The Problem with Divestment: Helping Wealthy Investors Instead of Victims

A lot of social movements call for divestment of the shares of firms which are opposed to their goals. In particular, many colleges and universities have faced student protests demanding that college endowment funds divest from fossil fuel companies. However, they should be concerned about divestment’s actual effects.

If a group decides to sell off its shares of some Company XYZ, the price of the shares will fall. However, nothing has changed about Company XYZ’s expected future cash flows. Therefore, nothing has changed about investors’ valuations of Company XYZ. So when the share price falls, other investors simply get an opportunity to buy the shares for cheap. Net result: no damage to Company XYZ.

Furthermore, by creating this buying opportunity for other investors, what divesting groups are actually doing is transferring wealth to said investors. This usually means transferring wealth to wealthy individuals in the First World.

Of course, one argument could be that divestments act as public statements and make action by others more likely. A Harvard Political Review article argues that this was the case with divestments from South Africa in protest of apartheid: they had little financial effect, but helped raise awareness.

But divestments are public statements that cost money. What if universities instead aimed for high investment returns and donated the difference to efficient charities? (Possibly charities aimed at helping victims of whatever is being protested.) The result would be transferring money to effective causes instead of wealthy investors. And universities could still publicize their donations to charity as a way of raising awareness.

Let me reiterate: the main impact of divestment is that a few wealthy investors benefit, while the offenders are unharmed. Is that really ideal?

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CEO Ownership as an Indicator of Stock Performance

Some time ago, I was going back through old bookmarks when I found this Motley Fool piece by Alex Dumortier on stock returns and CEO ownership. He cites a 2010 paper, which seems to have been updated in May 2013 and titled CEO Ownership and Stock Market Performance, and Managerial Discretion, by Ulf Von Lilienfeld-Toal and Stefan Ruenzi.

The paper generally finds that shares of companies with higher rates of CEO ownership deliver substantial excess returns. As it notes (pages 26-27):

Nevertheless, as an alternative approach, we also examine the returns of a completely passive buy and hold long-only strategy. We consider portfolios that buy into all firms with a CEO who owns more than 10% in the first sample year and portfolios consisting of the top 10% of all firms according to managerial ownership in the first sample year, respectively, without any re-balancing in the following years. The high ownership portfolios always deliver economically large alphas amounting to between 0.84% and 1.15% per month in the value-weighted case and between 0.60% and 0.78% per month in the equal-weighted case. Overall, these results show that even a simple low-cost buy and hold long only strategy based on managerial ownership would have earned substantial abnormal returns.

Some questions I can think of:
 
  1. Most notably, contra EMH, why haven’t investors taken advantage of what seems to be a passive means of substantially outperforming the market?
  2. Why are the effects of CEO ownership strongest in industries with weak product market competition? After all, if CEO ownership increases incentives for managerial competence (or is otherwise a signal of good management), it seems that this should be more useful for firms in more competitive industries. (One possible explanation is that management is more effectively “priced in” in companies in more competitive industries, as investors view said companies as more risky and needing of scrutiny.)