To like have the way people save for retirement is like through the stock market like and like through these index funds. So like instead of having a pension that your employer manages for you, and then pays out to you like through your retirement such that like the risk of a market loss on your employer, we switched it to sebe that like your employer gives you a bunch of money instead each year from part of your paycheck, and then the risk is on and then you invest that and then the risk is on you if the market collapses. So Leo Strine, he’s an ex-Supreme Court Justice of Delaware, you know, he has this idea of forced capitalists that like, a lot of people own Exxon, who like don’t even know they own Exxon, and like, frankly, don’t have a lot of different options for owning Exxon, like, if your paycheck is just deposited, just like some retirement fund, it’s really hard to sell a certain company or buy a certain company, you basically like are forced to own like big chunks of the market. And I just think that’s worth mentioning, when you’re thinking about like the other sort of weirdness of allowing that like one cranky pro-Exxon investor, to force the other investors to eat these externalities. It’s just a weird system we have,
Michael Livermore 21:13
Right? Because this is, you know, in a way, this is how we deal with retirement in the country. Yeah. And of course, I mean, I guess, you know, if someone wanted to be a stickler about this, they could say, Look, you know, that person could just have invest in bonds or something like that, just, you know, in government bills or something. But the returns on those, obviously, are, are so low that it’s kind of not a realistic scenario.
Madison Condon 21:36
Yeah. And like, can you put bonds in 401ks, is maybe I’m confused, but like, there’s, there’s a bunch of tax reasons that we sort of funnel people into, like, very specific products too.
Michael Livermore 21:45
We have to talk to some of our tax friends. So but just back to the, you know, to this idea of like shutting down the bad company, right, you know, what makes me think of that is, and it’s a very important point that you raise, it’s worth emphasizing that, you know, these big funds are limited in what they can do, right, they can’t just go out there and act like private equity funds and buy things up and shut them down, or, you know, whatever, they’re passive investors, they have seats on boards, they don’t actually have seats on boards themselves, I guess, but they vote shares. There are directors that, you know, in these that appeal to the interests of these kinds of large institutional investors, and so on. So they had some, some share, or some influence over the management of these companies via the board of directors and their ability to vote these shares, but they’re, you know, they’re not taking over companies and managing themselves. Which I think raises another interesting dilemma, and one that you mentioned earlier, which is given the limits of what these investors can do, and the fact that we have, you know, parts, at least of our corporate law, allow the cranky investor, as you say, to, you know, to press the issue of, of, you know, kind of maximizing profits. So if the independent directors are the ones that were most kind of, amenable to the interests of the universal owner types were to were to push efforts at the company and management was to kind of go toe the line, and adopt policies that severely reduced their profits, theirs, they would probably face litigation from those cranky shareholders that are saying that you are, you know, you’re you can’t do that, right, you have an obligation to me to maximize profits. So maybe we can just explain for folks who are familiar with that, what that litigation would look like, and then I think this, you know, will didn’t get us into the question of this kind of exit versus voice issue and some of those things. So just but just in the technical details, what is what does that mean for the cranky investor? Why does that cranky investor have any power whatsoever?
Madison Condon 24:01
Well, this is a really interesting question. So you know, the cranky investor could bring, you know, they would bring a fiduciary duty claim against the directors of the board saying you violated your fiduciary duties to me, because you’re beholden to these other institutional investors. So it would hinge on like a few things. So one thing it would hinge on is, are these institutional investors, you know, they individually own like, a few percent to maybe 10%, even of a company, but they don’t own more than 50%. So the only way to actually change the leadership of the board to be more beholden to them is to have a 50% coalition. So one question would be like, are they behaving like a controlling shareholder? Meaning like, have they is there collusion such that like, this extra set of sorts of scrutiny that we’re going to provide that Delaware provides for fiduciary duty analysis, would they apply to you know, does what Blackrock qualify as a controlling shareholder? That’s one question. Right now, you know, it’s not like they have like a voting agreement between these entities, it’s just like individually each in their own interests, they do cooperate a lot. They do have, you know, climate action. 100 Plus is the sort of convening institution that really like provides them with a lot of resources and coordinates them. And when working with these companies, I think that certainly this cranky, this cranky shareholder that we’re hypothesizing, we would allege that climate action 100 Plus sort of acts as like a facilitating group to constitute a controlling shareholder. So that’s one question. One big point is that we have in Delaware law, the business judgment rule, which means that the courts are like pretty reluctant to, they’re reluctant to analyze whether a business decision was a good business decision or not, they’re sort of like, that’s not our expertise. We’re not MBAs, we’re judges. That’s for the board and the management to decide. So as long as the directors can put forward sort of a plausible, firm, specific rationale, and you know, they can say, we’re not disloyal, we didn’t get any benefit from this decision, we just think it’s good for the company, then the courts would likely just apply the decision rule and say, this is, you know, this was a business decision. You don’t get any farther in this process.
