How Climate Shocks Turn Investors into Climate Activists

Climate risk is one of the greatest challenges facing the world today and investors are taking notice, but a full understanding of how investors exert influence remains elusive. In our recent paper, we propose a new time-varying portfolio level driver of investors’ ESG attention and engagement, conjecturing that investors’ exposure to climate disasters via one portfolio firm impacts the way investors engage on climate-related issues at other (non-disaster hit) firms in their portfolios.

To test this hypothesis, we collect extensive data on large climate disasters and institutional investors’ holdings from 2003 to 2019. We then measure investors’ portfolio exposure to climate disasters, accounting for disaster-hit firms’ geographic footprints and investors’ attention to these hit firms via portfolio weights. Importantly, we benchmark investors’ portfolio exposure to climate disasters by overweighting geographic areas that experienced worse disasters than that of the 1990s. Overall, we can intuitively interpret our main measure as the percentage of investors’ portfolio value exposed to a worse climate event year than would have been expected from the 1990s.

We next investigate our conjecture by testing if investors’ portfolio exposure to climate disasters predicts how they engage and eventually affect firms’ policies. We begin by using shareholder climate proposal votes as a setting to understand the extent to which investors react to their portfolios’ climate disaster exposure through shareholder activism.  We find that investors with portfolios hit by disasters in the previous year vote more for climate-related shareholder proposals on the other firms they own. This is in comparison to their own voting behavior at different times and the voting patterns of other investors on the same proposals.  More importantly, we study whether our findings are influenced by cases in which Institutional Shareholder Services (ISS) recommends against a proposal and find that the increased likelihood of supporting climate proposals is concentrated in cases where ISS recommended against them. This suggests that disaster exposure makes investors more active voters--- following proxy advisors’ recommendations normally correlates with a low-cost and passive approach to voting.

Our findings have important economic implications: a one standard deviation increase in disaster exposure in the previous two quarters predicts a 6-percentage point (or approximately 30%) increase in the probability of supporting a climate proposal. Given that climate and ESG-related proposals normally receive very low support from institutional investors – the approval rate has remained below 30% in the past 10 years – our finding indicates that portfolio climate exposure affects institutional investors and changes their voting decisions.

The sensitivity of investors’ voting behavior to climate disasters in their portfolio is driven primarily by large and value-relevant disasters, disasters hitting portfolio firms’ headquarters are also more predictive of a shift toward voting support for climate proposals at other portfolio firms. These affected climate proposals also tend to target “brown” firms that emit large amounts of CO2, like Exxon Mobil, and relate to policies like the promotion of greenhouse gas (GHG) targets. We find little evidence, however, that the effect varies depending on investor type. Thus, even the most impactful votes from the largest institutions, such as Blackrock or Vanguard, are affected. 

Surprisingly, we do not find similar effects for non-climate-related environmental proposals or social-oriented proposals. Collectively, the above voting evidence supports the contention that investors, by responding with support for more aggressive climate policy targeting brown firms, become more concerned about future climate risks when they experience climate disasters in their portfolio.

While the immediate impact on voting is a particularly powerful set of evidence, it remains the (revealed) tip of the iceberg for all the direct or background avenues of investor engagement in firms. To dig into these routes, we move from the tests at the investor level to the firm level by considering whether the aggregate disaster exposure of a firm’s investor base affects corporate outcomes. Specifically, we exploit the heterogeneous impact of our proposed time-varying exogeneous investor-level portfolio shock to climate disasters for differential levels of institution ownership in firms.

Armed with this spillover measure, we then studied the impact of investors’ climate disaster exposure on long-run environmental policy.  Our findings indicate that firms adopt specific governance mechanisms, such as linking their executive pay policies to GHG emission reductions and providing their boards with explicit responsibility for climate change in the two-year period following climate shocks to their institutional investors. Concurrently, firm-level GHG emissions and energy usage cumulatively decline, suggesting that changes in these governance mechanisms incentivize firms to shrink their carbon footprints.

Overall, our study contributes to a large literature on how and when shareholders gather the information they use in their voting and engagement decisions. Specifically, we introduce portfolio exposure to climate disasters as a high-frequency, time-varying, investor-level determinant of active support for climate proposals, and more broadly for firms’ ES discussion and policies. Our work is particularly important in the current context of increasing awareness and action against climate change. Our paper also contributes to the growing literature on climate finance and the role institutional investors may play in addressing the challenges posed by climate change. In particular, our conclusions speak to the debate on whether institutional investors should exit (divestment and boycott) or  voice (engagement) when aiming to make impactful, sustainable investments. We show that, when exposed to climate disaster events in their portfolios, institutional shareholders improve corporate sustainability performance through engagement and voting.

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By Matthew Gustafson (Pennsylvania State University), Ai He (University of South Carolina), Ugur Lel (University of Georgia and ECGI), Zhongling Qin (Auburn University)

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