Investing and divesting as tools for mitigating climate destruction
We know all the cliches: Money talks, BS walks. Money makes the world go round. Put your money where your mouth is. Follow the money. Yes, cliches are overused and trite, but that’s because they capture an essential truth. The simple truth is that in the campaign for a livable climate and mitigating climate destruction, money is key.
For better or worse, barring mobilization of vast numbers of people to confront climate destroyers via in-person direct action, using money is going to be how we win the battle for a livable climate and secure future.
This is the first of three articles looking at how financial impacts can be used to motivate change in climate-impacting companies:
- First, a look at how investing and divesting can influence corporate behavior
- Then, analyzing successes and failures resulting from investing and divesting approaches
- Lastly, “ESG” (Environmental, Societal, Governance) investing themes are evolving to help motivate change
Money is Leverage
In this first article, I’ll review the two financial levers with the capacity to move the massive weight of corporate dominance over climate health: investment and divestment.
Corporations know only one simple fact when all the complexity is reduced to fundamentals: money is either flowing IN to and enriching them, or money is flowing OUT and away from them and reducing their value. By controlling the flow of dollars into and out of corporations, they can be influenced. It’s that “simple.”
Here I’ll briefly discuss how ownership or sale of large blocks of stock, and banking and lending policies, can impact and shape corporate climate behavior. There are only two choices: Invest in and support a company financially to influence how it operates, or Divest from and remove support, at scale, to punish bad behavior, send a message, or make a personal statement. How does this work?
How Investing Practices Can Influence Corporate Behavior: A Primer
Shareholder Rights
The most important aspect of investing as a tool to influence corporate behavior is this:
“Perhaps one of the most important principles of corporate governance is the recognition of shareholders”
“The policy of allowing shareholders to elect a board of directors is critical. The board’s “prime directive” is to be always seeking the best interests of shareholders”
This is the fulcrum of the investment lever to promote corporate change: the shareholders own the company, they elect the board of directors, and the board of directors is mandated to put executives and mechanisms in place to serve the interests of the shareholders.
“This means that shareholders, effectively, have a direct say in how a company is run.”
Also, shareholders want to maximize the influence of their stake in a company, so they are motivated to reach out to current or prospective customers, government, or other external participants, to influence them to do what’s in their, the shareholders’, best interest. This is a “force multiplier” that reaches beyond the boardroom.
(See https://corporatefinanceinstitute.com/resources/knowledge/other/corporate-governance/)
Shareholders have additional rights to protect their self-interest, beyond voting on resolutions and board members:
“Opportunity to inspect corporate books and records. Shareholders have the right to examine basic documents such as company bylaws and minutes of board meetings. In addition, the Securities and Exchange Act of 1934 requires public companies to periodically disclose financials.
The right to sue for wrongful acts. Suing a company typically takes the form of a shareholder class-action lawsuit.”
(See https://www.investopedia.com/investing/know-your-shareholder-rights/)
Proxy Voting
Each year, companies hold a shareholders’ meeting in which governance issues are voted on. In preparation, relevant information is provided to the shareholders: financial reports, shareholder resolutions, executive compensation levels, and board member nominations. At the time of the meeting, shareholders can vote on governance matters directly, or via a proxy mechanism where they delegate their vote to an investment manager, hedge fund, company management, or other intermediary.
(See https://www.investopedia.com/terms/p/proxy-vote.asp)
This voting power gives holders of large blocks of stock a significant say in how a company is run, and how it is held accountable, or not, for behaving appropriately. If most of a large fund’s investors defer their vote to their fund manager by proxy (which is typical,) the vote from the fund could have major impact.
Even if a fund doesn’t have a large block of shares, it can still present resolutions for a shareholder vote, which also can be significant leverage.
Incumbent interests don’t want “activist” shareholders showing up and causing disruption over changes in company strategy. In response to this threat, legislation is being discussed that would limit the ability of large index funds to vote their very significant blocks of shares, to shield companies from progressive action being taken by the funds. Senator Dan Sullivan (R-Alaska) has introduced the “INDEX” bill that would stop giant investment funds like Blackrock and Vanguard from directly using shares they hold on behalf of their customers to force companies into doing more to mitigate their climate damage.
