Once more with feeling…

Since this will be my last ESG-themed post of this year, I wanted to go back to one of my favourite recurring topics: the effectiveness of engagement strategies vs. divestment strategies.

I have written several posts by now about why I think divestment strategies don’t work (see here or here). Meanwhile, the evidence that investing in companies and then engaging with company management to change business practices does work increases (see here, here, and here for some examples).

Now, Matthew Kahn and his colleagues have looked at the practices of one specific type of investor: public pension funds in the US. These make for some interesting objects of study because the control over these funds changes depending on which party is in control of state government and there is a well-known difference in the approach to ESG investing between Democrats and Republicans. Democrats believe that ESG investing is able to influence companies to reduce their greenhouse gas emissions, while Republicans do not (I am oversimplifying, of course).

When the government of a state changes hands from one party to another, the board of trustees of a public pension fund also changes control and that may provide a trigger for change in the way a public pension fund invests.

What the research found was that public pension funds that are newly controlled by Democrats tend to engage more with companies about their greenhouse gas emissions, i.e. the pension funds become a little bit ‘greener’.

But the way the engagement happens does make a difference. If a public pension fund engaged through adversarial means like voting or launching shareholder proposals, the impact on greenhouse gas emissions was limited and no different from instances where the pension funds did not engage. If the pension funds engaged in a constructive and productive way with company management, the reduction in greenhouse gas emissions would happen faster. A switch to a Democrat-led government and corresponding engagement of the affected public pension funds with corporate management led on average to a 3.8% larger reduction in greenhouse gas emissions after four years than at the start of the engagement.

That shows that engagement if done right, works. But what about divestments? The study found that a company’s behaviour and practices on greenhouse gas emissions did change if ‘green’ funds owned a larger share of the company. But it did not change its behaviour if ‘non-green’ public pension funds owned a larger share of the company. Yet, if a fund divests from a company, all it does is sell its shares to another investor who is presumably less green than the divesting fund. And that means that the share of non-green investors holding the stocks of the company increases, leading to no change in the emissions of the company. Hence, divestment strategies are clearly worse than engagement strategies.