Ethical Investing

Ethical investing is the practice of not investing in companies which engage in ethically reprehensible behaviour. There are many varieties, but, for example, some people refuse to invest in companies which sell tobacco. Does this make any sense?

There are presumably two goals here. One is to punish companies which act badly, in the hopes of changing their behaviour. To other is to discourage companies which currently behave well from starting to act badly, and similarly to discourage new companies which act badly from being created. Pragmatist that I am, I’ll neglect the “dirty money” issue: you feel better because your income does not come from contaminated sources.

For an existing company, when a pool of people refuses to buy shares in that company, it is possible for the share price to go down. Whether it really will go down depends on a number of factors. As I’ve written elsewhere, share price is largely a hallucination. It is rarely governed by any sort of supply and demand. The share price is a reflection of the perceived value of the company. If we assume that no more than, say, 25% of available investment money refuses to buy shares in the company, I see little reason to assume that the lowered demand would have any effect on the share price. However, it is certainly possible that a well-known share boycott would tend to make the company look bad, and push the share price down for that reason.

What is the effect on the company of having the share price go down? It becomes harder for management to raise money in the public markets, and it becomes harder for them to acquire other companies for stock. Executive management these days is generally paid in stock, so it becomes harder for the company to recruit executives from outside. It has no significant effect on sales or profitability.

These seem to me to be fairly weak long-range effects. Companies do often work hard to prop up their share prices, because it benefits the executives. However, as noted above, increasing demand for shares need not directly lead to an increase in share price, and it takes a long time to change a company’s image. If the undesirable behaviour is profitable, it is unlikely that a company would change it merely to prop up the stock price.

With new companies, the issue is different. Share prices during an IPO do have a lot to do with demand. On the other hand, only wealthy investors participate in IPOs; the behaviour of the average investor is irrelevant.

So it seems to me that if the goal is to change company behaviour, ethical investing is not very useful. It would be better to take steps to make the unethical behaviour unprofitable or illegal. It would be better to get wealthy investors to sign declarations that they will not participate in IPOs of unethical companies. Ethical investing might make you feel better, but I think it will have little practical effect.