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Can shareholder activism tame the financial system?

Activists are increasingly targeting businesses – from oil companies to gun manufacturers – on the stock market. But can this strategy lead to lasting change?

Owen Davis
15 February 2019
 PA

A demonstration outside of the Bank of England in London, during the 2009 G20 protests in the centre of London. Image: PAA surprising concern has arisen recently on Wall Street: markets are becoming socialist. The culprit? Passive investing. Instead of actively choosing which stocks to buy, or paying someone to do that, investors are devoting a growing slice of their portfolios to funds that simply own every stock in a broad index, such as the S&P 500 – made up of 500 leading American companies from a number of sectors, from Amazon to Delta Airlines. When investors indiscriminately own a small share of every company, the result strikes some as a form of socialism. One alarmed director at a major firm has gone as far to describe passive investing as “worse than Marxism”. For famed hedge fund manager Paul Singer, such funds are “devouring capitalism”.

The argument has precedent. In 1914, a prominent German banker surveyed the growing consolidation of industry under the control of major banks and grew uneasy. “One fine morning we shall wake up in surprise to see nothing but trusts before our eyes, and to find ourselves faced with the necessity of substituting state monopolies for private monopolies,” he wrote. Financiers would have abetted the rise of socialism, he argued, “accelerated by the manipulation of stocks”.

Evident then, as now, was a seeming paradox: that the tools of finance might serve ends other than pure capitalism. Indeed, the idea that finance could be a socialising force is an old one. For radicals preceding even Marx, corporate stock provided a template for both the socialisation of ownership and redistribution of income.

Evident then, as now, was a seeming paradox: that the tools of finance might serve ends other than pure capitalism.

Today, progressives, radicals, and social-environmental activists are gathering around the stock market, that border space between the productive economy and the financial system. Through ownership of corporate equity, they hope to spur changes in areas as diverse as climate justice, money in politics, gender and racial inclusion, and inequality.

In effect, they want a second shareholder revolution. The first, launched in the 1980s, saw the reorientation of business away from an array of stakeholders to stockholders alone. Spearheading this revolution were the infamous corporate raiders, joined by investors thirsty for returns after a long profit drought. Together they realised the vision Milton Friedman outlined in 1970: that corporate managers should have no other object but to ‘make as much money as possible’.

Agitating for the next shareholder revolution are three groups I refer to as social shareholders. The first of these are ethical activists, who use stock to push corporations on environmental issues, reducing high executive pay and human rights protections. Recently they have included nuns pressuring US gun manufacturers to account for mass shootings and a coalition calling for drug companies to address the opioid epidemic. British activists have pushed at least 4,000 companies to adopt living wage policies.

Next are pension funds, which have the ability and, increasingly, the inclination to use their trillions of dollars in assets to nudge businesses towards social responsibility; For as long as pensions have existed, they have used the retirement savings of workers more or less politically. But in recent decades, particularly in the US, pensions have expanded their investment offices and focused their holdings on a broader set of issues in business, notably tackling skyrocketing CEO salaries.

Finally, there are advocates of sovereign wealth funds (SWFs), publicly managed pots of money that pay back into the commonweal. To date, many existing SWFs owe their existence to oil revenues. But calls have multiplied among progressives for publicly owned funds that might distribute their dividends universally. Notably, Hillary Clinton considered adding the idea to her 2016 presidential platform, inspired by Alaska’s SWF success.

Unlike other social shareholders, the purpose of SWFs is primarily distributional, a fact apparent in recent SWF proposals of the American policy analyst Matt Bruenig and economist and financial journalist Stewart Lansley in the UK. Elected officials are also flirting with SWF-like ideas. British Shadow Chancellor John McDonnell’s Inclusive Ownership Fund would require large companies to transfer stock to worker funds. US Senator Cory Booker proposed a fund that would collect assets to be distributed to low-wealth young adults, a proposal that resembles a SWF.

 PA

Shadow Chancellor John McDonnell speaking at a Labour party conference on alternative models of ownership. Image: PA

This grouping of social shareholders reflects their mutual advantages, not any existing alignment. Social shareholders have the potential to realise radical aims to the extent that they embody a new power structure power within global markets. Smaller, disassociated shareholders gain leverage when they meet with larger allies, as pension funds have done for activists. If SWFs and other public vehicles take on the new role of centralisers, around which others cohere and magnify their voices, the combined power might finally provide a counterweight to financial capital within the ambit of finance.

History of the social shareholder

The corporation emerged as a tool of conquest. European governments needed a way to finance trade ventures while decentralising risk. In 1602, the Dutch East India Company became the first company to sell shares to the public. Other colonial powers soon followed, chartering what came to be known as joint-stock companies. By the Industrial Revolution, as production grew in size and complexity, these enterprises begin resembling modern corporations.