Michael Livermore 26:14
Right. So just the reason we’re talking about Delaware so much for folks is that that’s where most of the companies that were talking about our list are have their corporate headquarters, and that’s the law that is gonna apply. It’s a quirk of the US legal system that Delaware decides how exactly how our corporations are run. So, so yeah, so the business judgment rule courts are, you know, not or the Delaware court anyway, isn’t particularly inclined to interfere in judgments that are plausibly you know, essentially profit maximizing. But if Exxon were to say, we’re adopting the Bill McKibben, keep it in the ground.
Madison Condon 26:52
That would be a problem.
Michael Livermore 26:54
Exactly. Or if they were even to say, you know, oh, because we think is profit maximizing, even though it obviously is destroying all the value of our company, the court might say, Alright, look, that’s not really plausible anymore, right. And so the, you know, the cranky shareholder rule, that all of these steps, whatever the corporations are doing here have to be plausibly related to the profit maximization of the firm, basically, within some band of, you know, the discretion given by the business judgment rule, that puts a pretty substantial, I guess, we could argue, one could argue about how much that limits what the companies can and can’t do, or what the shareholders can and can’t require, you know, or push Exxon to do. But certainly shutting down the company, or, you know, like not like, for example, if exit wants to get out of the, the oil business, and it doesn’t sell its leases, it just holds on to its leases. very hard, very hard to justify that under the business judgment rule. So given that, what do we have in terms of what steps can be taken? Because ultimately, Exxon, is in the fossil fuel business? It it. Its whole business model? Is fossil fuel extraction and delivery, finding, delivering is that’s what it does. So what’s it what’s a greener exxon look like? Is it just you will? What was that? What does that look like? How do you envision a greener version of that?
Madison Condon 28:31
Well, I think that one point to be made, if we’re going to talk about Exxon, in particular, and I think actually, like, basically, many of the oil and gas companies that are US based is that there’s plenty of firm-specific reasons to think that the leadership of Exxon has been bad. And there’s plenty of reasons that better firm-specific leadership, like actually delivering more returns to shareholders would also reduce emissions. That’s sort of like low-hanging fruit, like double materiality. Like, you just have to put people on the board of Exxon who can possibly envision a world in which climate regulation is possible, which I think you should do as a business as a business matter, frankly, if you’re a shareholder, that’s like interested in not, you know, totally losing money if the world goes in one direction. That’s one thing. Another thing that is like very specific, but I think actually is like a good fulcrum, and a really important fulcrum is that shareholders have been really agitating for fossil companies to stop messing with the political process. So to really cut out their dark money spending, you know, so that basically, what dark what I mean by dark money is it’s really hard for shareholders right now to figure out exactly what the corporations that they are invested in are like, who they’re spending money on and for what causes mostly because they can give the money to a third party either like, you know, industry coalition or Chamber of Commerce or national association manufacturers or whatever, and then that organization can then fund a bunch of sort of, like lobbying against, for example, the Washington State carbon tax. So there’s been a bunch of successful, you know, 65% support, for example, shareholder proposals, which is, give us a report about how your lobbying is aligned with the climate agreement. So and that’s actually like a hook, because you can’t lie in materials that you give to your shareholders because you will be sued. And no one really wants to put out a report about how much money they’ve spent on fighting the Washington State carbon tax. So it actually has sort of like a spending decreasing measure. Again, it’s not the same as having Exxon sit on its oil fields. But I think it’s like not insignificant.
