BlackRock and Vanguard are by far the broadest global blockholders in listed corporations according to both the 3 percent and 5 percent thresholds. These blockholdings are located in a number of countries around the world; the majority, however, is in the United States. BlackRock has about two thousand 5 percent holdings in the United States; a non-negligible number when taking into account that in total there are only about 3,900 publicly listed U.S. corporations. In other words, BlackRock holds 5 percent blocks in more than one-half of all listed companies in the United States. That is significantly more than five years ago; According to Davis, in 2011 BlackRock had owned roughly 1,800 five percent blockholdings in the United States, while Fidelity owned 680. 44
Vanguard’s ownership positions also concentrate in the United States. Of the 1,855 five percent blockholdings, about 1,750 are in U.S. listed companies. As Table 2 shows, both BlackRock and Vanguard hold relatively few 10 percent blocks; the former owns about 300 of these positions in U.S. listed companies and the latter only 160 – note that this refers to the asset manager as a whole, the US 10 percent “insider” law only pertains to individual funds, however. State Street is much smaller in the large blockholdings, as its ownership profile is both narrower and shallower. With about 1,000 three percent holdings in U.S. companies, State Street is the fifth largest asset manager in the segment of these small blockholdings. Above the 5 percent threshold, however, State Street only has 260 blocks in U.S. listed corporations—and twelve above the 10 percent level. Two other asset managers shown in Table 2 are also noteworthy: Fidelity and Dimensional Fund Advisors (DFA). Fidelity is by far the largest actively managed mutual fund group (see also Table 1). In contrast to the Big Three, Fidelity has a much narrower and deeper ownership profile; it holds roughly 700 five percent blockholdings in U.S. corporations (the other 600 are international), and of this about 300 are 10 percent blocks. DFA has a very broad and shallow ownership profile that resembles that of a passive index fund; it holds approximately 1,100 three percent holdings and 540 five percent blocks in U.S. publicly listed companies, but virtually no 10 percent ones. Arguably, the reason is that DFA builds its own in-house quantitative models, using different company parameters, which focus primarily on small and undervalued companies. 45 The Big Three, on the other hand, replicate large and established stock indices, such as the S&P 500, which are publicly available. This necessarily leads to the situation that BlackRock, Vanguard, and State Street hold parallel ownership positions in an increasing number of publicly listed companies.
3.2 Combined ownership of the Big Three in the United States
As a consequence of their dominance in the asset management industry, a large and growing number of publicly listed companies in the United States face the Big Three—seen together—as their the largest shareholder. In 2015, this has been the case in 1,662 listed U.S. corporations, with mean ownership of the Big Three of over 17.6 percent (Figure 2). The total number of publicly listed firms in the United States amounts to approximately 3,900. Thus, when combined, BlackRock, Vanguard, and State Street constitute the single largest shareholder in at least 40 percent of all listed companies in the United States. Together, these 1,662 American publicly listed corporations have operating revenues of about U.S. $9.1 trillion, a current market capitalization of more than U.S. $17 trillion, possess assets worth almost U.S. $23.8 trillion, and employ more than 23.5 million people.
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Source: Authors calculations based on Orbis.
Figure 2: Statistics about the ownership of the Big Three in listed U.S. companies.
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When restricted to the pivotal S&P 500 stock index, the Big Three combined constitute the largest owner in 438 of the 500 most important American corporations, or roughly in 88 percent of all member firms. These 438 co-owned corporations account for about 82 percent of S&P 500 market capitalization. Large companies where the Big Three are not the main shareholders are typically dominated by private individuals: Alphabet (Sergey Brin and Larry Page), Berkshire Hathaway (Warren Buffett), Amazon.com (Jeff Bezos), Facebook (Mark Zuckerberg), Walmart (Walton family), Oracle (Larry Ellison), Comcast (Roberts family) and Kraft-Heinz (Berkshire Hathaway and 3G Capital). In the vast majority of the member firms of the S&P 500, however, the Big Three combined represent the single largest owner.
