1. The Financial Impact of Fossil Fuel Divestment
How Does Divestment Affect the Share Price of Targeted Companies?
Master Thesis of
Alison Schultz
M.A. Global Political Economy
Supervisors: Prof. Christoph Scherrer and Prof. Christian Klein
Arbeitnehmermitbestimmung

2. Agenda Introduction Related Literature Theoretical Framework Data
Methodology and Findings
Conclusions
Adress critical points where they fit

3. 1. Introduction The Fossil Fuel Divestment Campaign
Fossil fuel divestment “eliminating investments in major coal, oil, and gas companies and refusing to acquire new investments in such companies” Schneider et al. (2016, 109)
Divest Kassel 2017
Fastest growing divestment campaign in history
811 institutions have committed to divestment
≅ 5.58 trillion USD
Definition: read
2012 to now, social movement has spread rapidly over globe, campaigns and groups which pressure all kinds of institutions to divest money from fossil fuels: image Kassel
Fastest growing
Success in pressuring institutions to divest
Campaigns’ claim: by divesting form fossil fuels: read
gofossilfree.org, 2017
“We will choke off financing and social capital for fossil fuels by divesting our institutions.”

4. 1. Introduction Research question
Can fossil fuel divestment actually hurt the fossil fuel sector financially?
No empirical findings so far
How does divestment affect the stock price of the coal, oil and gas companies targeted by the fossil fuel divestment campaign?
Why should this question be answered?
Academic perspective: Add further piece to puzzle of sustainable investment’s opportunities and limits
Movement’s perspective: Understanding financial mechanisms behind divestment to effectively tailor campaign
This thesis’ contribution
Estimate direct, short term, and indirect, long-term, impact of divestment on stock prices of the 200 largest coal, gas and oil firms
Provide new data on divesting institutions (largest existing divestment database) ?
Reduced physical investment
Divestment
Depressed share price
Higher costs of capital
Reduced cost competitiveness
The present paper is an attempt to fill this gap. To improve understanding of the movement’s financial impact, divestment’s potential to depress stock prices of fossil fuel companies is scrutinized. The direct, short term, and indirect, mid to long-term, impacts of divestment on stock prices of the 200 largest coal, gas and oil firms are estimated. To this end, new data on divesting institutions was gathered. Including, inter alia, divestment dates, detailed sums divested, targeted companies and divestors’ motivation of 149 divesting institutions, the data set is the most extensive on divestment so far (including all previous campaigns, to the author’s best knowledge).

5. 2. Related Literature Fossil Fuel Divestment
acts as a lever for social change and politicizes environmental activism “sea change, from individualized sustainability efforts towards a youth-led collective political action and the recognition of climate change as a social justice issue” (Apfel 2015, Ayling/Gunningham 2015, Grady-Brenson/Sarathy 2015, Seidmann 2015)
induces costs for divesting institutions? Trading, diversification and compliance costs vs. reduced exposure to regulation risk (Cornell 2015, Bessembinder 2016, Fischel 2015 versus Hunt et al. 2016, Mercer 2015, Trinks et al. 2017)
has an unclear (financial) impact on targeted companies
Building on evidence of financial impact of former campaigns (c.f Ansar et al. 2013)
Divestment targeting South Africa and Sudan: inconclusive effect on companies’ stock prices and capital costs (Davidson et al. 1995, Ding et al. 2014, Teoh et al. 1999)
Divestment targeting ‘sin industries’: Higher capital costs for sin industries (Hong/Kacperczyk (2009), Kim/Venkatachalam (2011), Fabozzi et al. (2008), El Ghoul et al. (2011), Chong et al. (2006))
Evidence from former campaigns cannot be directly transferred to fossil fuel divestment
Campaign is stronger than previous campaigns
Against the backdrop of efforts to fight climate change, the fossil fuel sector is in a peculiar situation (Hunt et al. 2016, Mercer 2015)
no other ‘sin industry’ has been questioned on basis of its ability to generate future earnings. Fossil fuel investment, by contrast, is heavily exposed to regulation risk in the context of climate change policies. This risk could soon be captured by a broad investor base driven by purely financial considerations. Therefore, the current campaign’s potential to hurt the sector financially should supersede previous stock boycotts’ capabilities. However, these results come from merely three studies of which one has serious methodological flaws