In contrast to the various tools available to shareholders to affect company behavior, non-shareholders must rely on extrinsic forces to shape corporate actions. There are two primary means to do this: political involvement to influence regulation and legislation, and public pressure such as protest and boycott. These approaches have their own advantages and challenges, and have their place, but are at arm’s length from effecting change within companies.
Influence of Lending
Another mechanism for financial engagement with a company is to lend it funds. All large companies are in some way reliant on debt financing to operate, and the large amounts of money involved mean there are deep legal and operational ties between company and lender. Having the decision-making power whether to make a loan and under what terms gives the lender a mechanism for shaping the borrower’s behavior.
Commercial banks who use the public’s deposits for capital to invest can potentially be influenced to apply financial leverage in negotiations with prospective borrowers, putting conditions in place that reflect the will of the public. ESG Lending refers to setting loan terms that are tied to sustainability and other “social good” performance metrics, reflecting both public and financial industry pressure. Banks’ desire to both cultivate a positive image and satisfy regulatory risk management requirements contribute to the growing attention on “sustainable lending.”
(See https://www.jdsupra.com/legalnews/esg-loans-the-next-big-wave-in-fund-6869513, https://www.lsta.org/news-resources/what-is-esg-linked-lending-and-why-do-we-care — there are many internet sources on this topic)
How Divestment Works
Divestment is the term for selling off shares in a company and disengaging from it. Divesting could also mean refusing to issue or renew loans, and possibly accelerating existing loans. Once fully divested, there is no more connection between the divestor and the actions, profits, or losses of the company.
Divestment of large amounts of stock impacts a company primarily through lowering its stock price, drawing attention to the company’s behavior, affecting perception of the company by the public and the market, and adding risk which influences lenders and investors.
If a large block of stock is sold off quickly, the share price is likely to drop at least temporarily. Executive compensation as well as personal net worth are based significantly on share price, so a large enough drop in price for a sustained period could get the attention of the company executives and board. There could be a reaction from the market that exacerbates the share price drop, as perception turns negative, news gets around, and a crowd starts to follow the selling trend. All this is a strong social signal with potential to change behavior.
There may be a significant enough move in stock price, or in sentiment, to alert lenders that the company presents a higher risk as a borrower. This could result in increased interest rates with a corresponding impact on the bottom line and add to a company’s negative outlook.
(See https://fairholder.org/blog/how-divestment-works)
The effectiveness of divestment continues to be debated, largely because as a “negative action” it’s difficult to connect the dots between a divestment decision and a change in corporate behavior. However, there is wide agreement that divestment sends powerful signals and makes a statement. The next article in this series will examine this issue in depth to look more closely for cause-and-effect.
As with activist investing, the divestment movement has caught the attention of pro-fossil-fuels interests and they are starting to fight back. This is a clear indication that divestment has an impact that is felt. For example, West Virginia has banned Blackrock, a huge investment firm, from doing business with the state.
Up Next: What Is Effective?
The fossil fuel incumbents’ negative reaction to the use of financial leverage to influence climate policy shows that it has an impact, whether the lever is investment or divestment. As I say at the start of the blog money talks, and when it talks, people listen — they don’t have a choice.
After this rudimentary outline of how investing in and divesting from publicly owned companies might influence companies, the next blog will look at the organizations using these different approaches and what results have been achieved. With an objective evidence-based analysis of what tactics are producing favorable outcomes, organizations can make decisions around what initiatives they can support or propose, and we’ll be taking a deep dive into pension fund, hedge fund, and grass roots movements’ effectiveness to see what is happening out there.
After that: ESG
Evolving patterns of activist investing and divesting at scale involves large legal and cultural shifts, most visibly the rise of “ESG Investing.” There is intense activity in this space with involvement of giants in regulation, technology, corporate governance, and public relations. This explosion of interest and visibility has brought with it confusion, competition, progress, deception, and political intrigue that will be the subject of a third part in this series of blogs. ESG metrics will play a critical role in both investment and divestment decision-making so it is an essential part of the analysis.
Disclaimer: this article is necessarily a very simplified description of an extremely complex field. It’s intended as a primer for those with little or no experience in how corporate finance is structured.