In Figure 3 we visualize the network of owners of publicly listed corporations in United States, focusing on ownership ties larger than 3 percent. The size of each node shown reflects the sum of its ownership positions in U.S. listed companies (in percent, only counting positions above the three percent threshold). The 1,662 firms in which the Big Three (themselves in magenta) together are the largest shareholder are shown in green; firms in which they constitute the second largest shareholder are orange, and blue denotes cases where they represent the third largest owner. Finally, cyan nodes are companies in which the Big Three are not among the three largest shareholders. Grey nodes correspond to shareholders of publicly listed companies that are not themselves listed—e.g., Fidelity, DFA, and Capital Group. This visualization underscores the central position of BlackRock and Vanguard in the network of corporate ownership. Both are significantly larger than all other owners of listed U.S. corporations. Fidelity has the third biggest size, followed by State Street and Dimensional Fund Advisors. All three, however, are considerably smaller than Vanguard and BlackRock.
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Source: Authors, based on Orbis database.
Note: Only ties of >3% ownership are included.>
Figure 3: Network of ownership and control by the Big Three in listed U.S. firms.
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The size of a node in the visualization can be interpreted as the potential shareholder power of the particular owner within the network of control over listed companies in the United States. Thus, when seen together, the Big Three occupy a position of unrivaled potential power over corporate America. The graph gives a good impression of the fact that we witness a concentration of corporate ownership, not seen since the days of J.P. Morgan and J.D. Rockefeller. However, these finance capitalists of the gilded age exerted their power over corporations directly and overtly, through board memberships and interlocking directorates. This is not the case with the Big Three. Hence, we now examine the more hidden forms of corporate governance behavior of the Big Three.
4 Do the Big Three follow a centralized voting strategy?
The next question is to what extent the Big Three use their potential shareholder power through an active centralized corporate governance strategy. We therefore measure how coordinated voting behavior of asset managers is in corporate elections across their funds, as well as how often they vote with management. The voting data records the management recommendation and the shareholders vote. Shareholder votes were recorded as either, “For,” “Against,” “Abstain,” or “Withhold.” We grouped the shareholder votes into two categories: votes agreeing with the management recommendation are voting with management; all others are voting not with management.
Figure 4 shows the result of the analysis and includes the voting behavior of 117 distinct asset managers in our database, all with at least two funds voting in the same AGM at the same time. Internal disagreement measures the percentage of proposals where funds within an asset manager voted in different directions. External disagreement measures the percentage of cases where an asset manager voted against the management recommendation. Take for instance Calvert Investment, an activist investor. Figure 4 shows that over 40 percent of Calvert votes are against the management recommendation. Their management-unfriendly strategy goes together with a high level of internal agreement: in 99.985 percent of the proposals, all their funds voted in the same direction.
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Figure 4: Coordination and pro-management inclination of voting behavior.
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If we now turn to the voting behavior of the Big Three, a number of observations can be made. Overall, the internal agreement in proxy voting among the Big Three’s funds is remarkably high. In fact, BlackRock and Vanguard are on the forefront of asset managers with internally consistent proxy voting behavior. At BlackRock, in 18 per 100,000 of the proposals one of their funds did not vote along with the other funds, and for Vanguard this is even more consistent with only 6 per 100,000 of the proposals receiving mixed votes. State Street also shows a low level of internal disagreement, 195 per 100,000, though somewhat higher than BlackRock and Vanguard. This clearly evidences that the Big Three are able and do indeed apply centralized voting strategies. The very high level of consistency also implies that there is no difference between the passive and the active funds under their management, disregarding the funds’ arguably different interests as discussed in section 2. In fact, at least one prominent case has been reported where the active side of BlackRock convinced the central corporate governance team to adopt its stance. 46 Active asset managers show higher levels of disagreement, reflecting the freedom of its fund managers to cast the proxy votes. Fidelity, for instance, displays significantly higher levels of disagreement in its proxy voting, with internal disagreement in 3,144 per 100,000 votes.