6. 3. Theory 3.1 The Direct (Short-Term) Impact of Divestment
Asset prices determined by
Divestment’s effect
Law of One Price
Future cash flows
No effect
Capital Asset Pricing Model
(Sharpe
Exposure to systematic risk
No effect
1964, Lintner 1965,
Mossin
1966)
Exposure to all kinds of
Arbitrage Pricing Theory
(Ross 1976)
No effect
(macroeconomic) risk factors
What if two assumptions of these theories are loosened?
Not every investor does invest in
every stock
Number of investors investing
in a given asset and associated
Negative effect
 Segmented Markets
(Merton 1987)
opportunities for risk sharing
Miller and Merton genauer erklären!
Heterogenous expectations
 Divergence of opinion among
Holding investors’ evaluation
Negative effect
of the asset’s value
(> average evaluation)
investors
(Miller 1977)
H1: In the short term, divestment has a small negative effect on the share price of targeted firms.

7. 3.2 The Indirect (Long-Term) Impact of Divestment Background: Current Situation of Fossil Fuel Sector
»Stranded Asset Risk« and the »Carbon Bubble«
Against the backdrop of global efforts to fight climate change, the fossil fuel sector is exposed to serious risk
»Stranded Assets«
To limit warming to 2°C, 80% of proven oil, gas and coal reserves have to stay in the ground
However, their burning has already been priced in
Sector is overvalued and will most probably lose value soon
To maintain 2°C goal, up to 80% of proven reserves of oil, gas and coal cannot be burned
»Carbon Bubble«

8. 3.2 The Indirect Impact of Divestment Divestment as a Signal for Sector’s Overvaluation
In the context of the sector’s overvaluation, divestment could send a signal to raise awareness of the »carbon bubble« and catalyze its burst
Break »informational cascades« (Bikchandri et al. 1992)
Signal to enable rational traders to coordinate in the bubble’s burst (Abreu/Brunnermaier 2003)
DIVESTMENT!
INVEST NOT INVEST
DIVESTMENT!
INVEST NOT INVEST
“When should I leave exactly?”
 Carefully look for signals
Informed actors’ consideration:
“The sector is overvalued”
Some learn: 8
CAPM, APT “risk”, not in short but in long term
H2: Fossil fuel divestment has an indirect, medium to long term negative effect on asset prices which outperforms the direct, short term effect.
H3: The indirect, medium to long term negative effect of fossil fuel divestment on asset prices is stronger for financially motivated divestment.

9. 3.2 The Indirect Impact of Divestment Different Risk Exposure of Different Fossil Fuels
The exposure to stranded asset risk differs between different fossil fuels
…and markets
Higher risk exposure for companies operating in Global North, esp. for coal
COAL
NATURAL GAS
Costly energy production
High probability of regulation
Focus of civil society’s protest
(Ansar et al. 2013, Glomsrod et al. 2016)
Viewed as cheap, reliable fuel source
Little or positive regulation as a ‘bridge technology’
Considered as ‘clean energy’ by big parts of society
(Hausfather 2015, Paltsev et al. 2011)
Differentiation between oil and gas not possible, but all (?) companies of carbon underground 200’s oil and gas companies are involved in BOTH fuels
H4: Fossil fuel divestment’s impact is stronger for coal companies than for oil and gas companies.
H5: Fossil fuel divestment’s impact is stronger for companies operating mainly in markets of the Global North.

