First, they can divest from businesses whose targets they consider are not aligned with societal goals. For example, ESG funds may exclude “brown” companies from their portfolios, notably those involved in the production of fossil fuels.
Second, investors can make use of their rights as ultimate owners or privileged capital providers to engage with them on their journey towards sustainability.
Third, investors can finance the pursuit of projects that facilitate the sustainability transition.
Our research into the effectiveness and limitation of each of these three has found that, while there is no magic bullet, the last two are more promising than the first.
1. Divesting
This strategy is often adopted under the pressure of activists, which hope to bring about a “capital rationing” (sometimes also called “financial rationing”) effect on the target company, triggered by investors when they sell their positions in companies of which they disapprove. Our literature review, however, shows that this hope is generally based on unrealistic expectations.
That’s because such rationing can directly happen only on the primary markets (and even then, under a very limited set of conditions) in the case of new equity issuance or direct bank lending, while most investors are only active on secondary markets where they exchange assets between themselves without contact with the original issuer. This means that the company – the intended target of a divestment – remains largely unaffected.