How to Fix the Unhealthy Concentration of Corporate Voting Power In the U.S.

Published in Real Clear Markets.

The popularity of index and other mutual funds, combined with the current rules for voting shares of stock, has had an unexpected ill effect: concentration of corporate voting power in the hands of a few giant asset management companies.  Nobody did or would intend this outcome.  Fortunately, the voting rules can be changed. A great way for the SEC to start 2019 would be to take on and then fix this threat.

The asset managers holding the concentrated voting power are, economically speaking, mere agents.  They are not principals. One hundred percent of the risks and rewards of ownership belong to the beneficial owners of the funds: they are the economic owners.  The agent asset managers simply pass through these risks and rewards (minus their fees, course).  They have the stock registered in the fund name, but they are in no economic sense the owners.

They are in economic terms in exactly the same position as broker-dealers holding stock registered in street name, of which 100% of the risks and rewards (minus commissions) likewise belong to the customers.

The current voting rules for shares in mutual funds accelerate the famous “separation of ownership and control” in precisely the wrong direction: away from the substantive owners and into the hands of agents. As corporate governance scholar Bernard Sharfman has written to the SEC, “BlackRock, Vanguard, and State Street Global Advisors (the Big Three) now control enormous amounts of proxy voting power without having any economic interest in the shares they vote.”

The celebrated creator of index funds, John Bogle, rightly warned that “a handful of giant institutional investors will one day hold voting control of virtually every large U.S. corporation.”  In fact, the control would be exercised by a few senior employees of those institutions—the agents of the agents.  Said Bogle, “I do not believe that such concentration would serve the national interest.”  It certainly wouldn’t.

It also does not serve the interests of the economic owners, who are under current rules deprived of any ownership voting rights.  This contrasts strikingly with the case when investors economically own stock that is legally registered in their broker’s street name.  In that case, the rules work hard to align voting rights with economic ownership, as they should.

There is an additional problem with concentrating voting power in the hands of a few agents.  These highly visible organizations are subject to political pressure and influence on how they cast their votes.  They cannot fail to be tempted to take positions through voting on contentious issues which are politically and economically advantageous to themselves, doubtless accompanied by pious speeches, rather than to the principals. The temptation to signal political “virtue,” rather than vote the interests of the real owners, may be irresistible.  The severe agency problem is obvious.

What do the principals want?  You should ask them, just as the brokers have to do.

We are confronted with a problem of a concentration of not only economic, but also of political power, needing to be fixed, sooner rather than later.

The public discussion of the issue has included the charge that index funds, because they may own all the major public companies in an industry, will promote cartel and oligopoly behavior to favor the industry, not the individual competitors in it—an influence which, if true, is certainly not to be desired.  This led financial commentator Matt Levine to suggest that index funds “pose a problem under the antitrust laws.”

But the problem is not that these funds hold shares registered in their name on behalf of the beneficial owners.  The problem is that the funds are allowed to vote such shares without instructions, to suit themselves.  It’s not the surface “ownership,” it’s the voting power that must be addressed.  They don’t need to have anti-trust laws applied, just to have their voting rules fixed.

The analogy is compelling: in economic substance, the status of the shares held by a mutual fund and that of the shares held by a broker in street name is exactly the same.  They should have exactly the same rules for voting the related proxies.

So the fix is quite straightforward:  Apply the same proxy voting rules to asset managers as already exist in well-developed form for brokers voting shares held in street name.  In short, the asset managers could vote uninstructed shares for routine matters, just like brokers, assuring the needed quorums.  But for non-routine matters, including the election of corporate directors, they could vote only upon instructions from the economic owners of the shares.   Thus the economic owners of shares through brokerage accounts and through mutual funds would be treated exactly the same.  The intermediary agents would be treated exactly the same.

Of course, the asset managers would whine about the trouble and expense of getting mutual fund holders to vote their proxies.  But the brokers already have the same problem.  Overall operating efficiency would be enhanced by allowing the real owners to provide revocable standing instructions to both asset managers and to broker-dealers for non-routine matters with a choice like this:

1.       Vote my shares only upon specific instructions from me.

2.       Vote my shares for the recommendations of the board of directors of each company.

3.       Vote my shares for whatever the asset manager or broker-dealer decides.

It would be gigantic mistake to let a handful of big asset managers amass discretionary voting dominance of the whole U.S. corporate sector, including pursuit of political agendas, all without having any economic interest in the shares they vote.  We should instead create instead a governance structure which ensures that the principals control the votes.