On April 14, 2022, presenter Todd Gormley gave the lecture “Indexing and Corporate Governance”. The lecture covered the growth of indexing investment strategies and its implications for stewardship. Professor Gormley summarized recent and ongoing research that analyzes how stock ownership by index funds does (and does not) affect firms’ governance structures, the stewardship actions of other investors, and product-market competition. He also highlighted yet unanswered questions regarding what motivates stewardship actions by indexed institutional investors and indexing’s impact on informed trading by non-index funds.
View the slides from this seminar.
Below you will find the Q&A from the seminar:
 The research appears to ascribe the effect of board diversity to an individual actor when, in reality, many other investors have held strong views about e.g. board diversity for a lot longer than say State Street. How do you address this issue?
You are correct that some institutions had been pushing for gender diversity before the Big Three. I would refer you to our paper for details on how we tackle this identification challenge and separately identify the impact of the Big Three. The paper can be found at: http://ssrn.com/abstract=3724653.
 Blackrock CEO promotes the new concept about the purpose of the investee company. How do you explain this from the perspective of “” weak governance
Admittedly, I’m not sure I fully understand the question. However, I think you are referring to Larry Fink’s recent letters to CEOs telling them that BlackRock expects them to tackle ESG issues and consider the impact of their decisions on all stakeholders. I view this as another example of his institution attempting to use its size to influence the direction of companies. It is an example of stewardship because, as Fink explains, BlackRock believes that companies taking such actions will benefit the investors in its various funds. The question remains, however, as to how responsive companies will be to this pressure and whether other motivations might drive BlackRock’s actions on this front.
 Todd, how do you see the role o Proxy Agencies in the lack of stewardship who also have no budget and hands to evaluate thousands of company in such short period of time prior to the Annual General Assembly? Considering the recent creation of Independent Oversight Commette chaired by Prof. Stephen Davis.
The proxy advisory firms and their impact on stewardship is an interesting and important question, but I view it as quite different than the question of how the growth of indexing has mattered for stewardship. Given that, I’m going to largely punt on this question as I’m certainly not the expert on proxy advisory firms. Instead I would refer you to the papers of Nadya Malenko, Andrey Malenko, Yao Shen, and others that directly tackle the questions related to proxy advisory firms and their impact on companies and investors.
 these major investors have clearly had major impact on corporate governance includng climate change. However, specifically on global warming: many companies are responding to this pressure by putting reduced carbon footprint metrics into their business plan and executive incentives. However, many companies with large footprints are selling these businesses to private companies. there are examples where those assets are even ‘DIRTIER” now under private ownership. there is possiblity that under the rare circumstance of shutting these dirty businesses as shutting would do major short-term damage to the company and society. what should the large investors do about this?
I’d prefer to not pontificate on what large investors should or should not do about these specific activities. That said, I do think this example illustrates some of the potential limits of the Big Three’s approach to governance, which is to push broad-based reforms using low-cost methods. While these efforts can be effective, it likely has its limits. In particular, the Big Three might struggle to assess whether individual companies have taken actions they view as appropriate because this entails a much higher-cost form of monitoring that they might not be as adept at doing.
 You said a number of times that the managers “own” securities. However the fund management firm doesn’t own, the funds own the securities, those funds have fund boards – and external clients, for example in segregated mandates (e.g. public funds). Perhaps a further stream of research would be useful to look at the internal governance of the managers and how they set policies and their accountabilities.
I agree. The fund families do not own the assets; rather they are acting as fiduciaries for the owners. And yes, I agree that a better understanding of how their internal governance structures and allocation of voting power matters is important. As noted in my talk, this topic is something we do not know much about, and I think it would be great for researchers to take a closer look at this going forward.
 Given that thier management fees are so low, is it fair to expect a passive manager to do as much company analysis as an active manager? It seems like we are getting what we pay for.
