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E-MailDhruv Aggarwal is a Ph.D. Candidate at Yale University, Albert H. Choi is Paul G. Kauper Professor of Law at the University of Michigan, and Alex Lee is Professor of Law at Northwestern Pritzker School of Law. This post is based on their recent paper, forthcoming in the Southern California Law Review.
In the midst of the COVID-19 pandemic, in early 2021, the US stock market experienced a rather unusual phenomenon. Several publicly traded companies, such as GameStop, AMC, and Bed Bath & Beyond, experienced a dramatic influx of retail investors into their shareholder base. A large number of retail investors engaged in and responded to a coordinated buying campaign, and over a short period of time, affected firms’ stock prices surged to stratospheric levels. Some of those companies, notably AMC and GameStop, took advantage of the surge and were able to raise substantial amounts of capital at elevated stock prices, thereby improving their liquidity positions. While the stocks are no longer trading at such historic highs, prices are still much higher than pre-pandemic levels, and many retail shareholders are staying “loyal” to the companies.
This “meme surge” phenomenon, particularly the dramatic shift in shareholder base away from institutional ownership, presents a unique opportunity for analysts and scholars to (re)evaluate the current understanding of corporate finance and governance. Observers of the meme stock surge and its implications for corporate governance have focused on the idiosyncratic creation of online communities around individual stocks during the COVID-19 pandemic. However, in a recent paper, we take a broader and longer-term view of the technological developments undergirding the meme surge, and also sketch out a research agenda.
We argue, in particular, that the emergence of meme stocks is part of longer-running digital transformations in trading, investing, and governance. On the trading front, the sudden abolition of commissions by major online brokerages in 2019, initially popularized by Robinhood, reduced (or eliminated) entry costs, particularly for retail investors. Importantly, we note that zero-commission trading represents a modification of the payment for order flow (PFOF) system, which is itself a product of technological disruptions in the financial markets in the 1980s under which broker-dealers get “rebates” from wholesalers for delivering orders from their clients. In many ways, the elimination of trading commission for the retail shareholders, leaving broker-dealers to rely solely on PFOFs, was a logical evolutionary step from the PFOF system of the 1980s.
On the investing front, the emergence of social media communication amplified retail investors’ pre-existing dependence on social networks to make decisions regarding stock market entry and portfolio construction. If digital transformations in trading brought about changes in the business models of brokerage firms—thus providing the general public with greater access to capital markets—digital transformations in investing have changed the social meaning of investing for individual investors. No longer just a form of rationally deferred consumption, investing has become a social activity through which to bond with others and to express one’s preference and identity.
On the governance front, some startups have attempted to bring the shareholder experience into the digital age and help retail investors participate in governance. These apps can be seen as reducing participation costs for governance activities in much the same way zero-commission trading reduced the participation cost for trading. Potentially more impactful than the development of these apps, highly-publicized movements have taken place among shareholders of various companies to coordinate their votes. If such online communities were to become more commonplace and retail shareholders can potentially coordinate in their voting behavior, corporate governance can be democratized in ways akin to trading.
After examining the background technological developments, which, we argue, substantially contributed to the meme surge phenomenon, we sketch a research agenda for law and finance scholars to explore the concrete effects of meme investing on corporate governance outcomes. First, we ask whether retail traders can transform into enthusiastic retail shareholders engaged in corporate governance. Was the meme surge experience a social phenomenon limited to trading markets, or could it translate into a broader signal of governance engagement by retail shareholders? Some legal scholars have predicted that we will see more active retail shareholder engagement in governance issues, in terms of either traditional (bringing or voting on proposals) or contemporary (ESG performance, board gender diversity) dimensions.
At least in theory, one could argue that particularly those retail investors who remain as shareholders long after the surge would care about firm governance and performance, and more actively exercise their rights as shareholders. To a large extent, the digital transformations we have witnessed in trading, investing, and governance do suggest a future in which coordinated voting among shareholders can come to fruition. While the jury is still out, to the extent that the meme surge event was driven mostly by coordinated trading rather than coordinated voting, it remains uncertain whether such an explosion of retail governance would, in fact, occur. This is because investing and continued corporate shareholding are fundamentally different endeavors. In a separate working paper, we make an initial foray into this line of research.
Second, another puzzle presented by the meme surge was why some companies experienced the retail investor influx while other (similarly situated) companies did not. To address this puzzle, we explore a broader metric for “meme-ness,” and suggest that future scholarship should use modern advances in data science to better identify which companies are vulnerable to meme surges and social media-driven investing unrelated to their financial fundamentals. Overall, the meme stock phenomenon offers a valuable opportunity to study the role retail investors play in modern markets and in governance, but we should not lose sight of longer-running technological changes that have driven these recent events.
The full paper is available here.
