Leveraging Financial Markets for Social Justice
Is divestment effective?
This article is from Dollars & Sense: Real World Economics, available at http://www.dollarsandsense.org
This article is from the
January/February 2022 issue.
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Social justice activists often focus on changing the behavior of, or limiting the damage caused by, firms or industries that are hurting the well-being of groups of individuals or society as a whole. These “bad actors” could be entire industries, such as private prisons or tobacco, or individual firms, such as hedge funds or private equity firms that buy up non- financial firms and profit by running them into bankruptcy, leading to mass layoffs and destroyed communities. Some of the worst corporate bad actors are firms that are driving climate change.
Activist efforts to rein in bad actors include demonstrations to demand that states stop using private prisons and to limit the sales and advertising of tobacco products. Other efforts include lobbying for legislation to ban the use of fracking in the process of oil extraction and to limit the use of single-use plastic products. Other activists put their lives on the line to attempt to physically stop the completion of oil pipelines.
Still other activists see intervention in financial markets, as is the case with the push to get institutional investment funds to divest from fossil fuel companies, as a tool to effect change. Unfortunately, focusing on financial markets is often the least effective action to take. Climate change is an existential threat to life on the planet. To stop and reverse it, and halt other threats to our well-being, we need real change in personal and corporate behavior, and we will need to avoid diverting our time and energy on tactics that only produce superficial changes. Understanding how and why some tools and tactics are more effective than others in changing corporate behavior is, therefore, absolutely essential to success.
Financing a Corporation vs. Buying and Selling Existing Stock
To begin to understand why financial-market intervention is the least effective tactic for activists, we must examine some key concepts that are often confused. In public discussions of the world of finance, two completely different concepts are often incorrectly used interchangeably. Those concepts are: 1) buying or selling a share of stock on a stock exchange and 2) providing financing to a corporation.
Financing a corporation means providing money to cover the day-to-day operations of a firm or to allow it to expand. Several methods are used to finance a corporation. The first, which is usually used to quickly expand an up-and-coming corporation, is to purchase a share of stock directly from the firm when it is sold for the first time, at a firm’s “initial public offering,” or IPO. Lyft held its IPO on March 29, 2019, selling 32.5 million shares at $72 each. This brought in $2.34 billion of new cash that the firm could use to expand its operations, or to buy up its competitors. IPOs are extremely rare. IPO sales make up less than 0.2% of all stock sales in the United States each year.
A more common form of financing is for a firm to issue bonds (which are just IOUs), which allow them to borrow large sums of money. All large corporations borrow money in this way to cover long-term operations or to expand operations. The final, and most common, form of financing is bank loans. This bank financing affects the cash flow of the firm, and the ability to attract bank financing is critical to the functioning of a firm.
Buying or selling stock on a stock market does not finance a corporation. After the initial purchase of a stock share directly from the corporation, if the shareholder decides to sell their stock, they must find a buyer. This is the role of stock markets. Except in times of financial panic, finding a buyer is incredibly easy. When the share is sold, the buyer provides money to the seller, but the corporation itself is not affected in any way by this sale of stock. No money flows into or out of the corporation. The sale of the stock does not affect the corporation’s cash flow or its ability to function.
Once a share of stock is sold at an IPO, the shareholder has partial ownership of the firm, which gives them the right to have a proportional say in the operation of the firm and to receive dividend payments. However, given the huge number of shares issued by large corporations, individual shareholders have very little voice in how the company is run. When workers own a limited number of shares in their individual retirement accounts, they own a small part of “labor’s capital,” but they have no voice in the operation of firms. This is one of the many reasons defined-benefit pension systems are critically important. By aggregating labor’s capital, it gives labor a voice. Just as unions are necessary because individual workers have little power relative to their employer, labor’s capital has little power unless it is aggregated in defined-benefit pension systems. Pension funds that own a very large number of shares have much more power to affect the behavior of firms. The power of aggregating labor’s capital is part of the reason corporations and right-wing politicians constantly push to convert defined-benefit pension plans into individual uninsured defined-contribution savings plans, such as 401(k) or 403(b) retirement plans. Individual owners of stock are essentially voiceless.
Divestment Is Not Defunding
Two other financial concepts that are also very different and are also incorrectly used interchangeably are “divestment” and “defunding,” or ending direct financing. Selling a share of stock is called divestment. If an extremely large number of stockholders decide to divest at the same time, it has the potential to reduce the selling price of a firm’s stock temporarily, but it has almost no impact on the functioning of the firm, and the stock price almost always rebounds quickly.
