Introduction
A prevalent debate in ethical investing circles centers on whether socially responsible investors should engage with companies that have questionable practices or divest from them entirely. This dilemma, which some compare to the relationship dynamic of trying to change a partner, has significant implications for both investment returns and social impact. Should investors hold onto problematic companies to influence change from within, or should they divest entirely to support better companies?
Key Takeaway
Both engagement and divestment strategies can be effective, but their appropriateness depends on company specifics, ownership structure, and investor objectives. The most successful approach may involve a combination of strategies tailored to each investment situation.
The Engagement Approach
Shareholder engagement involves investors using their ownership stakes to influence corporate behavior through dialogue, filing resolutions, voting proxies, and exercising other shareholder rights. This approach assumes that investors can drive positive change by working with companies directly rather than abandoning them.
Advantages of Engagement
- Potentially achieves systemic change within existing structures
- Preserves financial value while driving social/environmental improvements
- Direct access to company management and decision-making processes
- Allows investors to witness and verify actual changes being implemented
- Provides ongoing influence to ensure continued progress
Disadvantages of Engagement
- Change may be slow and incremental
- Requires significant time and expertise to be effective
- Success depends heavily on management cooperation
- Risk of becoming complicit in harmful practices during engagement period
- Might provide cover for companies to maintain status quo while appearing receptive
"There is a bad cliché from doomed romantic storylines where one person in the relationship believes they can change the other - even when the situation is hopeless. While it makes for depressing TV, it might hold the key to a raging debate in the world of ethical investing: Should a socially responsible investor invest in bad companies to try to change them from within, or should they stay away and instead exclusively invest in the good companies?"
— Ethical Investing Review
The Divestment Approach
Divestment involves selling holdings in companies that don't meet ethical standards. This approach aims to reduce capital available to harmful companies and signal disapproval to both the company and the market. Divestment can be particularly effective when coordinated among many investors.
Advantages of Divestment
- Immediately removes financial support from harmful practices
- Clear moral stance that aligns investments with values
- Can create financial pressure on companies to change
- Signals market demand for responsible alternatives
- Redirects capital toward companies with better practices
- Protects investors from reputational risks
Disadvantages of Divestment
- Removes potential influence over company behavior
- May simply transfer ownership to less concerned investors
- Could reduce the effectiveness of shareholder advocacy
- Loss of potential returns if the company improves
- May be seen as abandoning those most affected by company practices
Effectiveness by Issue Type
Case Studies in Effective Strategies
Successful Engagement Examples
Institutional investors have successfully influenced companies on various issues:
- Climate change: Institutional investors successfully pressured oil and gas companies to improve environmental reporting and set emission reduction targets
- Board diversity: Shareholder advocacy has increased gender and ethnic diversity on corporate boards
- Executive compensation: Activist investors have curbed excessive CEO pay packages
Effective Divestment Examples
Divestment campaigns have also demonstrated efficacy in certain contexts:
- South African apartheid: Global divestment campaign contributed to policy change
- Tobacco: Reduced institutional investment influenced industry practices
- Fossil fuels: Divestment has redirected capital toward renewable energy
Strategic Considerations
The choice between engagement and divestment should consider: the nature of the issue (operational vs. fundamental), the company's willingness to change, the investor's influence capacity, and the timeline for desired change. Engaging with small companies where you hold significant stake may be more effective than engaging with large, entrenched organizations.
A Hybrid Approach
Many successful socially responsible investors employ a hybrid strategy that combines both approaches:
- Initial engagement with companies that have potential for improvement
- Setting clear timelines and benchmarks for progress
- Divesting if predetermined changes don't occur within agreed timeframe
- Re-engaging if companies demonstrate genuine commitment to reform
This approach allows for patience with companies making good faith efforts while maintaining accountability for results.
Conclusion
The debate between engaging with problematic companies or divesting from them reflects no easy answers. Engagement offers the potential for direct influence and systemic change but requires time and may risk complicity. Divestment sends clear signals and protects from associated risks but may remove potential for direct influence.
The most effective approach likely depends on each specific situation, including the company's responsiveness, the nature of the issue, and the investor's objectives. Successful investors often combine both strategies with clear principles and measurable objectives, allowing for both patience with promising efforts and decisiveness when companies fail to improve.