Michael Livermore 30:42
It’s something that’s worth pursuing. Yeah. Yeah. And again, I think just to clarify, you know, make sure that folks understand, we’re talking about decisions that are plausibly within the business judgment rule. So you know, yes. And so like, Look, if someone can argue, of course, well, it’s perfectly profit maximizing for Exxon to spend some money on, you know, fighting, you know, these policy proposals, and that’s kind of expected of profit-maximizing firms, etc, etc. But we’re not really arguing one way or the other. Doesn’t sound like you’re arguing one way or the other about what is in fact profit maximizing from the perspective of an individual shareholder of Exxon. The question is, you know, what is realistically going to be allowed by the Delaware court as plausibly justified?
Madison Condon 31:29
It’s extremely unlikely that a Delaware court would say, No, Exxon, you have to spend lobbying money. Right, right. Exactly. Right. They just wouldn’t do that. Or that. Yeah,
Michael Livermore 31:39
That’s right. That’s right. It’s just, yeah, yeah, exactly. So So then this kind of gets us to this divestment question and the exit versus voice. So it sounds like on the broader question of divestment, that correct me if I’m wrong, that you’re more on The Voice side, that there it sounds like you think there’s enough that can be done as a shareholder within the constrictions of existing law, the confines of existing law that would actually be useful and promote, you know, kind of good behavior and more sustainable practices, so that it’s worth actually remaining invested in these companies, rather than divesting altogether?
Madison Condon 32:25
I actually don’t think that’s true. I mean, I don’t think that there’s a one size fits all policy. I think that, you know, particularly for these large passes, there’s just they’re not going to divest. So I think that, you know, as a matter of like public, but you know, so for example, I think as a matter of public pressure, like I think you can acknowledge that Blackrock can’t straight up, divest. But you can acknowledge that they have control over like the indexes that they license. So if those indexes, so right now, this sort of these products are a little bit of mess in terms of like, funds that are labeled climate friendly, that are in fact, not climate friendly. And I think that, you know, pressing the institutional investors to press the index providers to be better about thinking about what is, is or is not ESG. And to be more transparent about that. I think that’s like another really important move. But in terms of divestment, I mean, so there’s been a lot of reporting, that cost of capital for dirty businesses alike is going up. And certainly, the industry is complaining that says that this is because of the divestment movement. The counter to that is like no, it’s just traditional investing. Like it’s a bad time to be in fossils right now, like the future looks bleak. I sort of think that they’re like a little bit the same thing. Like sometimes like if there’s commerce, like what isn’t is not ESG has become like, extremely porous, like, sometimes ESG seems to me, and just like anytime you’re thinking about climate change at all, even if it’s just for like, a purely bottom line reason, that’s labeled ESG.
Michael Livermore 34:03
Yeah, this is a complicated thing to just in terms of the you know, what is the, you know, this kind of transparency issue around ESG. But just just to put a fine point on the, on the divestment question. So. So you were saying that look, there’s the reality is these big institutions like Vanguard and Blackboard are not going to divest from fossils. And so they might as well be using their positions to promote, you know, these better policies. But there are folks out there who could divest and have divested, right. So like the universities are obviously the big example of this. They control nothing like BlackRock, but they have some money that they control. And so, so, so then, you think maybe it is a good idea to so even though as I said, these universities have a choice, they can maintain their positions on these as shareholders and then align themselves As with folks like Blackrock or others who are even more aggressive, and promoting, you know, these kinds of policies, or, or they could divest, and and how should they think about how to make that choice?
