The Divestment Dilemma
What moral obligations do investors have? It’s a question increasingly debated by individual investors and major Wall Street players, but there’s no single answer. And there shouldn’t be, because not all investors are created equal. Institutional investors, companies and organizations that invest substantial sums, own 80% of the S&P 500. That disparity in power means that institutional and individual investors should exercise their moral responsibilities in very different ways.
While dialogue over ethical investing often fixates on specific issues, the core conceptual debate has raged for decades. Milton Friedman articulated perhaps the most famous rejection of socially responsible business in his 1970 essay “The Social Responsibility of Business is to Increase its Profits”. Friedman wholeheartedly rejects the notion that businesses have moral responsibilities, arguing “Only people have responsibilities”. Notably, that doesn’t contradict the position that individual investors have moral obligations — but it does mean that these responsibilities no longer apply in a collective corporate setting.
Friedman’s view of investing is simple and straightforward: he believes that companies have responsibilities only to shareholders and that investment’s sole purpose is to maximize profits. In this view, sacrificing profits in the name of broader social interests not only harms investors but amounts to a political act from politically unaccountable businesses. Essentially, corporate pursuit of the common good is antidemocratic.
It’s a provocative, influential, and frequently debated stance, but Friedman’s argument doesn’t hold up nearly as well in a globalized world where profit maximization can entail grievous human rights abuses. Investments can quickly entangle you in global supply chains and their grim realities. Want to invest in electric cars? You might benefit from unsafe mining practices in the Congo. If you’re a fan of chocolate, you might benefit from child labor. That’s the dark side of maximizing profit, and it partly explains why Friedman’s position is increasingly unpopular.
In recent years, Wall Street and corporate America have embraced corporate activism, explicitly supporting social and environmental causes. Walmart and Apple have both announced donations of $100 million toward racial equity causes. And it’s common to see companies at least pay lip service to social movements, with PR releases supporting Black Lives Matter and detailing Pride Month initiatives. Rejection of Friedman’s position now goes far beyond these direct violations; moral responsibilities increasingly factor into investing decisions.
The most substantial manifestation of moral investing has been the ESG (environmental, social, and corporate governance) movement. Investopedia defines ESG as “a set of standards for a company’s behavior used by socially conscious investors”, and it’s often understood as a way to consider sustainability and ethical issues alongside pure finances. In theory, ESG involves both divestment from morally objectionable businesses and investment in those that meet a particular standard. In practice, it tends to focus primarily on environmental considerations, even at the expense of social ones. And though it’s not an explicitly partisan movement, ESG’s consideration of issues like racial equity and climate commitments has drawn criticism that it amounts to a surreptitious left-wing agenda.
Even with growing conservative skepticism, support for ESG has steadily grown both within the financial industry and among investors. From 2015 to 2020, ESG assets increased at a 30% annual rate due to cash inflows and market growth. After accounting for only 1% of fund inflows in 2014, ESG reached roughly 25% in 2020. And environmentally-minded investment has gone well beyond funds that prioritize sustainability. Nearly 1,500 institutional investors managing over $39.2 trillion have now committed to some form of divestment from fossil fuels.
Despite such high-profile divestment successes, there’s little sign of tangible change in the energy industry. Global coal consumption increased by 4.5% in 2021 and current government pledges remain insufficient to meet the Paris Agreement’s emission goals. The renewable space has seen significant growth, but it comprised only 29% of the 2020 global energy supply — and much of that came from unscalable hydropower. So ESG-minded investors might be better served by engaging with fossil fuel companies, leveraging shareholder votes to influence companies’ directions.
Given divestment’s ineffectiveness, engagement at least deserves consideration from institutional investors. In 2021, activist hedge fund Engine №1 won three seats on ExxonMobil’s board with the support of institutional investors. Yet the fund has stressed that it doesn’t oppose Exxon and other target companies; instead, it aims to “engage more actively where needed, to drive transformation and financial results”. For instance, Engine №1 founder Christopher James has worked with several oil companies to monitor methane emissions. Engagement won at Exxon, but it remains to be seen whether that means real change for the company and the broader energy industry. Engine №1’s victory is a first step and nothing more.
The dilemma over achieving change isn’t new, nor is divestment as a tool for social change. In fact, divestment played a prominent role in the anti-apartheid movement throughout the 1980s, generating international backlash against the South African government. While divestment succeeded in raising international awareness of apartheid, it also stoked debate over whether divestment or engagement was the more effective strategy.
There’s no clear answer to that pressing question, at least for institutional investors. While proponents of divestment often point to the successes of apartheid divestment, that’s been their only real success story — and even then, it’s unclear just how impactful divestment was. The movement helped turn international sentiment against the apartheid government, but international divestment’s tangible impact was certainly modest when compared with the efforts of South African activists. For all of divestment’s failings, engagement hasn’t had much empirical success either. Engine №1’s Exxon win is engagement’s most notable success to date, but it’s only a partial victory. And in a year of surging oil prices and record profits for Exxon, the company’s path away from oil has grown more complicated. With no clear answer between divestment and engagement, institutional investors should choose their strategy on a case-by-case basis.
But the calculus behind divestment and engagement differs for individual investors since they hold far less power than institutional investors. Every large-cap company has majority institutional ownership; Apple has over 58% and Meta has about 74%. Engine №1 owned only 0.02% of Exxon’s shares, so it spent $12.5 million lobbying other shareholders — a strategy that individual investors can’t hope to emulate. So for all the intoxicating rhetoric of a more accessible market, smart money still dominates Wall Street.
Since most individuals own a minuscule number of shares, whatever change they can achieve through engagement is profoundly limited. Any progress made by individual investors has to come from collective efforts — perhaps ousting an especially loathsome board member or approving a shareholder resolution. Even those can only be achieved in tandem with institutional investors who hold real voting power within companies. Whether individuals choose divestment or engagement, they’re not likely to make much difference.
While divestment is worth considering on an institutional level, individual investors’ powerlessness means that their divestment tends to be a futile gesture. Selling three shares of Exxon won’t speed up the company’s transition from oil; it achieves nothing aside from satisfying the investor’s conscience. In fact, it might even be counterproductive. As of June 2022, each of Exxon’s top 50 shareholders was an institutional investor, a reality that’s common across large-cap stocks. So when investors divest, they not only cleanse their hands of a stock, they outsource moral decision-making to institutional investors — mostly businesses that Friedman believes have no moral obligations aside from profit. Divestors surrender what little power they have and hope for the best, prioritizing their own consciences above tangible results. Individual divestment is thus a fundamentally egotistical act. But the ugly reality endures: immoral companies will profit whether or not you divest. Individual decisions simply don’t matter.
I’m under no illusion that individual engagement is likely to bring about much change — it isn’t. And it’s entirely understandable for investors to leave money on the table to keep blood off their hands. But unjust profit is a sunk cost. If you feel uncomfortable pocketing it, donate that money to a good cause, reinvest it to augment your tiny leverage, or vote against executives and policies that promote injustice. In those regards, engagement at least preserves individual agency. The logic of divestment, by contrast, exaggerates individuals’ agency while inducing them to discard what little they have. Individual divestment is an abandonment of moral responsibility, not an exercise of it. If individual investors want change, engagement’s the only path that allows them to contribute to it.
