ESG Choice with Polarized Investors

In today's polarized America, despite individual investors being sharply divided on environmental, social, and governance (ESG) issues, the major institutions managing their investments have settled into distinctly moderate positions. This disconnect raises fundamental questions about representation in corporate governance and the economic incentives driving institutional behavior.

Our paper explores this misalignment by examining the economic incentives and structural constraints that drive large funds toward moderation in an increasingly polarized investment landscape. We then investigate alternative voting mechanisms that might better align corporate governance with individual investor preferences.

Polarized Investors vs. Moderate Funds

Corporate decisions increasingly shape critical societal outcomes—from environmental policies to human rights, gender equality, and product safety. Our research reveals a significant representation gap between how individuals would vote their shares and how their financial stewards actually vote.

The polarization of American society along political lines has been well-documented across numerous domains, and our research confirms that this extends to individual investor preferences regarding corporate policies. A survey we conducted on Prolific revealed stark differences between self-identified Democrats and Republicans in their support of corporate climate initiatives and diversity programs. These findings align with broader research showing political polarization within numerous professions, including corporate executives and directors, suggesting that political identity strongly influences preferences for corporate policy across the socioeconomic spectrum.

Yet when we examine the voting patterns and engagement activities of major investment funds, we observe something unexpected: the largest fund families—BlackRock, Vanguard, State Street, Fidelity, and Capital Group—consistently occupy centrist positions on ESG metrics. Meanwhile, smaller specialized funds populate the extremes of the distribution, offering either aggressively pro-ESG or anti-ESG approaches.

The centrist approach of large funds has proven politically costly, attracting criticism from progressive voices for insufficient commitment to ESG principles and from conservative voices for excessive focus on social and environmental concerns at the expense of financial performance. Yet despite these political costs, large funds have largely maintained their moderate positions.

Why Large Funds Prefer Moderation

Our theoretical model explains this phenomenon by examining how profit-maximizing financial institutions compete for investments.

Smaller funds operate in markets characterized by competition and low barriers to entry. To attract investors in this environment, these funds offer customized portfolios and voting policies that cater to specific ESG preferences, allowing them to carve out market niches aligned with particular investor segments. This explains the greater polarization observed among smaller fund families.

By contrast, large funds are partially shielded from competition thanks to significant populations of ‘captive’ retirement-plan investors and others facing high switching costs. These ‘captive’ investor bases include both politically progressive and conservative individuals. To maximize asset under management and fee revenue, large funds must adopt positions palatable enough to prevent either group from divesting. This commercially motivated moderation dominates corporate governance because of these funds’ overwhelming market share.

Alternative Voting Mechanisms

The misalignment between institutional voting patterns and individual investor preferences, has prompted calls for reforms that transfer voting power back to individual investors.

We explore three potential reforms to corporate voting:

Direct Democracy: If individual investors directly voted their shares, our model predicts companies would implement more polarized ESG policies depending on company characteristics and the relative ownership size of different investor types. Since the ownership shares of different investors depend on their expectations of other investors’ purchasing amount and the resulting level of ESG that will prevail, multiple equilibria could emerge in some cases, where small shifts in investor expectations can push outcomes toward drastically different end states, potentially incentivizing company management or large funds to nudge outcomes toward their preferred result.

This approach faces obvious practical obstacles—most investors lack time, expertise, or interest to evaluate thousands of annual proxy proposals.

Limited Choice Menus: The ‘Big Three’ fund families have piloted programs allowing investors to select from pre-defined general voting policies the fund would implement on their behalf when deemed appropriate. These programs have attracted minimal participation (roughly 2% of eligible investors in Vanguard’s case), suggesting more fundamental reform may be needed.

Representative Governance: In a system resembling representative democracy, investors would delegate their votes to entities aligned with their values. These ‘political entrepreneurs’ might include activists, politicians, public figures, or specialized proxy advisors who would compete for individual investors’ proxies by campaigning on their values and priorities, much as politicians compete for votes.

This approach would inject contestability into corporate governance while maintaining practical efficiency. Investors would select representatives when opening accounts and could change their delegation periodically. Those making no selection would default to fund manager voting.

We already see early signs of this model emerging. Prominent investors like Bill Ackman and corporate leaders like Marc Benioff increasingly use social media platforms to signal their positions on contentious social and political issues. Financial ventures like 1789 Capital (whose board includes Donald Trump Jr.) and Vivek Ramaswamy's Strive Asset Management explicitly position themselves as alternatives to mainstream funds based on ideological differentiation.

We may see corporate governance increasingly adopt the language and tactics of electoral politics, leading to more expensive and high-profile corporate campaigns but generating higher individual investor engagement. The resulting ESG levels would more accurately reflect the preferences of underlying investor populations, though outcomes would vary based on share ownership and delegation patterns across different firms.

Notably, even under reformed voting systems, large funds would retain significant influence at many companies where they remain the median voter. However, their current influence over corporate governance would diminish, creating space for more diverse approaches.

Conclusion: Balancing Representation and Efficiency

As society increasingly relies on corporations to address contested social and environmental challenges, ensuring corporate governance mechanisms accurately translate individual preferences into corporate policy becomes ever more important.

Overall, our research highlights the economic and institutional factors driving large investment funds toward moderate ESG stances despite the strong polarization of their individual investor clients. We show that alternative voting mechanisms would better represent individual preferences and make corporate America more democratic but also potentially more polarized.

The full paper can be accessed here.

Nicola Persico is the John L and Helen Kellogg Professor of Managerial Economics & Decision Sciences at Northwestern University Kellogg School of Management.

Enrichetta Ravina is a Fellow at the Centre for Economic Policy Research and is a Visiting Associate Professor of Finance at Northwestern University Kellogg School of Management.