Protecting pensions in the face of climate change and corporate law

URBAN_NYC Skyline_MHoldenBy Molly Cohen — Jan. 21 at 10:25am

As climate change threatens to reshape our coastlines and rewrite our expected weather patterns, it poses another less obvious but very real threat: climate change may decimate  our retirement funds.

Investment funds, like other corporate forms, are bound by the bedrock corporate law tenets of shareholder primacy and profit-maximization. According to these principles, managers and officers are bound by their fiduciary duty to protect shareholders interests above all by seeking solely to maximize corporate profits. They are barred from considering outside interests at the expense of share value maximization (see, e.g., Dodge v. Ford Motor Co., 170 N.W. 668 (Mich 1919)). While corporations can act for the “public good” (by making donations), these actions must be framed as an instrument to maximize profits and benefit stockholders, for example, corporate donations increase goodwill (see, e.g., AP Smith Mfg Co. v. Barlow, 13 N.J. 145 (1953)). For years, investment fund managers have used the cloak of profit-maximization to avoid acting on climate change. To them, climate change is an ethical, non-financial issue, and therefore beyond the bounds of what they consider.[1]

And yet, there is a growing understanding around the world that climate change is an inherently economic issue.  The head of the IMF described climate change as “the greatest economic challenge of the 21st century.” Insurance companies are hopping on board as well, adjusting rates based on the increasing frequency of catastrophic weather events. Even the Department of Defense has begun incorporating climate change risks into its long-term planning. When your insurance company and your military start factoring climate change into their long-term economic decisions, shouldn’t your retirement fund do so as well?

Because climate change is an economic issue, it can be framed as necessary to profit-maximization and therefore can be included within the ambit of shareholder primacy.

Pension funds, with their enormous financial holdings and long-term strategy, are the perfect businesses to lead the way. Pension funds are inherently long-term investors, and their ultimate end is not just to raise money but also to ensure pensioners have a prosperous and secure retirement. Moreover, pension funds in the past have used their considerable financial clout to make investment decisions based on policy preferences. For example, a year ago, the California Teachers Retirement pension chose to divest from companies that manufacture firearms that are illegal in California.

By incorporating climate change risk and opportunity into investment calculus and strategies, pension funds can both increase fund returns and advance sustainability goals. Funds can both improve the environmental performance of companies already in their fund and also consider climate risk in evaluating and pricing new stock (e.g., might a company have to comply with costly greenhouse gas emissions regulations in the future).  Really forward-looking funds should invest in solutions offered by clean energy and energy efficiency companies.

Making climate change into an economic issue may not be sufficient, though. In Funding Climate Change, Claire Woods argues that fiduciary duties are just one part of a greater problem keeping institutional investors from acting on climate change. She argues that “the realities of human behavior,” including “inertia and myopia” serve as the greatest barrier to sustainability investment. Similarly, in a talk on global warming and psychology, Harvard Psychologist Dan Gilbert explains that our psychological impulses make it difficult for us to confront global warming. As humans, we’re programmed to respond most to threats that are intentional, immoral, imminent and instantaneous; in contrast, climate change is silent, amoral and slow, allowing it to sneak under the radar.

To ensure that pension funds actively address climate change, we must make the issue salient and relevant to their bottom-line and thus to their beneficiaries. Corporate law can help: we should consider passing legislation to explicitly include environmental considerations and climate change within the bounds of pension funds’ fiduciary duties. Beyond the legal element, though, we must stress to investors the losses that may result due to the ravages of climate change (behavioral economics has taught us that humans are hugely averse to loss). We must engage pension-holders and ask them to put direct pressure on their pension fund, explaining that their money is at risk. Pension funds are should be investing for the future; instead they’re investing in climate change.

[1] Courts for the most part would likely agree with managers’ vision of climate change as a non-financial issue outside the bounds of what they can consider, though there are rare exceptions. Courts have allowed investment funds to consider social impacts of investment decisions; for example, a Maryland Court of Appeals, ruling on divestment from South Africa, wrote “[n]evertheless, we do not believe that a trustee necessarily violates the duty of loyalty by considering the social consequences of investment decisions.”