Frictional Costs of Fossil Fuel Divestment

Abstract

Advocacy for fossil fuel divestment has been growing on college campuses nationwide in recent years. In contrast with prior literature, which focuses on the impact of divestment on returns, I investigate the “frictional” costs that college and university endowments incur in implementing fossil fuel divestment, including transaction costs and ongoing monitoring and active management costs. I find that these costs are likely to be substantial, for the following reasons. First, endowments are long-term investors that tend to hold illiquid assets that are costly to sell. Second, endowments frequently invest in mutual funds or commingled funds, which requires them to sell more than just fossil-fuel-related assets in order to divest. Third, since there is no well-defined and agreed-upon list of assets that are fossil-fuel-related, investment managers must undertake a degree of active management in order to maintain compliance with divestment goals. Overall, I estimate a total cost to endowments over 20 years due to the frictional costs of divestment that range between approximately 2 and 12 percent of the endowment’s value, which, for a typical large university endowment, would translate to a decline in value of between $1.4 billion and $7.4 billion.