The BlackRock Conspiracy [AUDIO SCRIPT]

This is a work in progress for my latest YouTube essay.

Intro - you might have seen this

There is a new viral conspiracy theory trend on social media where people claim all major corporations and even entire industries are owned by the same group of people.

The conspiracy that few individuals run the world is as old as time but this one is openly naming the culprits - BlackRock.

So according to the theory, BlackRock owns almost all of the biggest corporations around the world. They own the big tech, big pharma, big everything AND the mainstream media. This insinuates their hidden influence and secret agenda they supposedly enforce on the corporate world.

But like with most conspiracy theories on social media, this one is easy to dismiss. BlackRock is is indeed among the largest shareholders in the biggest corporations across all sectors of the economy. This isn't hidden information. Anyone can pull this up from publicly available sources.

But the catch is that BlackRock doesn't legally own anything. The $10,000,000,000 in assets they have are under management on behalf of their clients. The real owners are the people. Not just in the sense of "corporations are people, my friend". BlackRock's clients are pension funds, institutions, or retail investors... anyone who has decided to invest into stock market through BlackRock is legally and technically the owner of the equity managed by BlackRock. If BlackRock was to go bankrupt, assets would be liquidated and paid out to clients.

But... Is that really all there is to this story? My natural curiosity made me want to check what academic research had to say about this. And what I've found has actually blown me away.

As it turns out, the issue of BlackRock's power and influence has been well studied and analyzed by economists for years. It isn't just about raw numbers on the ownership list of big corporations.

Economists found that many major problems that plague our economy today can be directly attributed to the concentration of economic power by BlackRock and the like. Stagnation in innovation, rise of consumer prices, decreasing wealth of the working class, even income inequality.

I am strong proponent of the notion that there is no need to believe in conspiracy theories. Rational explanation is bad enough. So please join me on this ride. We are about to descend to hell and we only bought a one way ticket.

How big are they?

While BlackRock is a focal point of the conspiracy theories, economists actually include two other similar firms in the same pile - Vanguard and State Street. Researchers call them the Big Three. All three companies are passive investment funds that grew from insignificant in the equity market just in the middle of the 1990s, to essentially becoming the equity market by 2010s. The Big Three together hold a frighteningly monumental position in the corporate world.

Today, BlackRock, Vanguard and State Street control more than 80% of all assets managed by index funds. Their average combined stake in S&P 500 companies more than quadrupled since 1998. If that doesn't sound consequential, The Big Three constitute the largest shareholder in 88% of the S&P 500 firms. The combined value of all assets managed by the Big Three sits at around $20 trillion, more than any other shareholder anywhere in the world.

To get a better perspective of their powerful stake, look at this list of the top 15 global blockholders of corporate ownership from 2016.

BlackRock and Vanguard have by far the highest number of 3% as well as 5% blockholdings, with State Street not too far behind. Blockholders of 5% are considered highly influential. Blockholders of 10% are considered insiders according to the U.S. law. No other shareholder has stronger position than neither BlackRock, nor Vanguard. To illustrate this even further, there were about 3,900 publicly listed corporations in the U.S. in 2016. BlackRock had more than two thousand 5% blockholdings in the U.S., more than half of all listed US corporations.

Who are they and where did they come from?

There is absolutely no denying that these investment companies that very few have heard of before suddenly came to be the most influential shareholders on the planet. But they didn't spawn out of nowhere and they haven't always been this prominent. Economic researchers have been studying their sudden surge for years and this is what they found.

The Big Three are a relatively new financial innovation that started with the creation of Vanguard in the 1970s. In that time, investing was often costly and quite risky. Most asset managers were rather active, seeking to game the market by carefully picking winners and weeding out losers. This in turn meant higher costs for asset managers due to more extensive and resource consuming research that investors needed to do to pick the right stocks. The asset managers would offset these costs on their clients in the form of portfolio fees.

But then Vanguard came in with a competitive idea. Rather than spending time and resources to find the most winning stonks, Vanguard's investment strategy would be passive. They would invest into index-based products with industry-wide reach. They weren't looking for the best horse in the race and they weren't looking to crush the competition. They were looking to build a diversified portfolio of assets with guaranteed returns as cheaply as possible.

With this passive investment strategy, Vanguard didn't have to spend resources on extensive research into specific companies or invest into managerial stewardship to improve performance of individual firms in their portfolio. This allowed them to lower the fees far below what actively managed funds would charge.

At first, Vanguard was shunned and ridiculed. For one thing, their strategy was considered unamerican, because it would invest into winners and losers equitably, rather than chasing short-term profit by pushing the winners to crush their competition.

But Vanguard's low fees were undeniably attractive. And soon their strategy proved more effective. While active investors would rarely outperform the market, passively managed Vanguard guaranteed stable returns at the lowest fees in the industry.

