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The Business Lawyer

Summer 2022 | Volume 77, Issue 3

Least-Cost Altruists and ESG Firms

Saul Levmore


  • A strong argument in favor of a corporation’s attempt to sacrifice some profit in order to address environmental concerns or other social issues has been that it should maximize shareholder welfare rather than the firm’s market value. However, a significant number of shareholders might want to sacrifice some income in favor of a variety of social causes, either because some firms are “least-cost altruists,” with a comparative advantage in offering socially desirable things that shareholders want, or simply because some shareholders want to distance themselves from enterprises that are uncommitted to Environmental, Social, and Governance (ESG) concerns. If so, an efficient market will provide these shareholders with what they want. The argument is improved if shareholder voting mechanisms alone are unable to capture different intensities of preferences. It is weakened if shareholders can maximize their welfare on their own by offsetting their investments in ESG-deficient firms with investments in nonprofits or other organizations that offer the socially enhancing activities they desire. The argument that an ESG firm is welfare enhancing is most convincing when the corporation is best situated to advance this welfare, for otherwise its shareholders could maximize their own welfare by using dividends they receive as they see fit, including making gifts to not-for profit specialists. But this in turn means that, for investors to prefer ESG firms, investors must have some idea of how much they are paying for a corporation’s sacrifices (if any) in favor of socially beneficial causes, and some shareholders will want information about the mix of ESG concerns that each firm addresses.

    This article builds on the likelihood that market pressure will cause corporations to estimate the cost, or sacrifice, that shareholders will choose to endure. Ideally, a firm might estimate the costs and benefits it expects to generate and disclose these estimates to present and potential shareholders. But one reason a corporation will not be more transparent about expected cost/benefi t information about its ESG characteristics is that false information, often non-negligently provided, risks accusations and liability. Law encourages silence, when the market would function better with disclosure. At present, and increasingly, a corporation simply reveals itself as part of a category—whether ESG inclined or of B-Corp status (with the appropriate vote of acquiescence)—in which actual behavior, and its cost, is difficult to verify. One proposal in this article is that law should release its grip and at least provide a safe harbor for more informative disclosures, perhaps by trusting third-party verification of more detailed estimates than are normally provided by ESG firms. It is likely, however, that the transparency recommended here will disappoint socially minded activists, who might learn that they are better off taking their money and choosing environmental or political causes on their own. If so, investment in ESG firms will decrease at the time of their formation or their market prices will fall. An alternative is evolution towards a kind of divestiture movement, with a limited number of firms identified as ones to avoid, while most adhere to conventional value maximization. Another possibility is that some firms will maximize shareholder value, but then, on occasion, announce that they are making decisions that will sacrifice some profit in return for a particular social benefit. Investors could choose to exit or join this kind of enterprise. Finally, conventional intermediaries might offer investors information, and they or not-for-profit entities might serve as socially concerned intermediaries that shareholders could imitate.
Least-Cost Altruists and ESG Firms
iStock/Vladimir Sukhachev

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I. Firm Value Versus Shareholder Welfare

The conventional view, associated with Milton Friedman, is that corporate managers should be guided by the idea of maximizing firm value as reflected in the price of stock in an efficient market. There are many things to be said for this view. If held to it, managers will not impose their own preferences on the firm and its shareholders, but will rather encourage the efficient deployment of capital. Another positive attribute is that managers will be beholden to just one master or at least one goal. If asked to maximize two things, there would be conflicts that are difficult to resolve by contract. Investors might prefer to make their own choices rather than leaving them to managers. If, for example, a goal is to maximize profit subject to paying some attention to environmental causes or other laudable goals, shareholders can choose their own allocations among goals by using the funds they derive from one single-minded, value-maximizing firm in order to contribute to non-profits with a declared, and often a singular, goal of their own. A shareholder can choose both an amount to spend as well as an allocation among causes.

