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A growing movement calls on corporations to be more environmentally conscious. This emerging coalition—consisting of corporate law firms, institutional investors, and nonprofit associations—wants to change the way corporations are governed. They argue state corporate statutes should allow corporate managers to consider societal interests—including environmental concerns—when making business decisions (the “Corporate Social Responsibility Model”). These reforms are a departure from corporate statutes instructing managers to consider only shareholder value when making decisions (the “Shareholder Primacy Model”).
Although this environmentally concerned coalition is well-intentioned, its strategy—adopting the Corporate Social Responsibility Model—will hamper efforts to address environmental issues. Conversely, the Shareholder Primacy Model allows for more effective policy for preserving a healthy environment and combating climate change.
Consider, for example, two managers: Jack and Jill. Jack works for a firm operating under the Corporate Social Responsibility Model. Jill, meanwhile, works for a firm operating under the Shareholder Primacy Model.
Jack is theoretically accountable to both shareholders and society. In reality, though, he is accountable to no one. As Frank Easterbrook and Daniel Fischel explain in their 1991 book, The Economic Structure of Corporate Law, “Faced with a demand from either group, [Jack] can appeal to the interests of the other. Agency costs rise and social wealth falls.” Jack is not held accountable for failing to address environmental concerns, regardless of the lofty corporate governance goals to which his firm aspires.
On the other hand, Jill is accountable to shareholders demanding profit maximization. She cannot escape accountability by appealing to the interests of another corporate stakeholder. Environmental regulators can now incentivize Jill to act in an environmentally conscious manner by making undesirable activity (e.g., emitting greenhouse gases above a certain standard) costly. If Jill wants to keep her job, she must ensure her firm acts in an environmentally conscious manner.
Regulators have several tools at their disposal for making undesirable environmental activity costly. The following is a non-exhaustive list of possible market-based policy prescriptions that would all create incentives for profit-maximizing firms, like Jill’s, to protect the environment:
The Condominium Model for Environmental Maintenance:
Regulators require polluting firms to join associations formed to protect the surrounding environment. All members of the association are then assessed costs for maintaining environmental quality. Consider a simple example: Five factories operate along a river and join a river association. Each quarter, an environmental protection service checks the water quality and, if necessary, cleans the water. Each of the factories in river association are then assessed costs for maintaining the river. If the managers of these factories are interested in maximizing profits, they will keep river pollution low.
Strict Liability Regimes:
Instead of promulgating environmental standards, regulators hold polluters strictly liable for environmental disasters. The prospect of massive environmental liabilities incentivizes firms to purchase environmental liability insurance. Firms that cannot adequately protect against a possible environmental disaster face high insurance premiums and are priced out of the market. Profit-maximizing firms attempt to keep environmental insurance premiums low by taking precautions against environmental disasters.
Cap and Trade:
Regulators allot firms a cap on greenhouse gas emissions. The firms are then permitted to trade their allotments, with prices set by supply and demand. In an effort to please shareholders, profit-maximizing firms cut emissions and sell their extra greenhouse gas allotments. Regulators need not worry about setting specific environmental standards, leaving emission cutting methods to firm innovation.
Although the Corporate Social Responsibility Model aims to make corporations more environmentally conscious, its widespread adoption can have counterproductive effects. Managers of these corporations cannot be held accountable for implementing sustainable corporate policy. But widespread adoption of the Shareholder Primacy Model, matched with market-based regulations, can lead to more effective corporate environmental policy and can, in the end, better serve the goal of preserving a healthy environment for all.