This is an edited excerpt of a conversation held this past March in Chicago at Unpacking ESG: Exit vs. Voice, an event hosted by Chicago Booth’s Stigler Center for the Study of the Economy and the State and Booth’s Rustandy Center for Social Sector Innovation. The McKnight Foundation’s Elizabeth McGeveran, David Swift from investment fund Engine No. 1, and Booth’s Luigi Zingales discussed methods to advance corporate change, while Booth’s Marianne Bertrand moderated. Visit the Stigler Center’s website for a video of the entire discussion.

Marianne Bertrand: Luigi, you’ve been doing a lot of writing academically on the questions of exit versus voice. Can you help us frame the conversation in light of your work? What exactly are we talking about?

Luigi Zingales: I want to distinguish between the reasons investors are interested in ESG [environmental, social, and governance concerns]. First, people love ESG because it’s a good predictor of long-term stock returns. The reason is irrelevant, more or less. ESG is 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.

Then there is a deontological stand. If you’re Mormon, you don’t want to make money by producing wine. And as far as I understand the Mormon religion, you don’t necessarily want to prevent other people from making wine, nor do you mind that other people make money by producing wine. It’s just that you don’t want to involved with it. More recently, after the invasion of Ukraine by Russia, several people I’ve seen and heard have taken a deontological stand. You don’t want blood on your hands, so you don’t want companies that you invest in, or you work in or buy from, to have any dealing with Russia.

Then there is what I call a 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.

I don’t want to give an impression that one reason is better than another. Nevertheless, I think it’s important to ask what drives our ESG interests.

Now that we’ve classified the motivations, let me move to the strategies. There are two main strategies that, following [the late economist] Albert Hirschman, I will call exit and voice. If you’re an investor, exit means divestment. The alternative, voice, means voting at a shareholders’ meeting or engaging with management to make a change. If you are worker, voice can mean negotiating with management for a change.

The two strategies tend to be substitutes. On the one hand, if a fraction of prosocial investors choose to divest rather than engage, the chances of gaining a majority in any shareholder meeting on issues that are prosocial shrink. On the other hand, if a fraction of prosocial investors try to engage, it will ultimately undermine the effect of divestment because to engage you have to have votes, and to have votes, you have to have ownership. There is an important trade-off here, because if you are prosocial investors, you need to coordinate on a strategy. Clearly the first two motives are satisfied by exit, but the consequential approach leads more to justify voice.

Bertrand: David, you represent Engine No. 1, which made a splash last year for forcing some changes on the board of Exxon Mobil. I have a broad sense that your strategy, going back to Luigi’s framework, is one of voice. But I don’t have a good sense of your motivation.

David Swift: We started the organization, Engine No. 1, with a simple idea that if we’re going to really be driving the type and amount of change and impact that we want to have as investors, as capitalists, we would need to do that at scale in the public markets. We looked at the existing ESG landscape before starting Engine No. 1 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. I put those in quotes because the determining factor for good and bad is a little noncorrelated. 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.

We took a different tack. The first was to create a framework inspired by some of the work that Luigi and his colleagues have done—to quantify the material impact that a business has and net it against the profitability of the business. We call that our total value framework. We look at how a company generates its profits, and then at what type of damage (either environmental or social) it does in dollar terms to get to that profitability. We look for outliers. Exxon was an extreme outlier in the energy space. They certainly do generate a lot of profit, but along the way, they do a lot of damage.

If we can go in and engage with that organization and management team to think about a path to reduce the damage, that should be a net positive both for the company and its future profitability, but also for the environment and the world. That’s what we intended to do with the Exxon campaign, and it’s one of the reasons that we ran it the way we did. The broader idea is to continue to work with the management teams of organizations, hopefully in a collaborative way.

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, we focus on making compelling 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.

“The moment they [investment managers] live up to their lofty rhetoric, they realize that they are in a bit of a pickle.”

—Luigi Zingales

Bertrand: I tend to think that there is a trade-off between some of these externalities and the bottom line. You’re not taking that position. Is that because you think it’s important in terms of attracting investors?

Swift: The short answer to your question is that the trade-off is relative to your duration of investment. Over a brief period of time, companies have to internalize some of these damages. However, over an extended duration, which is different for every company, these economic outcomes should be positive.

If a company is on the right side of a business transformation, the short-term investments it needs to make should prove to pay off in multitudes over the long run. GM, as it evolves toward electric vehicles, is a prime example. Over the course of time, if it gets this right, it has the ability to take market share from other auto manufacturers. It has the ability to recruit and retain better employees. It has the ability to innovate internally. It should see continued support from investors and capital allocators. All those macro tailwinds should be a result of GM making short-term investments to increase the durability of its business over the long run. We would expect the company to experience better growth rates. And as market participants, we expect that to come with better multiples. We don’t think there are trade-offs if you extend duration long enough.

