When to Divest and When to Engage
As impact investors focused on sustainability, we are constantly faced with a critical question relating to companies that fall short on Environmental, Social, and Governance (ESG) matters. Simply put, we have to decide whether it’s better to engage with the corporation in question, or to divest our holdings entirely. So, we think it’s helpful to have a consistent framework that informs our ESG rules.
With this in mind, here is how we decide when to stay and when to walk away.
Engage on systemic issues affecting most companies
The stark reality is that no company, certainly none large enough to be publicly traded, would pass an ESG purity test. Indeed, divesting from companies that are ‘bad’ on some ESG-related issue, would leave a tiny investable universe of good companies remaining. In fact, there are some issues that are so prevalent, that using them as criteria for divestment would essentially eliminate all companies from consideration. Pay inequity is a case in point. It’s a society-wide problem, with women and people from marginalized groups unfairly being paid significantly less than (white) men.
Pay equity is also a good example of investors running into a data wall. Unfortunately, companies don’t typically publish statistics breaking down compensation by gender or race in a sufficiently meaningful way. One example of this, as Arjuna Capital notes in their pay equity scorecard, is the reluctance of companies to disclose “unadjusted pay gaps”, which allow for a direct comparison of how women and visible minority employees are paid vs. men and white workers. This, in turn, both obscures the problem, and also renders the “engage or divest” decision difficult. But it certainly doesn’t make the problem disappear: As the report notes, women make 83 cents on the dollar compared to men, and black workers are only paid 64 cents relative to each dollar earned by white workers.
Despite the lack of good information, though, engaging with the company rather than divesting presents opportunities for an investor. By remaining as a shareholder, an investor can push for change. While some investors choose to target companies with the most egregious problems for engagement, when addressing broad, systemic challenges, we believe that identifying and targeting those companies likely to be leaders and early adopters of the desired change can be very effective in setting new industry-wide expectations. We also believe that in the case of broad, systemic issues, it can be worthwhile to put companies across our whole portfolio on notice that we are paying attention.
Engage on issues which are not intrinsic to business models
As long as an issue isn’t intrinsic to a company’s business model, it can make sense to engage. A great example of this is residential solar installer Sunrun. Change Finance proudly supported a successful resolution requiring Sunrun to report on the impacts of its forced arbitration policy—a policy criticized as facilitating the cover-up of bad corporate behavior like sexual harassment and discrimination. Sunrun was able to make strides internally without having to restructure their operations.
In fact, in May of 2022, Sunrun’s leadership demonstrated commitment to progress by recommending a vote in favor of a shareholder-sponsored proposal asking for additional transparency on the use of concealment clauses in these instances. It is rare for a company’s management to recommend a vote in favor of a shareholder resolution, so for Sunrun to do so demonstrates a real commitment to progress.
Our engagement with BlackRock is another case study in addressing a particular issue that isn’t integral to a company’s business model. We reached out to them regarding their proxy votes on climate change resolutions, and have been pleased to see progress: In 2021, they (and other large asset managers) supported more resolutions than the year prior. This is evidenced, as last June’s As You Sow report detailed, by a record-breaking number of passing resolutions and by the number of resolutions which passed with very substantial majorities.
Divest on issues that are intrinsic to a company's business model
Some ESG cases are fixable. Others, meanwhile, are lost causes. In fact, with some companies, their issues aren’t so much bugs as features of how they do business. Take the fossil fuel industry. It’s very difficult to imagine that the business model of oil or coal production can be altered in a way that is both environmentally friendly and commercially viable. Meanwhile, a recent report by Deloitte underscores the harmful impact of unchecked global warming. The assessment demonstrated that climate change will wipe 2 full years’ worth of GDP growth off the table by 2070. By contrast, the pandemic has only wiped out 10% of annual global GDP, which works out to 1/20th the impact. This, of course, is in addition to the harmful effects of global warming on our planet and way of life.
If a company’s problems are so deeply entrenched, we think it’s better to just walk away (or not invest in the first place). Usually, this decision makes good investing sense, too---in the case of an industry like coal, engaging and being invested can be risky given the likelihood of sustained long-term underperformance. Along these lines, a 2019 report found that three major state pension funds lost $19 billion because they fossil fuel companies.
When it comes to engaging with or divesting from a company, how much impact we can make is a key determining factor in our framework for addressing these changes. If an ESG issue is fixable, we’ll lean in. But if we believe there’s no hope of meaningful improvement, we’re out.
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The opinions expressed are those of Change Finance, P.B.C. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Forward looking statements cannot be guaranteed.