Divestment Doesn’t Work

As campaigns to divest from Israel and fossil fuels gain steam on college campuses, it is important that we think critically about the mechanics of divestment as a political strategy. Divestment is the reduction of financial assets for financial, ethical, or political reasons. On campus today, divestment activists are asking the Stanford Management Company (the professional organization that manages our endowment) to right perceived ethical and political wrongs by selling shares in companies that, in their view, are complicit in moral atrocities. They hope that Stanford’s cash-rich endowment and high profile will create a financial selling tsunami that decreases the market value of targeted firms and forces them to change. Unfortunately, a look at how divestment actually works from a financial perspective suggests that this view is overly optimistic.

Divestment campaigns for ethical violations have taken place for decades. Institutions used divestment to fight apartheid in South Africa in the 1980s, big tobacco in the 1990s, and also against fossil fuels, financial companies, agriculture, retail, manufacturing firms, and countries such as Israel, China, Russia, and Turkey. The allure of divestment is its apparent power and ability to change bad behavior. However, like a first time congressperson, ethical divestment campaigns have a lot of hype, but usually fail to produce meaningful results.

By themselves, divestment campaigns are not successful because they fail to corral enough one-sided financial muscle to effect change. Since 2000, the Stanford Endowment has grown into a financial juggernaut with investments that span asset classes and geographies. At the end of August 2014, John Powers, the CEO of Stanford Management Company, oversaw an empire with a market value of $21.5 billion dollars. However, Powers does not have the power to actively buy and sell $21.5 billion dollars worth of securities. In fact, SMC (like any properly managed endowment fund) has a diverse portfolio with very little invested in traditional equities and bonds. At the end of the last fiscal year, Stanford actively managed less than $3 billion dollars worth of stocks listed on public exchanges and short term debt holdings (that is, stocks and bonds that can be quickly bought and sold). The vast majority of Stanford’s holdings are held with external hedge fund, private equity, and venture capital managers as well as in real estate and natural resources.

Students Confronting Apartheid by Israel has asked Stanford to divest from Ahava, Motorola, Caterpillar, Lockheed Martin, Riwal, Roadstone Holdings, Mekorot Water Company, and Veolia Transport. The combined market cap of these companies (excluding Riwal, Ahava, and Merkorot because they are private or government owned) exceeds $200 billion dollars. In addition, the United States has provided Israel with over 100 billion dollars in military aid throughout its history, including a $3 billion aid package in 2014. Stanford’s divestment of three billion dollars would have a minimal impact on Israel’s economic outlook and financial stability.

But what if Stanford’s action on divestment pushed other campuses to follow suit, creating a domino effect? If we use Stanford allocation percentages as a proxy for all university endowments, then the total financial muscle available to divest without leverage would be $55 billion. Fossil Free Stanford has asked for the university to “freeze any new investment in fossil fuel companies, and divest within five years from direct ownership that include fossil fuel public equities.” Even with all university endowments, $55 billion isn’t enough to make a dent in the fossil fuel industry. In 2014, the aggregate market value of coal companies worldwide was $233 billion while the aggregate value of all fossil fuel companies was $4.5 trillion. In addition, because we are divesting on emotional grounds rather than underlying business fundamentals, independent investors (with different views) would likely purchase our divested shares and stabilize the market price. Therefore, unless a worldwide quorum of investors including sovereign wealth funds, pension funds, mutual funds, hedge funds, governments, and universities find common ethical ground and divest together, the strategy is economically ineffective. Let’s design better solutions for the problems in the world we all came here to fix.

---

Aurelio (Toby) Espinosa is a graduate student at Stanford University in the Management, Science, and Engineering Department. Before coming to Stanford, Toby was an associate at Henry Crown and Company, a family-owned and operated investment company whose holdings include diversified manufacturing operations, private equity, banking, oil and gas and real estate companies. He graduated with honors from Brown University in 2012 with degrees in Economics and South Asian Studies.