Growing inequality and stagnant wages are forcing a much-needed debate about our corporate governance system. Are corporations producing returns only for stockholders? Or are they also creating quality jobs in a way that is environmentally responsible, fair to consumers and sustainable? Those same corporations recognize that things are badly out of balance. Businesses are making record profits, but workers are not sharing in those gains.
This discussion is necessary. But an essential player is missing from the debate: large institutional investors. For most Americans, their participation in the stock market is limited to the money they have invested in mutual funds to finance retirement, usually in 401(k) accounts through their employers. These worker-investors do not get to vote the shares that they indirectly hold in American public companies at those companies’ annual meetings. Rather, the institutions managing the mutual funds do.
Institutional investors elect corporate boards. Institutional investors vote on whether to sell the company and on nominations for new directors, and whether to support proposed compensation packages for executives. At the average S. & P. 500 company, the 15 largest institutional investors own over half the shares, effectively determining the outcomes of shareholder votes. And the top four stockholders control over 20 percent.
What this all means is that corporate governance reform will be effective only if institutional investors use their voting power properly. Corporate boards will not value the fair treatment of workers or avoid shortcuts that harm the environment and consumers if the institutional investors that elect them do not support them in doing the right thing. And they are unlikely to end the recent surge in stock buybacks as long as there is pressure from institutional investors for immediate returns.
And yet American workers must hand over money each paycheck to these same institutions to invest for their retirement.
If the American corporate governance system is to work better, then the institutional investors, who have a fiduciary responsibility to the workers whose money they invest, must represent the interests of these investors and vote to uphold high standards of social responsibility. The worker-investors are not single-issue voters, solely focused on shareholder returns. The vast majority of their income and ability to build wealth depends on continued access to good jobs. They will suffer unless corporations make money in a manner that works for employees, consumers and the environment.
Some leading institutional investors, including Vanguard and BlackRock, have recently called for corporations to respect all stakeholders and invest to support long-term, sustainable growth. They have begun to push corporations in the right direction and should continue to do so.
But reforms must make sure that mutual funds align their investing and voting behavior with the interests of the individuals whose capital they control. For example, retirement and index funds should have shareholder voting policies tailored to the objectives of long-term investors. And, if we want companies to operate in a socially responsible manner that creates sustainable profits, then institutional investors need to factor environmental, social, and most important of all, employee factors into their investing and voting decisions.
We must also reduce the constant mini-referendums at American public companies. Every year, there are over 30,000 votes for mutual funds to cast. With fewer but more meaningful votes, we can create a vibrant accountability system focused on sustainable wealth creation.
We should also provide better incentives for institutional investors to make long-term capital investment in our economy. By enacting a fractional tax on all securities trades and making lower capital gains tax rates available only on investments held for at least five years, we could discourage rapid portfolio turnover and help institutional investors focus more on long-term returns, and the thoughtful deployment of capital to serve the interest of American worker-investors.
The proceeds could be used to make long-term investments in the environmental efficiency of infrastructure, basic scientific research, better training for America’s students and workers, and in helping workers move from carbon-intensive industries to the sustainable-energy industries of the future.
American workers depend on good jobs and long-term economic growth for their economic security. With a more rational corporate governance framework that holds both institutional investors and corporations accountable, our nation can begin again to make our economy work well for the many, and not the few.
Leo E. Strine Jr. is the chief justice of the Delaware Supreme Court. Antonio Weiss is a senior fellow at the Harvard Kennedy School’s Mossavar-Rahmani Center for Business and Government.
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