Index Funds and The Future of Corporate Governance: Theory, Evidence, And Policy



the lighter to have the opportunity to present this paper here it's a joint work are we Scott Hearst and we look forward to your reactions okay so it's it's a longer paper for which we apologize if any of you ever reads the whole saying email us we send you a box of chocolates or or something yes it does have a lot of moving pieces different parts part of it develops building on our earlier journal of economic perspectives framework built an agency cost theory of index fund stewardship the second part the bigger part is puts together hand collected and public data to piece together a picture of the full range of the stewardship activities of the big three and we conclude that the body of evidence is of all consistent with the agency cost view that we put forward and then we put forward some policy proposals as well as identify implications to some of the heated on-going debates on hedge fund activism common ownership and the like okay even though it's it's a long paper it's part of a larger body of work we've been involved as I mentioned the paper builds on the analytical framework that we put forward in an earlier paper from the Journal of economic perspectives with ina cohan we recently issued some supplemental empirical evidence on the rise of the big three suggesting that the big three are on the way to become the giant three and they we estimate would cost as much as 40% of the votes on average in S&P 500 companies within two decades for anyone who doesn't know because we are Blackrock Vanguard and State Street the large index fund managers which we explain in in the paper there are reasons to expect heavy concentration by dominant players in that space another paper draws out more fully that we do in this paper the implications for common ownership that's the misguided attack on common ownership paper and we have some further working progress ok the agency costs view is just adjusted terms to describe an approach as all of us would agree the stewardship decisions of an index funds are not made by the beneficial investors but by the investment fund managers which means we might have agency problems and the benchmark we use for evaluating decisions is comparison to the decisions that would be optimal for beneficial investors we do not argue as to how the outcomes in today's world compare tonight for political world in which the shirts were held not by the index fund but by individual investors or by active funds we compare them to what will be optimal for the beneficial investors now you might say why focus on that because I well by definition we'll always have some agency problems but the reason why we think this is a useful benchmark and a useful lens on this subject is because one we think that the agency problems our first driver first-order driver of the stewardship decisions of index funds and you cannot really understand those decisions without carefully analyzing the agency problems and secondly the the knowledge of the agency problems is not just to complain and fetch about the state of the world it's also because it gives you a way of thinking that can enable you and we try to go in this direction to find ways to limit or reduce the cost of those agency problems and therefore enable agents enable index funds to deliver more on the promise that some suggests are they have okay there are two types of incentives problems that we identify going back to the Jaypee paper for index funds as well as for our tea fans but now I'll focus on index funds one is with respect to the quantitative dimension how much you invest in stewardship there is a strong incentive to under-invest in stewardship relative to what would be optimal for your portfolio for your beneficial investors secondly with respect to the qualitative choices you often make it's not that you spend more money on stewardship but with the same voting decision you can be more or less deferential via video managers I mentioned this in my comments earlier in the day we argue we analyze and conclude that index funds have strong incentives to be excessively differential to our corporate managers because of three sources of private benefits from being differential only one of them has to do with business relations another one that I mentioned because we think it's important is the fear that if you won't be differential if you throw your power around you might have to fear a regulatory backlash and that's something that might lead you to try to behave in a way that one I would not make managers strongly resist you and two we will not make you big power two salient okay let me turn to the evidence we have a much fuller analysis of incentives in the paper and we analyze both what the index funds and here will focus on the big three the index fans do and what in our view they fail to do so first of all what they do so in terms of the investment in stewardship which was one dimension so each of the big three are we document they have hundreds of positions that have a value of 1 billion dollar or more you could imagine that for such a position it would be worthwhile even if you could improve value only by 0.1 percent or an expected value basis it would make it worthwhile for you to have perhaps multiple professionals dedicating perhaps a substantial part of their time to monitoring the company and interacting with it that's what major of VC firms do even for positions where they don't have control they just have a limited position but they still have dedicated professionals now supporters of index fund stewardship have focused and big three leaders have stressed the fact that they've increased their stewardship staff considerably over the last several years but we place a spotlight on