In the following decades, the United States oversaw some dramatic pension reforms that encouraged companies and retirement savers to flock their pension funds into the cheapest asset portfolios with the most guaranteed returns.

Along came the Modern Portfolio Theory that successfully argued for diversification. By broadening their portfolio, an investor would get more diversification, which would increase returns, lower the risk, and spread the cost of research the larger the portfolio. MPT was the theoretical approval passive investment funds like Vanguard needed to win over the financial crowd.

And just like that Vanguard turned passive mutual funds from a ridiculed concept into a synonym for good financial advice.

How can they control things?

And now the Big Three manage $20 trillion in assets worldwide. With that kind of power, what are their mechanisms of control?

Shareholders that own voting shares have the right to participate in regular shareholder meetings where they can vote on proposals that direct corporate decisions or elect members of a company's management.

Despite not technically owning anything, it is the Big Three that votes on behalf of their clients at their portfolio companies. Clients are still the owners, they just don't vote. All of the voting power of the Big Three's stock holdings is thus concentrated within the central command of the investment firms.

This is where things get interesting. On average, the combined stake in S&P 500 companies managed by the Big Three is above 20%. Which already makes them the largest single blockholder. But their voting power is even greater than that. That's because not all shareholders who can vote generally do so, but the Big Three do. Their 20% shareholder stake can thus represent about 25% of voting power. Research predicts that the Big Three's voting stake will rise to 34% within the next decade and it will rise to 41% within the next two decades.

These aren't exactly controlling stakes. But they still translate to significant influence. A research by the Cambridge University found that the Big Three do coordinate their voting strategy and generally act as a block that can sway the support for or against proposals and management elections. An analysis of the Big Three's proxy voting found remarkably high rates of internal agreement. Compared to their actively managed counterparts, the passive asset managers overwhelmingly vote as a single consistent unit.

Another mechanism of influence is direct engagement. Phone calls, texts or meetings with corporate representatives outside of the shareholder meetings. The management cannot go against what the shareholders officially voted on, but it is in their interest to be on good terms with their investors. And the larger investors realize this potential. Up to 63% of large institutional shareholders have directly discussed corporate decisions with management and up to 45% of them have had private conversations with a company's board outside of the management. This is the case for institutional investors broadly and not just the Big Three. But given the Big Three is often the largest shareholder, they are most likely to have the ear of the management at most companies they invest in.

The third method of investor influence is pulling out. The same principle applies - the larger the shareholder, the more severe the impact on the share price. If the Big Three collectively decide to sell their shares at a company, it could have detrimental consequences to the firm. According to a 2015 survey, about half of institutional investors consider exit as a viable strategy when dissatisfied with a company's performance.

Do they actually exercise control?

During an annual shareholder meeting at Exxon Mobile, an activist shareholder successfully pushed the oil giant to adopt a policy to reduce their carbon footprint. This event instantly made big headlines. Mainly due to the fact that the vote wouldn't have gone through without the unanimous support of the Big Three who had sided with the activist and voted against Exxon's leadership.

The reaction to this news was ecstatic. Everyone involved took the opportunity to argue how big institutional investors exercise their power to push companies to do their bidding. BlackRock, Vanguard and State Street signed on to a promise to agitate their portfolio companies toward reaching net zero greenhouse gas emissions by 2050. A noble goal indeed. BlackRock was praised for supporting up to 47% of social or environmental proposals. Which is a weird way of saying they still rejected most of them.

But then all the enthusiasm quickly died down when BlackRock announced they will vote for fewer climate proposals because they don't want to micromanage companies or challenge their business models.

Several groups analyzed the Big Three's voting record and they all found an overwhelming rejection of climate proposals, with support for them no greater than 27% and as low as 10%.

For a long time, economists thought that higher concentration of asset ownership among fewer individuals would result in more coordination and active monitoring. In other words, the fewer owners and the larger their positions, the more influential they'd want to be. But the reality seemed to be the opposite.

The Big Three was found to consistently vote along with the recommendations of managers at their portfolio companies. In fact, the management could count on their support 90% of the time. This is not true just for the passive mutual funds. It applies to all asset managers in general.

What this signals though is a large disinterest of passive asset managers in corporate governance issues. When management recommends to vote against activist shareholders, the Big Three aligns with the managers up to 98% of the time. This means that the main power of the Big Three's alliance with management is within the ability to repel activist investors. Research shows that a large majority or a plurality of proposals rejected by the Big Three are related to environmental, social and governance issues.

The only area where the Big Three are in opposition to the management is when electing the board of directors. The split is 50-50, which suggests BlackRock, Vanguard and State Street use their power mainly to appoint company leadership. Leadership which they will then happily align themselves with.

These realities led economists to conclude that the Big Three lack incentives to intervene in managerial affairs. The index fund giants have been found to massively under-invest in company stewardship, while excessively deferring to the managers for corporate decisions.