For example, in the third quarter of 2021, the California State Teachers Retirement System (CalSTRS) held 7.48 million shares of ExxonMobil, which seems like a lot. But the average daily trade volume of Exxon stock was 21.5 million shares. If CalSTRS sold all their shares in one day, that would be about one-third of the trades on that one day and would have no effect beyond that day. This would not affect the price of Exxon stock and Exxon would likely not even notice.
On the other hand, the decision to end financing of a corporation has the potential to have a major impact on the functioning of the corporation. If a firm is not able to issue bonds because no one will buy them, it will be difficult for the firm to expand its operations. If the firm cannot get access to bank loans, it cannot fund its day-to-day operations. Small, “mom-and-pop” firms have limited access to this type of financing, which is why the failure rate of small firms is so much higher than that of large corporations. If a large number of investors decide to refuse to buy bonds that a firm is trying to sell, the firm will not be able to gain access to the cash necessary to run the business. The same is true if banks refuse to lend to the firm. This lack of financing is the most common cause for bankruptcy filings.
Pension Funds and Divestment vs. Defunding “Bad Actors”
There is a growing movement in the United States calling on institutional investors to divest from some “bad actor” firms and industries. When several very large pension funds around the country, including CalSTRS, the largest teacher-only pension fund in the world, and the New York State Teachers Fund, decided to divest from two firms in the private prison industry, CoreCivic and GEO Group, the share prices of those firms did not decline. In fact, the divestment of these two very large pension funds had no impact on the behavior of these two firms.
However, when JPMorgan Chase decided to stop providing financing to these firms, by no longer underwriting bond issues or making loans, it brought about an immediate reaction from these firms. Pushing banks to end the financing of bad actors has a much bigger impact than pushing for divestment. The idea is to cut off the cash flow.
The distinction between divestment and defunding is an important issue with respect to CalSTRS. CalSTRS holds some of its assets directly, but it holds many assets through contracts with outside managers. Some of these are mutual fund managers, and some are private equity managers. In these contracts, CalSTRS provides direct financing to the managers, who then invest the funds. Some private equity managers serve both the corporate and social interest, but some behave as “vulture capitalists.” The national research department of the American Federation of Teachers (AFT) provides periodic reports calling out these bad actors. Bad-actor managers, such as Mitt Romney’s Bain Capital, sometimes buy a controlling interest in a firm, drive down wages of workers, plunge the firm into debt, and transfer all this money to themselves. If these outside managers are engaged in bad-actor activities, their ability to function will be greatly reduced if CalSTRS pulls its direct funding and allocates it to other outside managers who behave in a more socially responsible way. If a large number of pension funds simultaneously pulled their money from one of these vulture funds, the fund manager would suffer a significant cash flow loss and might be put out of business.
Engagement vs. Divestment
Why Do Some People Believe That Divestment Is Effective?:
The (Misunderstood) Case of Apartheid-Era South Africa
Many people look back at the movement to get colleges and universities to divest from Apartheid-era South Africa as an indication of the effectiveness of divestment. But this is a misreading of the anti-Apartheid movement. The anti-Apartheid movement outside of South Africa, which started primarily in England and Europe, first focused on supporting the efforts of the South African people themselves in their struggles against Apartheid. These struggles took the form of work stoppages, mass demonstrations, civil disobedience, and, ultimately, armed struggle. It was these internal struggles that ultimately ended Apartheid, but international pressure did help.
The international anti-Apartheid movement focused first on developing boycotts of South African products and imposing sanctions on South African businesses and government officials. It also targeted major banks to stop lending to South African businesses. The goal was to restrict the flow of money to the South African economy. The movement was relatively successful, and the boycotts and sanctions expanded over time.
The movement in the United States for divestment from South Africa came later in the process. While the divestments had almost no direct effect on South African businesses, the consciousness-raising aspect of the movement greatly expanded the already existing boycotts of South African products in the United States. It led more U.S. companies, and popular performers, to stop doing business in South Africa. It forced some U.S. banks to defund South African businesses by refusing to make loans. It also increased pressure on the U.S. government to enforce already existing sanctions on South African businesses and members of the South African government. The increased social awareness ultimately led to the passage of the Comprehensive Anti-Apartheid Act in 1986, over President Ronald Reagan’s veto, which banned new investments in South Africa. Because Reagan’s enforcement of the act was lax, Representative Charles Rangel added an amendment to the 1987 Budget Reconciliation Bill that ended the ability of U.S. firms to claim tax credits in the United States for taxes paid in South Africa.
