KSG Divestment Rreport
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  • 1. Public Pension Fund Divestment: A Protest Tactic “When we’re dealing with investments of our membership’s funds, if we’re dealing with them with an eye to making or influencing social policy as opposed to an eye solely to the investment potential–the profitability–, then we’re really doing a disservice to our members.” –Suzanna Buriani-DeSantis New Jersey State Investment Council New Jersey Star Ledger (4/21/06) “We’re not setting foreign policy. We just don’t want to be associated with genocide and terrorism.” –Joseph Clary Illinois State Senate Attorney Wall Street Journal (5/8/06)
  • 2. This presentation examines whether public pension fund divestment is an effective and equitable tactic for achieving social goals. The presentation consists of the following sections: • Historical context • Review of positions of proponents and opponents • Framework for evaluation • Case: New Jersey divestment of Sudan holdings • Conclusions and recommendations
  • 3. CONTEMPORARY CONTEXT Since last year, states and cities have begun to divest their pension funds from businesses with ties to Sudan. These divestments protest violence in Sudan’s Darfur region, which the United States has labeled genocide. Over 200,000 people have died of government-sponsored violence there. New Jersey passed the first divestment statute in July 2005 and just one year later will have divested $2.16 billion from its pension funds. A growing student movement is also pressing for university endowment divestment. Harvard University took the lead by divesting PetroChina, an oil company that does business with the Sudanese government. Divestments since 2005 1 States: New Jersey, Illinois, Oregon, California State Teachers’ Retirement Fund Cities: Providence, RI; New Haven, CT Universities: Harvard, Yale, Stanford, Columbia, University of California system 1 Wall Street Journal, 5/8/06.
  • 4. HISTORICAL CONTEXT Divestment is one of three forms 2 of “socially responsible investment” (“SRI”) to emerge in the 1970s: Screening – Investment funds include or exclude certain businesses, industries, or countries in order to achieve social goals. Divestment is a form of screening. Shareholder activism – Shareholders form alliances in order to influence corporate policy. Community investment – Investment funds invest in underserved communities or industries. Examples of SRI 1970s Pax World Fund created in response to Vietnam War; the mutual fund screens for businesses involved in weapons production. 1980s Exxon shareholders push for environmental policies after Valdez oil spill. 1980s – 90s Universities and pension funds divest from South Africa in protest of Apartheid. 1990s Universities and pension funds divest from tobacco firms. 2000s New York City Comptroller (manager of Police and Fire Department pension funds) asks firms to end business ties with countries that sponsor terrorism. 2 Rivoli.
  • 5. CASE: SOUTH AFRICA AND APARTHEID Divestment was one among multiple tactics applied to South Africa during the 1980s and 1990s in the effort to end Apartheid there. The United States exerted political and economic pressure on South Africa in three ways: • 1986 Comprehensive Anti-Apartheid Act, which imposed sanctions on South Africa. • Divestment by private equity funds, public pension funds, and university endowments. • Withdraw of multinational corporations, including IBM, Ford, and Exxon. 3 These interventions were made within the context of strikes by Black gold miners, civil unrest, and daily violence in Soweto and Johannesburg. Apartheid ended in 1994. 3 Siew, Welch, and Wazzan.
