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Divest or engage on social matters?
As my readers know, I am opposed to divestment campaigns because I think they are largely ineffective. When investors have a problem with the practices of a business, they should put pressure on the management to change. And a new study that compares the effectiveness of divestment vs. engagement on social factors shows the difference in outcome quite clearly.
The study looked at controversies in all US-listed companies between 2010 and 2020 that fell into the social domain. This could be anything from health and safety violations to debates about the unionisation of employees to alleged discrimination on gender and race. If these controversies are made public, the share price initially reacts slightly negatively, dropping some 2% on average over the four weeks after the controversy emerged.
That is not much of an impact, but what does make an impact is how investors react to such a controversy. The study found that investors who divested from the company in question did not have any impact on the share price, nor did they manage to change the behaviour of the company. After divestments, the probability of the company being embroiled in another controversy is unchanged.
Meanwhile, if investors engage with the company, they have a meaningful impact on the behaviour of the company. If investors acquire 1% of the company embroiled in a social controversy, the likelihood of being involved in other social controversies nine months later has dropped by 13%.
This shows not only the value of engagement in making a difference, but it opens the possibility of a true impact investment strategy by becoming an activist investor. If a company is involved in a controversy about its behaviour, ESG impact funds should actively buy the shares of this company and engage with the management to change behaviour. This is likely to have significant social benefits with no downside (and I would argue some upside in the long run) on the share price.
Having said that, the trend in the US is unfortunately in the opposite direction. As investors flock to ETFs and index trackers, the share of assets held by finds with a divestment strategy is growing. Index trackers are typically rules-driven and will divest from companies with lots of controversies but there is no engagement with company management since managers of index funds have no credible threat to selling the shares since even if they don’t want to hold the company, they must in order to replicate the index.
Meanwhile, ESG funds that actively engage with companies to change behaviour have a decreasing share of assets because of the shift to index funds.
Share of assets held by US funds with different ESG approaches
Source Saint-Jean (2023)