Real Shareholder Democracy Is the Answer to ESG

Last year, 15 Republican state finance chiefs lambasted Blackrock Inc. Chief Executive Officer Larry Fink for sacrificing his investors’ returns to advance his climate agenda — and for profiting from investments in China at the expense of US security. In other words, they criticized him for maximizing financial return at the expense of one value (patriotism) and for not maximizing financial return in the name of another value (the environment).

Gone are the days when asset managers could do their jobs unencumbered by moral and political considerations. Today, large asset managers are pressured in different, sometimes irreconcilable, directions.

These demands have created a crisis in corporate governance that is yet unsolved. ESG advocates demand that companies balance the interests of stakeholders, but what that means in practice remains vague. Conservative politicians similarly demand that companies pursue values — just the opposite of the ones the ESG crowd prefers. And a cadre of traditionalists insists that profits must be put before all else, even when that’s not what shareholders themselves want.

None of these camps can claim wide social legitimacy, and no one wants to get specific about how companies should balance financial performance against other values. Meanwhile, thanks to the success of index funds, most corporate votes are concentrated in the hands of a few intermediaries who engage with companies on shareholders’ behalf.

Blackrock, Vanguard Group Inc. and State Street Corp. recognize that this concentrated power put a political target on their backs. In response, they have introduced pass-through voting, which lets some investors in their funds cast corporate ballots themselves. While this mechanism works well for large investors or endowments, it does not work for 401(k) and IRA holders, the close-to-100-million Americans who have been encouraged to invest their retirement savings in the stock market.

Collectively, these individuals own about 20% of major corporations, but they have no voice. Even if they were given the chance to vote, they would be too busy to read the 500 or more proxies of the companies owned by each of their index funds. Allowing investors to select guidelines according to which their shares will be voted can ease the burden, but even then many small investors may not have the time or knowledge to make a choice, leaving voting decisions in the hands of mutual funds.

Citizens’ Assemblies

There is a better way, and it builds on a political science idea that is gaining momentum: citizens’ assemblies. Citizens’ assemblies are relatively large bodies of individuals chosen at random from the larger population. Think of them as very large juries aiming to capture the full diversity of a population and, in the ideal scenario, offering an accurate demographic mini-portrait of it. They are typically convened to deliberate at length and come up with policy recommendations on value-laden issues like abortion, end-of-life, climate justice, electoral law and urban planning.

Governments started experimenting with citizens’ assemblies 20 years ago as a way to add democratic legitimacy to the policy-making process, regain the trust of their populations and improve outcomes by tapping into a wider net of opinions and views about issues.

One of the main advantages of citizens’ assemblies is that, given their demographic resemblance to the larger public and their deliberative nature, they give governments a good idea of what most people want and will get behind.

Ireland, for instance, used a citizens’ assembly to help decide what to do about its constitutional prohibition of abortion. The assembly’s recommendation — to repeal the prohibition and allow abortion without restrictions up to certain gestation limits — was subsequently endorsed by two-thirds of the voters in a 2018 referendum.

Recently France followed suit, organizing two back-to-back citizens’ assemblies — called citizens’ conventions — on climate justice and end-of-life issues, respectively. (One of us, Hélène, was involved in the organization of the latter.) Though neither led to a referendum, the first one shaped the 2021 climate and resilience law.

In the last 10 years, the use of similar methods, including so-called citizen juries and deliberative polls, has accelerated, leading the Organisation for Economic Co-operation and Development to talk of a “deliberative wave.” As of 2023, the OECD has documented 732 cases across 34 countries (96% in the OECD), including Canada, Ireland, France, Japan, South Korea and Australia, as well as Argentina, Brazil, China and Mongolia.

Investor Assemblies

Given the parallels between the crises of governance in politics and business, we propose to introduce “investor assemblies” in the governance structure of mutual funds. If properly selected, a sufficiently large sample of shareholders would closely resemble the underlying population of investors. If properly informed, this body would choose as the entire population of investors would if it had the time and ability to become informed and deliberate.

