Index funds own an increasingly large proportion of American public companies. The stewardship decisions of index fund managers—how they monitor, vote, and engage with their portfolio companies—can ...be expected to have a profound impact on the governance and performance of public companies and the economy. Understanding index fund stewardship, and how policymaking can improve it, is thus critical for corporate law scholarship. In this Article we contribute to such understanding by providing a comprehensive theoretical, empirical, and policy analysis of index fund stewardship.
We begin by putting forward an agency-costs theory of index fund incentives. Stewardship decisions by index funds depend not just on the interests of index fund investors but also on the incentives of index fund managers. Our agency-costs analysis shows that index fund managers have strong incentives to (i) underinvest in stewardship and (ii) defer excessively to the preferences and positions of corporate managers.
We then provide an empirical analysis of the full range of stewardship activities that index funds do and do not undertake, focusing on the three largest index fund managers, which we collectively refer to as the “Big Three.” We analyze four dimensions of the Big Three’s stewardship activities: the limited personnel time they devote to stewardship regarding most of their portfolio companies; the small minority of portfolio companies with which they have any private communications; their focus on divergences from governance principles and their limited attention to other issues that could be significant for their investors; and their pro-management voting patterns.
We also empirically investigate five ways in which the Big Three could fail to undertake adequate stewardship: the limited attention they pay to financial underperformance; their lack of involvement in the selection of directors and lack of attention to important director characteristics; their failure to take actions that would bring about governance changes that are desirable according to their own governance principles; their decision to stay on the sidelines regarding corporate governance reforms; and their avoidance of involvement in consequential securities litigation. We show that this body of evidence is, on the whole, consistent with the incentive problems that our agency-costs framework identifies.
Finally, we put forward a set of reforms that policymakers should consider in order to address the incentives of index fund managers to underinvest in stewardship, their incentives to be excessively deferential to corporate managers, and the continuing rise of index investing. We also discuss how our analysis should reorient important ongoing debates regarding common ownership and hedge fund activism.
The policy measures we put forward, and the beneficial role of hedge fund activism, can partly but not fully address the incentive problems that we analyze and document. These problems are expected to remain a significant aspect of the corporate governance landscape and should be the subject of close attention by policymakers, market participants, and scholars.
Financial economics and corporate governance have long focused on the agency problems between corporate managers and shareholders that result from the dispersion of ownership in large publicly traded ...corporations. In this paper, we focus on how the rise of institutional investors over the past several decades has transformed the corporate landscape and, in turn, the governance problems of the modern corporation. The rise of institutional investors has led to increased concentration of equity ownership, with most public corporations now having a substantial proportion of their shares held by a small number of institutional investors. At the same time, these institutions are controlled by investment managers, which have their own agency problems vis-à-vis their own beneficial investors. We develop an analytical framework for understanding the agency problems of institutional investors, and apply it to examine the agency problems and behavior of several key types of investment managers, including those that manage mutual funds—both index funds and actively managed funds—and activist hedge funds. We show that index funds have especially poor incentives to engage in stewardship activities that could improve governance and increase value. Activist hedge funds have substantially better incentives than managers of index funds or active mutual funds. While their activities may partially compensate, we show that they do not provide a complete solution for the agency problems of other institutional investors.
SAVING CLIMATE DISCLOSURE Hirst, Scott
Stanford journal of law, business & finance,
01/2023, Letnik:
28, Številka:
1
Journal Article
Designing a regulatory response to climate change is one of the defining challenges of our era. In an attempt to address it, the Securities and Exchange Commission (SEC) has recently proposed a ...historic rule requiring climate-related disclosure by companies, resting squarely on the rationale of "investor demand." The proposed climate disclosure rule has met with an unprecedented response, some of it reflective of investor demand, but also including a broad array of opponents critical of the rule, who cast doubt on the rule's validity. A judicial challenge is all but inevitable. This Article explains that the best way for the SEC to save climate disclosure and to protect investors is to let them decide. That is, the SEC should let companies opt out of all or part of their climate disclosure obligations if sufficient investors have voted to allow it to do so. This "investor-optional" approach would result in three important improvements necessary to save climate disclosure and best protect investors. First, it would make the design of the SEC's rule consistent with the SEC's core claim that there is investor demand for climate disclosure; if this is indeed the case, a mandatory rule is not necessary, creating a logical inconsistency that threatens the validity of a mandatory rule. Second, making climate disclosure investor-optional would circumvent claims that the rule is invalid, which-to the extent they apply at all-apply only to a mandatory disclosure rule. Third, an investor-optional rule would better protect investors than a mandatory rule, reducing their net costs, while preserving their benefits. As a result, the SEC is required to consider an investor-optional rule, and having done so, it will be difficult for the SEC to justify adopting a mandatory rule instead. As well as explaining why the SEC should let investors decide about climate disclosure, the Article explains how the SEC should design the rule to ensure that it best protects investors. Letting investors decide would have benefits beyond climate, not only for other "ESG" disclosure rules, but for the SEC's regulatory program more generally, and thus also for investors.
