Fund managers like BlackRock have accumulated too much influence: technology comes to the rescue
The question of how listed companies can be accountable to their owners has been a problem for centuries. Free market enthusiasts argue that the best solution is for companies to focus on maximizing their profits. The shareholder value doctrine has fallen out of favor. But the growing involvement of large institutional investors in the thorny issues of social governance creates a number of new problems. Fortunately, modern technology can come to the rescue.
In a famous opinion piece published in 1970 in the NYT, Milton Friedman argued that the social responsibility of companies was to increase their profits. The executives, as employees of them, were responsible to the owners and had to “run the company according to their wishes, which will generally be to make as much money as possible while conforming to the basic norms of society.” If the executives were distracted by their “social responsibility”, they would act against the interests of the owners.
More than half a century later, it is not obvious that investors are only interested in maximizing profits. Many also want companies to deal with the environment and other social issues. That’s all well and good when the investors expressing those views are the underlying beneficiaries. But it’s another matter when investment managers – the real owners’ agents – get involved.
The investment world has fervently embraced environmental, social and governance (ESG) issues. As the Davos 2020 Manifesto of the World Economic Forum proclaims, “a company not only serves its shareholders, but all its stakeholders”. In her new book, Share Power, Merryn Somerset Webb quotes the head of a large UK institutional who argues that fund managers need to “integrate ESG factors that matter to savers at the heart of the investment process”, adding to not vary that “what is good for the shareholders is not always convenient for all those affected”.
A 2021 Natixis survey revealed that more than 70% of investment institutions claimed to pursue so-called impact investing. Topping the list were giant index fund providers – BlackRock, Vanguard and State Street – which manage assets worth more than $20 trillion. In 2018, BlackRock boss Larry Fink instructed managers of companies whose shares are held by his firm that “every company must not only deliver a financial return, but also show how it makes a positive contribution to the society.” In 2021, he said the manager would use shareholder votes to get companies to reduce polluting emissions. [El martes, sin embargo, explicó por qué podría votar en contra de resoluciones para prohibir la producción de petróleo y gas.]
If investors can do good while doing good, what’s wrong? For starters, there is the thorny issue of return on investment. Many claim that fulfilling social responsibilities increases long-term returns. But limiting the universe of investment or the scope of a company’s activities is bound to affect. Somerset Webb cites a 2008 study that found that calls actions sin – tobacco, weapons, etc. – outperformed the market in 21 countries between 1970 and 2007. The US Department of Labor has stipulated that pension funds must not put ESG requirements before financial returns.
There is another problem. As Friedman pointed out, the notion of corporate social responsibility is ill-defined. There are also inevitable trade-offs. The interests of the various parties may conflict. How does an energy company balance the demands of investors to reduce investment in fossil fuels with the need of its customers to keep fuel costs low? What social concerns should take priority? Should a company give up the opportunity to move manufacturing overseas to keep well-paying jobs at home?
Savers are not likely to have exactly the same social preferences, nor are they likely to vote for the same party. Furthermore, many still adhere to the old-fashioned views of Friedman. A recent study by the Center for Policy Studies revealed that 45% of people thought that companies should avoid taking political positions.
Furthermore, the social priorities of professional fund managers may differ from those of their clients. It is observed that the remuneration of companies has remained relatively low on their agendas. Not surprisingly, since professional investors are among the highest paid on the planet: Fink’s compensation in 2020 was nearly $30 million. Private shareholders are four times more likely to vote against inflated executive packages than institutional ones, according to Somerset Webb.
But the more pressing issue is the political influence the Big Three investment firms wield when they vote on behalf of their clients. Charlie Munger recently warned of the “huge transfer” of decision-making power from companies to a select few. “We have a new set of emperors, and they are the ones who vote for stocks in index funds,” he said.
According to Somerset Webb, there is a way out of the quagmire. A technology allows institutions to return corporate governance decisions to the true owners. Legal & General, a large UK investment firm, is using software to directly connect more than 50,000 of its clients with the companies they own. US Securities Commissioner Allison Herren Lee has called for more transparency in how investors’ money is voted. She suggests that the blockchain it could be used to record beneficial ownership and run votes.
In 2021, BlackRock announced that it would give its largest clients a voice in the vote. But that just gives power from one group of fund managers to another. Somerset Webb argues that most people today own shares through pension plans and other savings vehicles. If you want to use your capital to change the behavior of companies, you have to let them have a say.