A very sharp little discussion group.
From the University of Chicago, Booth School of Business' CBR Capitalisn't pod, March 5:
In his recent book, The Problem of Twelve: When a Few Financial Institutions Control Everything,
Harvard law professor John Coates sheds light on the secrecy, lack of
public accountability, concentrated power, and disproportionate
influence of a select few institutions in our financial system.
On this episode of the Capitalisn’t podcast, Coates joins hosts Bethany McLean and Luigi Zingales to dissect the potential dangers of this era of financial consolidation and explore possible solutions, including accountability and transparency, to ensure a more equitable economic system. Specifically examining the “Big Four” fund groups (Vanguard, State Street, Fidelity, and BlackRock)—which collectively hold more than 20 percent of the votes in S&P 500 companies—and the transformative rise of private equity funds, they discuss the challenges posed by concentrated financial power and its impact on markets, economies, and society at large.
Audio Transcript
John Coates: When you have that small number of people controlling this big a portion of the economy, there’s always a risk that they will do things that are in their own interest or, at a minimum, just not in the interest of the public at large. That is a real democratic deficit for capitalism.
Bethany: I’m Bethany McLean.
Phil Donahue: Did you ever have a moment of doubt about capitalism and whether greed’s a good idea?
Luigi: And I’m Luigi Zingales.
Bernie Sanders: We have socialism for the very rich, rugged individualism for the poor.
Bethany: And this is Capitalisn’t, a podcast about what is working in capitalism.
Milton Friedman: First of all, tell me, is there some society you know that doesn’t run on greed?
Luigi: And, most importantly, what isn’t.
Warren Buffett: We ought to do better by the people that get left behind. I don’t think we should kill the capitalist system in the process.
Luigi: I wonder if listeners could guess the one topic where Bethany and I disagree the most.
OK, it’s pretty obvious, it is private equity. This might be an overstatement, but Bethany thinks that private equity is evil and represents everything that is bad in the world. And I have more mixed views. I think that there is some that is evil and some that might actually be good.
Bethany: Well, it might be an overstatement to say that I think private equity is evil, but modern, big private equity, maybe so. When Joe and I reported our book, The Big Fail, I was really struck by a study showing, basically, that private companies bought by private-equity firms are 10 times more likely to go bankrupt as those that aren’t.
As I think our listeners know, I’m a believer in capitalism, but I’m a believer in an old-school kind of capitalism, where people make money—even fortunes, yes—because they build a business that provides jobs for other people and services and goods that the world needs, not because they destroy the business and the jobs.
Luigi: But Bethany, you know that most people die in bed. It doesn’t mean that sleeping is a dangerous thing to do or lying down in bed is dangerous. It is that you’re more likely to lie down when you’re about to die.....*****.... Bethany: So, who better to discuss why private-equity funds get to be private and why your banal index fund actually poses a threat to democracy than Coates himself?
I thought we’d start with a pretty basic question. What is The Problem of Twelve, and what made you start working on this book?
John Coates: A few years ago, I was teaching at Harvard Business School, and they asked me to do a little primer for their MBAs on what are the big things that are ongoing changes to US public-company corporate governance. The big things that have changed the most are the rise of index funds and the rise of private-equity funds. Both types of asset-management companies enjoy pretty powerful economies of scale, so as they get bigger, they get better, and as they get better, they get bigger.
The resulting concentration in financial markets might raise traditional antitrust concerns, but that’s not really what I mean by The Problem of Twelve. What I mean by it is power over the economy. It’s not intentional—I don’t think anybody in either industry ever set out to get that much concentrated power—but it is true now that less than a dozen people across those two industries control in excess of 25 percent to 30 percent of all the equity of every US-listed company. That’s index funds. And 25 percent, roughly, of nonpublic equity is controlled by the private-equity industry and a small number of players in that industry as well.
That means when things don’t go well in the economy broadly, there is a perceived gap between the accountability and the legitimacy of how that economy is being run. It’s sort of a double problem, at least for index funds. I like index funds, to be clear, as a financial product. I use them, I think they’re wonderful, I think they drive down fees, I think they do all kinds of great financial things, but they’re so good at it, they’re producing real political risks for themselves.
The other side of the problem is when you have that small number of people controlling this big a portion of the economy, there’s always a risk that they will do things that are in their own interest or, at a minimum, just not in the interest of the public at large. That is a real democratic deficit for capitalism, to be perceived as being oligarchic in that way.
Luigi: I’m a hundred percent with you about the political cost, but very often people push back, and while everybody understands market power very clearly, can you give us a couple of examples of real political power that is different from market power and something that you are personally concerned about?
John Coates: The classic war story for index funds now is the Exxon proxy fight from a couple of years ago, where, for the first time in the history of the world’s largest oil company, the current board didn’t get to pick the board. A tiny little hedge fund that nobody had ever heard of before ran a slate that, 15 years ago, wouldn’t have had a chance in hell at getting elected.
How did it win with 0.01 percent of the stock of Exxon? It won by convincing the major index funds to support three of the four candidates, who then got elected. They’re not the only ones who voted in favor, but they were outcome-determinative.
The key point is, without the index-fund concentration, that hedge fund would have had to make its pitch to hundreds of dispersed asset managers and thousands and millions of dispersed individuals and almost certainly would have lost, but for the concentrated ownership of the index funds. That’s on the index-fund side.
As a more recent example, pending right now, there’s a proxy fight going on at Starbucks, run by labor. My bet is that it probably won’t work, but it has a chance, and it has a chance, in part, because they convinced State Street to support one of the initiatives last year, or a year ago, on disclosure related to labor treatment. That’s interesting, right? That’s a different kind of way in which labor is using different tools to pursue its ends.
Certain folks who don’t like labor power will view that with great horror, and those who love labor will think that’s great, but either way, it’s power. It’s a type of power channeled through the index funds that was not there previously. Private equity—....
....MUCH MORE
Previously:
"Bogle Sounds a Warning on Index Funds"
"When a Few Financial Institutions Control Everything"
The writer does have some street cred.*
"Three ongoing mega-trends are reshaping corporate governance" (or How Larry Fink and 11 Other Individuals Will Have Power Over the Majority of Public Companies)
Dean/Professor Coates knows some stuff. He is sort of an adjunct professor with tenure.
- "Traders' 'Gut' Feelings Separate Man From Machine - Study
- Why Success Breeds Success: The Science of “The Winner Effect"