Madison Condon 35:17
Well, I think, you know, if you, if you think that the rest of the institutional investors are going to start taking sort of a portfolio primacy approach or universal owner approach, you might not want to be invested in that company anymore, you know, you could help them but you also might as sort of an investment proposition, if the stock is gonna go down, not be invested in that company anymore. If you’re if you are, if you have those active choices, and you know, at some point, you know, there’s this, the divestment movement and debate has been like around a long time, and the pushback against it has always been divestment doesn’t do anything, there’s always going to be someone else to step in and take your place, there’s always going to be vice funds that are willing to take the profit of the other people who don’t, you know, are or that less savory of an investment. But at some point that the line runs out, like at some point, the divestment movement becomes big enough, it obviously starts to affect capital. And I think that we’re beginning to see a tipping point right now, with it actually getting harder to get fundraising for capital projects in the fossil space.
Michael Livermore 36:23
Right. So let’s talk a little bit about the greenwashing point that you’ve been making we’ve movements circling around it a little bit. So environmental, social governance funds have become a pretty big deal. I think probably a lot of people are invested in one way or the other in these kinds of funds. But there’s a question of what that actually means. So how confident should I be when I buy, you know, a fund that is as labeled as climate-friendly, that I’m actually only invested in companies that are, you know, doing good things for the environment?
Madison Condon 37:01
You know, that’s a really good question. And there should be way more transparency and way more research on this topic. You know, so far, it’s just sort of anecdotal. Vanguard got in trouble. They had a fossil-free fund that had Kinder Morgan and a couple others, maybe occidental in it, you know, so fossil fuel companies in the explicitly labeled Fossil Free fund. So that seems clearly like a problem. But then becomes, you know, you ask the question from an investor perspective, but maybe I’ll also answer it a little bit from the regulator perspective, like, it’s a question of like, what are you expecting, when you buy a low carbon fund, like you, Mike, like, what is your definition of low carbon? That’s a really interesting question from like, a securities regulation perspective, when you’re trying to say, No, Vanguard, this product that you’re offering, like, is, is or is not low carbon, actually, you know, like, which scenario Have you picked? Like, when do you think that all fossils have to stop being produced, like, you can look at what the European Union is going through right now. And they’re sort of they have this process sort of label every investment is green, or not green, and it’s erupted? All of these fights over sort of is natural graph is natural gas green, you know, it’s certainly less bad than coal and oil. I wouldn’t call it green. But there’s all of these borderline questions. And so it’s like, do you, as an investor know enough about what is green or not green to sort of police your decisions? Do the people making the indexes, like know enough about what they’re doing to label things green or not green? Do the regulators know enough? So that’s a really interesting question. I think that there’s gonna I think we’re just really at the beginning of seeing it all play out about, you know, it seems pretty easy to regulate fossil free or not, when people start to make claims about, you know, this fund is Paris compliant, or not, etc. Like, there’s so many questions about what that means. Does it mean that like, all the companies in the portfolio, have some sort of net zero commitment? Like, it might mean that but then there’s so many questions about like, well, has that been audited? Is that realistic at all? When, at all, like when the company made this net zero claim? Like, did it impact its financial sheet in any way? Did it like change capital allocation in any way? You know, these are all questions because plenty of companies right now are making some pretty ambitious claims. And it’s very clear that it hasn’t trickled down to the people who are sort of making the day to day decisions about like, what buildings to buy, like what suppliers to contract with. So it’s a real mess.
Michael Livermore 39:30
So when you have these funds do they have like, definite, I mean, when they say where the with Green Fund X or you know, socially responsible fund, why is there like a sheet, a term sheet or something that explains what is actually meant by that? Or is it just like a name for the fun like, how does that like just operationally work?
Madison Condon 39:51
You can look into the term sheets. Usually you can see the methodology that’s employed like often it will be like an underweighting overweighting methodology. The problem with that is that that in itself is like, pretty opaque because oftentimes they’re using ESG scores, which they’ve bought from a third party ESG provider. So like MSCI, or Sustainalytics, or s&p, they all have ESG scores that they compile themselves and then sell, which they themselves don’t have like a ton of transparency about, like, what actually went into this ESG score. How are you balancing all the different factors? Is the data that you use to make the ESG score, like real data? Or did you? You know, where do you get it from? Has it been audited at all? So if you’re an interested investor, that’s like actually trying to figure out the emissions footprint of your portfolio, it’s extremely challenging.