  • 6. PROPONENTS OPPONENTS FINANCE Divestment decreases stock values, thereby forcing firms to rethink corporate policy. In a perfect market, divestment won’t make any difference since politically indifferent investors will still buy divested stocks. POLITICS Pension fund divestment is a tactic that works when other options, from diplomacy to UN intervention, are politically untenable. Foreign policy is the responsibility of the State Department, not pension fund managers. MANAGEMENT Pension fund managers are elected and their decisions reflect investor interests. Divestment goes against the fundamental principles of pension fund management. ECONOMY Pension funds are huge. Divesting pension funds can have a significant impact on a firm, industry, or country. Countries in trouble are in need of foreign investment for infrastructure, education, and economic development. Divesting will only make conditions worse. RETURNS Firms that are doing harm will have unprofitable returns in the long run. Divestment policies make it difficult to earn any return from private equity at all. VOICE Pension fund investors shouldn’t have their “deferred payments” sponsoring firms or regimes they oppose. By divesting, pension fund investors give up their “shareholder voice” and the opportunity to influence corporate policy. WINNERS & LOSERS Divestment may create unintended winners and losers. Divestment may create unintended winners and losers. MORAL COMPASS The interests of humanity come before everything else. The interests of the pension fund investors come before everything else. POSITIONS OF PROPONENTS AND OPPONENTS
  • 7. 4 Siew, Welch, and Wazzan. UNPACKING THE FINANCE POSITIONS Strongest argument in favor of divestment is that Apartheid no longer exists in South Africa. Yet some argue that basic finance principles suggest divestment achieves nothing. The finance argument – In an efficient market, divestment may temporarily lower a stock price, but the present value of the stock’s future cash flows do not change. The marginal investor (who is politically indifferent) will perceive lower prices as a profit opportunity and purchase the stock. One study shows that the 1980s divestment had no negative impact on South African financial markets. 4 It should be remembered that divestment was one tactic among others in South Africa. Further, external pressures were intensified by internal social instability. Divestment might therefore be seen as one intervention that supports others. Example: The divestment of $9.5 billion by CalPERS contributed to the decision of GM and Exxon to withdraw from South Africa altogether.
  • 8. UNPACKING THE MANAGEMENT POSITIONS Strongest argument against divestment is that it violates fundamental principles of public pension fund management. “Standard of Prudence” 5 – ERISA (1974) establishes that investments should be made solely in the interests of the investors. Unless the divested stocks pose an investment risk, divestment deviates from this standard. Asset Allocation – Up to 90% of portfolio returns are attributible to asset allocation. Divestment may increase risk and decrease returns by reducing pension fund portfolio diversity. Transparency – In pension funds the fiduciary (decision-maker) and investor (stakeholder) are not the same person. It is problematic if the fiduciary chooses to divest without considering investors’ opinions. Benefit Principle – Pension fund investments are made today so the fund will fulfill its future promised payments. The operating assumption is that investors pay into the fund with “deferred payments” and share the burden of the future payments. If divestment today creates a pension shortfall in the future, then there is a problem of intergenerational equity. However, prudence is a vague and flexible concept. The legality of divestment is established by the South Africa and tobacco industry divestment precedents. Also is reasonable to believe that assets can be re-allocated to achieve comparable returns. 5 Peterson.
  • 9. UNPACKING THE ECONOMY POSITIONS The role of multinational corporations in the global economy gives reason for caution with divestment. Foreign investment is a source of jobs, infrastructure, and economic development. Economic isolation may make oppressive regimes in poor countries worse. Divestment tactics should identify a continuum of business activity. Divestment can “target” firms that contribute to harm, while avoiding firms that play a positive role. Divestment Continuum DIVESTMAYBE DIVESTDON’T DIVEST Manufacturer supplies equipment parts for local agriculture. Bank invests in government bonds issued for capital projects. Oil company pays export tariffs used by government to purchase weapons.
  • 10. BALANCING CONFLICTING PERSPECTIVES Divestment can be an effective tactic, but the evaluation of divestment proposals requires a balancing of conflicting perspectives. • Divestment is often intended to improve the conditions of oppressed people, but to do so, the fair treatment of ordinary pension investor must be considered too. • Divestment aims at achieving social goals, but the pension fund portfolio’s overall return must also be kept in sight. The framework for evaluating divestment must grapple with conflicting imperatives and provide clear decision-making measures at the same time.
  • 11. FRAMEWORK FOR EVALUATION The recommended framework for evaluation is composed of a Technical and Public Policy Report Card which is followed by a “Winners and Losers” analysis. The Report Card grades divestment in 8 categories on an A to F scale: Technical categories Pubic Policy categories 1. Transparency 5. Political Effectiveness 2. Clarity 6. Equity 3. Specificity 7. Operational Efficiency 4. Diligence 8. Accountability For a divestment proposal to be approved, it must receive an overall grade of A.
  • 12. REPORT CARD CRITERIA Technical Report Card Public Policy Report Card TRANSPARENCY Is there open communication between divestment decision- makers and pension fund managers and investors? When funds are re- allocated, is there a system of checks so that there exists neither conflict-of-interest or corruption? CLARITY Does the pension fund resolution or divestment legislation send a clear message? Will the divested firms know what they must do to avoid divestment and why? SPECIFICITY Is there a divestment continuum? Is the action a “targeted divestment” such that it effectively divests from firms that contribute to harm while minimizing negative impacts of the divestment on society? DILEGENCE Does divestment occur within the appropriate timeframe? Are there reliable sources of information on the business ties of firms? POLITICAL EFFECTIVENESS Does the divestment achieve its social goals? Is divestment a stand- alone tactic, or is it one source of pressure among many? Is there international support? Does divestment encourage similar actions from university endowments or private equity funds? EQUITY Is divestment fair to pension fund investors or does it compromise their future benefits? Will it create an intergenerational equity problem? In directing resources away from the divested country or industry, does divestment harm more than help? OPERATIONAL EFFICIENCY Will the divested pension fund remain competitive? Does asset allocation manage risk with portfolio diversity and maximize return by shifting funds to investments with comparable returns? ACCOUNTABILITY Does divestment set a precedent that holds firms accountable for their business practices?
  • 13. CASE: NEW JERSEY DIVESTMENT The following report card evaluates the State of New Jersey’s recent divestment from Sudan using information available from recent press and media. A legislative statute requiring New Jersey to divest its pension funds of investments in firms with business ties to Sudan took effect on August 1, 2005. New Jersey was the first state to pass such a statute. By August 2006, New Jersey pension funds will have divested $2.16 billion of investments in 17 firms. By comparison, the GDP of Sudan is $84.93 billion, 6 which makes New Jersey’s divestment from firms with business ties to Sudan the equivalent of 2.5% of Sudan’s GDP. 6 This figure is the “purchasing power parity” GDP, www.cia.gov/cia/publications/factbook/.
  • 14. NEW JERSEY REPORT CARD Technical Report Card 7 Bergen County Record, 6/2/05. 8 New York Times, 2/19/06. 9 New Jersey Star Ledger, 4/21/06. TRANSPARENCY The New Jersey State Legislature and Governor made the decision to divest over the objections of the State Treasurer, who advocated for shareholder activism. GRADE: B CLARITY The divestment statute itemizes grievances against the Sudanese government, which include arbitrary arrests, torture, and executions. 7 GRADE: A SPECIFICITY The statute requires divestment of any holdings with a business that has equity stakes, facilities, or employees in Sudan. The New Jersey statute is not “targeted divestment.” 8 GRADE: C DILIGENCE By August 2006, New Jersey will have divested itself of $2.16 billion in 17 firms doing business in Sudan. The divestment occurs two years ahead of schedule. The New Jersey Treasurer says the early divestment is in part due to the declining stock value of the firms. 9 GRADE: A
  • 15. NEW JERSEY REPORT CARD Public Policy Report Card POLITICAL EFFECTIVENESS New Jersey is the first state to divest its pension funds from Sudan. It therefore sets a precedent that has been followed by other states and cities as well as university endowments. The United States has imposed sanctions on Sudan since 1997 and in 2005 labeled the violence in Darfur genocide. However, significant international support for divestment has not yet emerged. GRADE: A OPERATIONAL EFFICIENCY The statute does not include a pension fund re-allocation plan. The New Jersey Treasurer said that divestment would make the pension funds less effective and less diversified. 10 Without information how those investments are re-allocated it is difficult to predict how the fund will perform. GRADE: B EQUITY The interests of pension fund investors are neglected by the statute, which did not guarantee that returns will remain the same after the divestment. Moreover, because this is not “targeted divestment,” it is assumed that some positive impacts of foreign investment in Sudan will be lost in the short-run. These short-run losses may, however, be a necessary trade-off if genocide is to end in the long-run. GRADE: C ACCOUNTABILITY The terms of divestment set a tough precedent for firms. Spread evenly over the 17 firms, the divestment amounts to over $100 million divestment per firm. That is serious money. GRADE: A 10 Wall Street Journal, 5/8/06.
  • 16. NEW JERSEY REPORT CARD Winners Losers • Pension fund investors (if the • Divested firms and their employees. values of divested stocks decrease in the long-run). • Firms to which divested funds • Sudanese government. are re-allocated. • Genocide victims in Darfur. • Sudanese citizens who benefit from activities of divested firms. • Society as a whole. • Oil consumers.
  • 17. NEW JERSEY REPORT CARD OVERALL GRADE: B The New Jersey divestment has significant flaws. • The State may have first exerted shareholder activism while it more fully considered divestment. The trade-off between divestment and shareholder activism, however, is time. (Shareholder activism has been successful, for example, in the New York City Comptroller’s campaign to persuade firms to end business ties to countries that sponsor terrorism. 11 ) • More consideration should have been given to pension fund investor interests; according to the available information, there does not appear to have been a re-allocation plan at the time the divestment decision was made. • The divestment is not “targeted,” which makes it likely that there will be unintended losers. EX POST FACTO GRADE: A Despite these flaws, New Jersey receives an A for taking a risk and assuming a leadership role in the effort to end genocide in Sudan. 11 New York Times, 3/10/05.
  • 18. CONCLUSIONS & RECOMMENDATIONS Divestment can be an effective and equitable tactic for achieving social goals. Decisions to undertake divestment should be evaluated within the framework outlined in this presentation and should be particularly attentive to the following points: • Divestment should give significant consideration to pension fund investors. While the equity goals of divestment are noble, it is only fair to protect members’ retirement investments as well. • Shareholder activism may be just as effective as divestment and can help to avoid unintended negative consequences of divestment. • The highest level of effectiveness and equity is achieved with “targeted divestment.” • Divestment should be thought of as one tactic among many.
  • 19. SOURCES Fried, Carla, “How States are Aiming to Keep Dollars Out of Sudan,” in the New York Times, February 19, 2006, p. 5. Gaffney, Frank, et. al., “The Terrorism Investments of the 50 States,” Center for Security Policy, Washington, D.C., August 12, 2004. Graham-Felsen, Sam, “Divestment and Sudan,” in The Nation, May 8, 2006. Hammond, William, “Fighting Terrorism with Funds,” in the New York Times, August 30, 2004, p. 13. McNichol, Dunstan, “State to Wrap Up Sudan Divestment by August: Panel Bows to Legislative Order Two Years Ahead of Time,” in the New Jersey Star Ledger, April 21, 2006. Munnell, Alicia and Annika Sunden, “Social Investing: Pension Plans Should Just Say No,” paper presented at “Costs and Benefits: “Socially Responsible” Investing and Pension Funds,” a conference at the American Enterprise Institute, Washington, D.C., June 7, 2004. Page, Jeffrey, “Message from N.J. to Sudanese Government,” in the Bergen County Record, August 2, 2005, p. L13. Peterson, John, ed., Local Government Finance: Concepts and Practices (Chicago: Government Finance Officers Association, 1999). Rivoli, Pietra, “Making a Difference or Making a Statement?: Finance Research and Socially Responsible Investment,” in Business Ethics Quarterly 13:3, July 2003 Siew, Teoh Hong, Ivo Welch, and Paul Wazzan, “The Effect of Socially Activist Investment Policies on the Financial Markets: Evidence from the South African Boycott,” in the Journal of Business 72:1, January 1999. Spencer, Jane, “Sudan-Divestment Laws Draw Attacks from Fund Managers, Business Groups,” in the Wall Street Journal, May 8, 2006. Stuart, Catriona, “Effort to Divest from ‘Rogue States’ Working, City Says,” in the New York Times, March 10, 2005, p. 4. Vick, Karl, “Oil Money is Fueling Sudan’s War; New Arms Used to Drive Southerners from Land,” in the Washington Post, June 11, 2001, p. 1.