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Woke Capital?


James F. Tierney (@JamesFTierney) is Assistant Professor of Law at Nebraska College of Law.

Criticisms of corporate power from the left often focus on “common ownership” by institutional investors. These investors—mutual funds and ETFs, pensions, and private equity and hedge funds—often hold portfolios of noncontrolling stakes in many corporations, including direct competitors. This is a major concern for the modern progressive antitrust movement, for instance, which correctly sees it as a means for institutional capital to flex market power, undermine competition, and redistribute wealth from workers and society to wealthy rentiers.

But theories of common ownership will remain incomplete without an account of the political economy of how certain of these funds view risk at the portfolio level. Institutional investors’ role has been changing for some time. Two important trends are the rise of “passive” strategies in which funds hold broadly diversified portfolios, and the ascendance of capital-allocation models that seek to reduce exposure to environmental, social, and governance risks (ESG) that are thought to be drags on investment performance. And recent literature in corporate finance has identified features of these trends that complicate debates about the desirability of common ownership and potential regulatory responses. In the public discourse, many of these developments have come to go by the label “woke capital”. 

Common ownership might give certain capitalist actors an incentive to think about factors that affect the stability of the entire system for provisioning goods and services—rather than the provincial interests of those shareholders that control single firms as components of the social provisioning process. To be sure, that “benefit” sits in tension with other significant commitments on the left—and debates among progressive scholars of corporate power—about definancialization and deconcentration of corporate market power. I suggest that left theories of common ownership should account for the diversity of shareholder interests and their regulatory implications—including how these ownership structures might be harnessed and tamed to promote the stability of the entire social provisioning system. 

Common Ownership Deserves its Bad Reputation

For decades, orthodox corporate law has seen managers as wasteful rent-seeking agents of shareholders, who in turn are thought the rightful and natural claimants to firms’ economic and governance rights. The “shareholder value” revolutionaries sought to solve this agency cost problem by aligning managers’ and shareholders’ interests, thus increasing firm value for all involved. Yet in practice, activist institutional shareholders ended up being rent-seekers too. They used takeovers, proxy battles, and other forms of activism to extract value from firms. They demanded firms reallocate economic and governance rights to the wealthy owners of capital. Private equity funds pioneered “extractive financial strategies” like the leveraged buyout. As a result, firms cut expenses, laid off workers, and outsourced and offshored production. They reduced their funding of investments in social provisioning through the real economy, disgorging cash to shareholders instead.

The result? A dystopia in which in an ever increasing share of gains go to investors, reinforcing the power of the wealthiest households. It is no innocent coincidence that the well-known productivity-pay wedge emerged alongside the rise of shareholder value capitalism, and the ascendance of agency-cost models of corporate governance overseen by activist institutional investors. As Lynn Stout has observed, the normative theory of shareholder primacy that drove this shareholder value revolution was an attractive vehicle for law-and-economics oriented academics and policy entrepreneurs—and “personally profitable for activist corporate raiders,” hedge funds, and corporate executives over the last 40 years.

As participants in this critical redistributive turn, common-ownership institutional investors are understandably cast in the role of villain. Many left critics of corporate power have thus focused on reducing the power of institutional investors. One juicy target for the modern antimonopoly project, for instance, is common or horizontal ownership by institutional investors of shares in directly competing firms. Einer Elhauge has argued that this kind of common ownership creates a “purely structural” anticompetitive incentive for firm managers to flex market power (rather than increase market share) to increase shareholder returns. Concentration of common ownership in this form is a plausible causal mechanism for the rise in economic inequality over time, as well as other broader dislocations in the social provisioning system that Marshall Steinbaum has identified. Others have focused on institutional investors’ role in entrenching practices that funnel cash out of companies, in the form of dividends and share buybacks, at the expense of productive investment. Economist J.W. Mason has argued that the working class should respond by allying with managers against shareholders to encourage investment in long-term growth over disgorging cash to activist shareholders.

