Clearing The Air

Based on research by Kunal Sachdeva

In recent years, activist investors have been voicing their wishes – and changing corporate governance – with growing vigor. Most research, however, tracks the way these investors shape these companies in order to increase shareholder wealth. In a groundbreaking new study, Rice Business professor Kunal Sachdeva has shown that activist investors can also change a company’s environmental choices – leading to lower toxic emissions, greenhouse gases, and pollution in the neighborhoods around specific facilities.

“The Real Effects of Environmental Activist Investing,” a working paper co-written by Sachdeva with professor Lakshmi Naaraayanan and doctoral student Varun Sharma of London Business School, recently won the Moskowitz Prize from Northwestern University’s Kellogg School of Management. The prize honors work that shows how shareholders can positively influence a company’s environmental impact. Here, Sachdeva explains his findings.

RBW: What drew you to this topic?

KS: People are increasingly interested in investments that align with social mandates. One of these mandates is addressing climate change and the environment. Traditionally, investors express this concern through divestment campaigns: selling or not investing in fossil fuel companies or utility companies that are large polluters. However, if you do that, you lose a seat at the table. You can’t use your voice within these firms because you are not an owner.

Our question was: Can investors use traditional tools such as activism to demand that firms improve practices such as environmental behaviors?

RBW: What was the answer?

KS: The answer was yes. We approached this by studying the New York City Pensions System, which instituted an activist campaign called the Boardroom Accountability Project (BAP). The project gave pensioners a long-term voice in the companies where they invest, and one of their key mandates was addressing companies’ effect on the environment. To get our answers, we looked at firms that the Project targeted over environmental issues. We specifically wanted to know how these firms responded, how local economies were affected and what the financial implications were for the firms involved.

RBW: What challenges did you encounter in this research?

KS: Our main challenge was accurately measuring and linking the change in a firm’s environmental performance to the activism campaign. For example, a firm may have already been in the process of improving its environmental practices. If this were the case, our study could overstate the impact of the activism. So we needed to find a setting that let us precisely measure the effects of investor activism.

Studying the Boardroom Accountability Project allowed us to compare facilities that had been targeted with facilities that had not been targeted. We then used data from the EPA to understand the exact changes that each company was enacting.

RBW: What outcomes did you see for the targeted companies?

KS: On average, the plants targeted by the BAP reduced toxic emissions by 13 percent. We also saw a significant drop in greenhouse gas emissions.

When we looked beyond the plant level to the neighborhoods around the facilities, we saw a marked improvement in air quality. 

We also tested whether the targeted firms were shifting their pollution output to offsite plants. There was no evidence of this. Nor was there any drop in production. What we did see was a striking increase in company’s abatement efforts and capital spending related to these plant-level efforts.

Finally, we wanted to understand how this activism related to stock prices. We found a slight decline in financial performance, but we are cautious when interpreting these results. Our study looked at a window of about three years. It may take more time than that for companies to see all of the financial benefits of investing in pollution-fighting technologies. 

RBW: What’s the takeaway for investors who prioritize company environmental policy?

KS: This research shows that it’s possible to change company environmental practices through investing. There has been research about hedge fund activists demanding that firms change operations, but the main goal in these cases has been to increase stockholder wealth. There’s been a dearth of research showing that we can also use activism to influence company environmental policies. Climate change is one of the biggest challenges in our lifetimes. We think this research shows one exciting tool for addressing it.

Kunal Sachdeva is an Assistant Professor of Finance with the Jesse H. Jones Graduate School of Business at Rice University.