Should investors and stakeholders who wish to influence companies to promote desirable social and environmental outcomes focus on actions like divestment and boycotts (exit), or would it be more effective to change companies from the inside (voice)? A recent Stigler Center/Rustandy Center panel explores this complicated question, as well as how voice and exit strategies may collectively bring about change.

Last year, Eleonora Broccardo, Oliver Hart, and Luigi Zingales published a working paper that compared two mechanisms by which altruistic investors can influence companies to adopt environmental and social goals: using their voting power to engage with a company’s management and drive change from the inside (voice), or divesting (exit). 

In their paper, Broccardo et al. found that engagement is “surprisingly” effective compared to actions like divestment and consumer boycotts. Yet as companies increasingly come under pressure by investors and other stakeholders to incorporate ESG goals into their corporate strategies and business models, the central dilemma explored by the paper remains: Should investors and stakeholders who wish to influence companies to promote socially and environmentally desirable outcomes focus on divestment and boycotts, or would it be more effective to change companies from the inside? A recent Stigler Center/Rustandy Center panel explored the implications of this complicated question, as well as the ways in which voice and exit strategies may collectively bring about change. 

The panel, part of the two centers’ “Unpacking ESG” event series, featured Elizabeth McGeveran, Director of Investments at the McKnight Foundation, a Minnesota-based family foundation; David Swift, the Chief Operating Officer at the investment firm Engine No. 1; and Luigi Zingales, the Robert C. McCormack Distinguished Service Professor of Entrepreneurship and Finance at Chicago Booth and Faculty Director of the Stigler Center (also, one of the editors of this publication). The conversation was moderated by Marianne Bertrand, the Chris P. Dialynas Distinguished Service Professor of Economics at Chicago Booth and Faculty Director of the Rustandy Center for Social Sector Innovation.

At the beginning of the panel, Zingales outlined the three main reasons investors are increasingly interested in ESG. “First, People love ESG because it’s a good predictor of long-term stock returns,” Zingales said. In that regard, he said, ESG can be “simply a directional bet that you’d like to make—the fact that this bet might or might not have positive collateral effects on the planet is not a decisive factor, but is maybe icing on the cake.” The second reason is more deontological in nature: for example, “you don’t want blood on your hands, so you don’t want companies that you invest in or work in or buy from to have any dealings with Russia.” Third is what Zingales called the “consequentialist” approach: “‘I have some goal—I want to improve the environment, promote diversity, you name it—and I’m not satisfied with the moral action per se; I care about the consequences of my actions.’”

When it comes to the question of exit vs. voice, Zingales said, “the two strategies tend to be substitutes. On the one hand, if a fraction of pro-social investors choose to divest rather than engage, the chances of gaining a majority in any shareholder meeting on issues that are pro-social shrink. On the other hand, if a fraction of pro-social investors try to engage, they will ultimately undermine the effect of divestment because to engage you have to have votes, and to have votes, you have to have ownership.” The consequentialist approach, he added, seems to support the voice option, but there is “an important tradeoff,” since one approach would risk undermining the other. 

Swift described Engine No. 1—which made headlines last year thanks to its activist battle to push Exxon Mobil to reduce its carbon footprint—as “firmly in the voice camp.” Inspired by the work of Zingales and other academics, he said, his colleagues and him created the company “with a simple idea that if we’re going to really be driving the type of change and impact we want to have as investors, we would need to do that at scale in the public markets. We looked at the existing ESG landscape and were wildly unsatisfied with a number of the approaches and investment strategies that were available. Most of them do sit in that divestment camp—they use varying data sources to screen out the “bad” companies and give you a portfolio of “good” companies. What you end up with, in most cases, is a portfolio of climate-friendly tech businesses that have low carbon footprints, which is fine, but it’s not going to inspire the type of change and impact that we really need to see out of the industries that are producing a lot of the environmental and social damage that needs to change.”

Swift added: “We sit in the ‘ESG is a good predictor of long-term economic outcomes’ camp. There are ideological reasons to pursue these paths, certainly. But for us, to have an argument across the different constituents that we need, we need to make economic arguments around these strategic changes that companies need to put in place so that we bring all different types of stakeholders to the table to support these initiatives. You don’t get mired in an ideological battle. These are about economic outcomes.”

McGeveran, who oversees the team that manages the McKnight Foundation’s $3 billion endowment, also described the foundation as “most certainly in the predictor of long-term stock performance, both in stock and in our private investments.” She added: “We are an absolute return investor, we’re not liability-driven like a pension fund—we have the luxury of having a 20-year horizon, and we’re pretty confident in our theory that over the long term, being attentive to these pressing economic issues is going to be valuable for the endowment. I’d also say we’re a consequentialist investor: we very much are using our money in different ways, and very purposefully, to build an economy that takes care of externalities, where companies are not incentivized by investors to always operate in one and two-year horizons.” 

As for exit vs. voice, McGeveran added a third category: “select-better.” “We participate in all three of these,” she added, noting that in addition to using its voice, the McKnight Foundation has been “actively decarbonizing its portfolio” since 2014, until it became “the largest foundation in the US to make a net-zero endowment commitment” in 2021. When it comes to “select better,” McGeveran defined the approach as “You don’t need to exit, and you don’t need to use your voice, if you’re investing in companies that are aligned with your views of the future and your views of opportunity in the first place. A large portion of our endowment is already aligned with our long-term thesis about the future of the economy.”

Watch the full video here: