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Examining the Concentration of Corporate Voting Power
Plus: how ESG politics are increasing the need for more direct-to-shareholder relationships
As we approach the 2024 US election cycle, the prominence and influence of major financial institutions like BlackRock, Vanguard, and State Street have ignited widespread debate in American politics. This discourse isn't confined to one end of the ideological spectrum but spans across various viewpoints, emphasizing the universal concern over financial powerhouses and their role in shaping the nation's future. This August, Harvard Law and Economics professor John Coates released his book, "The Problem of Twelve: When a Few Financial Institutions Control Everything." Through it, Coates expresses his concern about a looming crisis where twelve major financial institutions wield disproportionate power over a country's politics and economy. He emphasizes:
The Big Four index funds of Vanguard, State Street, Fidelity, and BlackRock control more than twenty percent of the votes of S&P 500 companies—a concentration of power that’s unprecedented in America
The rise of private equity funds such as the Big Four of Apollo, Blackstone, Carlyle and KKR, which has amassed $2.7 trillion of assets, and are eroding the legitimacy and accountability of American capitalism, not by controlling public companies, but by taking them over entirely, and removing them from public discourse and public scrutiny.
Larry Summers, President Emeritus of Harvard University and former Secretary of the US Treasury, adds:
Capitalism is determined by who controls capital. John Coates draws on a lifetime of experience and study to make a compelling case that American capitalism part way into the twenty-first century is dominated by a dozen insufficiently accountable institutions. His pathbreaking analysis and recommendations deserve the attention of all who care about our economic future.
This week's Roundtable Roundup highlights recent developments concerning the growing influence of large US financial institutions and measures being taken to address it.
Review: The ‘Problem of Twelve’ — redux (FT Alphaville)
Scale of Influence: Index funds and private equity combined control about 30% of US corporate equity, with private equity having more ownership than index funds.
Lobbying & Regulatory Avoidance: Private equity is partly a strategy to avoid regulations, intentionally structured to circumvent disclosure laws. The industry has played a role in shaping these laws through lobbying and political influence. Once a private equity fund acquires a company, its activities become less transparent and "dark," leading to concerns about accountability.
Addressing the Threat: Coates warns against extreme political reactions to the rise of these financial institutions. He believes that simple solutions, like caps or bans, might be detrimental. Instead, he argues for better disclosure from both index funds on their voting practices and from companies controlled by private equity, aiming to increase accountability and legitimacy. He suggests that managing the threat through disclosure and public oversight is more beneficial than seeking a perfect solution.
Empowering everyday investors through proxy voting choice (Vanguard)
Proxy Voting Pilot Program: Vanguard has launched a new pilot program allowing investors in three of its equity index funds to participate more directly in the proxy voting process. Traditionally, direct stockholders in public companies could vote on matters at shareholder meetings, and Vanguard is now extending similar choices to its index fund investors.
Specifics of the Program: Starting from February 1, 2023, until June 30, 2023, investors in the Vanguard S&P 500 Growth Index Fund, the Vanguard Russell 1000 Index Fund, and the Vanguard ESG U.S. Stock ETF can choose from four proxy voting policy options. Through this voluntary participation, investors can influence how the fund votes on ballot items for some of the fund’s significant holdings based on their fund ownership. Eligible investors will access a secure website to select a proxy voting policy.
Vanguard’s Commitment to Investors: Vanguard's initiative is part of its broader mission to empower individual investors and align their investment portfolios with their goals and preferences. Anne Robinson, Vanguard’s General Counsel and Corporate Secretary, emphasized Vanguard's dedication to offering a broad array of options to align with investors' individual goals and to gather feedback for better support.
Outcome and Future Plans: As an investor-owned asset manager, Vanguard is distinctively equipped to engage individual investors in the proxy voting process. This pilot program aims to discover the best methods for allowing investors to voice their opinions in proxy voting. In all endeavors, Vanguard's guiding principle is to champion the interests of all investors and provide them with the best opportunities for investment success.
BlackRock’s False Voting ‘Choice’ (The Wall Street Journal)
BlackRock's Proxy Voting: BlackRock has received attention for offering retail investors a say in proxy voting (similar to Vanguard’s pilot program outlined above). This move is seen as a way to counter criticism of its ESG strategies and its use of the $9.4 trillion in assets to influence public companies on ESG matters, especially CO2 emissions.
Concerns from Republican State Attorneys General: Nineteen Republican state AGs warned BlackRock CEO Larry Fink about potential antitrust issues tied to BlackRock's collaboration with other financial institutions on the Net Zero Asset Managers initiative. They also highlighted potential violations of fiduciary duty due to BlackRock's policy of penalizing corporate board directors who don't adhere to its climate directives.
BlackRock's Response: BlackRock announced that, starting next year, over three million retail investors in its leading ETF would have the option to select from various proxy voting policies. The implication is that if investors have a voting choice, antitrust and fiduciary concerns are addressed.
Limited Choice in Reality: Despite BlackRock's announcement, most of its predefined voting policies are formulated by the proxy advisory firms Glass Lewis and ISS, both of which are ESG proponents. The available options, even those not directly ESG-related, support measures like emissions cuts and board diversity. The company's claim of offering voting choices to investors is likened to Henry Ford's statement about car colors, suggesting that the choices are, in reality, limited.
Is The INDEX Act Workable? (Forbes)
Reps. Bill Huizenga (R-MI) and Blaine Luetkemeyer (R-AK) have reintroduced the Investor Democracy is Expected (INDEX) Act to the 118th Congress. The bill aims to guide how passively managed funds, like index funds, should vote shares during proxy shareholder votes. Senator Marco Rubio, who co-sponsored the same bill in the senate, added:
Individual investors and retirees, not massive Wall Street companies, deserve the right to vote their shares. This bill will empower retail investors and prevent large fund managers from abusing their influence to support crazy progressive agendas.