The Friedman view—expanded in Easterbrook and Fischel’s exploration of corporate law, which emphasizes the advantage of a single goal—is a bit exaggerated. Most firms have lenders as well as shareholders, and these include banks, bondholders, employees, and suppliers. The finance literature, beginning with Jensen and Meckling, teaches that managers can, in fact, be encouraged to serve (at least) two interests with different appetites for risk taking. The firm can structure managers’ compensation to mimic the debt/equity ratio of outside lenders/shareholders. A good match will encourage managers to take the appropriate risks because doing so will lower the overall cost of capital derived from both types of sources. Shareholders who do not like this mix can, as Modigliani and Miller saw, always buy bonds themselves so that they too match what is going on inside the firm. This solution is not always available in the case of shareholders (and lenders) when the concern is not debt/equity but something like care for the environment or other ESG goals. Managers can hold bonds or expect salaries, a kind of fixed return, but investors cannot so easily address their individual ESG concerns. If an investor in Exxon thinks the firm is insufficiently concerned about the environment, she might, in the spirit of Modigliani–Miller, borrow against her stock and donate money to the Sierra Club. This is an imperfect strategy, and not nearly as good as fulfilling the investor’s preference for a given debt/equity ratio by compensating for Exxon’s “excessive” debt through the purchase of Exxon bonds. Donating to the Sierra Club is also costly because one must actually donate rather than invest in the not-for-profit with an expectation of dividends or interest payments. Moreover, if Exxon fails to match a shareholder’s preferences because it sacrifices too much in favor of the environment, it is very hard for the shareholder to offset this with an investment. In the case of debt/equity ratios, one is trying to achieve some personal balance. In contrast, most people are likely to want to affect the environment rather than one’s own balance with respect to it. If one sells or buys shares of Exxon, a party on the other side of the transaction takes one’s place.

In short, if someone thinks a firm’s ESG/value-maximizing ratio is too high, it is difficult to offset what the firm does, and perhaps not easy to do so with respect to one’s own affairs. And even if an investor knows and approves of a firm’s ESG/value-maximizing ratio, the investor might not like the way the firm allocates among various socially minded causes within the ESG umbrella. This too is likely to be difficult to undo “at home” in one’s personal investing and philanthropic behavior, because the firm’s ESG activities cannot be reduced but only countered with additional philanthropic donations. Exiting and reallocating to a firm that better matches one’s preferences may also prove difficult when share prices already reflect ESG initiatives. It is likely that the best that most socially minded investors can do is to invest in firms with managers who have a proven record of supporting causes (or not) that the shareholders find compatible with their own.

With respect to some socially minded causes, ESG-oriented behavior might turn out to be value maximizing in the long run. If this is the case, there is really nothing new about the ESG movement. If a firm stops selling cigarettes because it thinks that this is profit maximizing in the long run, it is doing what is right for shareholders, who simply want value, and probably also for long-run social welfare; no revolution in conventional value-maximizing corporate law is needed. Similarly, if a firm says it is sacrificing short-term profits because, in the long term, a different treatment of the environment will prove to be profit maximizing, that too is consistent with the conventional value-maximizing view. Market value is presumed to reflect long-run prospects—even if managers are often (unwisely) rewarded for short-term accomplishments, like increased market share. A considerable number of for-profit firms already support local not-for-profit causes or encourage their employees to take (paid) time off to work on local projects. There is, however, no good evidence that these ESG-oriented policies raise firm profits in the short or long run. A correlation between giving and profitability may well run in the other direction. Law firms might attract associates with the promise of pro bono work, but any such attraction is likely because the new associates expect to enjoy the work, to gain experience, or to get utility from a connection to what they regard as socially worthwhile. The sentiment is not to be a perfectly efficient altruist, but rather to be associated with a firm that does little harm or perhaps to take a step toward the goals of effective altruism. I may like to pick up trash, and recycle some of it, even when I know that, if I did not, someone else will come along and do the job. The idea that ESG-oriented investments do nothing to change the world, but simply make investors feel good about themselves, would be offensive to most adherents. Still, the larger point here is that favoring ESG firms is unlikely to be consistent with effective altruism.

The more interesting part of the modern ESG movement is, therefore, that it encourages firms to consider the social good even when that detracts firms from maximizing value, but such consideration by those firms might well respond to their shareholders’ sentiments and preferences. This claim, associated with Hart and Zingales, is what is challenged in this article. The ESG movement asks managers to do the right thing. They might bring on more employees, or raise wages of the lowest paid employees, or produce environmentally friendly products, not simply because they hope—even though it is probably wishful thinking—that this makes the firm more profitable because it attracts admiring workers and customers. Instead, the ESG enterprise is expected to sacrifice some value in favor of maximizing shareholder utility, derived in part from the firm’s socially minded behavior.

Even if an ESG orientation does not maximize value, it might not be costly. Some investors might gravitate to an ESG firm because of their preference for the firm’s goals; in the best case, there will be a perfect clientele effect. Some firms will appeal to investors who simply want profits, while other firms will appeal to different investors’ preferences for different levels of ESG behavior, and even for different combinations of goals. An investor who cares about certain environmental goals, but not to the value of having women on the board of directors, might invest in firm A, while other investors might invest heavily in firm B, for it promises that half its board members will be women, and still other investors might invest in firm C, given its commitment that its workers will receive a minimum wage of $20 per hour, and so forth.