Friends or foes of management?
The external agreement on the horizontal axis indicates the share of proposals where the fund votes against management. Figure 4 shows that by and large, management can count on the support of asset managers. The voting behavior of BlackRock, Vanguard, and State Street is similar to that of most active mutual funds: They side with management in more than 90 percent of votes. This echoes increasing concerns of various stakeholders about the lacking response of investment funds on critical corporate governance issues such as executive pay. Understanding the topics on which the Big Three oppose management is therefore an important research issue. A thorough analysis requires coding and categorizing all the 8.6 million proposals in our database, a laborious undertaking that we leave for future research. We did, however, conduct an exploratory analysis of the cases where the Big Three do not vote with management.
Management can recommend to vote for or against a proposal, and the Big Three can choose to follow or oppose. A first telling observation is that only a small fraction of the opposition of the Big Three against management occurs in proposals where management recommends voting against (BlackRock 6 percent; Vanguard 2 percent; State Street 5 percent). Proposals that management recommends to oppose are typically issues put on the agenda by activist shareholders. This implies that the Big Three ally with management against such shareholder proposals—in fact, the ability to repel unwelcome activist investors may be an important part of the potential influence of the Big Three over management. Consistent with this finding is that a large majority of proposals where the Big Three vote against (against the proposal itself, not against the management recommendation) are related to Environmental, Social, and Governance (ESG), which are mainly proposed by activist shareholders. Based on additional data from ProxyInsight we know that 77 percent of BlackRock’s “against” votes are in the domain of ESG, followed by 44 percent of Vanguard’s and 43 percent of State Street’s. 47
Perhaps most interesting are the proposals where the Big Three oppose a positive management recommendation. We found that about half of them concern the (re)election of the board of directors (BlackRock 50 percent; Vanguard 46 percent; State Street 45 percent). This suggests a proxy voting strategy where the Big Three typically support management, but will use their shareholder power to vote against management when they are dissatisfied. This leads to two conclusions. First, the voting behavior of the Big Three at AGMs is by and large management-friendly and does not reflect a highly engaged activist corporate governance policy. Second, the high propensity to vote against management (re)elections is consistent with the idea that the Big Three use their voting power to make sure they have the ear of management. Instead of open activism, the Big Three may prefer private influence. In the words of Larry Fink, CEO of BlackRock: “As an indexer, our only action is our voice and so we are taking a more active dialogue with our companies and are imposing more of what we think is correct.” 48 BlackRock reports in detail on how many times it informally engages with management, including statistics broken down by type of meeting and region going back to 2010. From mid-2014 to mid-2015, BlackRock has performed over 1,500 private “engagements” with companies held in their portfolio, 670 in the Americas and about 850 in the rest of the world—Vanguard had over 800 company engagements. 49 Hence, the Big Three may choose not to oppose management overtly but rely on private “engagements” with their invested companies. In fact, BlackRock reportedly believes that “meetings behind closed doors can go further than votes against management”—and that the asset manager typically gives opposing corporations one year before voting against them. 50 Each of the Big Three alone holds considerable ownership and thus potential to influence hundreds of U.S. corporations in such private encounters. In addition to the direct influence of the Big Three, they may also exert a form of indirect or structural power.
3 Structural power of passive investors?
The analysis of the voting behavior underscores that the Big Three may be passive investors, but they are certainly not passive owners. They evidently have developed the ability to pursue a centralized voting strategy—a fundamental prerequisite to using their shareholder power effectively. In addition to this direct exercise of shareholder power, the extent of the concentration of ownership in the hands of the Big Three may also lead to a position of structural power. Structural power emerges from a set of fundamental (asymmetrical) interdependencies between actors, such that one actor pro-actively takes into account the interests of a structurally powerful other. 51 Structural power arises from the occupation of core positions within interconnected structures, such as global financial markets. 52 In comparative political economy it typically refers to the structural power business holds over the state, because firms and capital holders control the investment decisions on which the economy depends for growth. A similar logic underpins the concept of systemically important financial institutions: They are important because the system is dependent on them to function well. The dominant position of the Big Three in the network of ownership as visualized by Figure 3 provides them with what Young calls “structural prominence” in corporate governance. 53 This position of prominence may potentially lead to a kind of “disciplinary power” over management as Roberts et al. have found for active funds: “the discipline is realised in anticipation within the self, or at least is rationalised in a defensive way that presents the self as already wanting what the investor wants.’”
