Lakshmi Naaraayanan: ‘There is little guarantee that divestment campaigns are an effective means of achieving social goals’
Lakshmi Naaraayanan: ‘There is little guarantee that divestment campaigns are an effective means of achieving social goals’

Climate change is the most significant challenge facing humanity, and many commentators point to the malign influence of corporate profits, capital markets and investors in contributing to the trend.

But while some argue the best response is divestment, our recent work suggests engagement by long-term shareholders such as pension funds is an effective way to improve companies’ environmental impact. Activism, combined with monitoring and the threat of discipline by investors, can drive improvements.

My fellow researchers and I examined the campaign of the Boardroom Accountability Project, launched by New York City’s Pension Fund System in 2014. It identified companies that contributed significantly to climate change and those that lacked diversity, as well as other factors such as transparency in political contributions and excessive chief executive pay.

The campaign aimed to give long-term shareholders a voice at these companies by allowing them to nominate directors to their boards. At the start, shareholder proposals were submitted to 75 companies, and have since expanded to more than 150.

Climate change protests are piling on the pressure © Remko de Waal/AFP via Getty Images

We found that the factories of the companies that were targeted reduced the release of chemicals that caused cancer. They also cut emissions of the greenhouse gases that contributed to global warming, improved air quality within a one-mile radius, and had significant spillover benefits to the local economy.

Our analysis showed that companies were responding to the specific demands of the campaign, rather than to broader societal pressures for environmental improvements. They were introducing fundamental changes in their factories rather than taking greater risks or shifting pollution to third parties.

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These findings suggest that environmentally conscious shareholders may achieve their goals most effectively through climate-focused engagements. Such actions may also serve to boost the accountability of publicly listed companies, and provide a countervailing force to other parts of the market that are more difficult to monitor and regulate.

Historically, in response to demands from activists, socially conscious investors such as foundation endowments and religious trusts have pressured the boards of controversial companies to align with their social goals. Many, if not most, aimed to impose change by threatening to disengage — by selling their stakes.

In the late 1970s, for example, students urged the trustees of university endowments to divest from companies that were reluctant to reduce or eliminate their operations in South Africa, in order to put pressure on the country’s apartheid system.

Yet research suggests the sale of investments had little effect on valuations, or on South Africa’s financial market overall, if only because international corporate involvement was so small.

More recently, in 2016, Waltham Forest, a London borough, became the first municipal government in the UK to announce that its pension scheme would sell out of all fossil fuel investments.

Other investors, such as pension funds, have stopped investing in companies that operate in “sin” industries, such as alcohol, tobacco and gaming.

But such strategies come at a cost. Investors may lose out on returns from these profitable, albeit controversial, companies. For example, the California Public Employees’ Retirement System (Calpers), the largest US public pension scheme, resolved two decades ago to divest from tobacco. A report it commissioned in 2016 estimated that it may have forfeited $3bn in missed returns as a result.

Such divestment campaigns have become popular as money has flowed into funds earmarked for environmental, social and governance (ESG) targeted investments, and there has been broader awareness and activism around climate change.

Yet the academic evidence suggests that the downward pressure on stock prices through the use of negative screening and filtering to clean portfolios of companies violating these principles is on average small — and comes at the cost of lower future expected returns for the investors.

Just as important, there is little guarantee that divestment campaigns are an effective means of achieving social goals. They lead investors to lose their voice as part-owners of a company.

If they engaged instead, they would be able to speak up on how managers should address climate change and to exert influence over businesses on the front line of the climate crisis.

Take the recent watershed case of ExxonMobil Corp, where investors were growing increasingly unhappy with the lack of corporate strategy to tackle climate change. Shareholders engaged in a proxy battle that resulted in the unseating of two directors from the board.

Such examples reflect our research that investors may both achieve their social objectives and maximise financial return by monitoring and engagement with companies, rather than by divesting.

Lakshmi Naaraayanan
is assistant professor of finance at London Business School and a co-author of the research ‘The Real Effects of Environmental Activist Investing’

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