This literature reflects the well-founded concern that concentrated, common ownership by institutional investors is undesirable for competition, labor market composition, and real investment. But progressive theories of common ownership will remain incomplete without accounting for the variety of interests across common owners—and for the fact that passive diversification strategies by index funds start to make “market-based” capital allocation functions look more like socialized finance.

But Common Ownership is not just Bad

In an ironic twist, institutional investors have largely gone from “corporate raiders” to “passive investors” that “hold the market” rather than try to beat it. Modern portfolio theory, a cornerstone of modern orthodox financial thought, counsels that diversification can reduce investors’ exposure to firm-specific risk; broadly diversified portfolios expose investors to systematic risks that affect all firms in a market. Because passive strategies that hold a basket of diversified securities—such as by replicating an index like the S&P 500—can be executed at low cost, they’ve become very popular. They now make up about half of public funds and about 14% of the entire U.S. equity market, managed by dominant firms like BlackRock.

This secular trend threatens to turn corporate law’s traditional solution to the managerial incentive problem on its head. Well-diversified investors should care about risk-adjusted returns at the portfolio level, not about increasing returns from any given investment. The portfolio-level view puts institutional investors in a unique position to use their governance power toward different kinds of activist ends—not just disgorging cash for the short-term benefit of investors, but also potentially addressing systemic risks that individual companies lack adequate incentive to tackle but have economy-wide effects. This includes risks to the stability of the social provisioning system as a whole—like climate change, which Madison Condon has called “one of the most significant sources of economy-wide, non-diversifiable market risk” about which institutional investors care. This theoretical incentive to mitigate systematic risk is different in kind than the incentive identified in the common-ownership literature to encourage portfolio firms to engage in anticompetitive conduct. As Jeffrey Gordon has observed, it aligns the incentives of fund beneficial owners and the rest of society, rather than sets them at odds.

What is more, companies sometimes change their practices in order to fend off more costly regulation. Prescient institutional-investor asset managers are noticing—as did Leo Strine, former Chief Justice in Delaware—that “an economic system that is so skewed toward the few will not be continued to be tolerated by the many.” BlackRock’s CEO Larry Fink, for instance, predicted that climate change will bring about a “fundamental reshaping of finance” and “significant reallocation of capital.” In addition, law professors Michal Barzuza, Quinn Curtis, and David H. Webber have argued that fund managers’ ESG activism may be designed to capture future rents from privileged millennials who stand to inherit in the coming decades’ generational turnover in wealth—and who are believed to have more prosocial views on environmental, social, and governance issues.

Common Ownership and Just Transitions

Cautious alignment with the interests of institutional investors thus should not be discounted as a plank of a strategy to achieve progressive policy aims toward achieving a more just, equitable, and accountable economy. But we cannot forget that institutional investors have a spotty track record in their shareholder activism, earning a justifiably poor reputation on the left.

One tension with traditional left commitments against corporate power arises from the fact that these institutional investors owe legal duties not to society but to their ultimate beneficial owners. Those beneficial owners include retirement savers in 401(k) plans, college savers in 529 plans, and other “forced capitalists” who are effectively required to become private owners of capital by investing through these funds in the absence of a robust public safety net. Even if forced, they remain capitalists, and have interests in maximizing return regardless of who bears the cost.

These beneficial owners have other interests too, of course, as workers and citizens. Yet the channels of fund entity governance give atomized retail investors the choice between exit and loyalty, but not meaningful voice, in how passive funds engage in shareholder activism toward portfolio companies. So from the fund manager’s perspective, the portfolio-level view remains concerned the investment implications of existential risk; social crises that do not undermine risk-adjusted return at the portfolio level may not register.

Social inequality, for example, only really presents a problem for institutional investors insofar as it creates the specter of economy-wide social unrest that undermines returns across the portfolio. Likewise, passive funds didn’t take up Matt Levine on his suggestion last summer that they could reasonably demand Pfizer distribute free COVID-19 vaccines if portfolio-level gains “more than [made] up for bankrupting Pfizer.” It was possible to engage in business as usual—private owners of capital earning rents from Pfizer’s sales of vaccine to wealthy governments—without threatening the entire system. This counsels skepticism about the kind of risk that will precipitate action under the portfolio-level view.

