The corporation’s role in society is in flux. Previous generations saw government as an important bulwark against corporate harm. Today, by contrast, corporate America is thought to be a solution to government dysfunction around issues like inequality and the environment. In addition, the “Big Three” asset manager giants that specialize in index funds – Vanguard, State Street, and BlackRock – have voiced concern over these same issues and promised that they will push companies to address them.
In a new article, I evaluate this shift in the corporate political environment. I argue that demand for regulation has outstripped supply, and that indexed asset managers have stepped in to address the shortfall. More specifically, my article reveals that the Big Three are providing a form of privatized regulation – standards and mandates that are more stringent than existing law, enforced with penalties, and applied across the market.
In particular, the Big Three have launched policies in two areas of great social importance: increasing board gender diversity and reducing climate risk. As for the first, the Big Three mandated more board diversity, and some even specified a quota for women directors. The asset managers then enforced these mandates by voting against directors at non-compliant companies – a powerful motivator. As a result, their policies led companies to act where other measures had fallen short: Empirical research suggests that the Big Three’s mandates caused companies to add 2.5 times as many female directors in 2019 as they had in 2016.
The Big Three have likewise urged companies to reduce carbon emissions and improve their disclosure of ESG information. By 2020, soft engagements evolved into an aggressive voting policy when BlackRock announced it would require companies to disclose ESG information and operational plans in compliance with the Paris Agreement and committed to voting against directors at companies that failed to make sufficient progress. Vanguard and State Street followed suit shortly thereafter. And these climate policies have influenced corporate conduct: For example, one empirical study determined that greater Big Three ownership is strongly associated with fewer carbon emissions. Companies have also increased climate disclosure since the Big Three began to focus on it, and many credit their mandates as being a substantial motivator.
Therefore, in light of their size and “universal ownership” – the fact that they hold large stakes across the public market – the Big Three have been able to assume regulatory functions that typically reside in the hands of large government agencies like the EPA or SEC. Like those public bodies, the Big Three adopt market-wide standards governing firm conduct, assess compliance, and then penalize violations with their voting power. Although their enforcement relies on different tools – the ability to put management jobs and company reputations in jeopardy rather than the power to tax or fine an entity – it is no less coercive. In this way, the Big Three have supplied rules where public bodies have failed to move quickly (or at all).
As this discussion reveals, there is much that is puzzling about this dynamic. From starting principles, the concentration of regulatory power in the hands of three private for-profit companies that lack democratic legitimacy or electoral accountability is troubling. And yet, their chosen rules seem relatively benign and indeed offer benefits. For these reasons, commentators are divided on whether the rise of universal shareholder regulation is a benefit or curse.
My article provides a framework to evaluate this regulatory dynamic and these outcomes. Specifically, I theorize that market mechanisms constrain the exercise of power by the Big Three: Because they are profit-maximizing asset managers, the Big Three must secure broad consensus from their clients when adopting rules. Indeed, I posit that the Big Three are responding to demand for rules from these clients – and their institutional clients in particular – in the areas that they have been most active.
More broadly, my framework reveals that the issue of whether and how financial-intermediary agency costs undermine the interests of beneficial owners is more complex than many recognize. The literature has generally assumed that there is only a single intermediary standing between beneficial owners and portfolio companies, as occurs when an individual chooses to invest in an index fund managed by BlackRock. Instead, as my analysis reveals, intermediation is often more complex, with many beneficial owners having two layers of intermediaries exercising influence over their investments and the use of their governance rights (I call this “double intermediation”). Consider, for example, a state employee who pays into a public pension fund during her career. That public pension fund is fiduciary-bound to manage her investment prudently, and as such, may choose to invest in an indexed investment managed by State Street, in exchange for a fee. Consider too a corporate employee whose employer selects a menu of funds offered by State Street for that employee’s 401(k) contributions. In these examples, the beneficial owner’s governance rights would be exercised by State Street, but that mere fact obscures the reality that the beneficial owner is subject to two layers of intermediation (and accompanying agency cost issues) rather than one.
We can therefore predict that double intermediation will affect the Big Three’s policy initiatives. In particular, the Big Three’s interventions will be shaped by their desire to satisfy their institutional clients – the corporations and public pensions in the above examples – as well as those individual investors who invest directly. In addition to ensuring support from these clients (or at least avoiding client alienation), the Big Three’s interventions will be calculated to maximize support from the government, another institutional client as well as regulator of the Big Three’s activities. This separate constraint suggests that the Big Three’s regulatory interventions will take the public interest into account to some degree: If they were to veer too far afield, they would likely face public and regulatory backlash. But my framework also suggests an important limitation. In particular, the Big Three will never adopt socially beneficial policies that lack broad support from their clients, and particularly the corporate clients that supply a large percentage of their assets under management. Relatedly, the need to ensure client approval indicates that the Big Three will mandate only modest changes in corporate behavior, and that their rules are not likely to bring about the sweeping changes that may be necessary to address pressing social problems.
In addition to elucidating the forces that shape the Big Three’s policymaking, the observation that this activity is a form of privatized regulation leads to implications for our democracy. More specifically, the Big Three’s entry into the market for regulation represents the expansion of privatization dynamics that have shaped policymaking and legal scholarship since the 1980s. However, this is the first time that regulatory functions have been performed by mutual fund blockholders. And given that these powerful asset managers are here to stay, the time is ripe to contemplate how this dynamic affects society. On the one hand, there are reasons to embrace it. If government regulation caused companies to internalize harmful externalities, there would be no need for the Big Three to intervene; in the absence of such regulation, however, we might welcome intervention from private actors. Not only that, shareholder regulation may be subject to fewer pathologies than regulation by public bodies, and it also bypasses international coordination issues.
On the other hand, regulation by a handful of for-profit asset managers, acting in response to demand from their clients, is concerning. Unlike other private regulators whose policies affect the broader market, the governance officials and executives at the Big Three who make the rules lack democratic accountability, and there is little oversight or transparency surrounding their policies and how they are formulated. Moreover, there is no guarantee that these policies will further the public interest. Investors make up the wealthier half of America, and corporations likely embrace rules regulating their conduct for strategic reasons; in particular, out of a desire to forestall or co-opt future government regulation. For these reasons, the reforms wrought by asset managers are unlikely to lead to far-reaching changes in corporate behavior. Not only that, there is the risk that the provision of private regulation will take pressure off of the government to respond to these important issues.
As this discussion reveals, difficult normative questions loom. Traditional economic concepts suggest that shareholder “owners” should have the ability to influence the operation and governance of companies, including by having the companies they own be operated consistent with their values. Nonetheless, allowing three private investment companies that lack political accountability to set regulatory policies for the U.S. economy is dangerous for our democracy. My article begins the difficult task of weighing these normative tradeoffs, a task that will only become more important as the Big Three continue to wield great power.
 Todd A. Gormley, Vishal K. Gupta, David A. Matsa, Sandra Mortal & Lukai Yang, The Big Three and Board Gender Diversity: The Effectiveness of Shareholder Voice, Eur. Corp. Governance Inst. 1, 3 (Aug. 2021), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3724653.
 Jose Azar, Miguel Duro, Igor Kadach & Gaizka Ormazabal, The Big Three and Corporate Carbon Emissions Around the World, Eur. Corp. Governance Inst. 1 (2020), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3553258
This post comes to us from Professor Dorothy S. Lund at USC Gould School of Law. It is based on her recent article, “Asset Managers as Regulators,” available here.