Investor Activism and the Green Transition

We develop a model of impact activism in which activist investors contribute to a firm's green transition through engagement. Two intertwined free-rider problems imply that activists have limited or negative impact in equilibrium. First, an internal free-rider problem, where insiders and activists free-ride on each others' transition-related efforts, can render activism ineffective or even counter-productive. Second, an external free-rider problem, where activism-driven gains are reflected in the stock price and accrue to passive investors, prevents activists from investing or tilts investments towards firms that can transition without activist engagement. Carbon taxation strengthens these mechanisms. Sustainability preferences help overcome them.