In the world of responsible investing, one key trend that has persisted is the debate over the effectiveness of divestment vs. engagement – essentially, whether investors should sell assets or hang onto them and wield influence as shareholders.
The recent Russian-Ukraine conflict has exacerbated the debate on the best strategies investors can use to influence an organisation’s behaviour. In this article, we will investigate the divestment vs. engagement argument and explore how investors can engage with companies to support better corporate ESG performance.
As shareholders and stewards of corporations, investors are in a unique and highly influential position to shape corporate behaviour. By providing capital to corporations, investors have the opportunity to engage with companies, raise issues of concern, and have a say on outcomes. In turn, corporations are fiduciaries of the capital entrusted to them by investors and have the responsibility to create corporate value over the short and long term. Advocates of engagement policies maintain that breaking ties with organisations through divestment and exclusion does not encourage change and could ultimately result in the sale of those securities to investors who are less attentive to ESG issues. They also argue that divestment fails to address the systemic, long-term impacts of climate change and so prefer to use their investments to influence long-term structural change by engaging directly with companies or voting on shareholder resolutions.
Advocates of divestment believe that organisations will only change behaviour when they are forced to through legislative change. They argue that legislative change is not possible until the necessary groundwork has been laid by changing public discourse and generating voter pressure on politicians and that divestment plays a critical role in this regard. The question is not so much whether divestment has a direct financial effect on companies, but rather whether, by helping to shift societal norms and expectations, it creates more favourable conditions for legislative change.
Supporters of divestment argue that through divestment strategies, investors can influence a company’s climate-related activities by reducing its share price and increasing its cost of capital. Research by Jonathan Berk at Stanford Business School found that divestment announcements typically decrease the share price of fossil fuel companies and that ‘divestors’ can influence the share price of their target companies. As a result, organisations with poor ESG practices will lead to financial losses that have not yet been properly priced in by the markets. Therefore, supporters of divestment policies argue divestment ultimately shapes corporate behaviour as organisations and senior management have an incentive to maximise share prices.
Ultimately, there is broad agreement amongst investors that both divestment and engagement policies can shape corporate behaviour. There is also broad consensus amongst advocates of divestment and engagement that using one approach in confinement will not be enough to achieve ambitious climate objectives. Therefore, the discourse around divestment and engagement is perhaps futile and should not be perceived as an either/or matter, given that there is room for both approaches.