When capital gives up ownership – Bo Rothstein
As the ownership of companies is shifted to index funds controlled by algorithms, why not place the responsibility on their human employees instead?
History shows us that nothing is eternal. Sooner or later most social systems bite their tail. The saying that every system contains the seeds of its own downfall seems very true. Perhaps this is the case today with the system we have come to call capitalism – which can be understood to mean that those who own the capital used in production also hold power over corporations.
Swedish company law, for example, stipulates that those who sit on the board of directors of a company should have in mind only the interests of the owners. This property interest is then greater than the interest of the consumer, the employee and the whole. For this to work, of course, one thing is necessary: that there be owners. And it must also be possible to assert, for those who represent them on the board, what the interests of these owners are.
Two problems arose. The first is that more than 80 percent of the share capital of the Swedish stock exchange is now controlled by “institutional” owners, such as pension funds and many different equity funds. The situation is similar in most Western countries. It cannot be said that the absolute majority of those who have invested capital in these funds see themselves as owners of the companies concerned, let alone have a say in how they should be organized and operate.
The professional staff who manage equity funds usually don’t have a lot of knowledge about how companies should be run. Their role as “delegated owners” is usually limited to getting involved in appointing people to serve on boards – and the reasons for doing so are usually unknown to those who have put their savings in their hands. . Transparency and accountability are therefore minimal in practice.
The second problem is that these so-called actively managed equity funds have been challenged by a new type, “index funds”. In a relatively short time, these have grown into very large asset managers, a trend described by equity analysts as “explosive‘. During the 2010s, the proportion of fund capital on the Swedish stock exchange managed by index funds increased from 8 to almost 20 percent.
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Internationally, in 2019 on European stock exchanges, index funds held 39 percent of fund capital and in the United States nearly 50 percent. An American index fund is now the second biggest asset manager in the world and two others are, together, the largest owners of share capital on the Swedish stock exchange.
Index funds differ in two crucial ways from actively managed funds. First, no thoughtful decision are made on the shares of companies to buy. Instead, the investment strategy is deliberately broad and proportional to the majority of large publicly traded companies. Capital development is intended to follow the entire stock market index, hence its name.
Second, index funds not to exercise no power of ownership. These funds are characterized by very low fees and, among other things, they not to devote any resource for participation in the appointment of members of the boards of directors. While equity funds in general can be called “faceless” capital, index funds are “headless”: an algorithm is responsible for decisions regarding share purchases.
A few months ago, a relevant debate took place in a major Swedish business newspaper (Dagens Industry). Representatives of some actively managed Swedish funds have sharply attacked their index fund counterparts for their lack of interest in nominating committees that in practice appoint company boards, saying this shows irresponsibility of their role. go.
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The growth and popularity of index funds, however, stems from their low fees and, perhaps more so, their great financial success. Most actively managed equity funds, in which highly paid stock market specialists seek to invest where profitability is greatest, perform worse than a random number generator. Over the past ten years, at the same time, in the US stock index funds gave higher returns than the average of actively managed funds.
In a market as transparent as the stock market, all legal information about a company’s value and the opportunities for future returns is already updated in the current share price. So statistically there are only three ways to beat the hint: illegal “inside” information, luck, or foresight.
Given current trends, there is good reason to believe that the share of capital held by index funds on global stock exchanges will continue to increase. But what will this growing percentage of “headless” ownership mean for our businesses and society in general?
One thing is clear: if left unchecked, given the increasingly weak and disinterested owners, the financial rewards for the corporate leadership layer can only become more astronomical. They will not have a strong counterweight from active owners against such rent seeking.
So if capital is abdicating more and more de facto governing companies, who will govern them? One possibility, of course, is their employees. Companies managed and / or owned by their employees have been studied empirically for four decades. Overall, these companies are doing very well financially and, above all, in terms of staff well-being and engagement.
The idea, found variously in Karl Marx and Milton Friedman, that the power of a company is based on the ownership of the capital employed, is, as the ingenious American economist David Ellerman showedTotally wrong. In a market economy, capital can hire (i.e. employ) labor, and then the power belongs to capital. But in a market economy, those who want to start and run a business can also lease (that is, borrow) the capital, and then the staff decide on production.
Index funds, increasingly popular in modern economies, serve as financial backers for companies. The corporate governance void they reveal offers an opening to advance the conversation on the true democratization of working life. The best candidate to step into this void is the strength of those who are truly governed on a day-to-day basis in our business enterprises – the white and blue collar workers in the workplace.
Unions have been strangely ambivalent about taking up this challenge to date. New civil society organizations that see the potential for a more substantial economic democracy should also enter this conversation from the employee side and help make it happen.
An earlier version of this article in Swedish was published in Dagens Nyheter