where they are now and where they are now suggest that investment in stewardship might leave something to be desired so this is stewardship investments we basically take their stewardship reports we look at the numbers of people we make some conservative assumptions and so forth so first of all the bottom row here indicates the the stewardship expenses even though the big fear leader stress that stewardship is fundamental to their mission and what they do stewardship investments and budget are a fraction of 1% of revenues more importantly for our purposes if you look at the resources the personnel time it might seem arguably so we argue insufficient for the task so this is we take the number of people that they have we make some conservative assumptions about them not taking lunch and going on vacations and working all the time on stewardship and we do different scenarios as to how they are located in a one scenario at the top they allocated equally among companies or they allocated proportionately by market cap they allocate more to the u.s. even under the most the scenario that gets you the largest numbers which is scenario for you see that for each one billiard or position they are able to have the help on average between one point seven and three point two person days a year for that one billiard dollar position on average some companies perhaps more maybe there is an activist engagement but some companies that would mean less now if you want to think about this three days just looking where we did this research if you just look at the document that seemed important and we leads them to take a look at for forming some judgment you see the documents the company issues are in the hundreds of pages each year and you know there are a number of other things that we explain one needs to to look at I think that the number suggests or raise concern that the stewardship staffing of the big screen Able's them only a limited and cursory review on average or at least for the large majority of their portfolio companies second thing that they do and the stress is they engage in behind-the-scene communications a vanguard for example our stresses and you might have read similar observations from other big sri leaders they say private engagement is perhaps more important and other elements of our stewardship engagement is where the action is so the argument is you'll see soon that various tools are not used but the argument is instead the use behind-the-scenes invisible communication which is more effective and that's where the action is so we use the information in the stewardship reports to get a sense of how much of this is going on because they give the numbers and the types of engagements they have and what we see is that for roughly 83 or 90% there is no communication whatsoever during the year out of the about 10% where there is a communication the great majority seven to ten percent it's a single conversation single phone conversation during the year and it's only between point seven for State Street and six point nine for Vanguard where you have more than one conversation during the year so what this lead us to conclude is that they don't have engagement private engagement behind the great majority of companies and therefore for this majority of companies private engagement cannot be a substitute for the use of other stewardship tools – which I shall which I shall presently turn ok third thing that they do and many of you are familiar with it is they focus on what we call governance principles based stewardship we go over various things documented that's what they focus on deviations from the governance principles this is consistent with the private interests of the big three managers it enables economies of scale that reduce the required investment in stewardship and it also makes the power of the big three less salient by grounding what their decisions less indiscretion than in kind of general governance principles now some of it is definitely good definitely produces benefits but we argue that it also fails to take advantage of some potential benefits that can come from stewardship that is based on attention to business performance or individual director qualifications and that something that let me turn to now okay so let me turn now to what they in our view large defend to the first little attention to performance performance is important for the beneficiary investors of index funds we don't you don't need to hear what the slides say to to agree with this we analyze what the big Swede do and we see that they pay very limited attention to business financial performance you look over at all the case studies and that many of them described in the stewardship reports in none of them is under performance mentioned as a motivation for the engagement you go over all the proxy voting guidelines as to whether you vote for directors or you withhold support and none of them they take into account governance principles but none of them takes into account financial performance none of them to say it precisely in none of them would it make a difference on the margin whether you have outperformed the market by 20% or underperformed the market by 20% in the last three years now you could say could this be explained Oh could it be explained that the big three lack expertise and access to information to identify oppression improvements that's what hedge funds do that's suggested by one of the papers in the literature in our view this lack of in-house expertise which is true should not be taken as given this is an endogenous choice that the index fund managers make surely they have the resources if they saw this was advisable to hire hundreds of MBAs from get university from Stanford Chicago and so forth and do much more analysis so