The presence of ESG mutual funds in the market shows that some investors do not have much in the way of preferences among ESG causes. It would be nice if these funds served another purpose, such as vouching for the firms in which they invest, but the evidence suggests that these funds do not, or do not yet, necessarily identify firms that really do serve ESG goals, and there is at least some evidence that investors pay a price for the ESG label. The ESG funds may serve investors who want to engage in virtue signaling (even if just to themselves) or who want to do good but not put effort into allocating among causes. These are topics returned to later in this article.

Whether investors separate rather perfectly, so that some firms satisfy shareholders who are disenchanted with value maximization, while others want a given firm to pursue one social goal rather than another, there will be some conflict because shareholders will have varying intensities of preferences. In principle, some of this can be solved through shareholder voting. Shareholders who want a firm to pursue an environmental goal at the expense of some corporate profits or other goals, can vote for directors who will advocate accordingly and make trades with other directors who have other goals. Some state corporate laws allow shareholders to buy votes (or to hold shares for a short period during voting season) and this makes it easier to express intense preferences through voting. Both because this idea has been pursued in the literature and because it is impractical for small shareholders to coordinate, the discussion here sets aside this means of maximizing shareholder utility without an ESG declaration or any legal intervention.

II. Modigliani–Miller Applied to Social and Shareholder Welfare

But, even if the clientele effect is incomplete, why does a firm need to cater to socially minded investors? Why force investors to discover the socially minded decisions of a firm, when not all investors will favor the same policies? Rather than face conflicts, even the most socially minded firm could simply maximize value and allow shareholders to make their own decisions. Shareholders could use the dividends they receive, or they could sell shares at the higher prices a more profitable firm will bring about and use the proceeds, to invest directly in causes they consider worthy. Just as a firm might specialize in producing automobiles, it is likely that another firm, or not-for-profit institution, specializes in redistribution or in environmental causes. Each specialist is likely to be superior at its own activity, so why not maximize value and allow shareholders to choose the best specialists and encourage competition among them? Even the best ESG-inclined enterprise will spread its socially minded behavior across causes or focus on one of many causes, and shareholders are unlikely to favor the same distribution of effort among these causes. Setting aside tax considerations, which might be a small part of any picture drawn here, a policy of value maximization allows each shareholder to choose his or her own preferred allocation among causes.

The welfare (rather than value) maximizing argument for ESG requires that the transaction costs associated with shareholders managing their own socially minded preferences are overwhelming, or that some firms are best situated to pursue ESG activities within their control, or that shareholders get utility from an association with firms that are likely to serve social goals rather than value maximization alone. The second possibility, that a firm is often the “least-cost altruist,” is the path pursued by Hart and Zingales, as noted earlier; it offers a welfare-maximizing defense of ESGs. The idea is that firms, or at least those that declare themselves to be ESG adherents, know themselves best and are something like the least-cost avoiders of tort law. The argument is attractive, or at least plausible, for something like environmental policies. A firm, X, might have a choice about where to build a new facility or how to dispose of waste, and X might be the most efficient environment-improving entity that a given investor can locate. X knows more than government regulators and not-for-profit organizations about addressing the environment, so an investor, who is not sufficiently satisfied with existing laws aimed at the environment, would like X to be more motivated to make socially useful decisions about its own impact on the environment. If X does not take a step that is most environmentally sound, perhaps because it adheres to the more familiar notion of value maximization and expects to distribute more profit to its shareholders, then shareholders who put the environment highest on their list of socially minded causes might not be able to finance an environmentally sensitive cause or a not-for-profit intermediary that will do more good than the step that X is able to take at the same cost. If X is ESG inclined, it can aim to maximize shareholder welfare rather than firm value. This argument—that ESG firms like X are the least-cost altruists (from many shareholders’ perspectives)—is logical but it faces serious difficulties, except in the subset of cases where the firm can avoid a harm (like environmental damage) at lower cost than that needed to remedy it. This subset is attractive in the case of environmental damage, but seems implausible in most other cases, including wealth redistribution.

