[Anik Bhaduri is the Commonwealth Scholar and PhD Candidate at the Faculty of Law, National University of Singapore and Rudresh Mandal is a Principal Associate (Corporate & Securities) at Fox & Mandal, New Delhi.
This post is part of the IndiaCorpLaw Blog Symposium on ‘Corporate Law and Climate Change: Indian and Comparative Perspectives’.]
Over the last decade, securities regulators in several jurisdictions, including India, have introduced Shareholder Stewardship Codes that encourage institutional investors to play a more active role in the governance of their portfolio companies. In India, these Codes require institutional investors to engage with portfolio companies on ESG-related issues, including climate change risks. However, the effectiveness of stewardship remains uncertain in the Indian context, where ownership is often concentrated in the hands of founding families or the state, which retain sole control over corporate decision-making. In this post, we propose introducing a duty requiring controlling shareholders to disclose reasons for non-compliance with any proposal relating to climate change risks that has received the support of a majority of minority shareholders. We argue that such a duty would enhance the benefits of shareholder stewardship and activism by promoting accountability and dialogue, while avoiding the risk of subjecting controlling shareholders to short-term activist pressures.
Climate change, and the role of corporations in perpetrating it, is among the defining concerns of the twenty-first century. As jurisdictions brace for its impact on ordinary lives and businesses, the role of business in mitigating climate change has come under growing scrutiny. Securities regulators around the world have responded with the introduction of stewardship codes obliging institutional investors to play an active role in mitigating the climate change risks faced by their portfolio companies. However, as we show, its success has been limited in jurisdictions with prevalent controlling shareholders, such as India, necessitating an inquiry into alternative approaches.
Institutional Investors and Climate Change
In the archetypal Berle-Means corporation, the predominant aim of the management is to conduct business in a way that maximises shareholder returns, irrespective of the effect of such conduct on other enterprises, or the economy at large. Directors and management do not therefore have any economic incentives to mitigate adverse effects on the environment, and the imposition of negative externalities on the commons often becomes ancillary to business conduct. Further, any enterprise unilaterally seeking to adopt an environment-friendly strategy is likely to face higher costs than its competitors and might incur losses, reducing its incentives to mitigate adverse effects on the environment.
However, the rise of large investment funds has radically altered this calculus. Since large index funds own the stock of multiple enterprises and seek to maximise their returns across a diversified portfolio, any business conduct which profits one entity at the cost of others is detrimental to their commercial interests. Index funds, mainly BlackRock, Vanguard and State Street, have accordingly engaged their portfolio companies on climate change. Their influence across multiple companies also helps them resolve the collective action problem by simultaneously encouraging multiple companies to adopt environment-friendly business strategies. Smaller hedge funds and activists, who advocate directly for ESG concerns and occasionally litigate against portfolio companies over environmental harm, have reinforced this effort.
Despite the promises, however, the incentives and ability of institutional investors to drive their portfolio companies towards climate change mitigation remain questionable. Engagement demands considerable resources, time and research, and how willing and able institutional investors are to commit them is unclear. The recent anti-ESG movement in the US has further complicated the picture, raising questions about the logic and limits of institutional ESG activism, and about the regulatory and political economy within which it operates.
Climate Change in the Indian Stewardship Codes
While the ability of institutional investors to influence corporate governance and drive their portfolio companies towards sustainability became evident over the last decade, their willingness to do so remains contested. Securities regulators around the world sought to incentivise institutional investors to play a proactive role in corporate governance through the adoption of shareholder stewardship codes, which require, mandate, or at least urge institutional investors to engage with management on key governance issues.
In 2017, the IRDAI issued a stewardship code for insurers, followed by the PFRDA code for pension funds in 2018 and the SEBI code for mutual funds and AIFs in 2019 (collectively, the Stewardship Codes), together bringing most large institutional investors within their ambit. Principle 3 of each Stewardship Code imposes a duty on institutional investors to monitor various aspects relating to the business operations of their portfolio companies, including their ESG risks. The Codes do not clarify the precise scope and extent of ESG risks that institutional investors are expected to scrutinise and oversee, although it may reasonably be expected that the provision includes climate change risks.
