The Quiet Consolidation

Quietly and with little fanfare, the ownership of hundreds of public companies in the United States has moved from being dispersed among many players to being concentrated in the hands of a just a few.

But it's not big banks that are dominating corporate ownership, as in the past. Instead it's mutual funds that hold almost 30 percent of U.S. corporate ownership today, compared with 8 percent in 1990, according to research by Stephen M. Ross School of Business Professor Gerald Davis. Fidelity, Vanguard, and American Funds each have more than $1 trillion in assets.

These mutual funds, the Fidelity family of funds in particular, don't wield their power as past large holders have, nor are they necessarily long-term investors in a particular company. And they don't rock the boat by challenging management or putting a slate of directors up for election to corporate boards.

This makes the new structure unique in U.S. history, according to Davis' new paper, A New Finance Capitalism? Mutual Funds and Ownership Re-Concentration in the United States. That's partly because the new finance capitalism didn't develop by some grand plan from oligarchs, but by a trend in U.S. pension reform.

Many employers have shifted from defined benefit plans, such as traditional pensions, to defined contribution plans, such as 401(k)s. That has put more U.S. households and more money into the capital markets by way of mutual funds.

It's supposed to be the distinctive characteristic of the American system of corporate governance that ownership is highly dispersed, with no single owner holding a controlling position, Davis says. In fact, economists value this as a positive feature of the system because it makes decision-making less prone to 'cronyism.' So it's ironic that as scholars were arguing for the superiority of dispersed ownership, the U.S. was seeing ownership becoming much more concentrated. It was quite surprising for me to find that Fidelity is the largest shareholder in about one in 10 public companies. Who knew?

In some ways, the new concentrated ownership harks back to the early 1900s, when three large banks -- JPMorgan, National City Bank of New York (now known as Citigroup), and First National -- formed a powerful money trust that owned shares and debt of most important industrial companies. These banks also placed many of their partners on several corporate boards, giving them wide control of the U.S. economy.

But Fidelity and the other mutual funds do not act like JPMorgan of the early 1900s, Davis says. For one, the mutual funds buy their ownership stakes on the open market through arms-length procedures. They also do not have any obvious influence over a company's financing decisions, as they don't have control over access to debt. The funds also do not nominate directors, with a few rare exceptions.

And despite the fact that big mutual funds hold 10 percent ownership positions in some companies -- which normally indicates a long-term investment -- the funds move their money from company to company with surprising frequency.

I used to imagine that if you were a 10 percent owner, you were in it for the long haul, Davis says. To a remarkable degree, it's amazing that they're as agile as they are.

One unique quirk is a correlation between how often a mutual fund votes with management on shareholder issues and the amount of pension management business a fund's parent does with that company. This is particularly true in the case of Fidelity, according to earlier research by Davis and fellow Ross professor E. Han Kim. Though Fidelity has more than 300 separate, independently managed funds, shares held by Fidelity funds are voted as a bloc according to a firm-wide policy.

It's not that Fidelity votes with management at its clients and against management in non-clients, Davis says. It's that they have a centralized voting procedure so that all of their funds vote the same way, and it follows a very strict set of rules that are very management friendly.

Davis says it's too soon to tell what kind of effect the current financial crisis will have on the phenomenon. But it's unlikely that the crisis will change the ownership structure.

Unless people start a giant, full-scale withdrawal from their 401(k) plans, then that money is probably going to be in mutual funds and mutual funds are going to invest it in stocks, he says.

The recent financial crisis is helping to perpetuate another type of concentration. Banks are using the $700 billion Treasury bailout fund approved in early October to consolidate. Davis says there has been a long-standing fear in the U.S. of concentrated economic power. It goes back to Andrew Jackson's 1832 veto of the Second Bank of the United States and the breakup of the money trusts in the early 1900s.

Now we have three banks, Citigroup, JPMorgan Chase, and Bank of America, that are far bigger in relative and absolute terms than banks ever have been in American history, Davis says. We're going to end up with three banks that control much of American finance and probably three mutual funds with concentrated corporate ownership. It's weird that you don't see a lot of commentary on the extent to which this has been happening.

Eventually, Davis says to expect some sort of re-examination of the huge corporate ownership by mutual funds and the size of U.S. banks. At least, that's what history suggests.

There seems to be a recurring motif in American history that whenever power gets concentrated in financial institutions, there's political backlash that takes it down a peg.