Initiation Payments Hirst, Scott
The Journal of corporation law,
01/2023, Letnik:
48, Številka:
4
Journal Article
Recenzirano
...the Article explains how the adoption of initiation payments by investors-or their failure to do so-serves to test whether there is indeed under-initiation, and if there is, whether institutional ...investors wish to eliminate it. Investors initiating corporate changes receive only a small fraction of any value increases that result, but bear a larger proportion of their costs.9 Even for the investors that receive the largest fraction of any increases, activist hedge funds, the fraction is still very small-between 1% and 2%.10 So the activist hedge fund will only be incentivized to initiate a corporate change that they expect to result in benefits that are 50 to 100 times the cost of initiation.11 And estimates of those costs are substantial-$11 million on average, with some recent contests costing as much as $25 million.12 Of course, the activist hedge fund itself will only benefit if other investors support the change to the status quo (usually against management opposition), and if the change actually results in an increase in the share price of the company while the activist hedge fund retains its position. Because this will not always be the case, the expected returns must be even larger to justify initiating a change. The quantity of potential value-increasing changes that could be initiated likely declines as the value resulting from such changes increases.14 The number of changes that would result in the very-high-value increases necessary to incentivize initiation by activist hedge funds is likely to be orders of magnitude smaller than the number of potential changes that investors would expect to result in lesser increases in the value of the company, but that would nonetheless still be collectively-preferred.15 Regulatory intervention and practices developed by investors have created low-cost alternatives for investor initiation, the most effective of which are shareholder proposals.16 Thus, it is possible that investors could have incentives to initiate changes with shareholder proposals that investors would collectively prefer, but which would result in much smaller increases in the value of a corporation than from a proxy contest.17 But regulatory constraints on the use of shareholder proposals prevent them from being used for changes to the company's business operations or its management. ...satisfying initiating investors' non-pecuniary preferences will not cover the costs of investors' time or out-of-pocket costs.24 They will therefore be limited in how many corporate changes they can initiate with shareholder proposals.
THE SPECTER OF THE GIANT THREE Bebchuk, Lucian; Hirst, Scott
Boston University law review,
05/2019, Letnik:
99, Številka:
3
Journal Article
Recenzirano
This Article examines the large, steady, and continuing growth of the Big Three index fund managers-BlackRock, Vanguard, and State Street Global Advisors. We show that there is a real prospect that ...index funds will continue to grow, and that voting in most significant public companies will come to be dominated by the future "Giant Three. " We begin by analyzing the drivers of the rise of the Big Three, including the structural factors that are leading to the heavy concentration of the index funds sector. We then provide empirical evidence about the past growth and current status of the Big Three, and their likely growth into the Giant Three. Among other things, we document that the Big Three have almost quadrupled their collective ownership stake in S&P 500 companies over the past two decades; that they have captured the overwhelming majority of the inflows into the asset management industry over the past decade, that each of them now manages 5% or more of the shares in a vast number of public companies; and that they collectively cast an average of about 25% of the votes at S&P 500 companies. We then extrapolate from past trends to estimate the future growth of the Big Three. We estimate that the Big Three could well cast as much as 40% of the votes in S&P 500 companies within two decades. Policymakers and others must recognize-and must take seriously-the prospect of a Giant Three scenario. The plausibility of this scenario exacerbates concerns about the problems with index fund incentives that we identify and document in other work.
BIG THREE POWER, AND WHY IT MATTERS Bebchuk, Lucian; Hirst, Scott
Boston University law review,
09/2022, Letnik:
102, Številka:
5
Journal Article
Recenzirano
This Article focuses on the power and corporate governance significance of the three largest index fund managers commonly referred to collectively as the Big Three. We present current evidence on the ...substantial voting power of the Big Three and explain why it is likely to persist and, indeed, further grow. We show that, due to their voting power, the Big Three have considerable influence on corporate outcomes through both what they do and what they fail to do. We also discuss the Big Threes undesirable incentives both to underinvest in stewardship and to be excessively deferential to corporate managers. In the course of our analysis, we reply to responses and challenges to our earlier work on these issues that have been put forward by high-level officers of the Big Three and by a significant number of prominent academics. We show that these attempts to downplay Big Three power or the problems with their incentives do not hold up to scrutiny. We conclude by discussing the substantial stakes in this debate-the critical importance of recognizing the power of the Big Three, and why it matters.