this would they the fact they don't have it is really a product of incentives could it be also argued alternatively that they don't do this because the hedge funds do it give Sonnen gordon makes a version of this argument suggesting that the index fund can rely on or what the index funds do for us this is not a varied explanation because one the hedge funds engage only when under performance is very large and can be fixed quickly otherwise they don't have been said this to do it and they it might take them quite some time to arrive so there is a vast number of cases where the beneficial investors would benefit from paying attention to business performance secondly another thing that they fail to do or do too little is they pay little attention to many important director characteristics you can imagine two directors that from adherence to governance principles look the same all independent same process produced them but one of them might be jamie diam diamond who is great business leader and another of them might be your idiot cousin and in a contested situation people would pay a great deal of attention but if you look outside the small number of activists proxy fights you'll see four if you get a proxy voting guidelines you see that they would not give any weight in choosing whether to vote for or withhold support to any such characteristics now could it be somebody might say they don't do it in the voting but in other communication they have influence behind the scenes of the people who come up for vote are people like Jamie Dimon and not your you know idiot cousin well our evidence that we collect indicate that the answer is no to decide potus's and we gather data about 4,000 situations in which the big three held 5% or larger positions during the last 10 years in this kind of a situation if you have more than five percent and you communicate with the company about the rector eggs shouldn't be there or the rector or individual wife should be there you have to file certain D we look at the data we find that not a single certainty was filed by them during this long period and therefore we can infer that they avoided any communication based on analysis of the rector qualifications in their engagement okay next you know many of you know that proposals by shareholders on some issues where you can get majority support you focus on things for which there is broad support among investors they have had considerable influence may changes from adulty voting annual elections and you might think that not in general use sure the proposals for things that are controversial but for the things that are strongly there in the big three principles you would think that it would be natural for them to actively push for those changes because the Biggs we do focus on general conformity with governance principles and a large number of their 5% class positions do not comply with their own governance principles however when we look at the data we find that among the 4,000 corporate governance proposals that were submitted during the last 10 years including most importantly the very large subset that uniformly received support from the big three none of those proposals were submitted by the big three now somebody might say well they don't need to do it because other shareholders are doing it and therefore they just give their support and it's happening however if you look at the data you see that because of the limited resources of small investors proposals for many of the changes that the big swiff favored and that you can expect with practically hundred percent probability they would vote for and they would welcome if they were presented on the table those proposals are not brought in any given year or sometimes they are brought only after 10 years as a result a large fraction of the big 3 portfolio companies lack arrangement that they very much support and submissions of shorter proposals in those cases would get would pass and would bring about changes that by the own governance principles of the big three would be desirable for the beneficial investors let me just conclude with the last thing that they fail to do and I'll skip the policy discussion if it comes up in the Q & A they also the big sway in our view I mean they hold positions in many companies and therefore if you had wide scale governance reforms even reform had a small relatively small effect in any given company such reforms could have significant benefits for the portfolio of the big three and therefore the beneficial for the beneficial investors but we collect the the hand collected evidence that we put together shows that there is actually a pattern of limited involvement in this area two things at each time just to mention two things one is we look at all the comments later that were submitted on all the ATAC see proposed rule changes in the corporate governance area in the last ten years our expectation is that since the big three hold roughly 20% of the equities in all those companies in the whole US stock market you would expect them to express a view on each of those proposals on the table either to say we like it or support it we are against it or even if you think maybe they are indifferent to something cuz this thing is practically irrelevant that's also something given that there is a limited attention and resources for the SEC it would be variable for them to say this is something that is unimportant and shouldn't get significant part of the SEC attention however what we find when we collect all the comments on the SEC website we go over them we see that the big three submitted comments regarding less than 10% of the proposed rules either when you look at all the rules or even if you look at the rules the top rules in terms of the attention they got and if you look at cases of residential Securities Litigation there were ten important cases in the last ten years about 100 amicus briefs were submitted by affected parties were often cited by the judicial opinions however the big sphere remains fully on the sidelines they did not file a single amicus brief in any of this sweet cases of presidential litigation we think that this is also consistent with the agency cause view because it might be safest from your private interest perspective to stay on the sidelines if you explicitly support for shorter forms that might annoy our managers if you are explicitly opposed reforms that might make your deference to managers interest to salient possibly the safest most careful thing is to stay on the sidelines okay there are a lot of policy implications in the papers because it's for dependent debate let me stop here and just state our conclusion that the evidence we have collected is consistent with the agency cause view of index fund stewardship that we have put forward and that given the rise of index fund ownership the two agency problems that we have identified deserves the close attention of policymakers market participants and all the corporate governance scholars in our field Thanks [Applause] thank you so the first thing I'd like to do is congratulate the authors this is already forthcoming the second thing is I completely agree with the CGI when they warned it the price to this to this paper and you know it's a to the for so what I'm going to do is I'm going to mostly focus there are three big parts of the paper the theory they the evidence and the policy implication so I'm going to focus more on the thing I get paid for the evidence part I don't know as much theory wise but let's just start there and then I won't say too much policy wise but I think there are many people around the room who can contribute more to what what can be done so the first big picture or theories you know we all think about the separation of ownership and control all of us are are aware of the phenomenon that we have a paradigm the us paradigm of dispersed and optimistic shareholders that causes free-rider problems you know it's very well known but there have been changes the first change the papers speaking to is there's the rise of collective investment vehicles there could be mutual funds pension funds and so and so forth they are large they're professionally managed and you could expect them to perform some more monitoring functions through voice through exit number of the concepts we'll hear through the day but they can introduce a double agency problem they themselves could our intermediaries and and so that could be a problem the second change is within this sector the intermediate intermediaries are switching from actively managing their portfolios to more passively managing their portfolios whereby they take their you know tenets of Modern Portfolio theory and things I teach in in the business school environment and together with scale economies and you now see the rise of the big three and that is re concentrating on ership Indian so you had the atomistic model we all said you should form all the thing portfolios guess what they are now being formed by this top three so that's where the paper sits in and I think it's very timely it's very important to address these issues we should not be ignoring this issues the world is not the US however and we're not in the US right now so that it is true I don't have a pointer but it is true that there's high institution ownership in the US there's some are in between when you're out here in continental Europe you closer to that in the UK but the other parts of the world are not necessarily the same way but you do see the rise of history ownership through throughout the world so that's in the good news is this is data I've used so I thought maybe actually spend some time with this data to learn about the big three so that's what I decided to do so within that institution ownership which is now plateaued at seventy seventy five percent in the US market 50s or 40s in Europe and maybe ten twenties in Asia Pacific in in Asia let's just figure out who are the top who are among those institutional investors who are the top so what I did is more maybe one visualization is take who is number one who is number two number all the way to five and I'm coloring them that top the big three the states reads the vang word and Blackrock versus the traditional active ones you know Capital Group fidelity and so forth and you do see this big change since the financial crisis 2007 and eight in the you know the ordering so the the big three okay definitely becoming big the world is not the US all right statement but there are data for other confusion myself and my court remedial freya we've had multiple papers using that we also made that data available on words or facility access to other researchers so what if you were to doing the same loud you know like who are the top three around the world I myself do you know this so well this is the my best attempt at doing it but so just to highlight blue means passive or big three and orange would mean the traditional active so with one exception which is Canada that it is a little bit old so now it's become true that van Weyden and black have finally penetrated Canada's markets for mutual funds they had a hard time but it's interesting both in continental Europe and in in places like even Brazil or Japan Blackrock and Vanguard are are coming in so it's the very same big three and it's not just in you but number four which we'll hear from later is the Norwegians okay so that's a big player and the vicente i think you have a paper in the afternoon about them that's another one we should be considering but it's the same three around the world and someone else some small minuscule country with a lot of oil that's investing throughout the world and they're popping up all over so what fraction do they hold off the market i spend more time on the data than lucien this but I think it's very complimentary just to add more numbers to Lucian's argument they now hold twenty percent of the seventy five percent so twenty percent of the total sorry outstanding shares is in these three and you could project Lucien has another people where they project this out where can you end up being in five years or ten years that can be 30 40 percent easily within by the time you finish the next paper okay so this is something one should be studying but where is it how is it in other countries again I break down North America Europe and other places blue is still minuscule it's still only three to five percent this data of course needs continuous updating the cities of 2015 but that's maybe five percent now by 2017 2018 2019 still though but growing what's behind this it's that we've been teaching this to MBA students through the generations but many investors are becoming aware that actively managed funds on average underperform this passive strategy so this is one way to visualize that the S&P puts it out it's shaming the the active managers 80% of them underperform S&P based fund index funds same deal in Europe you can go through any time you like any market you choose evidence is fairly consistent within a five a three a ten-year window of course every single year you could have a slight variation in these numbers so investors are flocking out since they've become more aware of cost since the financial crisis out of actively managed into those passively managed products and the rise of ETS is sort of that now I'm kind of using the word passively very very loosely here many idiots are fairly active because they might be the only ones that are tracking that specific index and they might be called you know different things so I'm just using what maybe let's use it then the word top three rather than the fairly path so the theory that I mentioned I'm not going to spend too much time but you could think this is going to resolve the issues that Berlin means the dispersed ownership prom was causing the re concentration of ownership could be a good thing because there are universal owners so they can incorporate externalities across firms all over the world they can have large stakes which makes them meaningful they have no choice to sell so means they will have to engage they will be long-term there's no eggplant to sell they can be near permanent so that's some yen and other others have papers on this but they're the bad side which Lucian's pushing and giving evidence for is that what are really the incentives like if they're collecting so little fees if they go to if you go to a world where fees are zero and you're not that far from that world or fees go negative which are some are already introducing because they have security learning and other sources of revenues so what would be the budget for for this type of monitoring activities or the second channel that Lucien talks about is being the French hold what is their business interest to be opposing corporate because they have businesses like running pension money for corporations they may fear bad classes at listen pointy to so Lucien importers have a sequence of papers on that side I'd say that's the good and the bad side the ugly side I know if you ever watch the movie right I mean there's that third side to this which is mark you know Martin and others papers that are pointing to this could introduce even bigger issues like the creator that are sort of embedded in in in Japan or travel and other cross-ownership structures that exist can play itself in u.s. context or internationally I'm not going to take a stake on all this debate but I'm just highlighting the three sides on the evidence do I still have any minutes or okay so let me spend some time so these people forced me to look at the evidence I was truly you know thankful for for Lucien to make me do this because I don't know I didn't know all these numbers that well this is that as of 2017 these numbers they've gone up a little bit Blackrock stewardship team is probably the largest and 33 I think last year at the GC GC we had their commitment that they were going to go that number to 75 from the vice-chairman that they are they have plans to expand that but they're still like maybe 40 or 50 as we speak when were these smaller and State Street is 11 individuals so it doesn't matter how much you pay them they're not well paid and not the best paid people in the organization for sure if you divide that by the AUM or divided by the fees the number of solutions numbers are pretty stark nothing to do about this but the next question asked was what is the counterfactual like yeah you do have this top three what about the other ones how much are they spending so I went to look and morning's I actually had a survey on this so the way you should read this is take the top three black rock bangers and State Street and the next one's the next ones tend to be more blend they don't have just purely passive blue but they will have more reds you know like actively managed products so fidelity comes up mostly on the active side or that they do manage some index products as well or you know Deutsch or UBS etc which will be more blend and then what I did is I want to count how many staff do the other ones have so is this a big deal I guess so because they are actually the ones that have the highest staff compared to the other one so not to be too bad – Deutsche Bank I think they've taken meetings every day here in Germany but they have three dedicated staff in the asset management arm