Michael Livermore 40:44
Right, so then, so there are these third-party providers? That it strikes me Yeah, that would be a kind of an obvious thing that would happen in the market. And they’re questionable. I mean, are they not trustworthy? What’s the story with these third party actors, because I can imagine, you know, just in other domains, where this kind of thing has come up, like people wanted to buy, they want to buy coffee from, you know, that isn’t exploitive, so they get Fairtrade certified, or, you know, you want humanely raised meat. So you, you know, you’d have some certification for that, and you look for that in the grocery store, or you care about, you know, sustainably sourced paper products. And so there was different, you know, different entities out there who were each vying to become like the accepted standard for, for sustainable forestry practices. So is this just another manifestation of that? Are there like NGOs in this space who do a particularly good job? And it’s just a matter of kind of separating the wheat from the chaff? Or is there is this kind of like a fundamentally more complicated problem than what we’ve seen in the past?
Madison Condon 41:53
It’s definitely not an NGO thing. I mean, if anything, the NGOs are the ones who are sort of trying really hard to point out the greenwashing when they can find it, but they’re not the ones providing the ESG information. It’s sort of like the traditional index providers, or like traditional financial analysts that have expanded into the ESG space. And like the ones that have come to dominate, I just said are MSCI and Sustainalytics. And there’s been like a bunch of mergers and consolidations, like as this industry has become, like, very huge, rapidly in the past couple of years. It’s not, I mean, there’s like a bunch of problems. It’s not like any one organization is like particularly nefarious, although maybe the oil and gas companies are, but the data that they’re using is only as good, you know, the products that they’re selling to the investors or to the index providers is only as good as like the data that they get. And a lot of the data that they get right now is like voluntarily provided by corporations, either to CDP or otherwise. And none of that is audited, or like assured. Or if it is, it’s not getting the level of assurance that we would expect from a financial statement it’s getting like a different type of lower-level assurance. All of this, I think, is a very big problem given, given how much a thing like your emissions can be like a statistic, like your emissions can really be an input into a bunch of different investors’ decision makings and how to allocate capital.
Michael Livermore 43:25
So, so part of the question, I wonder is just how much demand there is for the truth of the matter, on these questions, versus how much do people just want to see, you know, oh, you know, ESG? And the title of the fund, right, like, do people actually care that much about the kind of the behind-the-scenes process? And if so, like, why doesn’t an actor like the Sierra Club or, you know, Environmental Defense Fund or whoever actually get into the business of providing kind of reliable estimates of, of the kind of ESG characteristics of some of these funds?
Madison Condon 44:09
Because it’s really, it really relies on a bunch of data that’s internal to the company, like, you know, you can do third party estimates and this that that is growing, like to be sure, like, one thing in particular, that’s growing as sort of remote sensing of methane emissions or remote sensing in general have different like deforestation or various emissions. So like that’s happening and like private providers are definitely moving into that space and sort of like snooping on companies for their environmental damage. It’s still pretty small, though. And like, at root, a lot of this data has to come from the companies themselves, like they have the data, they should give it to the investors. And I mean, just to be clear, like I think that that is going to happen like imminently the Securities and Exchange Commission is working on proposed rules that should come out I think soon, maybe in the next month, I think early next year, which will be mandatory climate risk disclosure rules in which I expect would require mandatory disclosure of certain categories of emissions, at least for certain industries.
Michael Livermore 45:15
Do we do this with any other ESG characteristics? Like, obviously, the SEC requires disclosure of all kinds of data about companies all kinds of information, you know, their balance sheet, and, you know, obviously, you know, that their exposure to risk and etc, etc. Is this, is the climate related disclosures that are on the horizon? Are those akin to other kind of socially relevant disclosures? Or is it, would it be something quite new.
