Are passive investors good stewards of corporate responsibility? A widely read Atlantic article, cited by a corporate governance panel at the Morningstar ETF Conference in Chicago, wondered aloud if passive investors “are evil.” Not so say representatives from passive goliaths Vanguard Group, Blackrock Inc and State Street Global Advisors. As passive investing is growing at historic levels, these passive managers are quick to point out that their engagement of management and the corporate board, voting against them at times, has made a difference in a variety of topical issues from gender equality to climate change.
Study, citing airline industry data, says passive investing leads to anti-competitive behavior
In April 2014, Joes Azar, Isabel Tecu and Martin Schmalz posted a draft of what would become a controversial paper, “Anti-competitive Effects of Common Ownership.” When developing the thesis as a doctoral candidate at Princeton, Azar might have reason to suspect the thesis would be ignored. Two decades earlier an argument from Princeton economist Julio Rotemberg, with help from then Harvard economist Larry Summers, was ignored, in part due to the lack of empirical data. But this time Azar and his team came to the table with documentation.
Examining the airline industry, they considered “common ownership” by investors with an interest in seeing competitors cooperate and generate higher profits rather than compete and cut prices. Their conclusion made waves, as the Atlantic pointed out:
If investors own a slice of every firm, they will make more money if firms compete less and collectively raise prices, at the expense of consumers. Knowing this, the firms’ managers will de-emphasize competition and behave more cooperatively with one another.
Pointing the finger directly at the Morningstar speakers, the report noted that common ownership by passive fund managers BlackRock Group, Vanguard Group and State Street Global Advisors led to ten times higher route concentration, which translates into higher ticket prices.
Not so fast, say corporate governance managers Glenn Booraem at Vanguard Group, Michelle Edkins at Blackrock Inc and Rakhi Kumar at State Street Global Advisors.
State Street Global Advisors, Blackrock Inc, Vanguard Group all fight for gender equality and climate change
Passive investors do monitor corporate behavior and have taken stands on politically popular issues. The trio at the Morningstar conference pointed to advocating for energy giant ExxonMobil to adopt a climate change risk disclosure as one example, an advisory vote that was approved by 62% of shareholders.
In that instance, the passive investor voices were public and carried significant weight. But where the passive investing giants are often most successful is where they engage a board of directors in private. Such engagement is “difficult” to publicly disclose, Booraem of Vanguard Group told the Morningstar audience, but resulted in “the most impact.” He tends to focus attention on those stocks that most impact the index.
Such engagement is “difficult” to publicly disclose, Booraem of Vanguard Group told the Morningstar audience, but resulted in “the most impact.” He tends to focus attention on those stocks that most impact the index.
“Being an index investor is like being married with divorce not an option,” Kumar of State Street Global Advisors quipped. Just like a marriage, Kumar noted there State Street Global Advisors and others have methods to change behavior other than a divorce. “The carrot is engagement and the proxy vote is the stick,” she said. “If the carrot doesn’t work, go to the stick.”
She considers gender diversification, water management and climate issues among the most significant, pointing to numerous instances of voting against management when there were no women represented on the board of directors. She also advocated against the inclusion of Snap in a major stock index because the firm did not believe in a one shareholder one vote approach.
Corporate governance experts: Engage directly with investors, don't assume shareholder proxy services are representative of investors
Edkins likes to engage directly with boards on issues and questions proxy advisory services, which were viewed as a middle layer not representative of the group. “ISS does not set the agenda here,” she said, speaking of one of the two major proxy advisories. “Come talk to us. ISS is not the investment standard.”
While the group did not address the primary charges made in the white paper head on, mostly avoiding discussion of market collusion and diminished competition among larger corporations, they lightly touched on corporate malfeasance. They said a good board structure and management process should be in place to root out such issues, and the if engagement on the issue did occur it would happen after the fact.