These financial innovations soon inspired radicals. Among them was John Francis Bray, a pamphleteer who influenced early Anglo-American radical movements. Bray saw in joint-stock enterprises "the best exemplification of the power which man may wield". In Bray’s utopia, the economy would be "one great joint-stock company", subdivided into numerous subsidiaries. Communities would "universally produce or distribute wealth, and exchange their labour and their productions on one broad principle of equality".

Bray left the details vague, but his ideas prefigured later arguments about the socialising potential of corporations. By dispersing ownership claims, joint-stock companies encouraged a more fluid distribution of profits. If the economy were a single corporation and every citizen a shareholder, two of the chief goals of socialism would be met. Nor was Bray the only early socialist to build a utopia on the foundations of the joint-stock company. In 1842, for instance, the pseudonymous Aristarchus proposed a system of ‘Interchanging Joint-Stock Companies’, which would form a ‘community of profits’ to supersede the ‘community of property’.

Few socialists better appreciated the revolutionary potential of corporations than Karl Marx. For him, the divorce of ownership from control represented ‘a mere phase of transition to a new form of production’. The single, private capitalist was being supplanted by collective, ‘social’ capital, which was ‘distinct from private capital’. The joint-stock company became ‘the abolition of the capitalist mode of production within the capitalist mode of production itself’.

Betting on a bubble in English stocks, Marx made a purported £400 – nearly £50,000 today.

Marx had some experience in this department. ‘I have, which will surprise you not a little, been speculating’, he wrote to a friend after coming into a windfall in 1864. Betting on a bubble in English stocks, Marx made a purported £400 – nearly £50,000 today. His justification: ‘It’s worthwhile running some risk in order to relieve the enemy of his money’.

The Gilded Age

Perhaps no country took to corporations as energetically as the US. Following the Revolutionary War, the young states issued a flurry of corporate charters. These entities served a range of purposes both civic and commercial, from schools to banks to cotton manufacturers. Nearly all of them promised some ‘public utility’ beyond that of profit-making.

But US corporations soon shook off their civic attire. By the mid-1800s most operated under the control of a small coterie of shareholders who appointed close associates as managers. Towards the end of the century, tycoons like David Rockefeller enacted a wave of mergers through complex stock manoeuvres and, occasionally, outright fraud. The corporation, once an expression of democratic impulse, became the locus of gilded-age plutocracy.

A similar process took place in Germany. Its highly concentrated banking system consolidated industry, bank loans to corporations supplanted stock issues, and the three large banks owned so much stock that exchanges atrophied. To Rudolf Hilferding, theorist and Weimar Republic finance minister, this evolution betokened a new stage in capitalism: that of ‘finance capital’. For Hilferding, it was not the corporation that held revolutionary potential, but the banks. “Taking possession of six large Berlin banks would,” he wrote, “greatly facilitate the initial phases of socialist policy”. Just as German bankers feared.

Banks were also ascendant in the US, where the likes of Andrew Mellon and J.P. Morgan helped forge twentieth-century US capitalism. But unlike in Germany, Wall Street’s rise empowered the small shareholder, as companies made use of burgeoning exchanges to mass-market their shares. Between the start of World War I in 1914 and the end of the 1920s, the portion of US households owning stock rose from around 3 per cent to nearly one quarter. Then came 1929.

The Golden Age

The regulatory response to the Great Depression altered the face of corporate governance for generations. In essence, executives were professionalised as banks and big shareholders were marginalised.

This was the age of managerialism. In the 1930s, economists Adolf Berle and Gardiner Means described how buccaneering investors had given way to staid careerists in navigating big business. Looking ahead, they suggested a ‘purely neutral technocracy’, control the corporations, resolving disputes and distributing income ‘on the basis of public policy rather than private cupidity’. Marxist economists Paul Baran and Paul Sweezy declared that shareholder control was ‘for all practical purposes a dead letter’.

Although some of this was overstatement, major financiers had indeed had their wings clipped just before the golden age of capitalism took off. But the New Deal legislation that reigned in Wall Street also empowered small shareholders in new ways. Thus, in the nadir of financial power, the corporate gadfly was born.

Gadflies reflected the social currents of their time. In 1949 Wilma Soss began gate-crashing annual meetings and lobbying for the inclusion of women on corporate boards. (One-fifth of listed US companies still have no women directors.) In 1948, Civil Rights activists James Peck and Bayard Rustin bought one share each of Greyhound Corporation and proposed that it consider desegregating its southern bus lines.

Bayard Rustin speaking with supporters before a demonstration in 1964.

Bayard Rustin (centre) speaking with supporters before a demonstration in 1964. Image: Library of Congress Prints and Photographs Division. New York World-Telegram and the Sun Newspaper Photograph Collection.

