Impact investing and climate change

The impact of green investors

Can important environmental problems be solved through private markets instead of government regulation? This is the question that Kahn et al. attempt to answer in this paper. More specifically, they provide an empirical assessment of the competing views in this debate by estimating how corporations adjust their carbon emissions, if at all, in response to green investors investment or divestment. The authors measure green ownership by focusing on public pension funds – which control $5.6 trillion in assets – for which environmental preferences can be proxied by the political party that controls the fund. They define a public pension fund as “green” in two ways: first, based on the governor’s party affiliation (because governors can influence pension fund investment through legislative and regulatory actions and by appointing pension board trustees in many states) and second, based on the partisan composition of a fund’s board of trustees. They find that:

• An increase in the fraction of shares held by green public pension funds caused companies to reduce their carbon emissions during the period 2010-2021. Kahn et al. estimate that a 1 percentage point increase in a company’s shares held by green pension funds was associated with an approximately 3 percent reduction in plant emissions over four years.
• Constructive engagement is more effective than confrontational tactics such as voting or shareholder proposals.
• Companies used scale reductions to achieve their emission reductions, for example, among plants that generated electricity, reductions in electricity output tracked emission reductions almost one-to-one on average. In addition, companies did not offset their greenhouse gas cuts with other polluting production processes. But, the authors find no evidence that companies achieved emission reductions primarily by divesting their high-polluting facilities.
• Private markets may be able to address environmental challenges without explicit government regulation.

Divestment and Engagement: The Effect of Green Investors on Corporate Carbon Emissions
Authors: Matthew E. Kahn, John G. Matsusaka, Chong Shu
From: University of Southern California, University of Utah

…a word of caution

Aswath Damodaran in this commentary makes several observations on the U.S. financial market that should serve as a cautionary tale about the ability of the private markets to address environmental challenges without explicit government regulation, as argued above.

• Investors are pricing fossil fuel companies with the expectation of much lower growth in the future but this is due to the fact that these companies are returning more of their earnings as cash and reinvesting less than they used to, and not due to an expectation that the days of fossil fuel are numbered.
• Fossil fuel companies are returning much of cash flows that they are generating to their shareholders in the form of dividends and buybacks, notwithstanding the pressure from activist impact investors that they reinvest that money in green energy projects.
• Many of the divestitures and sales of fossil fuel assets by publicly traded companies have been to private buyers, and the assets being divested are often among the dirtiest  of their holdings. Over the last decade, some of private equity’s biggest players have invested well over $1.1 trillion in fossil fuel, with the investments ranging the spectrum.

Fossil fuels account for a higher percent of overall energy produced in the United States today than they did ten or fifteen years ago, with gains in solar, wind and hydropower being largely offset by reductions in nuclear energy. If this is what passes for winning in impact investing, I would hate to see what losing looks like.

Good Intentions, Perverse Outcomes: The Impact of Impact Investing!
By: Aswath Damodaran – New York University