as surveyed by morning sir Morningstar sent out this survey and they responded we do have three individuals doing this work so this is very important because I think we shouldn't stop in the top three without comparing to the alternative right and the next thing is how much are they under investing not just stuff I you know what it comes and goes I the other thing that Lucien forced me to do is I ended up reading their stewardship reports I haven't done that I should have and like what's there you know let's just show you the index it's a lot so it's not like they're not doing anything there it's very deep you know types of analysis one item there is private engagement so that's the second dimension that Lucien has in a paper I found very useful as well how many companies percentage-wise in your portfolio do you engage and that's like I inverted the numbers a little bit but that's only 10% or 17% or a nine cent of your portfolio again low I agree but what about the other institutions you guys want to look ok so there is data on the other institutions so with one exception here they are among the ones that do the most so yeah it's a 10% of their portfolio but percentage-wise but actually in number fidelity would say 0 they don't engage why because they may have an alternative mechanism the exit mechanism or the sell the shares mekinese rather than the voicing mechanism I think it's worthy of pursuit academically to study these things right what would have been the alternative to so in this case they do have the largest staff all those small albeit small but they also have the largest number of engagements compared to the other ones who they are you have to go to their appendices Vanga does not disclose but the other to do so you actually have their names I once been that time I I was doing this on the plane I didn't have enough time to go out and give you the exact companies and whether that caused any outcomes well we should be studying those things I think as a profession to study the third I think part of the evidence that Lucien puts out is there's no engagement that's caused by financial in the performance again we have this debate about head whether they support or not the headphone activist I didn't have any evidence I could show you there so I agree with the point I think that should be studied more proxy Baltic how many votes are we had in Nikita and others talk about you know what is the percentage of this sense it's typically small right working against management is typically a low number it's 2 to 5 percent for these institutions again the question is what is compared to others and what is it compared to I assess or Oregon's Leo's like what if he didn't want to take on the due diligence yourself but higher you know I assess or glass a proxy advisor to do that so that would have been my comparison I would say as well there's also data on that so good so I don't know where we come out on that but there's on average they vote more with management the more more in ninety one ninety four ninety eighty six and some of them might be in a 78 77 for the other ones but we should be comparing and understanding these differences this is statistically different or not statistically different compared to others as well director selection so that's as you pointed out there's no director nominations were found because they would have to disclose a 13d rather than a 13g I just couldn't find the data so I not have much to say on that or shareholder proposals there is some data here so I thought I'd show you which is there have as you correctly pointed out there is the the big three do not seem to submit any single proposal but we have actually their votes on shareholder proposals compared to the other and I've run out of like time to organize this information but the way you read this is the the Blues the ones I circled are the top three the others are not top three and I only had fidelity there and BNI melon and the categories climate change environmental gender diversity and stuff like that so it would be good to study as well what is the difference between these two I visually find somewhat less in focus for shareholders but but it would be worse on the last one Corp Commons reforms Ellucian did compare them to public pension funds that's the other comparison group I would advocate I would just put a pitch for the neck ccgi conference which is in Riga if you have a chance to join us on Monday they may not be loving the SSC for reforms but they might be lobbying other groups so whether it's the next providers on the case of dual class shares where they've then go going on to exclude them from indices been very vocal on those because they might have given up on the SSC might have given up on on stock exchanges and might be going in a different route so I will not say much about public policy as I said but just congratulate again listen to you no forcing me to learn more about this and I encourage others to contribute with future studies to this topic [Applause] yes thanks a lot Pedro thanks for the kind of work from kindly encouraging people to read if if anybody of you reads the paper we send a box of chocolate both to you and also box to Pedro upon receiving your email now just a three we are change to some bigger picture comment first of all thanks a lot this was very useful and very interesting there are things there that would help us revise the paper we actually saw some big picture comments that are useful to relate things that we do to other things so one one thing that Pedro stressed is how does that compare with active managers and I mentioned early in my presentation that for us that's not the relevant question we are not asking the question of would it be better if the active managers had those shares of individual