The impact-investment hedge fund Engine No. 1 made a big splash in May 2021 when it managed to get three nominees elected to the ExxonMobil board of directors. It was an open effort to prod the oil giant toward renewable energy and test whether activist investing could make a difference.
“There’s a lot of investment money that would like to have a positive impact through public equities, and it doesn’t have any place to go.”
A year-plus later, Harvard Business School senior lecturer Mark R. Kramer says it’s still an open question. Engine No. 1’s long-shot bid to place dissident members on the board succeeded, but tabulating victory on a balance sheet has proved challenging—as has figuring out what to tackle next, dilemmas outlined in a pair of HBS case studies.
“Being the first player here has put them in a good position to attract capital,” says Kramer, who is a consultant for social-impact strategies. “There’s a lot of investment money that would like to have a positive impact through public equities, and it doesn’t have any place to go.”
Investor allocations toward impact investing hit $1 trillion last year. While investing in companies with social impact is a well-established approach across venture capital and private equity, the concept is newer to public equities and hedge funds. Socially responsible investors have long chosen stock portfolios that align with their personal values, but it is hard to attribute much social impact to owning a publicly traded stock. And, unlike mutual funds, hedge funds more commonly use short selling, investor activism, and other unconventional techniques, giving them ways to influence companies. The high-risk, high-return expectations of hedge funds make achieving impact more difficult, especially within the much shorter time horizon of a typical investment.
“You want to see an alignment: If you have an impact, you make more money,” Kramer says. “And if you make more money, you have more impact. But their Exxon return was actually contradictory—their profit came from the increased price of oil, not from a shift to renewables. Despite all the publicity and buzz, they have not achieved what they hoped to achieve.”
Even so, the drama of the shareholders’ meeting at one of corporate America’s most iconic boardrooms drew plenty of attention, particularly amid the increasing threats of climate change and a desire from investors to contribute to social good. Kramer wrote the case with HBS professor Shawn Cole, HBS senior lecturer Vikram S. Gandhi, and T. Robert Zochowski, program director of the Project on Impact Investments at HBS.
Impact investing—and an activist fund—are born
Christopher James launched San Francisco-based Engine No. 1 in December 2020, naming it for the fire department station that’s a block from the fund’s San Francisco office. James grew up in a small southern Illinois town that was dependent on the coal industry, so environmental problems felt personal.
He left for Tulane University and Wall Street hedge funds, then went to San Francisco, where he co-founded multibillion-dollar firms that invested in health and technology. Some of that money he returned to his hometown’s coal industry, funding an energy company there to create jobs.
He also put more of his wealth into philanthropy, toward programs for education, the environment, and homelessness. But he grew frustrated by the limited impact of such donations—and he didn’t have a good answer when his children asked how he could be an environmentalist when he was making money from fossil fuel investments.
“I was making my money in tech and health care, just like I was making my money in energy, but I had too much compartmentalization to feel good about what I was doing,” James reflected in the case.
Meanwhile, the notion of impact investing was gaining steam in private equity and venture capital. Mostly, early impact investing put capital into companies aiming to solve social problems, like micro-finance and housing. James had a different idea: Could hedge fund investments in publicly traded companies open the door to new ways to make a difference?
A high-stakes proxy battle
Engine No. 1 would focus on what Kramer refers to as “bad-impact companies”—fossil fuel giants that clean-energy investors generally shun. James and his team decided to use the upcoming proxy season to test the new idea.
Unlike typical activists elected to corporate boards, which look to restructure and maximize short-term returns, Engine No. 1 would use its shareholder investment and activism to focus on long-term value creation. Targeting ExxonMobil seemed easy. Beyond the environment, there was a financial case for change to make after a dismal year and the sense that the giant was lagging its peers on environmental issues.
“If you want to do impact investing with publicly traded securities, you have to be actively engaged with management.”
