Intrinsic Value and the Green Case for Individual Choice
These rules are a microcosm of a bigger theme, but still pack a punch individually; the Labor Department rule would affect $11 trillion in private pension plans, while recent energy regulatory decisions had the potential to affect compensation for customer-owned energy like rooftop solar by 50 percent. The labor rule would require retirement plan fiduciaries to base investment decisions exclusively on pecuniary factors, excluding other considerations except in cases of a “tie-breaker”. Meanwhile, the Federal Energy Regulatory Commission and state public utility commissions are deciding on a series of policies that affect the financial terms and market access of consumers who want to produce their own clean electricity supply, such as residential rooftop solar and industrial combined heat and power.
The legal merits of these decisions aside, both fields reveal the policy struggles of central authorities trying to appreciate the diversity of preferences that individual consumers and investors hold for environmental improvement. Specifically, these institutions operate in regulatory paradigms that often marginalize or outright ignore individuals’ intrinsic values.
Financial considerations are key, but do not encompass all determinants of investor and consumer welfare. Consider the fact that environmental, social and governance (ESG) investing has grown steadily over the past decade and hit a tipping point this past year. Explanations for this massive influx of green-motivated capital include intrinsic motivations like altruism and the “warm-glow” effect, as well as refinement of conventional considerations like risk management. Similarly, preferences for green electricity have long identified multiple motivations, including “warm glow” and impure altruism, as determinants of consumers’ willingness to pay a “green premium”. The two pathways have even merged, to a degree, as ESG has driven manufacturers and data centers to pursue clean energy procurement beyond what a conventional cost-risk evaluation would indicate.
Perspectives limited to tangible financial benefits will overlook the magnitude and variance of intrinsic preferences, thereby systematically understating the value of individual choice. Further, individuals do not place the same per-unit value on all means of environmental improvement. For example, customer-sited energy often carries greater intrinsic value. Many electricity customers prefer to produce their own power – rooftop solar being the most common – rather than buy an equivalent amount of clean energy on the bulk market, even when it has a cost advantage. This explains why some electric cooperatives buy more expensive, local wind power in lieu of clean credits derived from windier, lower-cost regions. This is even creeping into the corporate space, as companies are willing to pay a premium for on-site and physically-delivered clean energy over credits that accomplish the same environmental objective at lower cost.
The Labor Department’s proposal reflects the more myopic perspective, implying that a beneficiary is worse off if an ESG fund yields lower risk-adjusted returns than alternative investment options. First, the body of evidence on this is unclear, as the literature delineates contradicting theories on how ESG factors influence investment performance and the empirical results are mixed. But the ESG community has struggled in the past to illustrate that environmentally-focused investing does not sacrifice returns. While that is an important question in its own right, ESG can still bring tremendous value even if it yields lower returns. The point is that investors can increase their total net benefits if the intrinsic value outweighs the incremental reduction in risk-adjusted returns.
Similarly, the welfare of electricity consumers improves if the intrinsic benefit exceeds the added cost. Many critiques of electricity retail choice presume a homogenous product, when consumers are actually expressing a preference for what they view as a premium product.
This may seem abstract, but other examples are highly relatable. For example, I don’t grow my own vegetables because I can do so more efficiently than industrial agriculture (have tried and failed on that account). I do so because the private benefit of self-provision carries an intrinsic value (personal satisfaction and social benefits) that generic groceries do not – enough to justify a significant added cost for self-supply. They are, in effect, differentiated commodities.
Conventional regulations and studies often oversimplify commodity markets, such as those for distributed energy, implying homogeneity in goods and services. But heterogeneity in the environmental preferences of investors and consumers is sharply increasing, and the regulatory process has a long way to catch up.
Consider that Labor Secretary Eugene Scalia recently argued in the Wall Street Journal that the law governing private retirement plans requires fiduciaries to base investment decisions solely on financial performance, not the “fiduciary’s personal preferences.” Senator Elizabeth Warren countered Sec. Scalia’s piece by positing that ESG outperforms other offerings and that the Secretary appears to want climate considerations excluded from investment altogether. Both focus on the environmental perceptions of fiduciaries and third parties, while overlooking the environmental preferences of the beneficiary, which is where intrinsic value accrues. Institutional investors have made it clear that the greening of their investment thesis reflect the growing environmental preferences of their client base.
As noted by Richard Morrison at the Competitive Enterprise Institute, there is nothing wrong with people spending their own money as they please, but it is fair to argue that fiduciaries should not weigh non-pecuniary considerations based on bedrock pension law. If so, however, then a fiduciary would not represent the full set of considerations needed to represent the best interest of the beneficiary. Thus, if not via fiduciaries, how do beneficiaries integrate non-pecuniary considerations like environmental impact into their investment strategy?
Policymakers’ attention should focus on the vehicles to enable individuals to exercise their environmental preferences. In wonkier terms, reform targets should prioritize opportunities to lower the transactions costs and information deficiencies evident in environmental decision-making. In short, policymakers should focus on whether investors and consumers can easily make well-informed decisions, not second-guess whether their own preferences are in their best interest.
An emphasis on well-informed decision-making is paramount, as Sec. Scalia’s op-ed rightfully flagged the confusing and contradictory nature of current ESG ratings. ESG metrics are flawed, but also relatively nascent and rapidly evolving, whereas the broader “greenwashing” concept has been a long-standing problem undermining consumers’ ability to make environmentally-informed decisions. The intrinsic value of impact investing is especially vulnerable to a variety of cognitive biases. But the Secretary identified an information problem, whereas the relevant policy question concerns the role of a fiduciary in considering ESG, which would apply even if there was perfect information on ESG.
Electric choice faces a similar foe – misinformation that can harm consumer interests (e.g., fraudulent advertising) – but a shared friend – a greater appetite for green liberty. From 2010 to 2017, voluntary green power sales increased from 37 to 112 million megawatt-hours. Since then, voluntary corporate green procurement in particular has skyrocketed but remains held up by limited market access and regulatory uncertainty. Rather than isolate the root cause of problems – misinformation – and recognize why consumers would pay a premium for different electricity products, some states are backtracking on consumer choice, such as imposing requirements on competitive suppliers to beat a default rate. The countervailing forces of outmoded regulatory thought and greater consumer interest in autonomy has resulted in retail choice facing a resurgence in some states and increased restrictions in others.
Altogether, recent developments underscore that regulators should keep several factors in mind:
- Intrinsic valuation for environmental impact is sizable, growing and very heterogenous across the population. These conditions turn the policy focus to cultivating decentralized decision-making rather than centralized determinations. The base orientation of centralized energy, environmental labor and other regulatory institutions requires great adjustment to fit this context.
- Markets allocate the “green premium” voluntarily based on consumers’ and investors’ individual preferences. This is far more efficient and equitable than uniform mandates like renewable portfolio standards.
- Competition drives reduction in the “green premium.” Thus, enabling competition to flourish is key to improving private and societal welfare, as measured by both conventional and holistic economic metrics.
- Participation barriers and confusion can lead to suboptimal investment. Regulators should eye corrective measures that reduce transactions costs and information asymmetries between buyers and sellers, with a watchful eye to not accidentally erect new barriers to entry. Improving ESG metrics and access to energy choice information are key cases-in-point.
- To maximize investor, consumer and environmental welfare, regulatory approaches should aim to facilitate competition and enhance individual choice.
Image credit: Arthon.Meekodong