The boycotts, sanctions, and cancelation of business contracts had a direct and powerful effect on the cash flow of the South African economy, and it was this that put the most pressure on the government for change. Had these concrete sanctions and boycotts not already been in place, the consciousness-raising aspect of the divestment movement would likely not have had much impact.
Sources: Robert E. Edgar, ed., Sanctioning Apartheid (Africa World Press 1990); Richard Knight, “Sanctions, Disinvestment, and U.S. Corporations in South Africa,” 1990 (richardknight.homestead.com).
Another method used to attempt to change corporate behavior through financial markets is through engagement. If a pension fund, or group of pension funds, owns sufficiently large blocks of shares, they can submit resolutions at annual shareholder meetings. These resolutions can change the behavior of firms, change the makeup of the board of directors, and in some cases, lead to replacing the CEO. The effect of this type of engagement, while limited, is more effective in changing firm behavior than divestment.
CalSTRS engagement efforts have led to significant changes in the behavior of several firms. Coalitions of institutional investors have had success at several large corporations in getting more women and people of color appointed to corporate boards of directors. These changes in the board makeup have led to changes in the hiring and promotion practices at these firms. A very significant recent example involves ExxonMobil. A coalition of large institutional investors, led by a fund called Engine 1 and including CalSTRS and CalPERS removed three members of the Exxon board who have a “drill baby drill” focus, and replaced them with three new board members who have a clear understanding of the role of fossil fuels in driving climate change and have a focus on moving Exxon to become an alternative fuel company. While this success is more likely to change the behavior of Exxon than divestment would have, it is still a very limited success in the face of the current climate crisis because the change will come too slowly.
Unfortunately, financial markets have so many actors that attempts to change corporate behavior through either divestment or directly ending funding often have limited impact. When “moral” investors pull out, “immoral” investors step in. Thus, it is often much more productive to focus efforts to effect social change outside the financial sector. This can be done through boycotts of products. It can also be done through passing legislation that directly sanctions the behavior of firms, such as imposing fuel efficiency standards for new vehicles, imposing a state or national tax on carbon emissions, or ending government use of private prisons.
Is Divestment an Effective Tool for Social Change?
The reason we need to understand the limited role of financial markets in efforts to effect positive social justice change is so that we can understand the best policy recommendations and demands.
Many progressive economists, including Robert Pollin at the University of Massachusetts–Amherst and the Political Economy Research Institute, do not support the idea of divestment as a tool for social change. This is because research has shown that divestment, by itself, has almost no impact in changing corporate behavior. For a pension fund or college to divest from an industry, they have to sell the stock. They cannot sell unless someone else is buying the stock. Money goes from one shareholder to another, but there is no financial impact on the industry itself. Because there is no financial impact on the industry, corporations have no incentive to change their behavior. Almost every pension fund in the United States divested from the tobacco industry and the behavior of that industry did not change. The same is true for the gun industry. What has changed the behavior of the tobacco industry has been a significant increase in taxes on tobacco products and direct regulation of the sale and advertising of these products.
Historically, the main effect of divestment campaigns is consciousness-raising, i.e., making the broader public aware of an issue. That is a very important role, but by itself that is not enough unless there is a concrete focus for that new awareness (see sidebar, “Why Do Some People Believe that Divestment Is Effective?”). Unfortunately, many organizations that are trying to fight climate change focus on divestment as their only policy demand. Students are holding sit-ins and risking arrest trying to get their colleges to divest from fossil fuel companies. If the colleges do divest, many of those students, because they do not understand the effects of divestment, are going to declare victory and move on to something else. If that happens, the divestment campaign is actually counterproductive because it does not affect industry behavior and it diverts the energy of activists.
The policy debate between engagement vs. divestment is essentially the same as the economist Albert O. Hirschman’s concepts of voice vs. exit. When people find themselves connected to a problematic or declining organization, they face a choice between voice—trying to improve the organization by criticizing it or proposing improvements—and exit—just withdrawing from the organization. Engagement, while often limited in its level of success, is the exercising of the voice of labor’s capital. Divestment is a form of exit, which is justified only by considerations other than trying to change the behavior of the corporation (see sidebar, “Pension Funds, Divestment, and ‘Stranded Assets’”).
