Who’s Really Responsible for Woke Capitalism?: A Review of The New Power Brokers

In U.S. capital markets, it is “proxy season.” From February to June, most public companies hold their annual meetings, and shareholders cast votes on hundreds or thousands of items—some routine (election of directors, confirmation of auditors) and some less routine (advisory votes on executive compensation, shareholder proposals). Both prior to and during proxy season, many institutional investors also “engage” with the companies whose shares they hold—that is, through meetings and other communications, they advise the companies on their views. These voting and engagement activities—with a focus on asset managers—are the subject of The New Power Brokers: The Rise of Asset Manager Capitalism and the New Economic Order, a book by Sahand Moarefy published last year.

Mr. Moarefy identifies himself as a corporate attorney in one of the nation’s leading corporate activism defense firms. Although his practice is advising large public companies on dealing with activist hedge funds that seek significant changes in how a company is managed or operated, he sees parallels between the corporate governance activities of traditional asset managers and those of the activist funds with which he is most familiar. Full disclosure and disclaimer: this reviewer spent nearly 25 years in varying positions with two global asset managers, but the views expressed herein are entirely my own and not those of any former or current affiliations.

This book is required reading for anyone seeking to understand the history of corporate governance in the U.S., and how the rise of institutional investors as dominant shareholders coupled with changes in government regulations set the stage for what Mr. Moarefy calls the “new economic order”—and what others might call “woke capitalism.” One notable aspect of the book is its recency: the book was published in mid-2024 and thus covers the arc of Environmental, Social, and Governance (ESG) activity from its popular emergence in the early 2000s through its peak in 2021 to its quiescence today. Right now, in the U.S. at least, ESG as an investment strategy is hardly mentioned at all.

The first part of the book discusses the development of the corporation from early American state-chartered entities with constrained powers and concentrated owners with active involvement in the business to today’s modern corporation. Mr. Moarefy focuses on the economic and legal theory of corporations as championed by Adolf Berle in his book The Modern Corporation and Private Property, published in 1932. Berle identified (and lamented) the rise of a small number of corporations that dominated the U.S. economy, the dispersion of the shareholder base, and the control enjoyed by managers who often held few or no shares in the enterprise. These trends were characterized by Berle as the “separation of ownership from control,” and this concept underlies the thesis of The New Power Brokers.

Berle also recognized that, in the modern corporation, directors had become trustees for shareholders and owed them fiduciary duties. Mr. Moarefy correctly points out that today’s legal academics most often theorize corporate governance policy through the lens of disclosure and fiduciary duty, both of which are seen as a means of mitigating the principal/agent conflict inherent in the corporate structure.

For more than 50 years, corporate practices were grounded in principles derived from Chicago School free market economists. One of them, Milton Friedman, famously said in a 1970 essay, “the social responsibility of business is to increase its profits.” This “ideology,” as Mr. Moarefy deems it, of “shareholder primacy” held sway at least until the Business Roundtable (BRT) issued in 2019 its revised understanding of the purpose of a corporation. The BRT stated that companies should focus on creating long term value for all their “stakeholders,” listing them in this order: customers, employees, suppliers, communities, and shareholders. This statement did not meet with universal acclaim; the Council of Institutional Investors (CII) issued a rebuttal challenging the placement of shareholders last among stakeholders, and also the BRT reference to shareholders simply as providers of capital and not as owners. The societal disruptions of 2020—including the Covid-19 pandemic and the responses to George Floyd’s death—may have given stakeholder capitalism some lift, but it remains to be seen whether shareholder primacy has really been supplanted.

As with most of the legal and economic studies of corporate governance, the author focuses on the role of asset managers—entities that manage the assets of others. The book charts the increase in both institutional ownership and—with the advent of index funds in the mid-1970s—increasing shareholder concentration in the largest U.S. companies. Mr. Moarefy focuses his analysis on several types of asset managers: large index fund managers, traditional activist hedge funds, and ESG activists.

What is missing from this book—and indeed from nearly all of the academic literature—is a discussion of the role of “asset owners” in driving corporate governance norms and the focus on the E and S in ESG. Understanding the dynamics between asset owners and asset managers provides much of the explanation for the power of asset managers, which Mr. Moarefy and others find so concerning.

