American investors are increasingly acting on the realization that a broad-based indexing strategy is superior to investing in individual stocks or actively managed funds. That’s great news for investors, who will pay less and get better returns. But it has troubling implications for corporate governance.
No passive investor cares much about governance of a particular company. The impact on an index when a single company underperforms is usually either slight or offset by gains from its competitors. It may be rational for index funds to ignore governance, since the money they spend on improving it benefits not just them but also rival funds that invest in the same stocks.
So it’s a problem when these investors control voting outcomes for the companies that they invest in. This is often the case, since 88% of public companies count one of three large institutional investors— State Street Global Advisors, Vanguard, and BlackRock—as their largest investor. All investors have a stake in companies being well-run, but they aren’t always willing to pay higher fees for monitoring or governance. And because there is no such thing as universally good governance, the blind application of one-size-fits-all governance solutions across vastly different companies often has negative effects.
So how can the law ensure that these institutions make informed decisions about corporate governance? Three approaches are possible.
Read more at Wall Street Journal