This paper addresses the question of whether regulation-imposed environmental, sustainability, and governance (ESG) mandates affect the principal-agent relationship between shareholders and managers in public companies. In other words, are shareholders affected when a company’s management prioritizes ESG considerations over profit-enhancing decisions? This question is part of a broader corporate governance debate that has been taking place in recent years on the relative benefits and costs of a legal system that increasingly reflects a stakeholder versus a shareholder orientation. Under the traditional shareholder orientation model, management is directly and only accountable to shareholders and is responsible for maximizing firm value. Under the stakeholder orientation model, management is responsible to a broader set of stakeholders that includes but is not limited to shareholders, such as workers and the society at large.

Regulation-imposed ESG mandates potentially affect the incentives of management to act solely or predominantly in the interests of shareholders. Regulation-imposed ESG mandates likewise affect the ability of shareholders to monitor and govern management when it pursues non-profit maximizing activities. This topic has been examined in an influential paper by Bebchuk and Tallarita (2020), who conclude that stakeholder capitalism “would insulate corporate leaders from shareholder pressures and make them less accountable.” In the first part of this paper, I examine whether and how ESG mandates affect the incentives of managers to make efficient decisions that enhance shareholder value. I also go beyond the traditional principal-agent problems discussed in the literature to consider the ability of shareholders to monitor the decisions of managers.

The examination of regulation-imposed ESG mandates and managerial efficiency also involves consideration of externalities, or costs or benefits that may be imposed by a firm on stakeholders other than its shareholders. Tirole (2001) even defines corporate governance as “the design of institutions that induce or force management to internalize the welfare of stakeholders.” As such, the second part of this paper addresses the consequences of changes in the relationship between managers and shareholders resulting specifically from firms pursuing an ESG agenda. I document and assess both positive and negative externalities associated with regulation-imposed ESG mandates.

To briefly summarize, the evidence from the literature canvassed herein is consistent with the view that mandatory ESG mandates distort managerial efficiency and exacerbate principal-agent problems between management and shareholders. While there are potentially significant positive externalities linked to ESG mandates, there are also potentially significant negative externalities. There is no evidence that the positive externalities outweigh the costs from managerial inefficiencies and the negative externalities.