More generally, it seems unlikely that, of all the ways an investor can help the cause of improving the environment, it is some step that is in X’s hands—even if X’s own contribution to environmental damage is cheaper to avoid than to remedy—that is at the top of the list. If not, then the environmental cause is better served by X’s maximizing its value, and simply distributing the savings to its shareholders, so that those who are most concerned about the environment can use their portions to do more good than could X. On the other hand, perhaps X’s shareholders cannot identify superior strategies, and they require some intermediary to do this for them. Presumably, altruistic investors do not want X to over-pay its taxes on grounds that the government is best at choosing places where its expenditures will do the most good. There are many reasons to favor higher taxes, but few people would say that it is because the government is the least-cost altruist. The best case for X’s ESG orientation is that X itself might be this intermediary, even though X is not quite a least-cost altruist. The idea might be that X’s internal opportunity is a bird in the hand, or simply better than what X or its shareholders can find outside of X.

Another possibility, as hinted at earlier, is that many of these shareholders are not out to improve the environment in the best possible way, but rather that they wish to be associated with firms that aim to do more good than harm. They certainly do not wish to be associated with firms that are likely to do significant harm, and perhaps ESG firms are really promising not to be one of those firms. Meanwhile, the investors are also virtue signaling to themselves; they might not have found a least-cost altruist but at least they are not increasing that which they find objectionable. It is unlikely that they are virtue signaling to others, inasmuch as few people broadcast their stock holdings. One can support the ESG movement without proof of investment in it and without identification of a low-cost altruist. Moreover, to the extent that ESG-inclined investors choose ESG funds, rather than individual firms, there is evidence that they do not care so much about allocation among causes, as they do about aligning themselves with the overall principle. On the other hand, the fact that many companies (and mutual funds) do not broadcast an alignment with ESG sensibilities suggests that they think some investors want to signal displeasure with the ESG idea or simply associate the ESG inclination with lower rates of return. In any event, the most sophisticated argument for ESG as a means of maximizing shareholder welfare does not rely on feel-good sensibilities, so the argument here proceeds with the stronger claim that ESG might really be a means of maximizing shareholder welfare by bringing about real social change.

Arguments in support of ESG firms do not require any belittling of shareholder preferences. Most readers (and authors) would choose not to shop in a store owned and staffed by an avowed racist, despite the store’s excellent prices. This is so even if any money saved by shopping there could be given to a cause that more effectively promoted racial equality. Still, the ESG cause does not quite match this description unless the corporation is quite specific about what it does and provides evidence that it does it well. Most investors need better information before they believe that their welfare is improved by reducing their wealth in favor of this preference about associations. Some socially minded investors will not need all this information. They may not care so much about whether the corporation addresses environmental issues or income inequality, so much as they are pained by association with an organization that is, in their view, evil. These investors do not need the firm to use its inside knowledge to improve the environment (or any other social cause) in a way that is more efficient than what the shareholder can accomplish by taking a portion of dividends received and giving this money to a specialist in environmental (or other social) matters. But even these investors would like to know how the firm trades off shareholder value for ESG causes. Some will be happy if the firm barely reduces its value, because the shareholders want to feel good about themselves or virtue signal in one direction or another, and perhaps the disclosure will show them that they are indeed doing some good with their investments. Others might pay attention to the firm’s sacrifices; they might be eager for the firm to go so far as to reduce its profits by 10 percent in order to pursue ESG values. In any event, at least some disclosure will be valuable to just about every investor attracted to the ESG concept.

A subset of well-informed investors will also believe that a firm’s sensitivity to the environment, and a few other ESG causes, are value-maximizing in the long run. Investors attracted to this conception of the ESG movement might do so precisely because they think it is good for their own economic future and wealth, even setting aside the fact that it might be good for the world. When BlackRock and other important intermediaries support ESG thinking, they often say that it is value-maximizing in the long run and not a sacrifice at all. From this perspective, some investors think that the future requires different value-maximizing behavior now, and other investors do not. This is easy to see in the case of the environment, and perhaps where governance issues are concerned, but much more difficult to see when it comes to wealth redistribution and other causes. If the minimum wage is much higher in the future, it is hard to imagine that firms that raised their minimum wages early in time, when there is no requirement to do so, will somehow get credit for raising wages ahead of the law or before it became widely accepted that higher wages generated greater firm and national value. If it becomes clear that better employees or more customers (or investors) flock to a firm with higher minimum wages, then other firms will adjust and there will be no relative improvement in the value of the first-mover’s stock. If anything, there is likely to be a first-mover disadvantage. In contrast, building a factory that conforms to requirements for retrofitting that might be legislated in the future can certainly be value maximizing.

Environmental causes are probably the best ESG cause for the movement’s ambitions. It is likely that a firm knows more about its own ability to take steps that are in the social interest than does any government or not-for-profit entity. Still, least-cost altruists are—in the world of corporate law rather that in terms of the world as a whole (in which case a modest shift in investments or voting based on one’s shares is unlikely to do the most social good in global terms)—surely exceptional, and for this reason most of the discussion in this article works with the assumption that the ESG movement is about sacrificing some value in return for the perceived social good and satisfying shareholders who prefer to trade some wealth for other goals that they regard as important or virtuous.

