Indexing giants may be falling short on governance

New research suggests that they have significant portfolio ownership of public companies, but tend to be ‘excessively deferential’

Indexing giants may be falling short on governance

As index investing giants exert a stronger grip on public companies, they have an opportunity to change the way such companies do business for the better. But according to new research, the indexing giants may not be doing such a good job.

A new report from The Wall Street Journal cites researchers Lucian Bebchuk, professor of law, economics and finance at Harvard Law School, and Scott Hirst, law professor at Boston University School of Law. The duo recently published two papers on the power held and wielded by BlackRock, Vanguard, and State Street over US public companies.

“Together, [they] control an average of one in five shares of S&P 500 companies, and that portion is likely to jump to more than 33% of shares over the next two decades,” the Journal said, citing a working paper issued in June by the National Bureau of Economic Research. The three fund managers also reportedly own 16.5% of shares in members of the Russell 3000 index, and could grow to hold 30.1% over the next two decades.

But in a second report to be published later this year, Bebchuk and Hirst argued that the fund managers also collectively fall short in their oversight function as shareholders. The two researchers pointed to empirical evidence and analyses that suggest companies underinvest in stewardship and are excessively deferential to the corporate managers of portfolio companies.

This concern is exacerbated, the two said, by the fund firms’ outsized influence compared to the portion of shares they own. According to their second paper, they are together responsible for 25% of the votes cast in company ballots for S&P 500 companies, and 22% of those cast at Russell 3000 companies. Assuming their share of voting power expands at the same rate as their ownership of shares, they could together account for over 40% of all votes, on average, on shareholder resolutions at S&P 500 companies.

“[W]e worry that the increased concentration of shares in the hands of institutional investors will not produce the improved oversight of public companies that would be beneficial for public companies and the economy,” the researchers said.

In the new report, expected to come out in the December 2019 issue of the Columbia Law Review, they say index firms “very rarely” oppose corporate managers when it comes to votes on executive compensation. Compared to other firms, they added, the fund managers are less likely to oppose managers in proxy fights against activists.

“Our analysis of the voting guidelines and stewardship reports of the Big Three [BlackRock, Vanguard and State Street] indicates that their stewardship focuses on governance structures and processes and pays limited attention to financial underperformance,” the report said.

The researchers also contended that the Big Three spend an “economically negligible” fraction of their fee income on stewardship — reportedly less than 0.2% — enabling only limited and cursory oversight for the vast majority of their portfolio companies.

The three firms have all responded in disagreement to the analysis, telling the Journal that they act in their shareholders’ best interests. State Street pointed to its history of voting against companies on 266 companies; Vanguard referred to its philosophy of using corporate engagement in addition to voting as a way to effect change; and BlackRock cited multiple past comments where it declared commitments and announced manpower investments to be “active engaged agents on behalf of the clients.”


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