There is no such thing as an innocent stockholder.
- Louis Brandeis, 1935
Two salient features of fin de siecle economy in the United States and Western Europe are (1) the hollowing out of social relations between major corporations, their employees, and the communities in which they are located; and (2) the failure of the body politic to evolve socially protective responses to this change. Institutionalists and other concerned parties are moved to wonder: what combination of forces gave rise to the contemporary brand of hard-edged, shareholder value-oriented corporatism? And what might be done about it?(1)
The purpose of this article is to examine the following issue: to what extent has the growing concentration of control over financial assets in the postwar era (but especially since 1974) contributed to the (apparent) single-minded pursuit of shareholder value among many top-level corporate decision makers? Adolph Berle and Gardiner Means  claimed that the separation of ownership and control of tangible assets was a critically important aspect of the corporate revolution. The argument is made here that a widening fissure between the ownership and control of financial or intangible assets is a distinctive characteristic of the postwar era in the industrialized world. Moreover, a serious consequence of the rising concentration of control over the disposition of intangible assets has been a shift in the distribution of economic and political power in favor of the custodians of giant pension and mutual funds. The following sections argue that the expanding concentration of control over corporate equity, in combination with other factors (such as the change in proxy rules issued by the Securities and Exchange Commission [SEC] in 1992), has enhanced the feasibility of effective shareholder activism. Confronted with the new age threat of insurgency by large shareholder groups, top-level managers have in many cases placed heightened emphasis on "shareholder value" and have deployed an array of strategies (including stock buy backs, downsizing, and re-engineering) in pursuit of this objective. Furthermore, the strategic maneuvering in fidelity to shareholder interest has imposed a high social cost. The rise of institutional equity funds is a highly important factor in explaining the diminished emphasis on community and employee welfare by corporate policymakers in the 1990s.
The remainder of the paper is organized in five sections. The following section surveys the growth of institutional portfolios in recent decades and identifies the causes underlying this trend. The third section examines the incentives to shareholder activism. Factors affecting the feasibility of coordinated action among shareholder groups are analyzed in the fourth section. The fifth section of the paper reviews the evidence from the 1990s, and concluding remarks are contained in the final section.
Growth of Institutional Equity Holdings
The escalating importance of institutions in the market for corporate equity is told by these numbers: whereas in 1946 pension funds, insurance companies, mutual funds, and other institutions collectively held 6 percent of dollar-denominated corporate equity, by 1996 they held 50 percent. It should also be noted that since institutions have historically preferred shares of large-capitalization firms, the percent of outstanding equity of Standard and Poors (S&P) 500 firms under the control of institutions is often larger than 50 percent. For example, Brancato and Gaughan  report that institutions held 55 percent of the stock of the largest 100 U.S. firms in 1990 [Brancato and Gaughan 1991, table 19].(2)
The post-1946 era has also seen an increase in the importance of pension funds and mutual funds vis-a-vis other institutional holders of equity. For example, pension funds accounted for 25 percent of total assets held by institutions in 1996 (in 1946 the figure was 3 percent). Pension and mutual funds together controlled 37 percent of (dollar-denominated) corporate equity in 1996. Table 1 describes institutional equity holdings by group in 1991.