Asset owners include private and public pension plans, university endowments, foundations, and sovereign wealth funds. Asset owners may outsource some or even all of their assets to others to manage, and when they do outsource the management, they may or may not retain the right to vote their equity investments. There are also defined contribution plans (401(k) and similar) which provide investment options to individual participants, and these most often use pooled investment vehicles like mutual funds and collective investment trusts managed by external managers. And while individual retail investors may invest in individual shares, many invest through mutual funds.

Asset managers are in the business of gathering and retaining assets to manage. They are generally paid a fee based on the amount of assets under management, with sometimes a performance fee as well. Asset managers take direction from their clients; as fiduciaries, they are bound by their principal’s instructions. Asset managers vote proxies on behalf of clients under the managers’ proxy voting guidelines, unless they have made an alternative agreement with the asset owner.

As noted in the book, government regulation is part of the corporate governance landscape. The SEC has enacted a panoply of rules that, among other things, regulate company communications to shareholders, shareholder to shareholder communications, the ability of shareholders to place proposals on company ballots, and the ability of brokers to vote shares owned by their clients on a discretionary basis. While these rules were intended to give all shareholders a voice in company oversight, their actual result has been to further enhance the influence of asset owners and asset managers—in particular ESG activists and activist hedge funds.

As a result of decades’ worth of guidance issued by the Department of Labor, which administers the Employee Retirement Investment Security Act (ERISA), ERISA counsel advise managers of ERISA assets that they are required to vote all shares, unless in a particular instance it is too costly to do so (for example, if shares may only be voted in person in a foreign country). ERISA plan assets are to be invested solely in the best long-term economic interests of plan participants and beneficiaries, and proxy voting is subject to this same requirement. ESG’s relation to the ERISA requirement of “solely in best economic interest” has been interpreted differently by different presidential administrations in recent years, and this is well covered in the book.

The expectation that ERISA asset managers will vote all shares has also become the fiduciary standard for all asset managers, reinforced by SEC pronouncements on the obligations of investment advisors to funds. Voting in a fiduciarily sound manner is an expensive undertaking for any manager with a sizable portfolio of equity investments, which has led to the creation of “proxy advisory firms,” such as Institutional Investors Services (ISS) and Glass, Lewis & Co.

Proxy advisory firms provide a menu of services, but their core service is making vote recommendations based on their research and the application of the advisory firm’s proxy voting guidelines. Some also assist in vote execution process and mechanics. For managers with limited scale, it is easiest to fulfill their responsibilities by essentially adopting the advisory firms’ guidelines as their own, and voting consistent with the recommendations. As Mr. Moarefy points out, recommendations by these firms generally support activists—both traditional and ESG—not management, and thus corporate leaders often decry the perceived power of these firms.

Concomitantly with the growth of index funds and the growth (measured in assets under management) of external asset managers more generally, the larger firms established “stewardship teams” which undertake to establish and maintain voting guidelines, engage with companies on corporate governance and other issues, and exercise the vote of their clients’ shares. Though they are independent of the proxy advisory firms, these asset managers’ guidelines reflect asset owner expectations on governance matters (and environmental and social matters as well). After all, public choice economic theory would suggest that stewardship teams are not immune to the need to gather and keep assets.

Asset owners are powerful and organized advocates, as reflected in corporate governance and ESG developments over the last 20 years. Asset owners, led by blue state public pension funds, organized CII in 1985 and the International Corporate Governance Network (ICGN) in 1995. In 2005, these asset owners, other public sector pension funds, and asset managers in the U.S. and Europe collaborated in publishing the UN Principles for Responsible Investing (UNPRI). While “responsible investing” as a strategy had existed for decades prior to 2005, many date the rise of ESG to the publication of the UNPRI. There are also a number of organizations focused on effecting environmental and social change through shareholder advocacy, such as Ceres (the Coalition for Environmentally Responsible Economies) and As You Sow. All these networks and coalitions are dominated by left-leaning asset owners. While there are business groups such as the U.S. Chamber and the National Association of Manufacturers that episodically engage on the issues, there are no organizations of scale that focus on advocating for right-of-center approaches to corporate governance.

