Alexander I. Platt is the Climenko Fellow and Lecturer on Law at Harvard Law School. This post is based on his recent article, forthcoming in the UC Davis Law Review. Related research from the Program on Corporate Governance includes Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy by Lucian Bebchuk and Scott Hirst (discussed on the forum here); The Agency Problems of Institutional Investors by Lucian Bebchuk, Alma Cohen, and Scott Hirst (discussed on the Forum here); and The Specter of the Giant Three (discussed on the Forum here) by Lucian Bebchuk and Scott Hirst.
Three financial institutions now vote 25% of the stock in the largest U.S. public companies. Soon, the figure may be closer to 40%. Vanguard, BlackRock, and State Street Global Advisors—the so-called “Big Three”—dominate the market for index funds and other passively-managed investment vehicles. As passive investing has grown increasingly popular with investors, these institutions have accumulated astonishing levels of economic power.
To date, however, the debate over the rise of the Big Three has overlooked an area where this concentration of power may have a particularly significant effect: the corporate enforcement ecosystem. The analysis of some leading corporate governance scholars suggests that there is reason to worry that the Big Three’s rise could significantly undermine the current system of private and reputational mechanisms to hold companies and managers accountable for fraud and misconduct. Proponents of what I call the “Passivity Thesis” have argued that index fund managers have generally overriding incentives to refrain from meaningful corporate “stewardship”—i.e. actions to influence and enhance the value of individual portfolio companies. [See, Index Funds and the Future of Corporate Governance (discussed on the Forum here) and The Agency problems of Institutional Investors by Bebchuk, Cohen, and Hirst (discussed on the Forum here)] If that’s true, the Big Three might also be expected to use their considerable power and influence to effectively insulate managers and companies from accountability for wrongdoing.