Why Divestiture Movements Are Generally a Bad Idea

It is increasingly clear that climate change represents a significant threat to our way of life. While not undisputed, evidence that the present trend of carbon emissions will result in significant warming that will impose considerable economic, environmental, and social costs is compelling and getting stronger every year. It is an open question whether and how existing institutions will respond.

Over the past few years, a growing movement has called on investors, including institutions of higher learning, to divest their endowment funds of companies that produce fossil fuels. While a few large institutions such as Stanford and Harvard have rejected full divestment in favor of vague commitments to make their endowment investments carbon-free sometime in the future, most of the other schools with multibillion-dollar endowments have thus far said no to divestment outright. It is the schools with the smaller endowments and that can least afford it that are acting on this.

While well-meaning, these calls are unlikely to result in positive change and will most likely lead to smaller revenue for the intended beneficiaries of these endowments. Fund managers should continue to manage the funds entrusted to them to maximize the long-term risk-adjusted return, giving colleges maximum flexibility to meet the challenges of tomorrow. Those concerned about greater climate warming can have a greater impact by using ownership in these companies to press them to take advantage of the inevitable changes.

Smaller revenues would be especially painful in the short term for colleges and universities, as the coronavirus presents many colleges with an existential threat. The last several years have seen a growing number of smaller colleges forced to close down, unable to respond to demographic and financial challenges. National lockdowns have only increased the threats, significantly reducing college revenues even as they increase expenses. Michael Horn, an education professor at Harvard, forecasts that as many as one-fourth of all institutions might cease to exist as independent entities in the next decade — and that was before the pandemic.

In such a climate it is misguided to ask universities to focus on anything other than income and their students when managing their endowments. After all, most institutions do not have large endowments to fall back on: According to the American Council on Education, the vast majority of endowment wealth lies in the hands of a few of the top colleges. Fifty-three percent of private institutions have endowments of less than $10 million, and the median at private colleges and universities is $7.9 million. Only 62 institutions have endowments of over $1 billion.

Given their wealth, it may be tempting to demand these schools sacrifice some of it to pursue other goals, such as saving the planet from catastrophic warming, but it would still be unwise. For one thing, state laws, such as the Uniform Prudent Management of Institutional Funds Act, often restrict a trustee’s discretion to act on motives other than yield. 

More broadly, university endowments represent a compact between donors, the institution and future students. The vast number of supporters presumably donate to colleges to support the education of current and future students. Investment strategy and political causes are presumably not major concerns. Using these funds to pursue social causes that donors may not approve of and that lessen the impact of their gifts could reduce future donations. 

Another perspective is that universities hold their endowments in trust for students. A decision to accept lower returns in order to put pressure on oil companies would violate this trust while opening the door to various other politically motivated pressures to weaponize the endowment in the pursuit of various other social goals. 

Energy stocks are especially attractive to investors because they have a long history of steady dividends that are presently significantly higher than Treasury yields. This does not mean institutions should always own energy stocks: If the companies fail to pursue good management practices in the face of growing concern about climate change or if governments enact policies that reduce profits in the sector, fund managers will have to reassess their portfolios.

Divestiture would also be ineffective. Divested shares would be quickly purchased by other investors more concerned with profit than with politics. As a result, companies are unlikely to feel any pressure to change their policies or business models. 

Oil companies are perfectly aware that the world is changing and are trying to adjust as well. Some of them, like Shell, are attempting to diversify their energy production portfolio to include more renewable fuels, while others remain focused on improving productivity and preparing for a future that likely includes some sort of carbon tax. 

But the growing use of financial markets to pursue political goals is ultimately counterproductive, and it imposes considerable ancillary costs on people who can least afford it — in this case the students who depend on the financial aid and other assistance afforded by a school’s endowment. Students who want to effect change need to do the hard work of convincing both company management and the general public to support policies to lower emissions and increase adaptation to warming. This requires sustained effort and a willingness to engage in constructive dialogue with people that see the world from a different perspective. The strong history of liberal education should make universities ideal places for such an effort.

Joseph V. Kennedy is president of Kennedy Research LLC and a senior fellow with the Information Technology and Innovation Foundation. The views expressed here represent his own and should not be attributed to any organization.

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