In a recent paper, we examine the economic impacts of a new Texas law to throw light on whether the often-heated political debate over environmental, social, and governance (ESG) issues is empty political rhetoric or a reflection of substantive policy differences.
Our study is motivated by news reports that claim that ESG issues have become a political flash point in the United States. For example, in November 2022, the U.S. Department of Labor reversed a Trump-era restriction and created new rules allowing retirement fund managers to consider ESG factors in making decisions on investments and shareholder rights. But on February 28 and March 1, 2023, the U.S. House and the Senate voted to overturn these new rules, a decision primarily driven by Republicans, who called ESG investing irresponsible and “woke.” But the matter didn’t end there. On March 20, 2023, President Biden signed the first veto of his presidency, rejecting the anti-ESG measures. He said that “the legislation passed by the Congress would put at risk the retirement savings of individuals across the country.” Our recent research shed light on this heated political debate by examining the recent backlash against ESG investing by largely Republican state politicians.
Red states, led by West Virginia and Texas, either have passed laws or are considering bills to ban their state agencies from conducting business with financial firms that prioritize ESG investing. West Virginia has barred five major financial institutions from its state banking contracts because they advocate boycotting fossil fuel companies. Texas requires its state pension funds to divest any actively or passively managed investment fund that boycotts energy companies. Similarly, Florida approved a resolution to bar the state’s pension fund from considering ESG factors when making investment decisions. That resolution proposes to divest $2 billion of investment under management by BlackRock due to its putative use of ESG standards. A common claim made by red state politicians is that by engaging in ESG investing, financial institutions such as BlackRock “use the hard-earned money of our states’ citizens to circumvent the best possible return on investment.”
Are red states’ push against ESG investing a carefully thought-out economic decision, meant to serve the financial interests of those states’ investment beneficiaries, or imply political posturing? We use the new Texas law to investigate the economic substance behind this debate.
In September 2021, the Texas legislature directed its state agencies to divest from investment companies that allegedly promote ESG causes and “boycott” energy stocks. On August 24, 2022, the Texas comptroller announced the specific list of investment funds that are subject to the divestment provisions. We examine those that invest in U.S. equities and have data on their equity holdings in machine readable databases. We investigate three angles of our main question.
First, do banned funds boycott the energy sector, as claimed in the Texan legislation? Not surprisingly, more than 60 percent of the banned funds’ names contain words that suggest an ESG focus, such as “sustainable” or “sustainability,” “ESG,” “climate,” “biodiversity,” “fossil,” “social,” and “carbon.” At least on the surface, the titles of the funds in the banned list seem consistent with the intention of the Texas proclamation— to stop doing business with funds promoting ESG causes.
We analyze the top holdings of the banned funds and compare them with the holdings of size-matched funds that were not banned and invest in domestic equities (the control sample). We first look at the holdings of the control sample to determine what the investments of a normal, non-ESG-focused fund look like. Their rank-ordered, top 20 holdings are Microsoft, Apple, Alphabet (Google), Amazon, Tesla, UnitedHealth, Nvidia, Visa, Johnson & Johnson, JPMorgan Chase, Lilly Eli, Mastercard, Facebook (now Meta), Berkshire Hathaway, ExxonMobil, Danaher, Bank of America, Thermo Fisher Scientific, Adobe Systems, and Broadcom. Notably, except the fossil fuel giant ExxonMobil at the 15th spot, there is no energy stock. Thus, even if a control fund, which does not proclaim any ESG leaning, were to become a banned ESG fund, it would not change any of its top holdings, except perhaps selling just one stock. Supplementary analysis shows that many banned funds, labeled as ESG funds, are indexers.
We then examine whether allocations among industry sectors differ between banned and control funds. We find that banned funds invest less in energy, financials, and utilities sectors relative to control funds. Underweighting in energy allocations is offset by larger investments in the information technology sector. It is noteworthy that banned funds allocate 3.51 percent and not 0 percent of their assets to the energy sector. In fact, 61.4 percent of energy sector securities held by control funds are also held by the banned funds. These results do not support the Texan politicians’ claim that ESG funds boycott energy sector.
Second, do Texas retirement funds invest mainly in the energy sector? The answer would shed light on whether politicians’ actions reflect their words, consistent with the putative interest of Texas beneficiaries. We obtained pre-ban data on holdings of three large Texas public pension plans: Texas Permanent School Fund, Employees Retirement System of Texas, and Teacher Retirement System of Texas. We find that they invest even less in the energy sector (between 1.88 percent and 3.05 percent of total portfolio value) than do the banned funds (3.51 percent). Interpreted another way, the three retirement funds’ exposure to energy would go up, not down, if they increase their investments in the banned funds.
Third, does the boycott make any difference to the fortunes of banned fund management companies? The answer would indicate whether banned investment managers would be hurt enough to alter their ESG focus to prevent further retaliation. We find that risk-adjusted returns of the banned funds from before to after the ban are not significantly different from the control sample. The Texas ban may serve as a warning for other ESG funds if it imposes significant damage to the prospects of BlackRock, such as resulting in mass withdrawals from its funds, at an extreme. BlackRock’s average daily stock market returns in the three-day window surrounding the Texas ban announcement are not significantly different from the average returns of the financials sector. Contrary to the idea of massive fund withdrawals, BlackRock reported a net inflow of funds during 2022.
Our results indicate that the Texas ban on ESG funds, and replacing the amounts invested in banned funds by control funds, would not in any economically meaningful manner shift the allocation of Texas retirement funds toward the energy sector. No evidence exists that the fortunes of banned funds themselves were materially affected by the Texas legislation. Our results suggest that the Texas act is nothing more than political rhetoric, arguably designed to generate headlines and excite the Republican voter base. Our results also demonstrate that, at least in this case, political posture has little impact on ESG causes – or economic results.
This post comes to us from professors Shivaram Rajgopal at Columbia Business School and Anup Srivastava and Rong Zhao at the University of Calgary’s Haskayne School of Business. It is based on their recent article, “Do Political Anti-ESG Sanctions Have Any Economic Substance? The Case of Texas Law Mandating Divestment from ESG Asset Management Companies,” available here.