Investors have long been unhappy with certain governance arrangements adopted by companies undertaking initial public offerings ("IPOs"), such as dual-class voting structures. Traditional sources of ...corporate governance rules-the Securities and Exchange Commission, state law, and exchange listing rules-do not constrain these arrangements. As a result, investors have turned to a new source of governance rules: index providers. This Article provides a comprehensive analysis of index exclusion rules and their likely effects on insiders ' decision-making. We show that efforts to portray index providers as the new sheriffs of the U.S. capital markets are overstated. Index providers face complex and conflicting interests, which make them reluctant regulators, at best. We put forward an analysis of insider incentives in light of index exclusions and apply it to one of the most important applications ofindex exclusion rules to date, the recent decision by index providers to exclude from their indexes certain companies with dual-class share structures. We conclude that the efficacy of index exclusions in preventing disfavored arrangements such as dual-class structures is likely to be limited, but not zero. Index exclusions are a corporate governance experiment, one that has important lessons. We examine these lessons, and the way forwardfor corporate governance. These lessons are all the more important because of the central place of index funds, and therefore index providers, in our capital markets.
Frozen Charters Hirst, Scott
Yale journal on regulation,
01/2017, Letnik:
34, Številka:
1
Journal Article
In 2012, the New York Stock Exchange changed its policies to prevent brokers from voting shares on corporate governance proposals when they have not received instructions from beneficial owners. ...Although the change was intended to protect investors and improve corporate governance, it has had the opposite effect: a significant number of U.S. public companies are no longer able to amend important parts of their corporate charters, despite the support of their boards of directors and overwhelming majorities of shareholders. Their charters are frozen. This Article provides the first empirical and policy analysis of the broker voting change and its significant unintended consequences. 1 provide empirical evidence that the broker voting change has resulted in the failure of more than fifty charter amendments at U.S. public companies, despite board approval and overwhelming shareholder support, and that hundreds more companies have frozen charters as a result of the change. The rule change has also made it more difficult to amend corporate bylaws and given some insiders a de-facto veto in proxy voting contests. These costs substantially outweigh the negligible benefits of the broker voting change. I compare a number of solutions to address these problems and identify several that would be preferable to the current approach.
UNIVERSAL PROXIES Hirst, Scott
Yale journal on regulation,
01/2018, Letnik:
35, Številka:
2
Journal Article
Contested director elections are a central feature of the corporate landscape and underlie shareholder activism. Rules governing proxy voting by shareholders prevent shareholders from "mixing and ...matching" among nominees from the two sides of contests. This Article's analysis shows that these proxy voting rules can lead to distorted proxy contest outcomes: different directors being elected than if shareholders had been able to vote how they wished. These distortions are likely to have significant consequences for the affected companies and ex ante consequences for many more companies. Changes to corporate voting rules are currently the subject of an important policy debate. The Securities and Exchange Commission (SEC) has proposed a universal proxy regulation, which would allow shareholders to vote for their preferred mix of nominees, and would eliminate distortions in proxy contest outcomes. But the rule has been met with substantial opposition. This Article provides the first empirical analysis of the extent of distortions, and the likely effects of universal proxies. The Article 's empirical analysis uses a comprehensive and largely hand-collected data set. It demonstrates that distorted proxy contest outcomes are a real and practical problem. As many as 15% of proxy contests between 2001 and 2016 may have had distorted outcomes. Contrary to the claims of most commentators, there is no empirical evidence that universal proxies would favor special interests or lead to more frequent proxy contests. The Article analyzes how the SEC should implement universal proxies and explains that a rule permitting corporations to opt out of universal proxies would be superior to the SEC's proposed regulation, which would require all corporations to use universal proxies. If the SEC chooses not to implement a universal proxy regulation, the Article explains how investors could implement universal proxies through private ordering to adopt "nominee consent policies. "
Shareholders exert significant influence on the social and environmental behavior of U.S. corporations through their votes on social responsibility resolutions. However, the outcomes of many social ...responsibility resolutions are distorted, because the largest shareholders--institutional investors, such as mutual funds and pension funds--often do not follow the interests or the preferences of their own investors. This Article presents evidence that institutions with similar investors and identical fiduciary duties vote very differently on social responsibility resolutions, suggesting that some institutional votes distort the interests of their investors. Other evidence presented suggests that institutional votes on social responsibility resolutions vary significantly from the preferences of their own investors. Whether such distortion of preferences is a problem is an open question. If such distortion is considered to be a problem, it could be addressed by institutions changing their voting policies on social responsibility resolutions to better approximate the preferences of their investors. The stakes are high: eliminating distortion could significantly influence the behavior of corporations on social and environmental matters in a way that investors, and society, would prefer.
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