10. 4. Data Independent Variable: Divestment
Survey conducted among divesting institutions in summer 2017 (n=149)
Divestment announcement dates from 2012 to 2017 (77 general divestment announcements and 125 firm-specific dates)
Divested sums (n=48) ranging from USD to Mio USD
Dependent Variable: Stock price/return of targeted companies
‘Targeted companies’= »Carbon Underground 200« and firms named by respondents
Stock price: Total Return Index (RI) from Datastream, 2000 to 2017
Stock return: Log daily returns from stock price
Control Variables
Three Fama-French Factors: Market excess return, High-Minus-Low and Small-Minus-Big from Kenneth French’s website
Oil price: West Texas Intermediate crude oil spot price from Datastream

11. 5. Methodology and Findings 5.1 Event Study for Short-Term Analysis
Event studies are used to disentangle the stock price reaction on divestment from all price variations with other causes
‘Abnormal returns’ are estimated following divestment announcements
The effect is measured (1) on the specific company whose shares are sold and (2) on the whole industry
Estimation Window
Use firm-level data to estimate normal returns
Event Window
Calculate abnormal returns
time
Problem: Theoretically, larger sums divested should result in stronger price reactions (c.f. Miller 1977). The event study based on divestment announcements is unable to capture this prediction
Solution: Sector-wide analysis conditional on divested sums

12. 5.1 Firm-Specific Event Study Cumulated Average Abnormal Returns (CAAR) in 7-days event window

13. 5.1 Firm-Specific Event Study Coal Firms

14. 5.1 Firm-Specific Event Study Coal Firms in Global North

15. 5.1 Sector-Wide Event Study Cumulated Average Abnormal Returns (CAAR) in 7-days event window
CAAR (Sector-Wide) for 76 Divestment Announcements

16. 5.1 Sector-Wide Event Study Divestment Announcements with Financial Motivation
CAAR (Sector-Wide) for 14 Divestment Announcements with Financial Motivation
CAAR
95% confidence interval
Event Day
Is this relationship an artefact of a correlation between financial motivation and high divested sums?
Correlation between financial motivation and divested sum: 22.13%

17. 5.1 Sector-Wide Event Study Large Divested Sums (over 1 Million USD)
CAAR (Sector-Wide) for 55 Divestment Announcements above 1 Mio USD
1 mio = median
Amount of divestment is be important
It is however not the only reason for the importance of financial motivation

18. 5. Methodology and Findings 5
5. Methodology and Findings 5.2 Latent Growth Curve Model for Long-Term Analysis
Latent Growth Curve Modeling:
A ‘normal’ growth path is estimated for each fossil fuel company over the years 2007 to 2017
It is assessed if company-specific growth trajectory is affected by the accumulating level of divestment
Findings:
Positive effect of divestment announcement and divested sums on the stock price
Positive effect breaks down for financially motivated divestment
How can positive effect be explained?
No convincing theoretical argument  Problems with the applied method
 Results from Latent Growth Curve Model should be interpreted with caution

19. 6. Conclusion
Using new data on fossil fuel divestment, this thesis seek to shed light on the campaign’s influence on share prices of targeted companies
Direct, short-term impact of divestment
Theoretically, a direct effect of divestment should result from limited risk sharing (Merton) and the fact that assets can only be sold at a discount (Miller)
Empirically, announcement to divest from a specific company has no effect on this specific company’s stock price
This effect is however present for coal firms which mainly operate in markets of the Global North
Divestment announcements are found to have a negative impact on stock prices of the whole fossil fuel sector
This effect is even more pronounced for financially motivated divestment and large divested sums

20. 6. Conclusion Indirect, long-term impact of divestment
Theoretically, divestment should indirectly depress stock prices by informing other investors about the sector’s overvaluation
Empirically, a positive effect of divestment is found. This is most probably due to methodological problems.
At this stage it can be concluded that divestment has some potential to depress stock prices.

