Over the past year, the debate over Environmental, Social and Governance (ESG) standards in the United States has revealed stark policy contrasts between red and blue states. Red state officials have proposed and enacted “anti-boycott” bills which bar state business with firms that divest from favored industries. Blue states, on the other hand, have widely considered efforts to mandate divestments from the same industries. Neither approach makes economic sense. Recognizing this creates a real opportunity for a truce, based on fiduciary duty and the separation of political issues from investment decisions.

And we need a truce because the pace of legislation about ESG is only accelerating. Data collected by the law firm Simpson Thacher & Bartlett shows that at least 28 policies and laws have taken effect since 2021 alone and, as of the spring of 2023, there are at least 13 pending bills related to ESG. This doesn’t count the enormous number of existing policies–everything from preferences for small businesses to laws against investing state funds with companies that operate in certain countries–that would fall under the ESG umbrella if proposed today. While the stated financial protection and future-proofing objectives behind these proposals are worth consideration, they are bad policies likely to fail on their own terms while doing significant fiscal damage.

Let’s start with the red-state boycott ban bills which are typically directed at investment firms that limit firearms or fossil fuel investments. These bans represent an unwise ceding of legislative power that will cost states billions. Texas existing law’s language–typical of similar bills introduced across the country–defines a boycott as any effort to “penalize, inflict economic harm on or limit commercial relations with a company” involved in the fossil fuel industry without “ordinary business purpose.” The law, furthermore, allows the state comptroller’s mere “judgment” to be sufficient for making a determination that a firm has started a “boycott.” If such a determination is made, the state could discontinue business with a firm even if it has the best price, quality or performance record. Studies from the University of Pennsylvania estimate that this political move could cost the state over $400 million a year and $6 billion in the next decade.

But this may be an underestimate, in part because the law cedes so much power to the comptroller. Since mere portfolio rebalancing, something a major financial firm will do somewhere every day, can “limit” commercial relationships, a comptroller who wished to could likely disqualify almost any entity. Standards elsewhere ranging from an anti-ESG order issued by Florida’s chief financial officer to near identical Kentucky and Oklahoma laws that similarly restrict ESG investments will likely have similarly deleterious fiscal effects. In other words, efforts to “protect” state funds from ESG are likely to have very high costs for the states and represent an enormous grant of power by the legislatures

While anti-boycott bills are too new for anyone to have long-term evidence of their impacts,  there is little question that their mirror image–mandatory divestment policies–have negative fiscal consequences and fail to produce their desired outcomes. As such, a Maine law that requires the state pension funds to end fossil fuel investments–typical of proposals floating around in several blue states–seems almost certain to have roughly the same impact as past divestment policies targeting narrower classes of firms. Analysis conducted by California’s giant CalPERS and CalSTRS pension funds both show billions in dollars of losses resulting from that states’ existing divestment policies. Even worse for supporters of divestment efforts, the best evidence seems to indicate that they are actually counterproductive. A working paper authored by Vaska Atta-Darkua and three others indicates that divestment efforts do nothing to encourage the green innovation but simply reallocate capital towards firms that already have significant “green” revenues. Writing in Harvard Business Review, likewise, Tom Johansmeyer points out that divesting from any publicly-traded asset can actually attract new capital to that asset and actually improve its prospects.

The example of cigarette companies shows how this works: widespread divestment did temporarily drive down their stock prices beyond what their fundamentals would justify. But this made them more attractive and, as such, they outperformed other investments; Philip Morris International now has a higher market capitalization than household name companies ranging from Morgan Stanley to Bristol Myers Squibb. Even if stock prices remain depressed, a highly profitable company can still make itself an attractive investment simply by raising dividends. And the same dynamics that have made divestment a failure seem likely to apply to boycott bans over the long term even if they become widespread enough to impact stock prices.

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