investors had the shirts we actually have another paper in which we are looking at the artifacts gathered data that in part is similar to what Pedro showed you and we actually find that there are substantial problems both of excessive deference and their investment there as well and that it's not the case at all that in general active managers are better than index funds so you might say so then why are you complaining because we think that's not the right question think about corporate governance the agency probably the level of operating companies when we have controlling shoulders with agency problems we don't say wait but are those better or worse than the agency problems of corporate managers without controlling sure that's what we try to do is and we agree that sometimes those are large errors or sometimes those enlargers but in general what we are trying to do is in each context we are trying to understand the agency problems and reduce them and what we should be doing is we should try to figure out as fully as we can the agency problems for the index funds then you see problems for the ulti funds and try to reduce both of them and how they compare on average at any point in time it's not something that should lead us to accept things as they are to add a quick comment on the common ownership well thanks for saying that they are they are clear not we so that's a de Sun but some people conflate our work with that because both works are in a way critical of index funds but they are critical in opposite directions and what they are normally trying to push goes in opposite directions the concern in the common ownership literature's is that the big three are doing too much they are using the power too much and what we should do is kind of slow this down and scrutinize them more and our concern is not that they are doing too much but rather they are doing too little and we think that therefore the music and the discourse arising from the common ownership literature is pushing the system in a wrong direction because on the margin it can chill beneficial engagements on the part of index fund in the last comment on can we explain the fact that the big three are standing on the sidelines by saying look they've given up on the sec maybe they're also not submitting amicus briefs because they've given up on the courts but those bodies are making real decisions those are decisions that actually have an effect on the world those are decisions that then finance professors go and look at the announcements returns where those are made so they are going to make decisions one way or the other and therefore if you own 20% of the US stock market we think that it would be beneficial for you investors for you always to be attentive and always to try to move the needle a bit in the positive direction and that's why staying on the sidelines for us is more consistent with the agency cause view than with the value maximization view thanks better again so I want to make these remarks in a somewhat polemical way because it's more fun so it seems to me that the way the issue has been conceived here is exactly the wrong way because it does not accept the fact that the innovation of the index funds is really diversification across the market across the economy as a whole so firm specific governance intervention is idiosyncratic it can't improve the performance of the portfolio it can't make the beneficiaries better off it seems to me and indeed it does run the risk of the common ownership critique so to follow the point here any direct action by the index funds along the lines that have been suggested would deprive them the best defense that they have against the antitrust claim which is to say we don't have a channel we don't have a way in which we can influence so so therefore that there happens to be this the the parallel action that's not on us so don't come after us so don't threaten the business model that is good for air beneficiaries because we don't play play a role so so first firm specific governance intervention can improve the beneficiaries because of the fact of it's all it's all videos and kradic and secondly the effort to do so would put at risk the very low cost model that the beneficiaries want the follow-on point is that the real issue is what is the role for systemic stewardship that is to say you know the finance theory is all about how do you improve the performance of a portfolio well you can improve expected returns or you can reduce risk systemic risk and so it seems to me the real challenge that the big three need to figure out is the role that they want to play in systemic stewardship and the climate change stuff that they may be involved in the the stability social stability stuff that they they may be involved in each of which may have the potential to reduce the systemic risk that's where I think we ought to be focusing our efforts to help them to figure out the role that they can play that they can play in order to play thanks for this polemical intervention which was still very kind in delivery and more gentle than I feared but let me try to defend what we do to the best I can so one on I agree with you we all agree with you that there is some benefit from systemic improvements some people believe that staggered boards are bad then let's eliminate all staggered board some people think independent directors are good let's always have independent directors that's systemic that's something that fits their model very well even there even if you completely by this we have a problem of underinvestment and and excessive deference why because the big three if they wanted all firms to have annual elections fitting their systemic optimal system they could easily get it okay within three years but no as pedro mentioned