All else equal, the lower management fees of index funds will imply fewer resources and lower incentives to improve firm’s value. However, the scale and size of the Big Three fund families suggests their monetary motives to be engaged owners might be quite large in many cases. I would recommend reading the Journal of Finance article by Lewellen and Lewellen for a more rigorous analysis of how much incentives these institutions have to be engaged. It can be found at: https://doi.org/10.1111/jofi.13085.
 Any thoughts on Big 3 role in ESG issues like Carbon Disclosure, etc?
I think it is an open question of how much of an impact they will have on other ESG issues, including emissions. The impact of their board gender diversity campaigns (as shown here: http://ssrn.com/abstract=3724653) suggest the could have a considerable impact if they choose to. There is also a recent Journal of Financial Economics paper that argues to find evidence of an impact on emissions. That paper can be found here: https://www.sciencedirect.com/science/article/pii/S0304405X21001896.
 Thank you for your very interesting lecture! Do you think there is any association between indexing and dual class share structures?
Historically, the Big Three have generally opposed dual class share structures. My 2016 Journal of Financial Economics paper with Appel & Keim did find evidence that the Big Three had an impact on this front as well. In particular, firms with more index ownership were less likely to have such an ownership structure. That paper can be found here: http://www.sciencedirect.com/science/article/pii/S0304405X16300319.
 I give credit for passives moving the needle on board diversity even though it was a one-size fits all approach. But can that kind of success be expected from that approach with climate? Emissions are very much company-specific and should be analyzed by someone who understands the company’s business. Progress also can’t be easily fact-checked like board diversity.
Great question. It’s unclear that the Big Three’s approach to governance will be as impactful on issues related to emissions, where as you note, one could argue there will be a greater need for firm-specific information and higher-cost forms of monitoring. That said, there is a paper that argues to find evidence of an impact on emissions. It can be found here: https://www.sciencedirect.com/science/article/pii/S0304405X21001896. However, even if they do have an impact on emissions, there is a question of whether there could be some firms hurt by a “one-size-fits-all” approach to this issue. While the Big Three would argue they are careful to not enforce a one-size-fits-all model on firms, I do think it is an area where additional research is needed.
 In your personal opinion, what are your initial impressions about Big 3 allowing pass through voting for their own investors?
I’m not sure what the impact of this will be. It will likely depend on how much of their voting power they give over to fund managers and investors. E.g., in the case of Vanguard, it is allowing the actively-managed funds that are advised externally to take responsibility for their own votes. But that still leaves Vanguard’s proxy-voting committee a large number of shares to vote, and hence, a potentially large amount of influence to wield. It will be interesting to see how this unfolds in the years to come.
 Excellent talk. Thanks!!! Since the Big 3 account for 75%-80% indexed assets, should we ignore the other 20%-25% indexers? If not, is it because we expect them to still play an important but different role? If so, in which ways are the smaller indexers different?
I do not think we should ignore the other players in this index product market, which includes Charles Schwab. It’s just that the Big Three are clearly the ones with the most voting power, which is likely to give them the most potential influence. They also tend to be the most outspoken in their views regarding what constitutes good governance. That said, it would be interesting to know whether ownership by other indexers matters differently than that of the Big Three. I suspect it does for the aforementioned reasons, but that remains to be seen.
 I like the way you have framed the difference between “high-cost” monitoring and otherwise. It’s an important distinction. Active manager research analysts cover 30 companies max. Passive governance analysts cover hundreds. The math doesn’t work for high-cost monitoring.
Thanks, and I completely agree that it is important to be careful in distinguishing between the different forms of monitoring that owners can engage in. I think the evidence is clear that the Big Three are not engaged in the same type of high-cost activities done by hedge fund activists. That isn’t to say, however, that they don’t have other low-cost techniques they can use to still exert influence.
 Do you have some research agenda about index corporate governance focusing on emerging markets or developing markets, such as China? or any existing results about index corporate governance in other countries?
I do not, and I’m not aware of much research on indexing outside the U.S. I think this would be a great question for future researchers to tackle.