The annual shareholder meeting on May 26, 2021 saw the culmination of Engine No. 1’s six-month, $12.5 million campaign. Dissidents pointed to Exxon’s resistance to change and the environmental need to take action.
Halfway through the meeting, the CEO called an hour-long recess to rally major shareholders. Engine No. 1, with just $40 million, or a .02 percent stake in Exxon stock, hadn’t been expected to garner so much support. In the end, three of its four candidates won board seats.
“If you want to do impact investing with publicly traded securities, you have to be actively engaged with management,” Kramer says of the strategy. “I do think that makes sense. And there are not a lot of players who are trying to do what Engine No. 1 is trying to do.”
It was a major victory for climate-consciousness and impact investing. The most recent example of an activist member winning a place on a major board was back in 2017, when a $100 million campaign secured a spot for a single director on Procter & Gamble’s board.
The sticky problem of measuring impact
Quantifying success proved difficult—and hedge fund investors expect to see data.
In the run-up to the board elections James puzzled over how to account for social good on a balance sheet. The standards for environmental, social, and governance (ESG) reporting are voluntary and run the risk of confusing investors about whether so-called green investments are truly different or just a marketing pitch with a few negative factors eliminated (no tobacco or fossil fuel companies in the portfolio, for instance).
James decided to do something different. “Over the long term, we believe shareholder and stakeholder interests align, and companies that invest in their workers, communities, and the environment are better, stronger companies as a result. We seek to help companies optimize this potential by actively engaging to drive long-term value,” he says in the case.
Partnering with academics and PwC, Engine No. 1 developed a “total value framework” that used several data sources to evaluate long-term risks and opportunities from environmental and social impacts. It aimed to show CEOs how these factors could drag down value over time, and Engine No. 1 hoped the framework would be different and potentially more accurate than ESG ratings.
Meanwhile, the typical measurement of a good investment is making money—and ExxonMobil did that in the year that followed the Engine No. 1 board elections. However, short-term profits at ExxonMobil are closely tied to the rising price of oil. Brent Crude price was $68.46 per gallon when Engine No. 1’s Exxon board members were elected. A year later, in May 2022, it was $113.42, close to the 2022 peak. Oil prices have declined since.
James didn’t do badly either: After the proxy contest, the value of Exxon’s shares rose from $38 to $59, netting him an $8.5 million profit after the cost of the fight.
Too soon to tell
Going on two years after James founded Engine No. 1, the firm is at something of a crossroads. Kramer says it’s too soon to tell what impact ExxonMobil’s three Engine No. 1 board members may have.
Exxon says in the case they’ve made progress on environmental issues—and not because of Engine No. 1. “Exxon has reduced what they will spend on [fossil fuel] expansion,” Kramer says. “And they have increased their investment in renewable energy and carbon capture, but it’s pretty minimal.”
“By reducing demand for shares in bad-impact companies, you are raising their cost of capital, but that is a very tenuous link to any measurable social impact.”
There was some talk of shareholder action against Facebook, says Kramer, as a next target for the ambitious idea. “There’s no question Facebook has a bad impact on democracy, but that’s a different issue from carbon emissions, which is easy to measure,” Kramer says. “Can you do this when there’s a social issue that’s not well understood? With Exxon, Engine No. 1 had a social issue that’s easy to understand.”
Which, Kramer says, leaves Engine No. 1 with its original challenge: How do you have an impact if you just have publicly traded securities?
“That’s one thing the financial industry is wrestling with,” he says. “All you’re doing is buying stock from someone else; you aren’t actually funding the operations of a company that is helping solve societal problems. In theory, by reducing demand for shares in bad-impact companies, you are raising their cost of capital, but that is a very tenuous link to any measurable social impact. That is why it’s a real challenge to talk about achieving impact in public equities.”
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Feedback or ideas to share? Email the Working Knowledge team at hbswk@hbs.edu.
Image: iStockphoto/TomasSereda