BlackRock's and Vanguard's stewardship personnel and expenses are minuscule compared to the size of their portfolios. Even though they publicly stress the importance of good stewardship, their budgets are almost zero relative to the revenue from fees.

Economists provide an explanation for this lack of interest with a zero-sum game theory. If BlackRock wanted to increase performance of a particular company, they would have to increase their stewardship investment - find personnel, expertise, pay for the training. This would increase their total portfolio costs. Costs that would solely be born by BlackRock. If the stewarded company were to improve though, the benefits would be enjoyed by everyone in the equity market, including BlackRock's competitors.

BlackRock, Vanguard and State Street are so called horizontal shareholders. Their broad portfolio dragnets created hundreds if not thousands of parallel ownership positions. The firms the Big Three invest in are supposed to be in competition with one another.

While an active asset manager might want to own shares of Pepsi, but not Coca-Cola, the Big Three would hold significant positions at both of them. The active manager might want Pepsi to undercut Coca-Cola on price, but the Big Three would benefit most if they both avoided price wars. Encouraging one company to undercut the other could introduce a conflict of interests that could hurt the Big Three's bottom line. As asset managers, they act as investors in portfolio companies, but they are often their clients too. Companies often entrust the Big Three firms to manage their employee pension funds for them. So the main interest for the Big Three is to seek long-term performance of the whole index, rather than a short-term win of one competitor over another.

Consequences

While it may seem that all economists think that the Big Three keep their hands off of the corporate world, they actually point to several severe consequences such re-concentration of wealth management poses.

Because the Big Three doesn't benefit from improving performance, increasing competition, or contributing to social and environmental governance, economists have started to notice significant anticompetitive consequences that hurt consumers, workers and low-income earners. These theories sparked a little academic war but the results eventually came clear.

A study in 2014 found that airline tickets were 3% to 7% more expensive at companies with high rates of common ownership from big index funds. A similar study in 2018 found the same effect with drug companies. This academic backlash prompted BlackRock to fund a study to disprove these claims. But upon next revision of the economic literature, new research solidified the theory that increased horizontal shareholding proportionally increases consumer prices. None of these effects require communication or coordination of pricing strategies between companies or investors. They simply exist as a result of managers seeking to maximize their odds of re-election by big horizontal shareholders. The effect of shareholder voting alone is enough to lessen the incentives for corporate managers to compete.

Researchers also found horizontal shareholding has the same affect on the large gap between corporate investment and profits. Rather than re-investing profits back into the firm, which could create more jobs or increase workers' pay, horizontal shareholders would rather vote for higher compensation to managers and executives. Higher executive pays would be rewarded irrespective of their firm's performance. This gap was found to be driven by high levels of horizontal shareholding within any industry across the economy.

The widening investment-profit gap also coincides with the growth in corporate profits and decline in labor's share of national income. According to some economists, the sharp increase in horizontal shareholding in recent decades is responsible for the increase in income inequality. First reason for the income inequality correlation, is that high corporate profits are more likely to go to disproportionately wealthy shareholders, while higher prices are disproportionately borne by the non-wealthy. The second reason is that low corporate investment depresses wages and employment which disproportionately harms low-income earners. The third reason, is that the rate of increase in consumer prices has been found to be higher in products targeting lower-income households.

The Big Three may also command what economists refer to as structural power. Structural power seems to be an academic lingo for what the common folk may recognize better as 'too big to fail'. It's when a business holds such a prominent position that growth of the whole economy depends on it. The Big Three have risen to be such important financial institutions, that the whole system depends on them to function properly. This level of influence makes firms proactively internalize the Big Three objectives to earn their blessing for the next corporate elections. This structural power is hidden from direct view, but can materialize in the aforementioned anticompetitive consequences - higher consumer prices, disinterest of managers to compete, lower rates of profit reinvestment.

Many prominent figures in finance and academia have begun sounding alarms on the power and influence the Big Three suddenly claimed for themselves. Even Vanguard's founder, shortly before his death, wrote for the Wall Street Journal a dire warning about the power of index funds. He worried that too many shares may be in too few hands and could one day control the whole U.S. stock market. Michael Burry of The Big Short called index funds a bubble, and the global co-head of Goldman Sachs called it a "bubble machine".

The worrying consensus among economists seems to be that the Big Three are pivoting the economy from one that used to be driven by fierce competition and market forces, to one that is more stagnant, more unequal and less responsive.

It's always difficult to predict the economy. But these are the real concerns with concentration of economic power and it doesn't require one to believe in a conspiracy theory.

This is how the Big Three own nothing, yet control everything. There is no grand conspiracy. No secret agenda. Just every snowflake doing what it knows best, slowly piling up into a giant snowball. Maybe it will turn out to be a beautiful snowman.

I know what some of you will type in the comments. But let me be clear - all I want is to get a giant sponsorship from Bill Gates so that I can make a documentary about how effective altruism is a fascist ideology with mathematics as its branding. Patreon.com/thehatedone!