they always vote for this but what it means is that companies that don't have staggered board it depends on the happenstance of whether john shevardino is a well known individual investor happened to have them in the portfolio or some harvard sure the clinic happened to submit proposals dead here but then when the professor stopped teaching it it doesn't happen that doesn't seem to be the systematic approach that you are advocating because if you really think that you shouldn't have it then you shouldn't eliminate hundreds target boards this year just because there were more proposals and then afterwards you just wait and do nothing for the others similarly if you believe in systematic intervening in governance reforms in general that's exactly the most natural step you would expected to do but as we documented that is not happening and you mentioned the investors want them to do it in a way that is not expensive because the benefit is for index fund investors is that it's cheap and in the interest of full disclosure most of my portfolio is in index funds so I'm in the rebel future however the numbers we had on the board suggest that if they quadrupled their investments that would have no material effect on the cost because right now I mean if they are charging you know five basis points if they went the full way of implementing everything that we say that might go up from five to five point oh four basis points okay so and most of the stuff that I've been discussing is not very expensive lastly you said that for things that are company-specific that requires a company specific knowledge that can't be beneficial for your beneficial investor if you're holding a diversified portfolio I don't think that that's correct that's correct if the improvement that you are giving to company X would enable it to make profit at the expense of company y and then it cancels out but let's suppose that the problems are like what I mentioned before you have you know idiot cousins serving on some boards one idiot cousin doesn't cancel the other idiot council right so except you know just if it's about the strategy that you know they compete with each other but you know it might be the idiot cousins are just sleeping at the headquarters there are all the companies have a slag so generally we would think and we have a lot of evidence in financial economics that we improve governance arrangements and sometimes it's only company specific thing the performance of firms economy-wide goes up and value goes up and therefore if they did the various thing that we were mentioning so for example if you generally pay more attention to performance and that has both exports and ex-ante effects that might have an expected average effect that would be positive across all the firms in your portfolio and that's what you would expect to see any word you would want to see in under the very maximization view sorry for the length but you know I had to given the to describe it as polemical I try to my friend okay I'll make it very quick I think on the theory side you seem to be obviously right because there's dispersed investors and they go through an intermediary they have to be agency cost and says a collective action problem at intermediary level and so on I think that's clear like then the question then is how bad is this problem so the imperatives were the improvs come in and I had one reaction or two reactions one is that what's the benchmark and Pedro made that in his comment but the other question is for some of your measures like submissions to the SEC or plaintiffs being a plaintiff named plaintiff in a security litigation the big funds they go through the investment company Institute and they make submissions to the SEC or when they make other interventions in policy and for litigation they tend to opt out of the class and actually get pretty large settlements or in litigation much larger than the class action lawyers get so they are active in that sense actually in the next revision paper that would be even painfully longer we give evidence that kind of fully addresses this and shows that those are not cannot explain what we view as too little activity so on the reform I mean you could say they don't need to do something because the investment company Institute which is their trade group is doing something well this wouldn't be clearly a good answer because the investment company Institute aggregates active funds short term active funds and long term index funds and one of the things that the Biggs we often say is we are very different we have different interest so you would think that they would often want to have their own position of the special securities however let's assume that there is always overlap in interest between the active funds and the index funds if you add the comments by the investment company Institute we still get substantial lack of involvement investment company Institute is very active you know when when you are talking about regulation of mutual funds mutual fund fees lots of activities but if you go to the corporate governance reforms or if you go to the presidential integration those cases and you add the investment company in submission you don't get any change in the overall picture in the oil on the auto out we actually looked at their numbers and yes there are a few cases in which they opted out but we are talking about a very small number of cases over the last ten years and out of a sample in one of the saddest 2000 cases so basically the standard mode of the big three is outside a very small handful of cases is not to take an active role in a plaintiff litigation even when their stake is quite substantial in terms of either percentages or dollars you

Maurice Vega

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