Concretely, an index fund could draw 150 people from among the entire pool of its investors to participate in a grand jury that sets the voting guidelines for all the investors who are too busy to choose on their own. Those with a larger investment would have a higher chance of being drawn, but everyone would have an equal voice once in the assembly.

As in court juries, the 150 people assembled would listen to experts from both sides of an issue and then vote on a guideline to follow. For example, what restrictions are appropriate for corporate lobbying? How much money should food companies spend to ensure that the animals they slaughter do not suffer? Assemblies would deliberate and vote on these questions, which would then inform how mutual funds voted on resolutions going forward.

How could some randomly drawn investors be entrusted with such important decisions? Surveys and case studies suggest deliberative assemblies increase participants’ knowledge and even make them more sympathetic to evidence-based policymaking. And in the US we have no qualms about letting criminal juries — bodies of ordinary citizens chosen by lot — decide on matters of life and death. Countries with a jury system experience less corruption and have a more effective criminal justice system than countries that entrust the same decisions to judges.

As ever, the devil is in the details. The randomization should be properly stratified to ensure sufficient representativeness. The selected investors should have broad discretion over the agenda, including the information sources and the experts from whom they will hear. They should also be shielded from lobbying pressures during the period of deliberation. Unlike in legally mandated jury duty, dissenters could opt out; anyone who wants to take a purely passive approach to their investments is welcome to.

Since participation would be voluntary, participants should be adequately paid (and provided with child care, etc.) to minimize the problem of self-selection. And if some investors want the thrill of casting their votes personally, they can choose pass-through voting instead — but they will be excluded from the lottery. (In a recent working paper, we spell out all these details.)

Feasible, Economical and Politically Neutral

Investor assemblies are not only feasible but also easy to implement. Indeed, a proof of concept has just been successfully carried out in the Netherlands, with 50 shareholders randomly drawn among the investors in a Dutch pension fund. And, if introduced initially as purely advisory bodies, investor assemblies do not require any legislative or regulatory change. They can be implemented voluntarily by large index funds, and there is not much risk in trying them.

This system is also very economical. It does not burden investors and can be administered with a relatively small budget. Importantly, it keeps politicians off asset managers’ backs, leaving them free to do what they do best: Maximize financial return within the ethical constraints set by their investors, but without unwanted political interference.

Last but not least, investor assemblies are also a politically neutral solution. The change in the decision-making process is procedural rather than substantive: It does not build in any specific outcome. And the expected result is sufficiently uncertain that no side can claim to be disadvantaged by this system. Conservatives should like the fact that shareholders are empowered to choose, rather than a wider list of stakeholders. Liberals should like the fact that an investor assembly devolves power and is more representative than the existing system.

With the election of Donald Trump and the Republican sweep across all three branches of the US government, ESG advocates are on the back foot. In response, many businesspeople and investors might be tempted to believe they can go back to a time when they could make controversial decisions without any pushback or where they could focus singularly on financial return. That would be a mistake.

The GOP is not the pro-business party it used to be — just look at the nominations of Lori Chavez-DeRemer, a pro-union leader, as secretary of labor, and of Robert Kennedy Jr., an environmental advocate, as secretary of Health and Human Services. These selections are further evidence of widespread dissatisfaction with experts and resentment toward their decisions.

If 401(k) and IRA investors have not revolted yet, it is only because they are unaware of their power. When the 100 million 401(k) and IRA holders realize that their voting rights have been cast in their names by unrepresentative technocrats, leading to decisions they dislike, they will demand legislative changes — which will be much more draconian and intrusive than investor assemblies. Asset managers should get ahead of the problem while they still can.

Oliver Hart is a professor of economics at Harvard University and co-winner of the 2016 Nobel Prize in Economics. Hélène Landemore is a professor of political science at Yale University and a former member of the governance committee of the 2022-23 French Citizens’ Convention on End-of-Life Issues. Luigi Zingales is a professor of finance at the University of Chicago and co-host of the podcast Capitalisn’t .