Henderson on Divestment and Financial Illiteracy

Divestment and Financial Illiteracy

The state of financial literacy in America is rotten. A Dodd-Frank-Act-mandated study of financial literacy recently concluded: "investors have a weak grasp of elementary financial concepts." Or, consider the 2009 National Financial Capability Study finding that only 52 percent of investors understand owning a broad basket of stocks provides a safer return than investing in a single company stock. This is like saying 52 percent of people believe in gravity.

The divestment wave hitting college campuses looks like another example of financial ignorance. Students for a Just and Sustainable Future (SJSF) is pressuring universities across the nation to force their endowment funds to divest their investments in fossil fuel companies. Students at Swarthmore, for instance, recently shouted down dissenting voices at a campus meeting on the subject, where Swarthmore's investment manager was describing the expected costs ($200 million over 10 years) of divestment. The students' tactic seems to be trying to put pressure on the stock price of fossil fuel companies, and therefore force the firms to change their behavior. Unfortunately for SJSF, there is little evidence to suggest this is likely to work.

A central tenet of corporate finance is that demand curves for individual stocks are approximately horizontal. For most things we buy, demand curves slope downward. This means if we demand less, less will be supplied and at lower prices. But stocks are not like other products. The stock price is merely an estimate of the cash flows that ownership of the stock will produce in the future, and therefore is not determined by a "demand" for the stock. Unless the sale of stock conveys information to the market about the future cash flows, no individual sale can move the price.

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