Madison Condon 45:48
So they’re simultaneously considering or working on, I should say, proposed rules for disclosure in the realm of human capital management, which is basically like, HR slash diversity, or like, you know, human resources treatment, broadly defined. Um, so that I think counts, you know, I’ll just, I’ll just say a defense of the climate disclosure rules like this is where I get frustrated with the definition of ESG. Like, I don’t think there’s anything that’s special about the climate risks, other than everyone has, like a weird block about them and decides to treat them differently. Like, it’s obviously relevant to investors, like if you’ve told all of the world that you are going to reduce emissions by a certain date, it’s up to normal investors would like to know, like what that means. And on your balance sheet, like, are you going to start investing in x and y? Or are you going to transfer this? Or like, what is the plan? That’s just a basic financial, I think that’s obviously like, that should be a thing, that companies need to do a better job of disclosing to their investors. And similarly, like, normal investors, like should be, should be worried about are corporations, factories and floodplains like, are they prepared for the Internet to go out like a certain category of storm? Like, there’s a bunch of super-relevant financial risks that are being ignored by the market? And these just seem like, clearly material, so not special in some sort of way? You know, so you framed it as sort of like, are there other disclosures in which we asked for, like social disclosures, and I’ll say, like, the one I can think of which no longer exists, is the conflict minerals disclosures in which companies were sort of supposed to, there was a post-Dodd Frank era regulation that finally got rolled out, which was, you know, disclosure of payments if you work in the conflict, mineral space, outside of the US territory, but it no longer exists, because it got killed by the Congressional Review Act. So that to me is a purely social disclosure, you know, like, tangentially related to the bottom line? I don’t think that that’s what climate disclosure, the two climate disclosure rules are, I think that they are bread and butter, materiality, investor concerns.
Michael Livermore 48:04
So are they covered by existing rules, then, and it’s just the rules need to be applied more vigorously? It’s that same kind of a clarification.
Madison Condon 48:12
I mean, I think it’s a big failure of enforcement. So like, there was a 2010 guidance about how you know, like, if climate risks are material, they should be disclosed, that should capture like a lot more than what the market is currently delivering to investors. It just hasn’t, and the SEC hasn’t been an investment enforcement priority, you know, under the last administration. So I think there’s easily an argument that a lot of these disclosures are already required, but there’s also so much confusion in the space and it is admittedly like a very rapidly moving and new field. And so I think that new regulatory guidance is like, absolutely necessary.
Michael Livermore 48:52
So just to take a step back, we, you know, obviously, we’ve been talking a lot about the financial industry and investment and, and how kind of financial markets respond to these risks and so on. And one question, I’d be curious how you how you think about this is, obviously, there are a lot of the risks associated with climate, really don’t touch on the market or touch on the market, very, very little, you know, so, flooding in Bangladesh, which is going to cause you know, a really substantial amount of human suffering. You know, obviously, one can argue that that could be destabilizing, and there could be kind of political consequences. But, you know, there’s also just going to be things that are going to cause human suffering of people who do not have a lot of money and do not participate in financial markets, and are essentially, you know, at the very fringes are almost entirely excluded from the, from the global economy. They operate, you know, within a local, a local economy that’s mostly cut off from the rest of the global economy. So there are clearly even if Blackrock is act, you know, can act in a way that maximize the interests, you know, its own interests or the interests of its, you know, of the people that own its funds in a very kind of portfolio oriented way. There are lots of effects of climate change that are outside the portfolio effects on species, obviously. So, so what does that mean for that? Is that an important limitation on what we can accomplish through this type of kind of corporate governance, you know, ESG type of, you know, mechanism? Or is there the reasons to be less concerned about that, and to feel that as though if we actually just get the financial markets operating properly, then, you know, we will be making efficient investments in in climate change and or, you know, in climate change reduction or not investing in fossil fuels or whatever else?