Consider, for example, shareholders who are most concerned about the distribution of wealth in their home country. They are apparently not in the effective majority at the national level, so they hope to bring about greater equality at the corporate level where they might have some influence. Similarly, they might prefer a higher minimum wage. Again, we might assume that these shareholders’ first choice would be a legislated increase in the minimum wage, or even a global minimum wage, but this has not occurred and so the second choice is to raise that wage closer to home, and bring about some redistribution where one has influence. Perhaps the best these shareholders can do is to invest in firm Y because—while firm W aims to maximize shareholder value and firm X focuses on the environment—Y focuses on redistribution. Again, Y or its shareholders could give money directly to the poorest people it observes, but such a process might be costly or subject to corruption, and Y is well situated to raise the wages of its own low-paid employees. It is also likely that many shareholders simply get utility when associated with a company, like Y, that pays living wages, even though most effective altruists would tell Y and its well-meaning shareholders that they can raise overall welfare far more by redistributing to truly poor people.

The ESG welfare-maximizing argument is surely weaker here than in the case of X, the company that might be the least-cost altruist when it comes to the environment. The wages Y pays can easily be publicized, and those shareholders who wish to redistribute can take portions of their dividends and redistribute to destitute people around the globe while some shareholders, with slightly different preferences, can return the money to Y and insist that the money be used to raise the wages of its lowest-paid employees. Some shareholders might even invest in W and then use the money to intentionally over-pay their federal income taxes, because they have confidence in the government’s ability to spend money, often for redistributive purposes. If this argument seems too extreme, or even sarcastic, it should be noted that it is of a piece with the assumption of Hart and Zingales about shareholder welfare and the likelihood that the market, containing some ESG-oriented firms, will produce a clientele effect that maximizes shareholder welfare. If there is even one ESG firm in business, it is technically possible that it maximizes shareholder welfare by thinking about shareholder preferences for social causes rather than firm value alone. It can sacrifice some value in order to pursue a set of social goals that matches the intense preferences of enough shareholders so that overall shareholder welfare is maximized. It is yet more plausible that this happy result is accomplished when there are numerous ESG-oriented firms, so that shareholders can gravitate to those firms that match their preferences. Again, this requires that these firms perform their ESG functions in ways that are more efficient than what can be accomplished with a different and more familiar kind of specialization—namely that firms like W, but also X and Y, maximize value, because they are good at making products or providing services, and then enabling shareholders to fund the causes that most appeal to them.

The discussion thus far has, in part, been directed against the contemporary claim (and perhaps wishful thinking) that ESG firms are, or can be, efficient, because they maximize shareholder welfare rather than value. However, the larger aim has not been to satisfy ESG skeptics, but to argue that, without much more information about exactly what an ESG firm plans to do, and the cost associated with this ambition, it is almost impossible to imagine that ESG ought to be associated with shareholder welfare maximization. Most shareholders who are attracted to the ESG movement, and then to agreeable corporations, will, over time, have some preferences or faith in a corporation’s ability to promote diversity, to redistribute income, and to take environmentally sensitive steps, to take just a few prominent causes normally put under the ESG umbrella. The shareholders will better satisfy their own goals if they know the cost of the firm’s divergence from value maximization as well as the allocation of its efforts (and money) among these aims of diversity, redistribution, and environmental causes. The cost of this divergence is likely to vary from firm to firm and to be unknown to shareholders. If there is no cost, perhaps because employees are drawn to a firm that sacrifices for the sake of the environment, and willing to work harder there, or to take lower salaries, then ESG is simply advertisement and not at all inconsistent with value maximization. It is then nothing new, and no different from a value maximizing firm explaining its gift to a local charity or its hiring an expensive architect to design its headquarters because these costly steps are said to be indirect paths to attracting consumers or employees, and are therefore easily protected by the business judgment rule. A fiduciary that causes a firm, somewhat unexpectedly, to give employees a half day off before Thanksgiving, is hardly in danger of violating the duty of care or that of loyalty. The decision might benefit the fiduciary, who will also enjoy the half-day, and it might in fact cost the firm some sales, but the decision can easily be defended as raising employee morale and long-term profitability. The ESG idea is most significant if it is accompanied by the notion that the firm is willing to give up some shareholder value.