 In terms of value implications the Big Three seem to explicitly focus on value creation and enhancement rather than value preservation. Do you think there is a requirement to explicilty focus on value preservation?
I’m not sure I see the distinction here. They claim to take actions that will improve value of the underlying companies, which then benefits fund investors. So, if you are improving value, you are also inherently preserving existing value (and adding more to it). I apologize if I’m missing something here.
 Can you talk about the practice of share lending, how prevalent it is with the Big Three, and what impact this has on governance?
The Big Three certainly engage in share lending as it is one additional way they generate revenues, which helps them keep fund expenses low for investors. The impact on governance is less clear. Prior data has shown that institutions tend to reduce their lending in the lead up to big votes, but that work is a bit older and didn’t specifically look at the Big Three. If they bring back their shares for votes, then the impact of their lending on governance is likely minimal. Though… making it easier and less costly for other investors to short could presumably matter for governance. I’m not sure there has been direct work to analyze this potential indirect impact of indexers on governance. Probably worth a look.
 Excellent presentation, congratulations to you all.
 A point of clarification, BlackRock was not the first index manager to allow clients to split votes
Apologies if I wasn’t clear on that front. I certainly did not mean to imply that indexers had never allowed funds (or their investors) to vote differently in the past. E.g., there are certainly instances of the Big Three not voting all their shares in the same direction on a particular vote. E.g., I believe Vanguard let each fund make its own decision in the CVS-Caremark merger. What I was referring to was an announcement by BlackRock in Fall 2021 that it would be giving voting power in some cases to the investors in its funds. This shift is more systematic, and details can be found here: https://www.blackrock.com/corporate/about-us/investment-stewardship/proxy-voting-choice.
 Blackrock has said that 75% fo their funds need to have net zero carbon emissions. Practices change, not just disclosure. How will that change on their passive side of the business if they do it on the active side?
This is an interesting question. As mentioned in the talk, I think the interaction between the active funds and index funds within these institutions is not particularly well understand, and it is something I’m currently working on in a work-in-progress. Stay tuned.
 Isn’t lending stock to short-sellers an important source of revenue for indexers? If so, I wonder how much such lending by indexers is before shareholder meetings. That would cut into their influence on voting matters.
Yes, it is a source of revenue for them, and it could matter for governance. Please see my above answer to another question on this topic.
 “Thanks again! Very helpful. I thought your points on common ownership and market share were interesting — demonstrating that market share is (obviously) more important on influencing firm behavior, particularly anti-competitive behavior. I wonder if common ownership has any kind of compounding effect in any way?”
From a conceptual standpoint, I tend to think it is implausible that common ownership caused by indexing matters for product market competition, and I think the recent publications I cited in my talk provide pretty compelling evidence and findings to confirm this view. I would suggest taking a look at those papers, especially Lewellen and Lowry (RFS 2021), Dennis, Gerardi, Schenone (JF forthcoming), and Gilje, Gormley, Levit (JFE 2020).
 Isn’t lending stock to short-sellers an important source of revenue for indexers? If so, I wonder how much of such lending by indexers is before shareholder meetings. That would cut into indexers’ influence on voting matters.
This question was already answered above.
 Congratulations Jun and Todd on an excellent event
Todd Gormley is a Professor of Finance and the Finance Area Chair at the Olin Business School at Washington University in St. Louis. He joined Olin in 2006 after graduating from M.I.T. with his PhD in Economics before moving to The Wharton School in 2009 and then returning to Olin in 2016. His earlier research focuses on why managers sometimes fail to act in the best interest of shareholders and what governance and ownership arrangements mitigate these conflicts. His most recent research has analyzed the impact of passive institutional investors’ rise on stewardship and firms. Todd’s research has been featured in major media and won numerous best paper awards, and he previously served as an Associate Editor at the Review of Financial Studies and currently serves as an Associate Editor at the Journal of Financial Economics, Review of Finance, and Journal of Financial & Quantitative Analysis.
For further information on the webinar please contact Professor Jun Yang, Director of the Institute for Corporate Governance at email@example.com.