21. Thanks for Listening.
Active Divestment groups as by December 2017

22. References (1)
Abreu, Dilip and Markus K. Brunnermeier, “Bubbles and Crashes,” Econometrica, 71 (2003), 173–204. Apfel, Daniel C., “Exploring Divestment as a Strategy for Change: An Evaluation of the History, Success, and Challenges of Fossil Fuel Divestment,” Social Research: An International Quarterly, 82 (2015), 913–937. Ayling, Julie and Neil Gunningham, “Non-state governance and climate policy: The fossil fuel divestment movement,” Climate Policy, 17 (2015), 131–149. Bikhchandani, Sushil, David Hirshleifer, and Ivo Welch, “A Theory of Fads, Fashion, Custom, and Cultural Change as Informational Cascades,” Journal of Political Economy, 100 (1992), 992–1026. Chong, James, Monica Her, and G. M. Phillips, “To sin or not to sin? Now that's the question,” Journal of Asset Management, 6 (2006), 406–417. Cornell, Bradford, “The Divestment Penalty: Estimating the Costs of Fossil Fuel Divestment to Select University Endowments,” Browser Download This Paper (2015). Davidson, Wallace N., Dan L. Worrell, and Abuzar El-Jelly, “Influencing Managers to Change Unpopular Corporate Behavior through Boycotts and Divestitures,” Business & Society, 34 (1995), 171–196. Ding, Ning, Jerry T. Parwada, and Jianfeng Shen, “When does a stock boycott work? evidence from a clinical study of the sudan divestment campaign,” (2014). Fabozzi, Frank J., K.C Ma, and Becky J. Oliphant, “Sin Stock Returns,” The Journal of Portfolio Management, 35 (2008), 82–94. El Ghoul, Sadok, Omrane Guedhami, Chuck C.Y. Kwok, and Dev R. Mishra, “Does corporate social responsibility affect the cost of capital?,” Journal of Banking & Finance, 35 (2011), 2388–2406. Fossil Free, “About Fossil Free,” Fischel, Daniel R., “Fossil fuel divestment: A costly and ineffective investment strategy,” Compass Lexecon (2015). Grady-Benson, Jessica and Brinda Sarathy, “Fossil fuel divestment in US higher education: Student-led organising for climate justice,” Local Environment, 21 (2015), 661–681.

23. References (2)
Hunt, Chelsie, Olaf Weber, and Truzaar Dordi, “A comparative analysis of the anti-Apartheid and fossil fuel divestment campaigns,” Journal of Sustainable Finance & Investment, 7 (2016), 64–81. Hong, Harrison and Marcin Kacperczyk, “The price of sin: The effects of social norms on markets,” Journal of Financial Economics, 93 (2009), 15–36. Kim, Irene and Mohan Venkatachalam, “Are Sin Stocks Paying the Price for Accounting Sins?,” Journal of Accounting, Auditing & Finance, 26 (2011), 415–442. Lintner, John, “The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets,” The review of economics and statistics (1965), 13–37. Merton, Robert C., “A Simple Model of Capital Market Equilibrium with Incomplete Information,” The Journal of Finance, 42 (1987), 483–510. Miller, Edward M., “Risk, Uncertainty, and Divergence of Opinion,” The Journal of Finance, 32 (1977), 1151–1168. Ross, Stephen A., “The arbitrage theory of capital asset pricing,” Journal of economic theory, 13 (1976), 341–360. Schneider, Jen, Steve Schwarze, Peter K. Bsumek, and Jennifer Peeples, “The Hypocrite’s Trap,” in Under Pressure: Coal Industry Rhetoric and Neoliberalism (London: Palgrave Macmillan UK, 2016), 105–133. Seidman, Gay W., “Divestment dynamics: Mobilizing, shaming, and changing the rules,” Social Research: An International Quarterly, 82 (2015), 1015–1037. Sharpe, William F., “Capital asset prices: A theory of market equilibrium under conditions of risk,” The Journal of Finance, 19 (1964), 425–442. Teoh, Siew H., Ivo Welch, and C. P. Wazzan, “The Effect of Socially Activist Investment Policies on the Financial Markets: Evidence from the South African Boycott,” The Journal of Business, 72 (1999), 35–89. Trinks, Arjan, Bert Scholtens, Machiel Mulder, and Lammertjan Dam, “Divesting Fossil Fuels: The Implications for Investment Portfolios,” (2017).