III. Current ESG Visibility

It should be clear that the welfare-maximization argument regarding ESG is greatly enhanced if investors have information about the cost of socially minded steps taken by an ESG-oriented company. Some of these costs are partly visible, and the unknown costs and benefits may be unclear to the firm as well as to its shareholders. Disclosure requirements will be of little use, unless they cause a firm to study things it now brushes aside. For example, consider an ESG-inclined firm that announces that it has a goal of bringing about gender diversity on its board of directors. The aim might be stifled by unexpected nominations and shareholder votes, but this is unlikely. Absent a bylaw requirement, management has a good deal of control over board composition. Shareholders can easily monitor the ESG firm’s compliance. On the other hand, the cost and benefits are probably unknown and difficult to ascertain. There are some empirical studies that claim to show some cost in terms of firm value associated with a non-gender-diverse board, but the matter is likely to be firm-specific and the impact will change over time. Put differently, the firm has little internal, hidden knowledge of the cost of this ESG policy. At the same time, and unlike the case of caring for the environment or redistributing income, it is not as if the firm can satisfy shareholder preferences by distributing slightly higher dividends and allowing interested shareholders to use these funds to promote gender equality on the boards of other firms or in society at large. The interested shareholder is likely to want firms to have diverse boards, and it is unlikely that diversity can be outsourced to another entity that is somehow the real least-cost altruist or least-cost diversifier.

Wage scales, along with the goal of income redistribution, provide a slightly different example. A company’s performance when it comes to meeting this stated goal can be easily monitored; workers who are paid less than the asserted minimum in-firm wage can be expected to make any non-compliance well known. And if the goal is to adhere to some ratio of CEO pay to employee pay, that too will become well known, at least in the case of publicly traded companies. On the other hand, investors might have some difficulty in knowing exactly what these policies cost the firm, while the firm will have better information. Higher wages might attract better workers and reduce turnover, and the firm will have much better information about the degree to which these benefits offset the more obvious cost of raising some wages.

There are ESG policies that may be visible to shareholders, but the opportunity cost of these policies may be so difficult to evaluate that even the firm itself can do no more than roughly estimate the hidden costs. The ESG-motivated firm might open a factory in a particular location in order to increase employment or to spend in an underprivileged area, or it might close a factory to avoid eco-imperialism. In both cases, the costs are extremely difficult for investors to discern. The firm, at least, has some knowledge about its alternatives, and the duty of care virtually requires the board to investigate alternatives and to consider their costs. The firm can probably offer a range, if not a reasonable estimate, of the costs associated with its adherence to these familiar ESG goals.

Finally, and by way of both repeating and summarizing much of the argument here, consider an ESG-motivated investor, or a corporation dealing with its own practices, that favors more generous parental-leave policies. Value-maximizing firms do not, at present, satisfy such an investor; some firms offer generous leave policies to highly valued employees, as do many law firms that try to attract new associates, but they merely abide by the bare legal requirements when it comes to parental leave for assistants or mailroom employees. The overall leave policy does not meet the standards some socially minded investors favor. The first choice of many of these investors would be for a government-mandated standard. It is appalling, they say, that our country is not among the most generous countries in terms of parental leave. The policy, they say, should be available to all citizens and funded either by employers or by the government. A second-best option would be to invest in a value-maximizing corporation and then to channel the higher dividends to parental-leave programs. But such programs do not exist. Similarly, I know of no program that tells its employees that they are free to contribute to a fund that the firm will use to pay fellow employees who are on parental leave. A more interesting possibility is to use the money to help raise the stock price of companies that do offer more generous parental leaves, and then hope that the market will interpret the increase as a sign that generous parental-leave policies are shareholder-value maximizing.

Most of these alternatives to a government mandate come close to the idea of accomplishing ESG goals through specialists. An employer is likely to be the least-cost altruist in this case, though altruist is hardly the right word when applied to one’s own employees, if only because a more generous leave policy may not be profit maximizing, but it surely attracts and retains some good employees. Hiring a specialist (however implausible that is at present) and getting the firm in which one invests to accomplish this goal can be seen as two separate approaches, and different investors are likely to rank these approaches differently. But in order to compare these options, shareholders need to know the expected cost (and benefit) of different parental-leave programs. Without this information—something that the firm can project far better than any investor—it is hard to see how shareholders can rank options, and how the firm can be said to maximize shareholder welfare. The discussion in Part IV offers some means by which this information problem can be overcome.

In sum, shareholders are likely to have dissimilar preferences about ESG goals and about their willingness to sacrifice wealth to accomplish or be associated with these causes. Shareholder choices and welfare maximization thus requires information about allocations and costs. A firm is likely to be best situated to provide this information, and there is every reason to think that shareholders, and especially ESG-inclined investors, would welcome the cost of acquiring this information.

