Unicorns, Guardians, and the Concentration of the U.s. Equity Markets

• Publication year: 2021
• Citation: Vol. 96

96 Nebraska L. Rev. 688. Unicorns, Guardians, and the Concentration of the U.S. Equity Markets

Unicorns, Guardians, and the Concentration of the U.S. Equity Markets

Amy Deen Westbrook(fn*) and David A. Westbrook(fn**)

TABLE OF CONTENTS

I. Introduction .......................................... 689

II. The Republican Equity Market of the Twentieth Century .............................................. 698
A. Law as Response to Marketplace Power in the Late Nineteenth and Early Twentieth Centuries ........ 698
B. Corporation Law and the Threat to the Republic . . . 702
C. Securities Law, Disclosure, and Bureaucratization . 704
D. Participation ...................................... 712

III. Private Equity Markets ............................... 715
A. Introduction ....................................... 715
B. The Rise of the Private Equity Market and the Relative Decline of the Initial Public Offering Market ............................................ 716
C. Reasons for the Rise of the Private Equity Market and the Decline of the Initial Public Offering Market ............................................ 720
1. Cost ........................................... 720
2. Deep, Nonpublic Pools of Capital ............... 721
3. Interest Rate Environment ..................... 724

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4. Modest Capital Requirements of New Businesses .................................... 725
D. Requiem for the Public Equity Market? ............ 727

IV. The Contemporary Public Equity Markets ............. 727
A. Introduction ....................................... 727
B. Rise of the Institutional Investor .................. 728
C. The Shift from Actively Managed to Passively Managed Funds ................................... 730
D. Possible Consequences of Institutional-Investor Dominance ........................................ 733
E. Guardians ........................................ 737

V. Conclusion ............................................ 738

I. INTRODUCTION

Social institutions, such as stock markets, have conventional, widely understood meanings. For example, people think they know what the Dow Jones Industrial Average (DJIA)(fn1) means. More generally, people have understandings about the roles institutions play within their social, economic, and political contexts. "Just so stories"(fn2) about these roles provide legitimacy, form the basis for education, and guide regulation. So, for example, much of U.S. corporation law and finance is taught and understood on the basis of the importance of public equity markets in the fostering of the entrepreneur and thus our economic and even social progress. Under the pressure of developments, however, such understandings of how an institution fits-what an institution means to its society-may come to seem less plausible. Just so stories may no longer seem "just so."

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This Article argues that developments in the private and public equity markets are changing the role these markets play in the United States and concurrently what "stock market" means as a matter of political economy. For several generations, a broad middle class invested directly in bureaucratically run corporations that were disciplined by securities and other laws. The governance of firms and thus much of the economy was answerable to this broad middle class. Perhaps most importantly, citizens understood their investments and the markets as their own, thinking of them as "the free enterprise system" or even "the American way." The establishment of this "republican capitalism" is discussed in Part II.

The turn of the century, however, revealed a decisive shift away from broad-based ownership of publicly traded companies: Republican capitalism appears to be waning. Ownership of U.S. firms, and so a great deal of the economy, has shifted into the hands of very few people.(fn3) Consequently, Americans now speak of "the one percent," and populist anger over the economy has flared across the political spectrum.(fn4)

Concentration of ownership interests can be observed in both private and public equity markets. For reasons of economic practicality and legal regulation, relatively few people are qualified to participate in private equity markets. At the same time, private equity is increasingly the preferred method of capital formation. The rising importance of private equity markets is epitomized by the emergence of whimsically dubbed "unicorn" firms valued at over one billion dollars without being publicly traded. Private equity markets are discussed in Part III.

Part IV of this Article discusses public equity markets, which are increasingly dominated by institutional investors with billions, and in some cases trillions, of dollars under management. Such sums are unwieldy, and more and more capital is placed in passively managed index funds rather than actively managed. By design, index funds require little human input and therefore minimal staff. As a result, a small number of people controls substantial portions of the public equity markets.

This Article concludes by noting that the governance of U.S. firms is now largely a matter of grace. We must hope that those who manage funds make good decisions about the allocation of capital, the governance of firms, and the preservation of portfolio value on which individuals and institutions rely. We call the people who make such

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decisions "guardians." What this might mean for the vast majority of citizens who are not involved is left to the judgment of the reader.

The basic developments at issue here, and even many of the likely causes, are relatively familiar. The rise of private equity markets, highlighted by the sudden plethora of unicorns, is no secret. Nor is it a secret that public markets are dominated by institutional investors entrusted with the welfare of countless individuals and socially crucial organizations; such investors perforce have assumed the role of guardians in the market. The reasons behind these developments include the increasing inequality of asset ownership in the United States, the shift from defined benefit to defined contribution retirement plans, and the efforts of many institutions to operate as funds. Yet tying such developments together is difficult.

As is often the case, a look backward can help bring the present into focus. Adoph Berle and Gardiner Means's 1932 classic The Modern Corporation and Private Property(fn5) is often remembered for characterizing the institution of the corporation by the separation of ownership (the shareholders) from control (the managers).(fn6) In this view, shareholders are numerous, dispersed, and relatively powerless, while managers are few and powerful. A major function of corporation law, and particularly the structure of fiduciary duties, is to prevent managers from taking advantage of shareholders without unduly compromising the ability of managers to use pooled capital for business

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purposes. Such purposes might include, for example, the construction of factories, the founding of airlines and similarly capital-intensive enterprises, and other projects beyond the capacity of the individuals involved to self-finance.(fn7) As discussed infra, securities law served the same ends, although in different ways.(fn8)

During the twentieth century, corporation and securities laws were seen as supporting the strengths and offsetting the vulnerabilities of corporations as institutions.(fn9) But-and this is often forgotten-Berle and Means were not solely concerned with the institution of the corporation for its own sake. Berle and Means worried that the corporate form was the vehicle through which the few, managers of the predominant firms, would undermine the authority of the many, middle-class shareholders. Corporation law gives managers direct control over the assets and operations of the company. Conversely, individual shareholders have little power of their own and generally are dispersed, so having little capacity to organize. Therefore, Berle and Means argued, managers are free to operate businesses in the interest of management, effectively unopposed by shareholders. The corporation was thus the institutional mechanism through which managers could, unless constrained by law, concentrate wealth and power in their own hands and become oligarchs, "princes of industry."(fn10) Broad-based, middle-class republican capitalism would come to its end.

While Berle and Means were worried about the republican consequences of dispersed capital and concentrated management, in recent years, both capital and management have become concentrated. Private equity markets are, by legal definition, not popular, and in many cases one must even qualify, perhaps as an accredited investor, to participate.(fn11) In a country of over 320 million people,(fn12) there are a large

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number of accredited investors, but demographically, they are a small minority.(fn13) At the same time, public equity markets are increasingly dominated by giant institutional holdings, often across industries. The public markets also do not rely on widespread individual public participation. We no longer see the equity markets as instantiations of the free-enterprise system or the American way. They now seem exclusive and distant from the majority of Americans.

Berle and Means were trying to protect a relatively new and progressive understanding of capital markets and corporate governance. Capitalism in the United States changed character in the first few decades of the twentieth century.(fn14) The late nineteenth century was the era of "robber barons" or "titans"-men like J.P. Morgan or Andrew

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Carnegie.(fn15) "Business" was dramatic and exciting-maybe even dangerous. The middle of the twentieth century, in contrast, was the era of The Man in the Gray Flannel Suit(fn16) and the far blander culture of Dale...