Contributed by Robert Lyman © 2019   Robert Lyman is an Ottawa energy policy consultant and former public servant and diplomat. Robert’s full bio can be read here.


Financial markets constitute an increasingly prominent front in the war waged by those who believe that humans are causing catastrophic global warming against fossil fuel companies. One of their strategies has been to harness the power of institutional investors – such as mutual funds, pension funds and insurers – to lower the share prices of companies that do not “do enough” to reduce greenhouse gas (GHG) emissions. The mechanisms used include socially responsible investment funds (SRI or “green funds”) and initiatives such as the Coalition for Environmentally Responsible Economies (Ceres) with its Investors Network on Climate Risk (INCR) and Global Reporting Initiative (GRI), the Institutional Investors Group on Climate Change (IIGCC) and the Carbon Disclosure Project (CDP).


These organizations have almost unlimited funds at their disposal to wage attacks on the energy industry and on large energy consumers; they can far outspend not only the few organizations skeptical about the climate catastrophe thesis but also many governments. They can influence investors with trillions of dollars at their disposal. Further, every year, their activities grow.


Only a few academic studies have been done on the results of their efforts and even fewer empirical assessments of how much change they have achieved. However, I was recently made aware of a paper by Adam Harmes of the Massachusetts Institute of Technology that offered a thoughtful discussion of the theory behind the effort.[1] This article provides a simplified summary of the 20-page Harmes paper. Those who wish to learn more should refer to the longer paper.


The Essence of the Theory Behind “Green Investment” Promotion


The advocates of green investing with respect to climate change base their actions on a number of premises:


  • That human-induced GHG emissions will cause higher global temperatures and other climate effects that will have adverse, potentially catastrophic, consequences;
  • That the present and future damages associated with GHG emissions can be calculated in present value terms;
  • That the global costs from climate change can cause genuine financial risks for firms and investors today;
  • That once these risks are identified, institutional investors can promote emissions reduction through a two-stage process: first, using their power as shareholders to pressure firms to disclose their exposure to climate risks; and second, after disclosure, by pressuring companies into incorporating the climate risks into their investment decision-making.


Specifically, the advocates of this approach want to promote “investment switching” (i.e. reduction of investment in high-emissions firms and activities and an increase of investment in so-called “green” or “clean” firms and activities often related to wind and solar energy and other favoured businesses). The mechanism by which this allegedly could work is by changing the price of the firm’s shares and thus bringing shareholder and Board of Governors pressure to bear on corporate management. Rarely do studies of this assess the actual incentives created by climate “risk” or the likely effects of the pressures applied to different types of institutional investors. The article aims to assess the two main assumptions that underpin investor environmentalism through carbon disclosure: the power of institutional investors and the “business case” for companies to invest in climate change mitigation.


The Power of Institutional Investors


There are different types of institutional investors; the incentives that drive investment decisions vary considerably among them.


Mutual fund companies sell mutual funds to the public and/or manage institutional funds on behalf of pensions, insurers and foundations. A growing number of them (over 60%) delegate the management of their portfolios to external investment companies.


Pension funds are composed of trustees who oversee the fund, as well as fund managers who conduct the actual asset selection. They have a legally-mandated “fiduciary duty” to minimize risk, maximize returns and preserve capital. They also tend to use both in-house and external fund managers.


Insurers are publicly-listed companies that also have a fiduciary responsibility to maximize revenues for both shareholders and policy holders.


The fourth category includes large hedge funds and private equity funds, as well as various foundations. Hedge funds and private equity funds operate in a more competitive environment than other investment companies.


A significant finding is that, like corporate managers, fund managers operate in a “structural context” that severely limits their ability to take into account any non-market investment criteria when assessing investments. If the fund manager did so and the fund underperformed compared to others, even for only a year, the fund manager would be out of a job. Active fund managers simply are not able to take climate change into account for non-market or “ethical” reasons.


After examining the institutional environments in which these different institutional investors operate and what specifically motives the people who make the investment decisions, Harmes observes:


“Overall, the specific incentives and constraints faced by different institutional investors lead to two initial conclusions about the potential effectiveness of investor environmentalism. The first is that, with the exception of certain public defined benefit pension funds, SRI funds and foundations, most ‘mainstream’ institutional investors will not be able to promote climate change mitigation for non-market or ethical reasons, although some may do so in a ‘soft” manner for their own reputational reasons. While most proponents of investor environmentalism emphasize the business rather than the ethical case, this conclusion is relevant in terms of empirically assessing the actual practices of investor environmentalism. Specifically, if the investors who are most strongly promoting climate change mitigation are primarily the public defined-benefit pension funds, SRI funds and foundations, it provides an indication of the weakness of the business case, as they are likely doing so for ethical rather than business reasons, even though they may discursively frame their activities in business terms.”


Even worse for the theory of environmental investing, if a number of ‘ethically-motivated” investors sold off the shares of a company that they considered to have poor environmental performance, causing the stock price to drop, other investors, through a process known as ‘arbitrage”, would view that company as under-valued in market terms and would quickly purchase its shares, causing the stock price to soon return to its original value.


