Larry Fink, ‘Emperor’?

National Review Online, February 19, 2022

We live in an age when the Left is increasingly focused on the supposed evils of business concentration, from the “big is bad” ideology of the new antitrust enforcers at the FTC to the attempts to blame inflation on Big Grocery, Big Oil, or any of the other “bigs” allegedly exploiting the beleaguered consumer. And yet the concentration of corporate ownership positions held by a relatively small number of massive investment funds, particularly (but not only) the indexers, has drawn comparatively little criticism from the same quarters. Perhaps their managers’ role in helping create our emerging corporatist state through an ever tighter embrace of “socially responsible” investment and larcenous stakeholder capitalism has acted as a shield of sorts.

Nevertheless, the degree of that concentration has been something to see.

In the course of her thought-provoking article in the Atlantic last year on the ascent of index investing, Annie Lowrey observed that:

Some $11 trillion is now invested in index funds, up from $2 trillion a decade ago. And as of 2019, more money is invested in passive funds than in active funds in the United States. Indexing has gone big, very big. For nine in 10 companies on the S&P 500, their largest single shareholder is one of the Big Three. For many, the big indexers control 20 percent or more of their shares. Index funds now control 20 to 30 percent of the American equities market, if not more.

Indexing has also gone small, very small. Although many financial institutions offer index funds to their clients, the Big Three control 80 or 90 percent of the market. The Harvard Law professor John Coates has argued that in the near future, just 12 management professionals—meaning a dozen people, not a dozen management committees or firms, mind you—will likely have “practical power over the majority of U.S. public companies.”

This consolidation has, the Wall Street Journal reports, attracted the attention of Charlie Munger, the vice chairman of Berkshire Hathaway and Warren Buffett’s long-term business partner. The rise of index funds such as those run by Larry Fink’s BlackRock “has resulted in an ‘enormous transfer’ of the power to sway corporate decision making. That shift will ‘change the world,’ [Munger] said, and not for the better.”

The WSJ:

“We have a new bunch of emperors, and they’re the people who vote the shares in the index funds,” Mr. Munger, 98 years old, said at the annual meeting of Daily Journal Corp., a publishing company he has chaired since the 1970s. “I think the world of Larry Fink, but I’m not sure I want him to be my emperor.”

The Journal’s editorial board approved: “When you’re 98 years old you can say things others can’t, so bravo to Charlie Munger for daring to speak an important but too muffled truth about today’s financial markets.”

But back to the WSJ’s original report:

BlackRock and Vanguard Inc. are two of the biggest managers of passive investment funds, which track indexes instead of trying to beat the market by picking specific stocks.

The funds have become the default investing option for small investors and large pension funds alike, delivering better returns than many active funds during the market’s decadelong rally. The shift has boosted passive funds’ share of the total ownership base—and corresponding voting power—at many public companies.

The surging popularity of index funds has made their managers the biggest investors in most large stocks. The firms, including BlackRock, have sought to wield that power in ways that have at times made corporate executives uncomfortable. Investment managers have had more sway over important company decisions, including takeovers, the fates of executives and plans for long-term sustainability.

Mr. Fink is an advocate of stakeholder capitalism, the idea that companies have societal obligations that extend beyond maximizing value for shareholders.

“Capitalism has the power to shape society and act as a powerful catalyst for change,” Mr. Fink said in his annual letter to shareholders last month.

That’s true. Capitalism can indeed shape society and act as a catalyst for change, but that should be the product of innovation and wealth creation, not of working towards political ends unrelated to the proper purpose of a company in a free-market regime, which is to put its shareholders first.

But that’s not what those in charge of these funds seem to want.

The Journal’s editorial board:

Rather than push companies to pursue higher returns, they’re trying to impose their political agenda on corporate America. CEOs and corporate boards can find themselves on the wrong end of a shareholder vote if they refuse to accommodate BlackRock’s policy preferences on climate and “stakeholder capitalism.” Hail, Caesar, er, Larry.