When an asset owner seeks to place new funds with an asset manager, the request for proposals will seek confirmation as to the manager’s acceptance of corporate governance principles as embodied in UNPRI and similar codes and whether the manager is a member or participant in ESG-focused organizations. This is true for general mandates, not just those with specific ESG criteria, such as low to no carbon emissions. The incentive to gather assets then aligns the manager with the goals of these organizations. To be sure, not all asset owners require this allegiance, but those that do expect the manager to use the proxies it controls across its portfolios to vote all shares consistent with their principles.

Several chapters of The New Power Brokers are devoted to the impact of ESG, in particular the negative impact of anti-fossil fuel initiatives on the U.S. economy. Mr. Moarefy correctly points out that shareholder pressures on publicly held energy companies have resulted in divestures into private companies not subject to such pressures—but have not resulted in any reduction in emissions. Some asset owners do vote their own proxies, but the dynamic between asset owners and their external managers explains much of the success (until recently) of environmental and social initiatives. This is not to say all asset managers have been pushed into activism by their clients; some have embraced environmental issues by identifying fossil fuels as “investment risks,” and others have touted diversity in company hiring and board composition as “producing better corporate performance.” But whether push or pull, by their voting and engagement activities, asset managers amplify the existing power of activist ESG asset owners.

The rise of ESG propelled a focus on the power of asset managers. Some were frustrated that managers did not do enough with this power to effectuate ESG-oriented changes in corporate practices; others thought managers were doing too much. Some have raised antitrust concerns about asset managers’ participation in ESG-focused organizations; others claim that asset managers are not sufficiently passive to rely on certain FTC or SEC disclosure filing exemptions.

Critics have proposed various solutions to curtail the power of asset managers, including prohibiting managers from voting, requiring a mirror vote (whereby asset managers’ proxies are divided in the same percentages as those of other shareholders), or required so-called “pass-through” voting. Mr. Moarefy proposes two solutions involving government intervention: 1) establish within the government a dedicated stewardship team that would have sufficient resources to analyze companies, and have that team exercise the vote in a more informed and less biased way; or 2) establish through notice and comment a set of rules that asset managers are required to follow in voting proxies.

To this reviewer, either of these supposed solutions would instead be the ultimate separation of ownership from control. The author does not address how proxy-voting decisions would be insulated from elected officials or special interests or how public employees would be held accountable for their decisions. Importantly, it is not clear this solution would result in a better economic outcome for shareholders and the U.S. economy writ large.

In response to concerns about their power, some large asset managers have instituted limited pass-through voting programs. In general, the design of these programs allows certain clients who hold “eligible assets” to instruct the manager to vote according to one of several proxy guidelines provided by the manager. But most of these guidelines follow the corporate governance “consensus” found in the guidelines of proxy advisory firms, although one manager recently provided the pass-through option of “vote management recommendations.” Overall, the use of pass-through voting programs by institutional investors has been underwhelming.

There are asset owners who care about how votes are cast, and there are asset owners who do not. The latter are likely primarily focused on portfolio returns/performance and are content to use proxy advisory firm services or allow their external managers to cast votes under their guidelines. Asset owners who care about votes will argue that they are focused on long-term improvements in their portfolio companies to the benefit of their participants and beneficiaries.

A market solution to the power of asset managers is to “return” the vote to asset owners. If more asset owners who have to date delegated their votes instead decided to vote them, it is conceivable that we could see more balance between asset owners who are ESG activists and those who are not. While pass-through voting on a security by security basis is likely not achievable for technical and legal reasons (not to mention its implementation costs for both manager and owner), the scale solution would be to require pass-through voting programs to be adopted by all managers over a certain size, and to require that a wide range of guidelines be available. For asset managers under that size, consideration should be given to whether they should be required to vote all shares. Both of these approaches may reduce reliance on proxy advisory firm services. And finally, asset owners should be required, as mutual fund managers are today, to publicly report how their equity holdings were voted. This disclosure would not only encourage asset owners to oversee their votes, but would have the salutatory effect of allowing pension participants, endowment contributors, foundation founders, and others to see how their assets are being deployed.