IV. Pathways to Transparency

A. Safe Harbors

There are at least two reasons why firms do not yet provide information about the costs and allocations of their present and planned ESG deviations from value-maximization. The first is unattractive. The ESG-motivated firm might have little regard for clientele effects, and it might want to retain shareholders who hope only, or largely, for the firm to maximize its value. The firm might hide the cost of socially minded decisions, and especially those that are likely to recur, in order not to reveal things to those shareholders who are simply in it for the money and, if informed, would wish to exit and invest elsewhere. Whether this withholding of information can be defended, it is entirely at odds with the welfare-maximizing case for ESG firms. The second, more interesting, explanation for non-transparency is familiar to students of corporate law. The law often penalizes affirmative steps and certainly misleading disclosures, while it is tolerant of silence (so long as disclosures are not required by securities and other law), even though silence may serve the selfish aims of fiduciaries and be as costly to shareholders as misleading disclosures.

Consider a disclosure by a corporation that its rate of return may increase by 2 percent because it will build factories now that are ahead of the game; it expects law to require more energy savings in the future, when the cost of retrofitting will be greater than that of initial construction that is environmentally friendly and that the firm expects to be required by law in a few years. The firm reveals that its rate of return, or even its value, might, instead, decrease by 10 percent because it could be mis-predicting the future or the cost of construction. Alternatively, it simply knows that environmentally sensitive construction is not value maximizing. Value-maximizing competitors might be rushing to construct dirtier factories while these are still permitted. The firm might be fortunate (plus 2 percent) or unfortunate (minus 10 percent), but on average it expects a 4 percent decline with some bell curve distribution ending at the extremes of plus 2 percent and minus 10 percent. With its ESG orientation, the firm is willing to lose 4 percent for the sake of a better environment and for what we might see as shareholder welfare. Assume that the cost was actually 9 percent (barely within the announced distribution) and that a better study of alternatives and likely outcomes would have revealed that the real range was from plus 1 percent to minus 14 percent, with an expected value of minus 6 percent. The error might have come from employee optimism, from vendor misrepresentations that the firm could have discovered but did not investigate, or from some other source. A class action now proceeds, with the claim that investors would not have bought shares if they had known the true distribution of outcomes. It is apparent that full disclosure is risky. The firm is better off saying that it is of the ESG kind, and then saying no more. Investors know that ESG ambitions might come at a cost, but only some insiders would know the true distribution of these costs. Rather than disclosing, the fiduciaries abstain from trading and disclosing; they certainly do not purchase or sell shares for their own accounts. To be sure, the Private Securities Litigation Reform Act of 1995 (PSLRA), designed to discourage frivolous litigation with the hope of profitable settlements, gives firms some protection, but false statements remain actionable. One small error in the firm’s announced estimates can open up a firm to lawsuits, and especially so if the firm’s stock price falls. Law could encourage more useful, or in this case probabilistic, disclosures without increasing the threat to corporations that they will be found to have falsified information when they actually sought to provide better information. Meanwhile, insider trading law poses no risk to the fiduciaries.

At present, and as I have argued elsewhere, law offers no safe way for the firm to disclose its estimates; the firm cannot be sure that no employee will err or leak information to outsiders. To be sure, once the firm identifies with the ESG movement, or touts something like its sensitivity to climate change, savvy investors might work to figure out the cost of this socially minded decision—but the firm is likely to possess this information, and it can certainly acquire it at less cost than any shareholder. Under current law, it is dangerous to disclose a best projection about the future, unless it is in a form specifically required by the government. Most disclosures are sensibly made as vague as possible in order to comply with the law, or perhaps to attract investors with preferences for something other than value maximization, but it is difficult for a firm to avoid later (ex post) claims and judgments that disclosures were misleading or knowingly incomplete. In short, identifying with the ESG movement comes with very little risk, but providing information about expected costs, benefits, and allocations comes with significant risk.