The “Big 3” investment advisers (BlackRock, Vanguard, and State Street) manage:
Over $20 trillion in combined assets
Vote around 25% of all votes cast at annual meetings
Are the largest owner in around 90% of the S&P 500 companies
Manage 82% of all assets flowing into investment funds over the last decade
Control between 73 percent and 80 percent of the ETF market.
Coverage: The act affects passively managed funds including private funds, employer-sponsored retirement funds, and more.
1% Voting Power Limitation: Investment advisers only require voting choice if they hold more than 1% of a company’s voting securities.
Routine Matters Exception: Advisers can't vote without fund investors' instructions, except for routine matters.
Mirror Voting Exception: For votes requiring a majority stock, advisers can “mirror vote”.
Disclosure and Broker Obligations: Advisers must provide proxy statements to fund investors and allow third-party voting recommendations.
Cost Burden: Funds or their investment advisers must bear the costs of pass-through voting.
Safe Harbor: Advisers can opt-out of voting without legal consequences.
Addressing the "Triple Agency Problem”: The bill looks at the problem of multiple intermediaries mediating between an individual and a company. This setup can misalign the individual's goals (like ensuring a comfortable retirement) and the intermediaries' objectives.
Direct Democracy Model Concerns: While the bill seems inspired by Switzerland's direct democracy model, its practical application for corporate retail voting might lead to poor governance outcomes due to issues like voter capture and apathy.
Rise of Retail Proxy Advisory Services?: Proposals like the INDEX Act could give outsized influence to advisory services who guide retail investors on voting. However, this brings its own set of challenges, mirroring the issues with existing advisory firms.
Addressing Time Horizons: The act doesn't address how index funds consider the long-term interests of their beneficiaries. Making such responsibilities clear might benefit the investors.
'Not just money and math': Young people are willing to sacrifice returns for ESG (CNBC)
Aligning Investments with Personal Values: The article introduces us to Hannah Cohen and Matthew Ivler who exemplify a rising trend among young investors to ensure their portfolios align with their personal values, such as addressing climate change. Ivler, for example, shifted his portfolio towards renewable energy and water resources after starting with more traditional holdings like Home Depot and Chevron.
Generational Trends in ESG Investing: A U.S. Bank survey highlighted that two-thirds of Gen Z investors aim to support causes they believe in through their investment choices. This is in contrast with 59% of millennials, 45% of Gen X, and 30% of boomers. Notably, a majority of these younger investors are willing to accept lower returns if it means investing in alignment with their values.
Challenges in ESG Investing: Despite the enthusiasm, young investors like Cohen and Assi find challenges in identifying truly ESG-compliant companies. While there are ESG reports available, they often come from the companies themselves, posing a potential bias. This makes it tough for investors without access to expensive screening software to find credible ESG rankings.
The Psychology of ESG Investing: Julie O’Brien, head of behavioral science at U.S. Bank, emphasizes the significance of ESG investing in expressing one's identity and the inherent human connection to it. Younger generations, with access to abundant information and the influence of social media, feel a stronger connection to ESG principles. Investing, according to O'Brien, is as much about human values as it is about monetary returns.
Troop rallies retail investors to get out the proxy vote (Tech Crunch)
Rise of the Retail Investor: The past years have seen a significant increase in retail investors, positioning them as potential influencers in shareholder proposal voting. Despite their increasing numbers, retail investors face hurdles when competing with large fund managers who dominate shareholding in major public companies.
Troop's Vision: New York-based startup, Troop, aims to empower retail investors, striving to even out the power dynamics. Felix Tabary, Troop's co-founder and CEO, was inspired by the tactics of activist hedge funds and saw potential in adapting them for retail investors. A notable example that influenced him was Engine No. 1's impact on ExxonMobil's board decisions regarding climate change.
Long-term Goals: Troop is focusing on fostering a vibrant investor community to enhance information flow and boost retail investor engagement. Their platform offers an environment where retail investors can connect anonymously, thereby creating a space for collective decision-making. Troop believes that retail investors can be game-changers in pivotal proxy votes. The company aims to engage this group during the initial stages of shareholder activism, building momentum towards annual shareholder meetings.
American capitalism is shifting within a delicate balance between power, regulation, and stakeholder engagement. As giants like Vanguard and BlackRock take steps towards more democratic asset management practices, the urgency for companies to amplify retail shareholder participation is paramount. Typically, an individual decides to invest in a company because they believe in it (and for Gen Z this decision is values driven) and these passionate shareholders should play a significant role in corporate decision-making. Case in point: at Berkshire Hathaway’s Annual Shareholder Meeting last May, the dominant retail shareholder base overwhelmingly backed management on various proposals that came from across the idealogical spectrum. However, data from Broadridge reveals an engagement gap for most companies — in 2022, while retail investors owned 31% of shares, they only voted 29% of them. In comparison, institutional investors voted 82% of their shares. The implication is clear — the concentration of power, as highlighted in ‘The Problem of Twelve,’ becomes less concerning when individual shareholders are motivated to directly engage with companies. (We covered in a previous Roundtable Roundup interview with Professors Sautter and Alberto Gramitto Ricci why retail shareholders have historically not been motivated to vote).
Coates suggests that drastic measures aren't the answer to this potential crisis, and echoing this sentiment, Stakeholder Labs champions simple solutions — create more direct-to-shareholder relationships. Our primary goal with Roundtable software is to allow companies to digitally verify their individual shareholders and develop more loyalty and engagement. This strategy helps ensure a protective buffer against external influences that don't align with the company's shareholder base, allowing leadership to spend more time on business execution and less time and money managing political activism.