The Dual Strategy of Exclusion and Engagement: Impact on Asset Prices and Green Transition

This paper develops a theoretical asset-pricing model to examine how sustainable investors can combine exclusion and engagement strategies to accelerate corporate transition. Firms are classified as green, brown, or reformable, with the latter being polluting firms that can reduce emissions under shareholder pressure. Sustainable investors exclude brown firms but may engage with reformable ones when majority ownership enables them to enforce a transition. Engagement is modeled as a costly but effective mechanism that lowers emissions and generates non-pecuniary benefits for investors. Our main result is that only a moderate share of sustainable investors (around 22.5% of market wealth) is sufficient to trigger reformable firms' transition, provided they derive a modest non-pecuniary benefit (about 2.3%) from sustainability improvements. In this equilibrium, sustainable investors are willing to concentrate their portfolios in reformable assets, enabling these firms to adopt cleaner technologies and reduce their environmental footprint. The model shows that a relatively small but motivated coalition of investors can induce meaningful environmental change through targeted engagement.