Big Three Passive Investors: When Computers Call the Shots

In a financial landscape dominated by the Big Three passive asset managers—BlackRock, Vanguard, and State Street—owning roughly 20-25% of an average S&P 500 company’s stock, a crucial question emerges: What happens when your largest investor is not a person, but a computer program, such as a passive index fund? This often-overlooked aspect of our capital markets raises challenging issues for both corporate management and regulators.

For CFOs, determining which investor or owner to engage with to shape strategy becomes complex. Despite their significant ownership stakes, these major investors, particularly BlackRock, seem less focused on traditional corporate governance issues, like selecting auditors.

Securities laws and governance frameworks in the United States are designed to protect shareholders. However, when the largest shareholders are passive index funds, it raises questions about the effectiveness of these regulations. Who should regulators, such as the PCAOB and the SEC, be writing rules for when the largest shareholders are often passive funds that may not engage deeply in policy consultations or disclosure requirements?

The relative absence of engagement by the Big Three in the nitty-gritty of rulemaking has potentially led to superficial governance practices that fail to address substantive issues. For example, CFOs often prioritize pleasing analysts during conference calls, yet analysts’ opinions may sway short-term investors, whose views may not align with long-term index investors.

Similarly, audit firms sometimes feel that they negotiate audit fees with CFOs, rather than with the investors they are supposed to serve. This disconnect can lead to audit practices that prioritize cost over quality.

The lack of direct engagement from the Big Three in regulatory discussions raises concerns about whether the voices of real, long-term investors are being heard. This could result in rules and practices that cater more to preparers (CFOs and auditors) than to the ultimate beneficiaries of these regulations—investors.

As passive investing grows, these challenges will likely become more pronounced, affecting not only U.S. markets but also global markets, including non-U.S. markets and credit and bond markets. The evolving nature of passive investing raises fundamental questions about the role of shareholders in corporate governance and the need for regulatory frameworks that effectively balance the interests of all stakeholders in the capital markets.