The IRDAI Code is premised on a comply-or-explain model, while the PFRDA and SEBI Stewardship Codes are couched in mandatory terms. Neither Code, however, specifies any penalty for non-compliance, and accordingly, despite their mandatory language, remains soft law guidelines in effect. In the absence of adequate data regarding the changes in voting patterns before and after the introduction of the Stewardship Codes, it is difficult to conclusively state whether the Stewardship Codes have incentivised institutional investors in India to engage with their portfolio companies regarding the mitigation of climate change risk. Nonetheless, as we outline below, the shareholding structure of Indian companies makes it inherently difficult for institutional investors to succeed in such efforts, and the Stewardship Codes therefore remain inadequate.
Controlling Shareholders and the Way Ahead
The Indian Stewardship Codes draw heavily on their UK counterpart, which predominantly sought to mitigate the agency costs between dispersed shareholders and self-seeking managers. However, unlike the UK, public companies in India are often characterised by the presence of promoters and/or the state that hold a majority of the voting power and are therefore able to unilaterally determine corporate strategy. Under these circumstances, even determined and committed institutional investors cannot effectively influence the management or press for climate risk mitigation, undermining the promise of activist-led sustainability.
Controlling shareholders justify their position as essential to the pursuit of long-term growth, framing activist investors as driven by short-term gains. According to this narrative, founding families and/or the state seek to preserve the value of the company for subsequent generations, while activist investors, who typically hold stock of the company for only a few years, push for immediate returns at the cost of long-run growth. Ironically, ESG activists contend the exact opposite, and claim that their intervention in corporate governance maximises long-term value at the cost of immediate profits, apparently seeking the same objectives as controlling shareholders. Despite this apparent convergence, however, controlling shareholders frequently override shareholder proposals seeking implementation of strategies aimed at mitigating climate change risk. While there have been no specific instances of climate change activism in India yet, public companies with controlled shareholding are frequently implicated in allegations of environmental pollution.
This dichotomy presents two competing narratives advanced by controlling shareholders and ESG activists, each casting the other as self-interested or misguided while presenting itself as well-informed, altruistic and future-oriented. Retail investors, who hold shares in these companies directly or through investment funds, are often unable to adjudicate between the narratives offered by management and fund managers, resulting in uncertainty, confusion, and wasted resources. While the stewardship codes require investment funds to disclose the extent and nature of their engagement with portfolio companies, controlling shareholders can simply dismiss shareholder proposals without engaging with them at all. In order to further the debate, Stewardship Codes should impose a duty on directors to engage with ESG proposals that are backed by a majority of the minority shareholders.
Under this framework, a controlling shareholder who declines to act on a shareholder proposal backed by a substantial majority of minority shareholders should be required to explain its decision to the shareholders, as well as the markets at large. While such reform would not enable institutional investors to influence corporate conduct, it would allow them to compel the disclosure of information that allows retail investors and the public at large to adequately assess corporate strategy. It does not alter the corporate contract, and residual rights of control remain with the controlling shareholder, and it offers a middle ground that allows institutional investors to contribute to corporate governance without compromising the ability of controllers to pursue long-term growth despite objections from short-term investors. Further, such disclosure would also prompt public deliberation and dialogue between controlling shareholders and activists, potentially helping resolve their divergent narratives about corporate strategy and long-run growth.
A climate stewardship model suited to controlled companies can borrow from Singapore’s Stewardship Principles for Family Businesses, which fix stewardship obligations on controlling shareholders rather than institutional investors. Our proposed disclosure duty moves in that direction – re-aiming climate accountability at the actor who actually sets corporate strategy.
Conclusion
India lacks the complementary institutions that make Western climate stewardship work – a plaintiffs’ bar to litigate climate risk, judicial decisions interpreting climate obligations, and activist shareholders to enforce decarbonisation commitments. Layering enforcement-heavy climate mandates onto that vacuum only widens the gap between law-on-the-books and law-in-practice. However, a narrow duty to disclose and explain the rejection of minority-backed climate proposals works with the grain of India’s institutional reality, without any undue interference in corporate governance.
– Anik Bhaduri & Rudresh Mandal