While companies could generally secure regulatory approval to block such proposals, by 1970 regulators sided with the gadflies. The floodgates opened, particularly environmentalists and Vietnam war protesters, as long as their proposals avoided ‘ordinary business operations’. Progressive activists like Ralph Nader and Saul Alinsky used shareholder campaigns to build publicity and hit companies in the soft spot.

The golden age of capitalism also produced attempts to build public vehicles to invest in financial assets and deliver social dividends to citizens. The most ambitious application of such a fund took place in Sweden. Authored by economist Rudolf Meidner, the plan proposed to transfer corporate stock into publicly owned ‘wage-earner funds’ until they were majority owners. What took effect, however, was a watered-down compromise; from 1984 to 1991 only 5% of Sweden’s equity entered the funds.

This was, after all, the age of Thatcher and Reagan. After a period of relative quiescence, the forces of financial capitalism had been gearing up for a counter-revolution. In the 1980s, they pounced.

Maximising shareholder value

In 1976, business theorist Peter Drucker warned that the rise of pension funds – which then held around a quarter of US equities – would produce ‘pension fund socialism’. Wrote Drucker: ‘If “socialism” is defined as “ownership of the means of production by the workers” . . . then the United States is the first truly “socialist” country’.

It is ironic, then, that the neoliberal power shift back towards finance was abetted by US pensions. In the 1960s and 1970s pensions (both public-sector and those operated by private-sector unions) emerged as powerful investors. With their newfound financial might, labour-backed pensions sometimes deployed their funds in the service of workers. Yet the primary purpose of the funds was pecuniary.

Institutional shareholders – insurance companies, mutual funds, pensions, etc. – had grown from marginal players in the 1960s to major forces by the 1980s. This growth coincided with a crisis of capitalist profits, amid oil shocks and stagflation. By the 1980s, institutions were agitating for management to trim their bureaucracies and get cash flowing again.

Pension funds made their influence known in the wave of hostile corporate takeovers in the 1980s. When companies felt targeted, they often attempted to ward off corporate raiders using measures seen as harmful to shareholders. Pension funds were initially divided over these tactics. Public pensions stood with other shareholders against the measures, arguing that they had a fiduciary duty to protect beneficiaries’ returns. But union-backed private-sector funds faced a conflict: takeovers often entailed layoffs and even the capture of pension assets. Nonetheless, labour-run pensions soon fell in with the rest of the shareholding class.

The evolution of pensions reflected shifts in economic thought. The idea that businesses should operate exclusively to reward investors required a new intellectual framework: shareholder value theory. Michael Jensen argued that corporations could act sensibly only if they focused entirely on maximising shareholder returns. Milton Friedman pondered, ‘If businessmen do have a social responsibility other than making maximum profits for stockholders, how are they to know what it is?’

As pension funds matured, their approach grew more nuanced. Throughout the 1990s and 2000s pensions launched the majority of proposals seeking to increase accountability among corporate management. A recent pension-led campaign pushed the number of S&P’s 500 companies allowing proxy access – a policy that allows investors more easily to challenge board incumbents – from 1 per cent in 2014 to nearly two-thirds today.

Potentially more consequential, however, have been the ripple effects created by the emergence of institutional investors as power centers within the stock ecosystem. Their rise gave the previously hodgepodge ethical activists more powerful and concentrated targets for their campaigns. The confluence of these factors holds lessons for social shareholders in the future.

Looking ahead

Three broad themes emerge from the history of social shareholders. First, there has always been, as John Maynard Keynes put it, “the tendency of big enterprise to socialise itself”. For as long as the corporate form has undergirded industrial capitalism, radicals have recast that form in an egalitarian or democratising light. There is, arguably, a real socialising potential inherent in the form of equity finance.

For as long as the corporate form has undergirded industrial capitalism, radicals have recast that form in an egalitarian or democratising light.

The second lesson is the importance of legal frameworks in regulating shareholder power. Activist investors won new rights in the mid-twentieth century, yet remain limited in their influence over corporate affairs. Pensions have similarly expanded their ambit, but remain hamstrung by law (and their own beneficiaries) to prioritise the bottom line. For these groups to approach real control over corporate affairs would require a legal regime change.

Finally, size matters. Few developments have been so decisive in the power of the social shareholder than the growth of institutional shareholders, which fundamentally changed the nature of corporate governance. As researchers have found, the more institutional ownership a stock has, the more likely it is to be targeted by activists.

Yet even if we classify pension funds unambiguously among them, social shareholders still control just a fraction of the stock market. Their antagonists include hedge funds and others whose activism focuses primarily on disgorging cash and ousting board members. The structure of a firm’s stockownership, particularly its institutional makeup, matters for how it is run. Researchers have found that funds with more ‘transient’ institutional ownership (e.g., hedge funds) invest less and offload more cash to shareholders.