Two years ago Mr. Fink wrote a letter to CEOs threatening to vote against corporate managers if they didn’t follow environmental, social and governance (ESG) disclosures prescribed by the Sustainability Accounting Standards Board. That Michael Bloomberg -backed outfit wants companies to report minutia from how much plastic they use to sales from sugary beverages.

In his annual letter this year, Mr. Fink did have some nice words about capitalism, which has been very, very good to him. But he also lectured CEOs that “employees are increasingly looking to their employer as the most trusted, competent, and ethical source of information,” and “stakeholders” including employees, customers, communities, and regulators “need to know where we stand on the societal issues intrinsic to our companies’ long-term success.”

Mr. Fink will also tell you what stand to take on those issues. He and his allies have become major swing votes in proxy board battles and shareholder resolutions. Climate-focused activist fund Engine No. 1 held only 0.02% of ExxonMobil shares, but it nonetheless managed to oust three board members last summer with the support of the Emperors’ club.

To be clear, putting shareholders first typically means working in their economic interest. That is the formula responsible for so much of the prosperity and so many of the technological (and other) advances that we enjoy today, shareholders or not. There is rather less conflict between shareholders and stakeholders than the propagandists for stakeholder capitalism would have the gullible believe. Reinforcing that argument is the reality that companies that alienate their customers or their employees (two classic examples of stakeholders for those fond of brandishing that term) are likely to run into problems sooner or later. Their shareholders will not thank management for that.

Munger’s use of the word “emperor” was entertaining — and pointed. In a democracy, broader decisions about the direction that society should adopt are (or ought to be) made either organically — as a consequence of how millions of people choose to live their own lives — politically, through the democratic process, or through a combination of both modes. The idea they should be made in the name of a country’s “stakeholders” by a modest number of (unelected) businesspeople, working in conjunction with (unelected) activists, (unelected) bureaucrats, (unelected) regulators, and, maybe, a faction within the government of the day, looks more like corporatism than democracy. Corporatism can be tolerably benign, but it should be remembered that, at its worst, it has provided a significant part of the theoretical underpinnings of fascism, a doctrine that, in practice, has tended to revolve around a single individual — an emperor, if you like, but with a title that sounds somewhat less antique, whether it’s Mussolini’s “Duce” or the various designations that Xi Jinping is trying on for size as he continues transforming China into a fascist state.

That, mercifully, is not on the American horizon. But if we were to descend fully into corporatism, our emperor would probably be a composite, a coterie of the like-minded exercising powers that it should not have. And we are closer to that moment than we should be.

A key part of the conundrum posed by the rise of the investment giants is that they are often huge shareholders in the companies they are endeavoring to steer away from the traditional emphasis on the bottom line. And if enough of them feel that way (not much of a bar to clear given both the size and overlapping ideological agendas of some of these funds’ managers) shouldn’t they, if shareholder primacy is to mean what it says, then get their way? One of the reasons why shareholder capitalism has delivered so much to so many has been shareholders’ expectation that the businesses in which they have invested will be run in a way intended to give them a good return. But that will be sabotaged if a small or smallish group of very large shareholders is willing to hobble the companies in which it has stakes for the benefit of a socio-political program disconnected (however much its members may claim to the contrary) from maximizing profits for the firm’s owners.

As a rule, such shareholders are prepared to do this because, for the most part, their shares belong ultimately to their clients. Sacrificing some return won’t cost their nominal holders, the investment managers, anything. In fact, it might yield them additional financial reward, and/or a pay-off in the form of the power, influence, and peer approval that comes with their activism.

To his credit, Fink now appears to acknowledge (if only implicitly) the conflict of interest that this creates between those managing money and those whose money it is.

The Wall Street Journal:

Mr. Fink has said the company is committed to a future where all investors have the option to vote their shares. BlackRock in October began allowing certain institutional investors to cast votes tied to their holdings.

That’s a good move, and it should be copied by other funds.

In the end, however, there needs to be a full restoration of the principle that those investing on behalf of others must, unless specifically authorized otherwise, do so with the sole goal of generating maximum (risk-adjusted) return. There is nothing wrong with people opting to sacrifice (or risk the sacrifice of) some potential profit for “socially responsible” motives, but that should be their choice — and not one that that kicks in by default, either.