Elizabeth McGeveran: I’m from the McKnight Foundation. One of our largest grant-making programs is called the Midwest Climate & Energy program, because the American Midwest is the largest region that produces greenhouse gas. If it were a country, it would be the sixth largest producer of greenhouse gasses in the world.

It’s our view that 5 percent of our endowment we have to provide as grants every year, and the other 95 percent of the endowment, about a $3 billion foundation, also needs to be working for more sustainable, long-term, transparent markets.

We are most certainly in the “predictor of long-term stock performance” camp, in both our stock and private investments. 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 run, 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 are using our money in different ways, and 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 strategies, such as exit versus voice, I’m going to add a third category: select better. We participate in all three of these areas. In terms of exiting, in 2014, we introduced 10 percent of our endowment for impact investments, but we decided not to divest. Instead, we’ve been actively decarbonizing the portfolio since that time. Which leads us to 2021, when we became the largest foundation in the United States to make a net-zero endowment commitment. That will require us to divest from fossil fuels and also decarbonize.

We certainly use our voice, particularly as a customer of financial services. At our size, that’s a place we can have greater impact with our managers, rather than with the portfolio holdings. Then, with select better, 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.

Bertrand: A common reaction to exit is that it’s better to have people who “care” hold the assets. What is your reaction to that?

Swift: Without the structures in place for some of the big asset management organizations to contemplate these issues, and without the general push from all investors to make these issues more material, it would’ve been much more difficult for us to be successful. We certainly needed BlackRock, State Street, and Vanguard, among others, to support our shareholder proposal last year.

Despite the amount of ESG rhetoric that has come out of those large institutions over the past two years, the actual execution on a voting strategy is not as good as one would hope. One of the reasons that we launched an index product, with the ticker VOTE, was to do a better job of executing on shareholder proposals that contemplated environmental and social issues. If you went back and looked at our campaign and tried to figure out how Vanguard or State Street voted, you would have had a hard time figuring that out.

McGeveran: What mechanisms do some of these large institutional investors have to try to figure out the preferences of the people investing through them? I’m sure I’m investing money via BlackRock. How does it know what my preferences are, and how I would want it to vote on all particular issues? It looks like there’s a huge transaction cost in the process of getting shareholders to be able to exert their preferences.

Zingales: Until recently, there wasn’t much pressure to even try to elicit those preferences. Now things are changing, to some extent because people like David put pressure on BlackRock to live up to its lofty rhetoric.

The moment they [investment managers] live up to their lofty rhetoric, they realize that they are in a bit of a pickle. They have a bunch of investors who want one thing, and other investors who want another thing. And they are realizing that they might be accused of being too powerful, so they’re trying to share their vote with the ultimate investors. This month they are rolling out a system where they give institutional investors the right to vote the way they want.

Another thing is that ISS (Institutional Shareholder Services) has some custom policies. There is a Taft-Hartley policy that is basically for labor unions. There is a Catholic-faith policy for people who have certain religious beliefs. There is another that is environmental. The only thing they don’t have is a policy for people who don’t care about anything other than money. The last challenge that we have is how to aggregate the preferences of individual investors in a 401(k).

Bertrand: It requires a lot of attention and people paying attention to and thinking carefully about issues. Let’s assume that people have this motivation and want to do the right thing. There’s still going to be the issue of information.

None of this is easy to measure. Let’s separate the E, the S, and the G, because my sense is that when it comes to the E, there’s at least hope that things can be measured and shareholders can make an informed decision. But when it comes to the S side of things, I find things particularly difficult. What information do you rely on to make the right decision?

Swift: It’s an imperfect system. We’re far from a place where we can just close our eyes and have everything we need to make a decision. We look at each individual company and then dig into the material factors for that business.

On the social side, it’s very challenging. We use a bunch of third-party data sets, and we have data scientists on our team help us source, verify, and bring those data sets into the analytical framework that we use on the fundamental side to make investment decisions.

On the environmental side, it’s easier but still hard work. You’re able to quantify the carbon footprint for a lot of businesses to the degree you have reporting. The SEC (Securities and Exchange Commission) is pushing for better transparency, and we need universally accepted accounting standards that we can all rely on. We’re still pretty far off on the environmental side, and the social side’s behind that.

Our view is that over the next two or three years, the transparency around the data and the availability of the data are going to increase exponentially. We have to be ready for that and build the system to digest it.

Marianne Bertrand is the Chris P. Dialynas Distinguished Service Professor of Economics at Chicago Booth. Elizabeth McGeveran is director of investments at the McKnight Foundation. David Swift is CEO at Engine No. 1. Luigi Zingales is the Robert C. McCormack Distinguished Service Professor of Entrepreneurship and Finance and the George G. Rinder Faculty Fellow at Booth.

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