The exact extent of the structural power exerted by passive index funds is a crucial question for future empirical research, as it may have far-reaching consequences. For instance, passive index funds have no reason to support aggressive price cuts or other measures that aim to take away revenue from competitors, because in many concentrated industries they own most of the competing firms. Elhauge calls the hundreds of parallel ownership positions by the Big Three “horizontal shareholding”—the constellation in which “a common set of investors own significant shares in corporations that are horizontal competitors in a product market.” 55 And when firms proactively internalize the objectives of the Big Three, their common ownership in competing firms could entail significant anticompetitive consequences. A small but growing body of empirical research suggests that this anticompetitive effect may indeed be significant. Recent work shows that for the U.S. airline industry common ownership has contributed to 3–11 percent increases in ticket prices. 56 Azar et al. analyzed within-route airline ticket price variation over time to identify a significant effect of common ownership. In addition, they have confirmed their findings with a panel-instrumental-variable analysis that utilizes the variation caused by BlackRock’s acquisition of Barclays Global Investors in 2009. They conclude that, while enabling private benefits such as diversified low-cost investment, common ownership by large asset managers leads to decreased macroeconomic efficiency through reduced product market competition and thus has significant hidden social costs.
Another study on banking competition in the United States has found that common ownership by asset managers and cross-ownership (the situation in which banks own shares in each other) are strongly correlated with higher client fees and higher deposit rate spreads. 57 An additional study, using the variations in ownership by passive funds that are due to the inclusion of stocks in the Russell 1,000 and 2,000 indices, found that index funds influence the corporate governance of firms, leading to more independent directors and the removal of takeover defenses. 58
These findings support the thesis that the Big Three may exert structural power over hundreds, if not thousands, of publicly listed corporations in a way that is “hidden” from direct view. In most cases, BlackRock, Vanguard, and State Street need not overtly enforce their opinion on firms by voting against management, because it is rational for managers to act in a way that conforms to the interests of the Big Three. The large and growing concentration of ownership of the Big Three together with their centralized corporate governance strategies we uncovered underscores the importance of a research agenda that further investigates the consequences of this form of new finance capitalism where passive asset managers occupy positions of structural prominence.
6 Asset management capitalism and new financial risk
The recent rise of the Big Three has already led to serious concerns that “it cannot be good for capitalism.” 59 A first and major concern is that a further increasing market share of passive index funds could impair efficient price finding on equity markets, as the proportion of actively traded shares would continue to shrink. This concern already led some to polemically argue that because passive funds take active fund managers out of the role of allocating capital, the outcome is “stealth socialism.” 60 One of the most outspoken regulators concerning this topic is Andrew Haldane from the Bank of England. In a speech in 2014, he argued that we have potentially entered the “age of asset management” due to enormous growth of assets under management in the last decades and the relative retreat of banks after the global financial crisis. 61 He sees indications that passive investing could increase investor herding and thus lead to more correlated movements of markets. In this way, passive index funds could intensify the pro-cyclicality of financial markets.