If investors understand this problem, the firm might pay a price, at least in a well-functioning market. It might absorb the cost of possible litigation in the interest of ESG causes. But a less expensive way to avoid trouble is to use an accounting firm to certify the information that the firm provides. Even though accounting rules allow firms to provide less information than is actually available to them, some information is better than none. An accounting firm will say that corporate disclosures were verified in compliance with generally accepted accounting standards, but this is presumably inferior to the accountant’s disclosure that “[w]e investigated the corporation’s report of income as well as the cost of its environment-friendly policies, and we certify that the cost has been and will continue to be no more than 15 percent of income each year, with an expected value of 4 percent.” If the corporation is later accused of misrepresenting these numbers—perhaps a seller of stock complains about under-statements, or a buyer sues because of over-statements—it will normally be on safe ground if it adhered to those generally accepted accounting principles as to both past estimates and future projections. The corporation needs to fear litigation only if it intentionally misrepresented or held back information from the accountants. The reliance on accounting conventions is striking. In some cases, like the reporting of interest expenses, the accounting information is precise and readily compared to that produced by other companies. But other information is similarly vague and of little use to investors. It is not surprising that a firm that is considering the takeover of another investigates assets and past performance, and will rarely rely on accountants’ previous reports. Better information is available to the prospective acquirer even if the target tries not to be accommodating. Law seems satisfied, or more comfortable, with what certified accountants and their conventions provide.

There is room for improving upon this state of affairs, and the fact that law might be in the way of more useful disclosures by ESG-inclined firms. One approach would be for law to promise that, so long as the information disclosed was as informative as that found in minimally compliant documents or announcements, disclosing parties would find themselves in a safe harbor, protected from future litigation and discoveries that some pieces of information were inaccurate. Accounting firms could be drawn into the role of certifying that the disclosure was in fact “more informative.” The market might then encourage the provision of useful information. Most applicants to a law school would prefer to be told that, “with your numbers, there is a 20 percent chance of acceptance and it rises to 24 percent for those who come here to interview,” or to know that “44 percent of our graduates were unable to find legal employment within one year of graduation,” rather than read that “we encourage applications, and there is a definite advantage to coming here for an interview,” or “most of our graduates have found rewarding legal jobs by graduation.” Similarly, most investors would prefer estimates of the costs associated with ESG ambitions for a given firm, and an estimate of how the firm expects to allocate its efforts and these costs among various worthy causes. There is the danger that the information provided will be inaccurate, through error or intent, but the idea is for disclosure to be protected so long as it provides more information than that offered by glossy talk embedded in B Corp status or ESG declarations. Ideally, a corporation would be within this safe harbor if it gave probabilistic information about projected benefits and costs.

B. Intermediaries with Reputations

The safe harbor proposal has its problems but, fortunately, there is another way to take advantage of market forces. CEOs can develop reputations for managing corporations in ways that are sensitive to socially minded interests. Investors might trust them and follow the CEOs that match their own preferences. Better yet, specialized intermediaries can develop reputations for finding companies that produce social benefits efficiently or that allocate their efforts to specific kinds of socially minded causes. This approach can be thought of as a subset of the effective altruism movement, focused on combining profit and social welfare. In consumer markets, we are accustomed to evaluations by intermediaries, but these simply require sampling rather than a study of detailed information. B Corp certification is an attempt to provide this information, but significant investors are likely to do a better job. Just as Warren Buffett might attract investors who free-ride on his skill when it comes to choosing investments (to take advantage of his economies of scale or his greater voting power), and donors are beginning to rely on information about effective altruism, there might develop a market with experts who specialize in finding companies that efficiently sacrifice some value for environmental and other causes. These intermediaries might offer information about the tradeoff between value maximization and social benefit, or they might set an example by investing themselves in companies that are least-cost altruists. Such specialists can be rewarded when their chosen stocks rise in price because of investments by those who follow their lead. Alternatively, not-for-profit entities, like universities, might even get into this business both to increase their endowments and to satisfy and attract students. It is somewhat surprising that there has not been pressure on universities to provide just such a service.

It is possible that a skilled intermediary of this kind will learn that no publicly traded firm does, or few firms do, more good than a value-maximizing firm that distributes income and allows individual shareholders to “invest” in causes on their own. The informed intermediary might then turn to listing firms to avoid, because they are especially destructive to the environment or other causes. But setting aside this form of divestiture (as currently practiced by Norway’s Government Pension Fund), the intermediary might tell interested shareholders that their preferences are better served by using dividends, or by selling some shares of conventional, value-maximizing firms, in order to be able to make contributions to a non-profit organization that buys and holds undeveloped land or that lobbies the government to pass stricter anti-pollution laws, and so forth. If so, the ESG movement will fail on its own terms or turn into a limited divestiture movement, as most firms will return to value maximization. The movement will succeed even as it disappears. It seems more likely that the ESG movement is here to stay and that useful intermediaries will identify least-cost altruists and encourage investments in them.

I benefited from interactions with Tony Casey, Ryan Fane, and Eric Posner, and I am grateful for the support of the Lawrence T. Hoyle, Jr. Faculty Fund.