Question

In recent years, large financial institutions such as mutual funds, investment bank and pension funds have become the dominant owners of stock in the United States. The research shows that about 73% of ownership in large U.S. corporates are held by these institutional investors. In German, the dominant shareholders are usually Investment Bank. Moreover, these institutions are becoming more active in corporate affairs. What are the implications of this trend for agency problem and corporate control?

Answer 1

I think the implications are a mixed bag and somewhat complex. Mutual funds can have shorter-term time horizons than many buy-and-hold individuals might. They may have a desire to not “rock the boat” and may be less inclined to vote against proposals recommended by directors, or simply not devote resources to examining such proposals. As such, between having a few very large individual shareholders who are extremely engaged, it will definitely tend to disperse accountability and increase the chances that management will get away with (shareholder) murder. The trend of giving large amounts of stocks and options away, funded by immense buyback schemes regardless of price, certainly is inconceivable under a system where a few large multi-millionares and billionares hold all equities.

On the other hand, a small percentage of ESG focused funds (Environmal, Social, Governance) have emerged - those are more likely to care. Mutual funds and pensions democratize capitalism, tending to limit vast inequalities of wealth (I know we have a very unequal distribution right now, I’m saying it would be worse without them). I am hopeful that if mutual fund investors start showing a preference for funds that behave responsibly to constrain what I call “evil management” (ie self-serving misallocators of capital that Warren Buffett talks about in many of his annual letters), more fund managers will realize that they need to up their game in this dimension.

Another very interesting question is how the movement of funds from active to passive management will impact shareholder-favorable voting in corporate director elections. If passive ETFs and funds become the majority holders, what these firms do with their votes will really start to matter. I am of the (perhaps shamelessly optimistic) view that people who have made it their mission to cut fees of 1–1.5% a year down to 0.15% a year will similarly view it as part of their shareholder mission to get this nonsensical share and option give aways to management under control and let shareholders or ordinary workers keep more of the astounding amounts of wealth being created by corporate America, rather than the top 5–10 executives siphoning it away.

After all, if it is possible to outsource away almost every level of job within US companies to other countries to “control costs”, surely there are competent CEOs, CFOs, CIOs, heads of research all over Europe and Asia and Latin America who would jump at taking jobs at US companies for 1/5 the take of the top 500 CEOs in America? Why hasn’t this happened? I think the fact that it has not is an indication of hidden cartels in the business of the director/executive nexus. The best case scenario would be if passive managers such as Blackrock and Vanguard were at the forefront (vanguard!) of this movement.