“Even if all institutional investors, with the exception of hedge funds, could be convinced to allocate their capital on an ethical or reputational basis, their investment-switching activities would still be rendered ineffective by hedge funds.”


The Business Case for Companies to Invest in Climate Change Mitigation


The business case for investor environmentalism argues that climate change already creates real financial costs for firms, in the form of six varieties of climate risk: regulatory risk, exposure to the physical effects of climate change, product risk, risk to reputation, energy costs and exposure to climate change litigation. (Those who take a skeptical view might note that most of these risks are the direct result, not of climate change, but of the political activities of the advocates of climate alarm.) The case further argues that disclosure of these costs will create market incentives for institutional shareholders.


Harmes considers that the business case fails at the theoretical level.


Exposure to Costs and Regulatory Risks


The largest emitters do not bear the costs of the emissions they produce; they are borne by the world.

Measuring a firm’s carbon dioxide emissions or broader “environmental footprint” is not the same as putting a price on them; someone has to calculate this value, but even if they do, externality costs are not real in accounting terms, because firms do not pay them unless governments try to impose the costs in other ways.


If companies face the risk of being regulated or taxed by governments due to their emissions, why would these risks and costs not create an incentive for the firms to act even without investor environmentalism?


In countries where governments already impose carbon taxes and stringent environmental regulations, why is investor environmentalism also needed?


Exposure to the Physical effects of Climate Change


Exposure to extreme weather events (assuming present emissions even cause extreme weather events) will only affect a firm’s costs in certain circumstances; even if the costs were generally felt, this would create an incentive to pay for adaptation that would specifically benefit the firm, not mitigation.


Product Risk


The product risk is the risk that a company will experience declining sales of its “climate-unfriendly” products (e.g. “I am going to stop riding in oil-powered vehicles to protest Shell’s production of gasoline!”). More likely, product risk is simply an extension of regulatory risk and therefore is dependent on government action. Again, If the government is already acting, why is investor activism needed?


Risk to Reputation


Most risks to reputation that lead to investment-switching result from specific environmental events – such as oil spills, chemical leaks or illegal dumping – rather than from a general lack of action on broadly-caused environmental issues like climate change. It is almost impossible for investors to assess an individual firm’s climate-related reputational risk.


“Ethical consumerism” is limited to a small number of participating consumers; where it has been successful, it is generally the result of NGO campaigns.


Energy Costs


The risk of “energy cost” increase is generally related to the potential for new and higher energy taxes. Where it concerns increased energy market prices, the fossil fuel producers stand to gain, not lose.


Litigation Risk


The risk of litigation is primarily in the United States (although it is coming to Canada). Here the claims of liability are at best uncertain and often outside “the frontiers of existing legal doctrines”.


Some Real-Life Evidence


When the Carbon Disclosure Project sought to survey its signatory investors on the extent to which they made use of CDP data, only 80 of 385 even responded to the survey. In other words, simple participation in an investor environmentalism initiative should not be viewed as evidence that investors are incorporating climate change into their investment decision-making.


A 2008 study on investor environmentalism among UK fund managers found that “virtually without exception, the interviewees cited the EU ETS (European Union Emission Trading System) as the critical – and, in many cases, the only – driver for them explicitly to consider climate change in their investment analysis.” In other words, fund managers are far more likely to respond to present financial costs than to prospective and poorly-defined future risks.




Harmes concludes that the potential of using institutional investors to create real financial incentives for climate change mitigation, through share price performance, has been considerably overestimated. There is not even a strong theoretical case for why “carbon disclosure” should work in this regard.


“This suggests that, even if all firms disclosed carbon risks in a complete and usable way, mainstream investors are unlikely to incorporate them due to the inherent weakness of the business case, while the actions of ethically-motivated investors will be counteracted by arbitrage.”


Harmes’ article, of course, has not persuaded the large number of well-funded SRIs, politically-motivated investment funds, and certain international finance organizations from continuing to “name and shame”, intimidate, harass, and lobby against investors in fossil fuel industries and other firms that fail to adhere to the catastrophe thesis. Even if such bullying tactics have only limited chances of success in altering investor behaviour, they seem intended to serve a broader political objective.


[1] Adam Harmes. “The Limits of Carbon Disclosure: Theorizing the Business Case for Investor Environmentalism”. Global Environmental Politics. Vol. 11, N0.2, 2011



Friends of Science Society’s Aug. 27, 2017 letter to the Ontario Securities Commission in response to demands from the transnational, unelected, unaccountable UNPRI to make ‘climate risk’ disclosure a mandatory part of Canadian corporate reporting. 

Friends of Science Society issued two reports in 2017 rebutting the notion that ‘climate risk’ reporting was relevant or even within the scope of expertise of corporate boards. We rebutted a Koskie Minsky law firm report claiming that ‘climate denial is not an option’ – directed at pension fund trustees and institutional investors.