Carrot or Stick? Strategic Corporate Governance and the Incentivization of Attention to Environmental, Social, and Governance Issues

Abstract

When seeking to influence firms’ behaviors, investors have a range of strategic alternatives through which pressure can be exerted. These approaches range from collaborative dialogue with firms, to other more coercive methods such as divesting their shareholdings. However, limited consideration has been given to the relative effectiveness of the various corporate governance decisions available to investors. Consequently, this study proposes a behaviorally-grounded strategic view of corporate governance whereby intendedly rational investors choose their corporate governance decisions based on whether the expected response from the targeted firm is preferable to the response from investors’ other alternatives. Doing so enables investors to more efficiently allocate their monitoring resources. I operationalize the study by analyzing investors’ strategic decisions relating to the use of shareholder proposals. Focusing on environmental, social, and governance issues, I find that investors’ use of incentives for collaboration — by withdrawing shareholder proposals — produces more effective outcomes than the coerced enforcement of control — putting the proposal to a vote. A key mechanism relates to firms’ cognition of issue salience and the external legitimacy which investor activism signals. In doing so, these findings suggest that investors can strategically channel firms’ attention and effort to substantively address the issues raised.