What factors explain the mushrooming growth of pension funds (both public and private) and mutual funds in the United States from 1974 to the present? There are several. First, the Employment Retirement Income Security Act (ERISA) of 1974 gave favorable tax treatment to funds committed to pension plans.(3) The extent of institutional participation in equity markets increased sharply after May 1975 when the SEC mandated fully negotiated brokers' commissions.(4) The most important and well-publicized factor is the movement of a huge segment of the population born after 1946 (the baby boomers) into the peak years of the earnings life-cycle - a trend that has gained momentum in the 1990s. Other things being equal, an increase in the percent of the population in the 35-55 age bracket (the peak years of the earning cycle) will result in an increased flow of tax-deferred pension and individual retirement account (IRA) contributions. Moreover, the evidence shows that a "representative" IRA or 401(k) contributor (or mutual fund holder) in the 32-71 year age bracket holds 50 percent or more of his or her retirement assets in one or more stock funds.(5)
Table 1. Five Largest Groups of Institutional Shareholders in the United States, 1991 Group Amount (billions) Private pension funds $667.7 State and local pensions 290.2 Open-ended investment companies 239.2 Life insurance companies 116.7 Other insurance companies 94.3 Source: Brancato [1991b]. Incentives to Shareholder Activism
The proponents of shareholder activism proffer it as the best available solution to the "agency problem" - i.e., the problem of reconciling the potentially dissimilar interests of managers and shareholders [e.g., Coffee 1991; Bathala et al. 1994; Porter 1992]. Shareholder activism can be (and has been) directed toward the achievement of a wide array of purely economic and non-economic objectives, including: (1) election of "independent" directors;(6) (2) reining in "excessive" executive compensation packages; (3) veto of management decisions concerning acquisitions, acquisition of debt, or disposition of assets; (4) placement of constraints on the ability of a corporation to pay "greenmail";(7) (5) ouster of executives and/or the appointment of new ones; (6) veto of poison pill strategies; and (7) "social responsibility" issues such as the use of replacement workers during strikes, marketing campaigns for cigarettes and beer aimed at youths, racial and gender discrimination, and downsizing - just to name a few.(8)
A survey of the past 10 years reveals that there are two types or categories of activists among institutions. The first type of activist is a close relative of the corporate raider. These insurgents manage private equity funds commonly referred to as hedge, risk arbitrage, value investment, or vulture funds. Thomas Briggs [1994, 102] writes that
Unlike many institutions, these investors do not tread lightly. . . . [A]ctivism does not mean putting a resolution on management's proxy card asking shareholders to vote to end discrimination practices or redeem a poison pill. For these investors, activism means securing board representation with a view to fundamentally changing a company's policies, dismissing management or taking over a company. These investors . . . may be distinguished from institutional investors by their readiness to conduct a proxy contest for corporate control if management does not accede to their demands.
Whereas the typical stock mutual fund is highly fragmented, value investment or vulture funds tend to be concentrated in the shares of a handful of target companies. The concentrated nature of these portfolios makes it possible (at least in some cases) for fund managers to present a credible threat. A fund manager of this type will often search out companies with "free" cash flow available for stock buy backs. Or, the insurgents may pressure management to develop a downsizing or re-engineering plan with the expectation of drawing a favorable reaction from market analysts. In either case, the objective is to engineer a short-term capital gain.(9)
The second category of activist institutions is the long-term or relational investors - i.e., institutions that "see themselves as long term investors in the firm - owners - rather than as short term traders or arbitrageurs" [Gordon 1994, 127]. These institutions hold large blocks of shares that would be difficult to redeem without significant transactions costs.(10) Other things being equal, the expected return to resources committed for shareholder initiatives is a positive function of the "holding period" of the stock. In the case of "high turnover" portfolios, the investment manager may be reluctant to commit resources in as much as the position may be liquidated in the not too distant future. Public pension funds are in the vanguard among active shareholder institutions. The data in Table 2 reveal that public pension funds are among the largest institutional investors. Though the degree of diversification in a typical public pension stock fund is so great that it could pass for an index fund, these portfolios will, by virtue of their sheer size, contain large (and potentially illiquid) blocks of shares in companies such as International Paper, AT&T, Citicorp, and Wal-Mart.
It would appear at first blush that, in view of the explosive growth of stock mutual funds in the past 20 years (and also taking into consideration the extremely competitive nature of the mutual fund business), investment managers would have both the opportunity and the incentive to be aggressive champions of shareholder rights. Yet with rare exception, mutual fund companies stick to the Wall Street Rule - i.e., "vote with management or sell." A closer examination reveals a number of factors militating against activism by mutual funds...