The permanence paradox: why shareholder value always wins

The powerful ‘Big Three’ index funds managers will not protect their portfolio companies from hedge fund activists. This battle for the future of corporate America is as perplexing as it is unpredictable. 

The years since the 2008 financial crisis have seen two paradoxical trends in the American stock market. On the one hand, index fund managers BlackRock, Vanguard, and State Street have rapidly grown to become the largest shareholders in corporate America, collectively owning roughly 22% of the S&P 500. These “permanent universal owners” could be a potent force for enabling corporations to take a long-term perspective, investing in their workers, aggressively reducing their carbon emissions, and building enterprises to last. 

Yet the mid-2000s also saw a spike in hedge fund activism aimed at maximizing share price immediately. Activism leapt just in time for the 2008 financial crisis and has not ebbed since, reaching such stalwarts as Coca-Cola and Procter & Gamble. In any given year, 200 companies face a hedge fund demanding cost cutting, increased dividends, board representation, or often major asset sales or restructuring – particularly those companies that distinguish themselves by being too oriented toward stakeholders. 

Which of these forces has had the biggest impact? This battle is not over, but for now, it seems clear that shareholder primacy is not likely to be replaced by stakeholder capitalism anytime soon. 

The rise of index funds 

In 1981, the US Internal Revenue Service issued a ruling clarifying the tax treatment of the 401(k) plan that allowed employees to direct some of their pay into mutual funds and other investments for retirement. These “defined contribution” retirement plans quickly spread across employers, and within a few years much of the American population found itself invested in funds run by Fidelity, Vanguard, and Capital Group. The industry’s assets under management increased 200-fold from $132 billion in 1980 to $27 trillion in 2021. 

Fidelity, the biggest mutual fund family, focused on actively managed vehicles advised by internal experts, and by 1995 its ballooning assets made it the largest single shareholder in roughly 400 US corporations. Fidelity often found itself owning stakes of 10% or more among competitors in the same industry. Vanguard, in contrast, focused on highly diversified indices such as S&P 500 and rarely accumulated a significant stake in a single company. Meanwhile, in 1993 State Street Global Advisors launched its SPDR, the first exchange-traded fund (ETF) that also tracked the S&P 500. Unlike traditional mutual funds, ETFs trade on a stock market just like a share in a company. The ETF model became wildly popular, and the predecessor of iShares launched in 1996, spawning dozens of ETFs. By 2003 iShares’ parent Barclays was the second-largest blockholder on the US market behind Fidelity, and in 2009 Barclays sold the iShares business to BlackRock.