A second concern regarding increased risk relates to the practice of securities lending. Passive asset managers regularly lend out shares to short-sellers to generate additional income. According to Cetorelli, BlackRock has increased its securities lending operations significantly in recent years. Indemnification of securities on loan by BlackRock more than tripled from U.S. $40 billion in 2012 to over U.S. $130 billion in 2014, while for State Street the value was even U.S. $320 billion one year before. 62 Such securities lending—like most activities of large passive asset managers—seems to be unproblematic in good times, but could impair liquidity significantly in times of serious market stress. These developments have led global regulators to examine whether large asset managers, such as BlackRock, should be labeled “systemically-important financial institutions.” In mid-2015, the Financial Stability Board in Basel decided not (yet) to apply this label—after fierce lobbying by the industry. 63 On the other hand, concerns about reduced liquidity due to passive investment strategies may be moderated by the observation that ETFs themselves have become the object of active trading strategies. The first passive stock tracker—the SPDR S&P 500 ETF—is the single most heavily traded listed security on the planet. 64
The active trading of passive index funds may have far reaching consequences. When passive index funds do indeed become the main building blocks for active investment, we are confronted with a fundamental reorganization of contemporary corporate governance. Because the voting rights reside with the asset managers who supply the passive index funds, and because the passive index fund industry is concentrated in the hands of the Big Three, this effectively means that the separation of ownership and control may potentially come to an end. After all, the active investors who trade with the passive building blocks no longer have access to the voting rights. And the Big Three accumulate the voting rights without much concern for short-term considerations. What is more, their interests are not restricted to the well-being of any particular firm. As mentioned, passive index fund managers arguably have little interest in fierce competition between their co-owned corporations, because this constitutes a zero-sum (or even negative-sum) game for them. Rather, they have industry or market-wide interests. Such developments may lead to a situation where the large owners of corporate businesses have limited incentives to engage with firm-level corporate governance beyond fulfilling their fiduciary obligations.
7 Conclusion
Since 2008, an unprecedented shift has occurred from active towards passive investment strategies. We showed that the passive index fund industry is dominated by BlackRock, Vanguard, and State Street. Seen together, these three giant, passive asset managers already constitute the largest shareholder in at least 40 percent of all U.S. listed companies and 88 percent of the S&P 500 firms. Hence, the Big Three, through their corporate governance activities, could already be seen as the new “de facto permanent governing board” for over 40 percent of all listed U.S. corporations. 65
An original and compressive mapping of blockholdings revealed that in the United States the market for corporate control shows unprecedented levels of concentrated corporate ownership. The Big Three occupy a position of “structural prominence” in this network of corporate governance. We furthermore found that while the proxy voting strategies of the Big Three show signs of coordination, they by and large support management. However, BlackRock, Vanguard, and State Street may be able to influence management through private engagements. Moreover, management of co-owned companies are well aware that the Big Three are permanently invested in them, which makes it possible that through this “disciplinary” effect they may internalize some common objectives of the passive index managers. On balance, we find significant indications that the Big Three might be able to exert forms of power over the companies held in their portfolios that are hidden from direct inspection.
When Vanguard pioneered its index fund concept in the mid-1970s it was attacked as “un-American,” exactly because they held shares in all the firms of an index and did not try to find the companies that would perform best. Therefore, the new tripartite governing board of BlackRock, Vanguard, and State Street is potentially conflicting with the image of America as a very liberal market economy, in which corporations compete vigorously, ownership is generally fragmented, and capital is generally seen as “impatient.” 66 Benjamin Braun has argued that passive investors may, in principle, act as “patient” capital and thus facilitate long-term strategies. 67 Hence, the Big Three have the potential to cause significant change to the political economy of the United States, including through influencing important topics for corporations, such as short-termism versus long-termism, the (in)adequacy of management remuneration, and mergers and acquisitions.
We reflected on a number of anticompetitive effects that come with the rise of passive asset management, which could have negative consequences for economic growth and even for economic equality. As well, we signaled how the continuing growth of ETFs and other passive index funds can create new financial risk, including increased investor herding and greater volatility in times of severe financial instabilities. The ongoing rise of the Big Three and the concomitant fundamental transformation of corporate ownership today clearly warrants more research to examine their impact on financial markets and corporate control—in the United States but also internationally.
Source: Cambridge.org