Madison Condon 50:57
Yeah, I mean, you’re you’re totally right, I make this point in the, in the, in the externalities paper as well, like, the ideal level of emissions reduction for Blackrock from a cost-benefit perspective is less than the preferred global level of emissions reduction? So like Blackrock can handle that, you know, so there’s a trade-off that Blackrock has to make, you know, how much profit am I going to sacrifice from oil and gas and in return receive sort of like reduced emissions to my portfolio? The comfortable temperature for Black Rock is higher than the comfortable temperature for the world, the world would choose to stop producing oil earlier and to keep the temperature lower? That’s yeah, I mean, that’s bad. I mean, so I think that’s important to point out. So I’ve talked about this in the paper, but it’s, it’s also important, you know, my paper has been read, as advocating for Black Rock is like the Savior of the world. And that’s just like very much not the position of the paper. The paper tries to be pretty descriptive, because I think a lot of what the work is doing in the article is just sort of pointing out what is going on, and like what the incentives would are, and, you know, just arguing that it’s already happening. But yeah, I mean, so the short answer is yes, Blackrock has different incentives than like the global governance or even like, the citizens of America. So the question is, like, what to do about that, like, what does that mean? Does that mean that you have concerns about Blackrock acting as like a pseudo regulator? And like, I think your concern might be that it would like displace the government? Like, what if we rely on Blackrock to solve our problems, like, instead of the government, I think, is one concern. There’s like a crowding-out effect. I think that’s really legitimate. I mean, I think our current government is like, pretty broken. So I don’t think that Black Rock is like a great solution in any way. I think it’s in response, like, partially in response to, like a broken government.
Michael Livermore 52:57
I mean, in a way, it’s just illustrative of how out of whack our policies are, if they’re not even maximizing value for an entity like Blackrock or Vanguard, right? They’re not even I mean, what does that mean? They’re not?
Madison Condon 53:12
You mean, like, even politically and like powerfully entities? Is that what you mean? Yeah, exactly.
Michael Livermore 53:16
Like, who’s the who’s, you know, if we’re not maximizing? The essentially what we’re talking about is the returns to financial markets in the United States. Right? If we’re not maximizing that, then what are we maximizing with our policies? Like, whose interest are we actually promoting? If it’s not the owners of our economy? And it’s certainly not, you know, in this instance, it’s not the interest of regular folks.
Madison Condon 53:40
I will, I will say that Rex Tillerson was the Secretary of State. So I just think, you know, I think that I think of government capture is like a very big, obvious point, you know, part of the story here.
Michael Livermore 53:53
but it’s, but just to be clear, to put a finer point on it. It’s not captured by, you know, the owners. And it’s not kind of owners versus non-owners. It’s not management versus labor. It’s not rich people versus people who don’t have a bunch of money. We’re actually saying that the US policy is not promoting the interests of rich people as well as it could, which is, you know, pretty amazing.
Madison Condon 54:17
Yeah, it is interesting. You know, it depends. Yeah, I mean, to be fair, definitely, it’s rich people who own the stock market. That’s definitely true. There’s definitely a bunch of other rich people who’s interest would be to keep maximizing fossil fuels. Right.
Michael Livermore 54:29
Right. That’s right. That’s right. But it’s just like if you take kind the ownership class in a very general sense, it’s not maximizing their interests. And that’s, that’s fascinating, I that you know, that that seems to be a very strange state of affairs, pretty pathetic state of affairs. Not that we should be maximizing the ownership class,
Madison Condon 54:49
But the maximization of benefits of the wealth ownership classes, like my main goal right.
Michael Livermore 54:54
but I guess what I mean by that is, if we’re not going to maximize the benefits of the ownership class, it would presumably be, so that we could promote the interests of non-owners and you know, people who don’t have a lot of money, workers, and you know, all of that. But that’s not what we’re talking about here. Right? We’re talking about promoting the interests of some subset of wealthy people at the expense of everybody else, including the ownership class in general, which is a pretty, pretty pathetic place to find ourselves. Yep. That’s where we are. Okay, well, on that note, you know, there’s nevertheless, there’s a lot of exciting stuff happening in this space. You know, some good some bad and it’s, it’s great that there are smart people who are paying attention to this and can keep all of us updated and alert to developments in the sector. So thanks very much for your work on this on these issues and for taking the time to chat with me today.
Madison Condon 55:53
Thanks so much, Mike. It’s been really fun.
Free Range Podcast 