Can Divestiture Bring About Change?

Not long ago, I wrote about the “ESG boo birds” who disapprove of the idea that fiduciaries and asset managers can be guided by more than just returns when selecting investments. In that post, I argued that – for some investors – personal ethics and social priorities can be more important than returns in making investment decisions, and that those preferences are legitimate factors for any fiduciary to weigh.

Investing has become more sophisticated over the past 40 years, and investors and fund managers now have many more choices when it comes to how to direct their investments. If the thought of investing in companies that produce and burn fossil fuels leaves you cold, you can reallocate (or divest) those investment dollars away from those companies and into investments and funds with similar risk and return profiles. The same is true at a more macro level: Organizations with large pools of assets – colleges and universities, philanthropic organizations, state and local governments, pension funds, sovereign wealth funds – often have a great deal of choice and discretion when it comes to where they want to invest their resources – and where they want to divest from.

Divestiture as a means to create social change has a long and storied history in the United States. Modern-day divestiture campaigns have drawn attention to tobacco companies, arms manufacturers and more recently industries that focus on transporting and burning fossil fuels. There are three common investor rationales for divestiture:

• It can create better alignment with personal or organizational values. If human rights are important to you, you might not feel comfortable investing in a company with a history of human rights violations. In its Socially Responsible Investment Guidelines, for example, the U.S. Conference of Catholic Bishops called for divesting from any company whose activities include euthanasia or assisted suicide.
• It might effect behavior change. A well-publicized and coordinated divestiture strategy might increase a firm’s cost of capital. If a company’s activities become less attractive (from the standpoint of a potential investment), divesting could affect the decisions made by management and boards of directors.
• It could politically weaken the cause you’re divesting from. Citing $40 trillion in climate-related divestment, the nonprofit advocacy organization Stand.earth trumpets, “with this growth, divestment has proven successful at its core goal of helping to delegitimatize fossil fuel companies as political players.”

The question is: Is divestiture an effective strategy?

It’s hard to say, especially when compared to strategies such as product boycotts and shareholder engagement (such as advocating for change with corporate management and boards or supporting shareholder resolutions). Academic research has found that if all the capital purported to be held by climate-sensitive investors were to be divested from fossil fuel companies, it would not meaningfully affect strategy or decisions about how to deploy capital – one study from the Stanford Graduate School of Business estimated the change in the cost of capital to be less than 0.01%, which in the author’s words “cannot possibly make a difference to corporate investment.” Speaking about divestment efforts to “capital-starve companies making steel and gasoline,” Bill Gates told The Financial Times in 2019 “divestment to date has probably reduced zero tons of emissions.” Why? Because, as the book Accountable: The Rise of Citizen Capitalism points out, “For one investor to sell a share, another must buy it. Period. An unhappy shopper can complain to management or take his business elsewhere, but an unhappy shareholder simply replaces himself with someone who cares less.”

It also creates a slippery slope. My home state of Minnesota has by either legislative or administrative action divested its pension fund assets from six countries around the world. Florida and at least six other states have divested from ESG-aligned investment strategies managed by Blackrock. Which raises the question: Where will these lists of prohibited investments end? For example, if you decided to divest from any company that uses gasoline to transport goods, what companies would be left to invest in? How would that decision impact your portfolio and plans?

Given these pros and cons, I’d recommend that if you’re thinking about divestiture, make sure you also think about why. If a company you’d divest from is doing something that doesn’t align with your values – and your values are more important to you than the potential return the investment is generating – selling probably makes sense in the long term. But if you’re selling in the hope that it could change someone else’s behavior, history would tell you it probably won’t. The best advice I’ve received about divestment was offered by Stanford’s Business School Insights: “The best way to effect change is to invest, not divest.”

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