Perhaps the right way to think about the tensions is to understand institutional investors as instrumentally useful to certain left efforts at systemic transformation, even if they are not actually allies. To the extent that social movements present a credible threat at some form of systemic change—focus on the transition to a less carbon-intensive production system for example—institutional investors can serve to neutralize some of the opposition among capital owners and to accelerate the transition process.

This is one reason to lean into policies like robust mandatory ESG disclosure. Writing in LPE Blog, Federico Fornasari has urged us to “understand the mandatory production of ESG information as an important part of democratizing and making corporate activities socially accountable.” Armed with ESG disclosures, institutional investors might allocate less capital to firms in disfavored industries—reducing stock returns, depressing stock-linked compensation for managers, and increasing firms’ cost of equity capital. This would meanwhile eat away at the wealth of those with idiosyncratically concentrated holdings in these firms’ equity, like their CEOs and other major backers—shifting economic and governance power away from them, in service of portfolio-level concerns for the stability of the system as a whole. Fights over ESG disclosure reflect the immense power that institutional investors wield both in markets and in regulatory politics. (This dynamic is partly why the Trump Administration fought so hard to constrain institutional investors from considering ESG factors. It’s the same reason why corporate managers, and their dutiful cheerleaders in the conservative policy ecosystem, are so opposed to “woke capital.”)

That sets up an institutional design challenge: how might we harness the prospective benefits of common ownership while constraining and neutralizing the market-distorting and shareholder-first pathologies that have historically been characteristic features of activist institutional investment? One solution is the “public option.” Noting that the transition to a more just economy will be a “fundamentally political undertaking, which involves making explicit distributional choices and using governmental powers to turn them into reality,” Saule Omarova has called for a publicly governed and democratically accountable National Investment Authority to serve the role of making these kinds of centralized resource allocation decisions.

By the same token, the now-private institutional investors making the same decisions shouldn’t be democratically unaccountable. If funds’ incentive to consider the portfolio level makes them like a government, then perhaps they ought to be run more like one. This harkens back to the market socialism debate three decades ago, such as James A. Yunker’s proposal to make public companies truly “public” by folding them within a “national government public ownership agency.” A central plank of the transition to a more just and equitable economy, then, will to check the governance power of institutional investors—if not nationalize them outright.

Toward a Critical Theory of Investment Fund Regulation

Organizing forces of production to address climate change and systemic inequality call for us to think creatively about how regulation should promote the allocation of capital and exercise of governance rights that promotes not private ends but the stability of the social provisioning system as a whole. In coming years, an important project across disparate areas of law and regulation will be to fasten the governance reins on these pools of capital—making them more responsive to the public at the portfolio-level view, and less likely to pursue the kind of extractive practices that have characterized the shareholder value revolution.

While I only sketch out the beginning of such a conversation here, a theory of investment-fund regulation informed by political economy perspectives would have to grapple with two regulatory aims—encouraging funds’ centralized capital-allocation functions to support democratically led efforts to steer social provisioning and planning, while also improving the accountability and legitimacy of these funds’ governance structures. These matters implicate broader scholarly conversations in law and political economy about the role of corporate power and common ownership. Sanjukta Paul’s work on antitrust, for instance, seeks to reorient whose interest matter and thus how power is distributed across firms’ capital structure. Largely missing from debates about common ownership and competition policy, however, is attention to the institutional design of the ownership structures through which investors exercise that power through common ownership. Their regulation at the manager- and fund- level will be an important component of the law and political economy program about corporate governance and power.

Make no mistake—neither “woke capital” nor investment fund regulation will bring about a more fair or equitable economy. Finance will not build worker power, bring about social democracy, or transmute shareholders into altruists. But as William Boyd has argued in these pages, “there is no alternative to getting down in the trenches” of market design. The broader goal is to consolidate governance power in democratically accountable institutions—like reinvigorated labor market protections, disclosure of corporate money in politics, board constituency mandates, and antitrust reform. Judicious engagement with investment fund structures will be an important plank of other market-design and political reforms designed to throw off the yoke of concentrated corporate power in our politics.