Friday, 30 October 2015

Why divestment doesn't punish firms' share price (and why you can't reward ethical firms that way either)

Some of you will have been following the campaign to urge the University of Otago to adopt a policy of not investing in fossil fuels (following similar policy by Victoria University and other organisations). The University has deferred the decision for now.

I haven't been following the Otago debate very closely, but a recent article in The New Yorker by William Macaskill caught my attention. In the article, Macaskill lays out the argument against divestment, if the purpose of the divestment is to punish the companies you are divesting from:
if the aim of divestment campaigns is to reduce companies’ profitability by directly reducing their share prices, then these campaigns are misguided. An example: suppose that the market price for a share in ExxonMobil is ten dollars, and that, as a result of a divestment campaign, a university decides to divest from ExxonMobil, and it sells the shares for nine dollars each. What happens then?
Well, what happens is that someone who doesn’t have ethical concerns will snap up the bargain. They’ll buy the shares for nine dollars apiece, and then sell them for ten dollars to one of the other thousands of investors who don’t share the university’s moral scruples. The market price stays the same; the company loses no money and notices no difference. As long as there are economic incentives to invest in a certain stock, there will be individuals and groups—most of whom are not under any pressure to act in a socially responsible way—willing to jump on the opportunity. These people will undo the good that socially conscious investors are trying to do.
Consider the efficient markets hypothesis - all information (good and bad) about the firm's future cash flows is already captured in the firm's share price. Essentially, the firm's market capitalisation (the value of all of its shares) should be the discounted value of all of its future cash flows (in most cases this isn't true, but for firms in Western share markets it usually isn't too far from the case). So, when the Fossil Free petitioners try to argue:
We urge the University of Otago and associated Foundation Trust to avoid fossil fuel extraction investments as they are economically insecure in the long-term.
That information is already captured in the share prices of fossil fuel extraction firms. This information is not a big secret. Holders of shares in those firms are already aware of this information, and how it will impact future cash flows for the firms, and have evaluated whether it makes sense to hold onto those shares.

If a fund divests itself of fossil fuel shares, then that increases the supply of shares to the market, and the price will fall slightly. Given that the previous price had already accounted for the future decreases in cash flows, the shares are now under-priced relative to their 'true' value. Buyers will swoop in to buy those shares, increasing demand and the share price, until it returns to its original share price. So, we shouldn't expect any impact of divestment on the share price. Which is indeed what research has found, as Macaskill notes in the article:
Studies of divestment campaigns in other industries, such as weapons, gambling, pornography, and tobacco, suggest that they have little or no direct impact on share prices. For example, the author of a study on divestment from oil companies in Sudan wrote, “Thanks to China and a trio of Asian national oil companies, oil still flows in Sudan.” The divestment campaign served to benefit certain unethical shareholders while failing to alter the price of the stock.
This argument could equally apply (albeit in reverse) for "ethical investment". It's not possible to reward green firms through a higher share price. Since the price already reflects the true value of the firm, then if a fund wants to buy shares in Corporation Green-Yay, then that will slightly increase the demand for shares in Corporation Green-Yay, and slightly increase the share price. Other holders of those shares will recognise they are now overvalued compared to their 'true' value, and sell them. This increases the supply of those shares and lowers the price back to where it was before. Again, no impact on share price.

Finally, Macaskill notes that divestment may have a positive effect in the long run:
Campaigns can use divestment as a media hook to generate stigma around certain industries, such as fossil fuel. In the long run, such stigma might lead to fewer people wanting to work at fossil-fuel companies, driving up the cost of labor for those corporations, and perhaps to greater popular support for better climate policies.
This is a much better argument in favor of divestment than the assertion that you’re directly reducing companies’ share price. If divestment campaigns are run, it should be with the aim of stigmatization in mind.
And similarly, there may be long-run benefits for green firms if campaigns to invest in them are used as a media hook to encourage more people to work at those firms (thus lowering their labour costs). Essentially, this would create a compensating differential between the wage paid to workers (in the same job) at the green firm, and those at the fossil fuel extraction firm. Because working at the fossil fuel extraction firm is less attractive than working at the green firm, workers must be compensated (through a higher wage) for working at the fossil fuel extraction firm. One might argue that this compensating differential already exists, but perhaps divestment campaigns might increase its effect?

[HT: Marginal Revolution]

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