How can environmentally conscious investors most effectively influence the practices of polluting industries?

Does divestment actually help reduce emissions blamed for climate change, or is it more effective for green investors to hold stock in companies that emit greenhouse gas emissions?

A new paper co-authored by a University of Utah business scholar concludes investor engagement is far more effective than divestment in reducing climate-altering emissions of greenhouse gases by publicly traded companies.

Without a carbon tax or other government-imposed mechanisms in place to make U.S. industries pay a price for the toll their emissions make on global climate systems, these companies have little financial incentive to change their behavior. This is where investors can make a difference, according to the study.

“In the current political environment, it’s very hard to regulate the carbon emissions or to address climate change issues through legislation,” said Chong Shu, an assistant professor of finance at the Eccles School of Business. “Another way is the private sector. Consumers can boycott the companies that they don’t like. So we take another view that perhaps investors can also do that.”

The study was posted as a working paper on Nov. 9 by the National Bureau of Economic Research, or NBER. Shu and his co-authors—Matthew Kahn and John Matsusaka of the University of Southern California—found that holding shares in polluting companies is a superior investment strategy for reducing corporate emissions.

Overall, these findings support the notion that private markets can address environmental challenges in the absence of explicit government regulation and mandates.

NBER working papers are not peer-reviewed studies, but they are publicly circulated to facilitate discussion. Such discussion is of particular relevance to the U itself.

In 2016, a divided Academic Senate voted to investigate whether the school’s endowment should be pulled out of stock in companies trafficking in fossil fuels. A committee was empaneled to examine the $60 to $90 million the U holds in fossil energy assets. Its 61-page report, released two years ago, urged “a strategic realignment of the university’s endowment investments toward promoting positive sustainability investments.” U administrators are still weighing the next steps.

According to Shu’s paper, titled “Divestment and Engagement: The effect of green investors on corporate carbon emissions,” fund managers can promote sustainability through collaborative engagement with polluters, as opposed to outright divestment.

His study explored how investors committed to social responsibility can best influence companies’ operations associated with carbon emissions, which mostly come from the burning of fossil fuels, but also are released from agricultural operations and landfills.

One path is divestment, which is endorsed by climate activists because it deprives capital from polluting companies. The other path is to acquire and hold shares in those companies, which enables investors to apply pressure on managers to clean up their act.

“As shareholders, they are the ultimate owners of the company. So they can direct the policy of the company,” Shu said. “What we find is that the engagement is more productive to reduce the corporate carbon emissions than divestment.”

To demonstrate this point, Shu and his colleagues examined the 30 largest state pension funds benefiting public employees, with a total of $5 trillion in assets under management. Funds were defined as “green” and “not green” according to the political party of the state’s governor or the fund’s board of trustees.

University endowments, which are often influenced by principles of social responsibility, known as ESG, were not covered by the study.

Democratic-controlled pension funds, such as those based in California, were deemed “green,” while Republican-controlled funds, including the Utah Retirement Systems, were deemed “not green.” The study paid close attention to the California Public Employees’ Retirement System, or CalPERS, worth more than $100 billion.

That agency has been resisting a proposal in the California Legislature that would force public pension funds to divest from fossil fuel companies. CalPERS argued its ownership of such stocks empowers it to influence the priorities of polluting companies.

Shu’s research found evidence supporting this claim, but first, it had to distinguish whether a company’s green ownership is a reaction to the company’s decarbonization or a cause of those actions. The researchers could ferret out these causal associations since U.S. industries are required to report their domestic carbon emissions on an annual basis.

The team looked at changes to reported emissions from 42,504 facilities operated by 3,726 publicly traded companies, Shu said. They found a 1 percentage point increase in a company’s shares held by green pension funds was associated with a 3% reduction in plant emissions over four years.

“We find no association between non-green ownership and changes in carbon emissions,” they wrote. “Engagement reduced emissions and divestment appears to have been counterproductive.”

Shu and his colleagues also found evidence that ownership and constructive engagement were more effective than confrontational tactics, such as voting or shareholder proposals. And companies held by green investors were not more likely to just sell off their polluting facilities, a practice derided as “greenwashing.”

“A somewhat puzzling aspect of our findings is that relatively small shareholdings seem to influence company behavior,” the authors wrote. “The number of shares held by public pension funds is large in absolute terms, but nowhere near large enough to have effective control of the company.”

One possible explanation is that public pension funds are followed by other investors or are effective in forming coalitions, they speculated in pointing out directions for further study. Stay tuned.

• Brian Maffly Science writer, University of Utah Communications
  801-573-2382 brian.maffly@utah.edu