24. Theoretical Mechanism between Divestment, Share Prices and Carbon Emissions

25. The Stock Market with Heterogenous Expectations
Source: Own representation based on Miller (1977)

26. Miller’s model under Divergence of Opinion
Source: Own representation based on Miller (1977)

27. 3. Theory 3.2 The Long Term Impact of Divestment: Background
In times of climate change, the fossil fuel sector is exposed to three kinds of risk:
Technological breakthrough could make clean energy more competitive
Public policies fighting climate change could impede the companies’ continuation with ‘business as usual’.
Social factors, such as a societal transformation towards a low-carbon society, could break down demand for fossil energy (Mathieu 2015: 7).
»Stranded Asset Risk« and the »Carbon Bubble«
»Stranded Assets«
To maintain 2°C goal, up to 80% of proven reserves of oil, gas and coal cannot be burned
To limit warming to 2°C, 80% of proven oil, gas and coal reserves have to stay in the ground
However, their burning has already been priced in
Sector is overvalued and will most probably lose value soon
»Carbon Bubble«

29. Taylored Design Method
Establish Trust
Show authenticity and legitimacy of request: Postal address provided, contact opportunity by and phone
Sponsorship by legitimate authority: Reference to University of Kassel and International Center for Development and Decent Work
Assure confidentiality and data protection: in invitation, questionnaire and elaborated in second reminder
Professionalism: in communication and design of questionnaire
Decrease costs
Reduce length and complexity: just 15 questions, simple wording and smart filters
Use good visual design
Make responding convenient: respondents just click on link and enter code, easy to send around within organization
Avoid uncomfortable modes: web-based or fillable PDF options
Avoid offering choice of modes: PDF option introduced as a later offer to facilitate response
Minimize request for sensitive information: two sensitive questions in the end of questionnaire
Avoid subordinating people: adult-to-adult communication style
Increase benefits
Tell how results will be used: importance for divestment campaign and fight against climate change is stressed in invitation, reminders and questionnaire
Ask for help: in invitation and reminders respondents are asked for help, in the questionnaire they are thanked for their help
Ask interesting questions: questions about moral reasons for divestment and financial assessment of fossil fuel assets in the beginning
Convey that others have responded (in reminders)
Use a legitimate and trusted sponsor: University of Kassel and International Center for Development and Decent Work with logos
Stress that opportunities are limited: in reminders
Do not deny benefits
Source: Own representation based on Dillman, Smyth, and Christian (2014: 42)

30. 2017 Fossil Fuel Divestment Survey

33. Different Risk Exposure of Different Fossil Fuels Divested Fossil Fuels in Sample
Source: Own representation

34. 5. Methodology and Findings 5.1 Event Studies for Short Term Analysis
Event studies are used to disentangle the stock price reaction on divestment from all price variations with other causes
‘Abnormal returns’ are estimated around divestment announcements
The effect is measured (1) on the specific company whose shares are sold and (2) on the whole industry
Estimation Window
Use firm-level data to estimate normal returns
Firm specific analysis:
5 years up to 30 days before the (firm specific) event
Sector-wide analysis:
1/1/ /31/2013 (27 days before the 1st announcement)
Event Window
Calculate abnormal returns
starts 1 resp. 3 days before announcement
ends 1 resp. 3 days after announcement
time
Problem: Theoretically, larger sums divested should result in stronger price reactions (c.f. Miller 1977). The event study based on divestment announcements is unable to capture this prediction
Solution: Sector-wide analysis conditional on divested sums

35. 5.2 Latent Growth Curve Analysis Model Specification
Firm type
(coal vs oil/gas)
Intercept Factor
Linear Slope Factor
Quadratic Slope Factor
Cubic Slope Factor 1² 1 4² 2² 1³ 4 1 3 2³ 1 1 3² 3³ 1 4³ 2
Share Price
Day 1
Share Price
Day 2
Share Price
Day 3
Share Price
Day 4
𝜀 1
𝜀 2
𝜀 3
𝜀 4
Divestment Level Day 1
Divestment Level Day 2
Divestment Level Day 3
Divestment Level Day 4
FF & Oil Price Day 1
FF & Oil Price Day 2
FF & Oil Price Day 3
FF & Oil Price Day 4

36. Divestment from Southern Coal Companies

37. Divestment from Northern Fossil Fuel Companies

39. 5.2 Latent Growth Curve Analysis Findings
Alternative method for long-term analysis
Extend sample by non-public (i.e. fully state-owned) coal, oil and gas companies which should be exposed to similar economic developments but unaffected by divestment
Mimic experiment in which stock price of companies ’treated’ by divestment can be directly compared to the ‘non-treated’ control group (e.g. propensity score matching)