Dominating the markets are gargantuan asset managers like Vanguard, Amundi and Aberdeen. It is here that stock markets have most evolved since the financial crisis. Asset managers’ passive trading vehicles, such as exchange-traded index funds, have attracted trillions of dollars and reoriented shareholder power. Everyone from individual speculators to major institutional investors utilise passively managed index funds to some degree. While these investors still technically own the underlying stocks, it is the asset managers that take responsibility for prerogatives such as voting in corporate elections.

The shift into passive has contributed to changes in the way markets operate. Passive ownership means that large index-fund investors do not sell when they are upset with a company, since that would mean selling every other stock in the underlying index as well. Instead, somewhat paradoxically, passive investors engage, through board votes and shareholder resolutions. Asset managers also constitute vectors for activism: getting BlackRock or Vanguard on your side can often turn the tide in a shareholder battle.

Rudolf Hilferding wrote that capturing the six largest banks would pave the way for socialism. Today he might advocate capturing the the six largest asset managers. In the absence of a citizens’ takeover of BlackRock, however, the focus falls on the social shareholders.

Ethical activists

Ethical shareholders have eclipsed the motley gadflies of the 1970s. Numerous non-profits devote their efforts to boardroom advocacy. The number of proposals filed by such shareholders have doubled since the mid-2000s, and they have rubbed off on large asset managers. To get a sense of the zeitgeist, see the recently penned Activist Manifesto, a nearly word-for-word rewrite of the Communist Manifesto aimed at socially responsible investors.

Yet ethical activism has its limits. Most importantly, proposals must avoid the day-to-day functioning of a business. Climate activists, for instance, have pushed energy companies to issue reports outlining their plans for policies that would keep global warming below 2°C. When ExxonMobil succumbed to such a proposal, the result was, in the words of one financial research firm, ‘a finely crafted public relations piece’.

Of course, not all activism is impotent. A 2011 study found that shareholder agitation at US chemical companies reduced certain toxic emissions by more than 3% annually. But this kind of result is an exception. Ethical activism depends largely on developments in the surrounding shareholder ecosystem.

Pension funds

Pension funds have long grappled with tension between the interests of workers today and retirees in the future. In the 1980s, labour-aligned institutions made bedfellows with corporate raiders. Today, pension funds push governance reforms that increase both boardroom accountability and stock prices. Ironically, pension funds now play a signal role in ensuring the orderly flow of profits.

One study found that when CEOs with abnormally high pay are targeted, their compensation falls by an average $2.3 million.

Yet pensions have also heightened their activism on matters like board diversity and climate preparedness. One area where pension funds’ efforts seem to have paid off has been CEO pay. For years, pensions have dominated protest votes against outsize compensation. One study found that when CEOs with abnormally high pay are targeted, their compensation falls by an average $2.3 million. (Other studies have found more muted effects.)

Pension funds have undeniably achieved enormous influence, but they have fallen short of the ‘pension fund socialism’ Drucker envisaged. This is due in part to the worker–saver paradox, as well as a problem of coordination. Though there are groups that coordinate pension activism, there is no larger structure around which pension funds might gravitate.

Sovereign wealth funds

Here is the great unknown among social shareholders. Although there are more than 50 wealth funds worldwide, we cannot generalise about their operations. Still, SWF advocates have taken inspiration from examples like Norway’s massive complex of publicly owned funds and the Alaska Permanent Fund, which pays at least $1,000 a year to each citizen in the state.

Yet the impact of SWFs on corporate governance remains unknown. Norway’s funds have only recently increased increased their activism. Were the US to institute a fund on the scale of Alaska’s or Norway’s, it would hold assets in the tens of trillions of dollars – easily half of the current stock market capitalisation. But SWFs would face the same contradictions as pension funds. Would a SWF support a CEO laying off thousands of workers or shifting production abroad?

Regardless, SWFs would almost certainly invite a structural shift in power among investors. The emergence of pension funds and other institutional investors concentrated and magnified the power of activists. SWFs could serve the same function for the relatively uncoordinated institutional actors and ethical activists out there today.

For some, the idea that that the financial building blocks of capitalism could undo its worst excesses might seem over-optimistic. Yet the history of the finance is one of large, unexpected swings. Half a century ago, Marxists and capitalists alike pronounced the death of the shareholder. Since then, shareholder power has only grown – mostly to the benefit of the rich. If there ever was a time for the social shareholder, it is now. The confluence of sovereign wealth funds with an emboldened pension fund community and widespread ethical investor-activists could, more than ever before, uncover the egalitarian potential of the stock certificate.

 


 

This is an edited version of an essay that originally appeared in State of Power 2019, an annual anthology published by Transnational Institute (TNI).

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