Bypassing the Market
It would be far more effective if these students were sitting in and risking arrest at state legislatures demanding the implementation of a state-wide carbon tax, or state-level regulations. They could also be picketing the headquarters of banks making loans to fossil fuel companies. These campaigns would serve a consciousness-raising role, but unlike calling for divestment, calling for direct intervention in the market, if successful, would actually have a significant impact on slowing the climate crisis. Given that we live in an economy in which the market allocates almost all resources, changing the functioning of the market through direct intervention is an important policy goal. Many progressive economists support the idea of a “carbon tax.” This fee would be charged on all forms of carbon, not just fossil fuel companies. If everyone in society had to pay for the full environmental cost of the carbon they use, they would have an incentive to find ways to reduce their carbon footprint. They would find ways to buy less gasoline, use more efficient methods to heat their homes, and buy less plastic packaging.
Pension Funds, Divestment, and “Stranded Assets”
Trustees of pension funds have the fiduciary responsibility to manage fund assets. If the climate justice movement is successful, the global economy will abandon the use of fossil fuels. The share price of fossil fuel companies’ stock is determined, in part, by their assets, and much of their assets are reserves still in the ground. If these assets become “stranded” because they are no longer in demand, the share prices of the companies will decline. While we know that this will occur, the timing of this decline is still being debated. When it does become imminent, more investors will dump these stocks.
Two large New York pension funds recently announced they were divesting from fossil fuel companies. In their statements explaining their actions they did not claim divestment would change the behavior of these companies. But rather, they referred to the potential loss in value as a result of stranded assets. In this case, divestment is not the cause of the movement away from fossil fuels, but rather the result.
When the price of gasoline spiked in 2008, people stopped buying Hummers and other huge trucks and started buying smaller, more fuel-efficient vehicles. Unfortunately, when the price of gas came back down, the sales of big pickup trucks went back up. A carbon fee would permanently raise the price of gas. From a social justice perspective, this creates a significant problem because low-income households would be hard pressed to pay the higher prices. This is why advocates of a carbon fee recommend rebating the revenue raised back to households, using a progressive formula in which lower-income households would receive a larger rebate. The same approach would be used to cover the increased cost of home heating.
More than 50 cities and counties in the United States have passed ordinances to eliminate the use of natural gas for heating and cooking in all new construction. The state of California will end the sale of fossil fuel powered automobiles by 2035. These are examples of bypassing the market completely and using direct regulation. When the downside risk of a market activity is very large and potentially irreversible, direct intervention to bypass or control the market is often the fastest and most effective method to change behavior.
A Policy Test: What Do Corporations Resist?
The best way to judge the potential effect of a policy recommendation is to watch the industry response to a proposal. The sugary drinks industry spent millions of dollars to fight a small tax on soda in San Francisco, but the tobacco and weapons industries spent very little money to fight divestment. Chevron is not spending much money to fight the divestment movement, but they are spending millions to fight a carbon tax and increased regulation.
Part of the climate justice movement, especially in Europe, has focused directly on getting banks to stop lending to fossil fuel companies. A good example is NatWest, the largest bank in Scotland and until recently the largest bank in the world, which has committed to ending loans to fossil fuel companies and moving their financing to firms and industries that are fighting climate change. Cutting off cash flow to fossil fuel firms has a direct effect on their ability to function and their response has been quick in coming.
The American Legislative Exchange Council (ALEC), an organization funded by climate change deniers and ultra-wealthy right-wing donors, creates policy language on many issues, and provides fully written legislative bills for their right-wing allies to introduce in state legislatures. ALEC has already developed policy language to make it illegal for banks to refuse lending to fossil fuel companies. The threat of cutting off the cash flow is what scares the industry.
Climate change presents an existential threat to the planet in the form of increased intensity of hurricanes and other storms, such as the extreme tornadoes that hit the Tennessee Valley on December 11, 2021, which was well beyond the normal tornado season. At the same time, climate change has increased the number and severity of droughts. Both storms and droughts threaten food systems. Climate change will lead to increased conflict over resources and the forced migration of millions of people. In addition to its effects on humans, it will also lead to ocean acidification and mass extinction of animal species.
There is no time to lose in the fight against climate change. So, the argument comes down to the question of which tactic is going to have the quickest and most significant impact. The climate crisis is real, and the damages are already occurring. The failure of the recent United Nations global climate summit in Glasgow drives home the need to focus efforts on those tactics that will have immediate and concrete impacts. Focusing activists’ attention on financial markets and especially on divestment is not our best option. If we use the most effective tools available, such as direct regulation, taxation, and a Green New Deal, we can either change the behavior of some of these firms or put them out of business altogether.
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