Major index fund operators have been criticized as ineffective stewards of the firms in which they are now the largest shareholders. While scholars debate whether this passivity is a serious problem, index funds’ generally docile approach to ownership is broadly acknowledged. However, this Article argues that the notion that index funds are passive owners overlooks an important dimension in which index funds have demonstrated outspoken, confrontational, and effective stewardship. Specifically, we document that index funds have taken a leading role in challenging management and voting against directors in order to advance board diversity and corporate sustainability. We show that index funds have engaged in a pattern of competitive escalation in their policies on environmental, social, and governance (“ESG”) issues. Index funds’ confrontational and competitive activism on ESG issues is hard to square with their passive approach to more conventional corporate governance questions. To explain this dichotomy in approaches, we argue that index funds are locked in a fierce contest to win the soon-to-accumulate assets of the millennial generation, who place a significant premium on social issues in their economic lives. With fee competition exhausted and returns irrelevant for index investors, signaling a commitment to social issues is one of the few dimensions on which index funds can differentiate themselves and avoid commoditization. For index funds, the threat of millennial migration to another fund is more significant than the threat of management retaliation. Furthermore, managers themselves, we argue, face intense pressure from their millennial employees and customers to respond to their social preferences. This three-dimensional millennial effect—as investors, customers, and employees—we argue, is an important development with the potential to provide a counterweight to the wealth-maximization paradigm of corporate governance. We marshal evidence for this new dynamic, situate it within the existing literature, and consider the implications for the debate over index funds as shareholders and corporate law generally.

This Article shows that a variety of fundamental rules of corporate law are based on myth. The Article explains that the myths on which corporate law is based play an important role in attracting public acceptance and support for what otherwise would likely be unpopular and controversial regulations. Thus, one can view the role played by myth in corporate law in a particular context as having either positive or negative characteristics depending on one’s opinion of the social value of the underlying legal rule that is being buttressed and affirmed by the myth.

Four political and sociological myths that continue to play important roles in law are examined. These are: (1) the myth that corporations are owned by their shareholders and represent ownership interests in businesses rather than mere financial claims on the cash flows of those businesses, coupled with certain political (voting) rights that protect those claims; (2) the “shareholder value myth,” that corporate officers and directors are legally required to maximize firm value; (3) that subsidiary companies are entirely independent from and not subject to the control of their parent companies and must remain so in order for the parent company to avoid liability for the contract and tort debts of the subsidiary under various alter ego and piercing the corporate veil theories of corporate law; and (4) the legal regulation of insider trading is justified because of the necessity of creating a “level playing field” among participants in financial markets. Reasonable people can disagree about whether the role played by these myths is normatively positive or negative in each of these contexts.

Big investment managers, such as Vanguard and Fidelity, have accumulated an astonishing amount of common stock in America’s public companies—so much that they now have enough corporate votes to control entire industries. What, then, will these big managers do with their potential power?
This Article argues that they will do less than we might think. And the reason is paradoxical: the biggest managers are too big to be activists. Their great size creates intense internal conflicts of interest that make aggressive activism extremely difficult or even impossible.
The largest managers operate hundreds of different investment funds, including mutual funds, hedge funds, and other vehicles that all invest in the same companies at the same times. This structure inhibits activism, because it turns activism into a source of internal conflict. Activism by one of a manager’s funds can damage the interests of the manager’s other funds. If a BlackRock hedge fund invests in a company’s equity, for instance, at the same time a BlackRock mutual fund invests in the company’s debt, then any attempt by either fund to turn the company in its favor will harm the interests of the other fund. The hedge fund and mutual fund might similarly come into conflict over the political and branding risks of activism and the allocation of costs and profits. Federal securities regulation and poison pills can create even more conflicts, often turning activism by a hedge fund into serious legal problems for its manager’s entirely passive mutual funds. A big manager, in other words, is like a lawyer with many clients: its advocacy for one client can harm the interests of another.
The debate about horizontal shareholding and index fund activism has ignored this truth. Research on horizontal ownership tends to treat a manager and its funds as though they were a single unit with no differences among them. Traditional analyses of institutional shareholder activism tend to go the opposite direction, treating mutual funds as though they were totally independent with no connection to other funds under the same management.
By introducing a subtler understanding of big managers’ structures, I can make sense of shareholder activism more clearly. Among other things, I show why aggressive activism tends to come entirely from small managers—that is, from the managers whose potential for activism is actually the weakest.

In a 2017 Virginia Law Review article, The Untenable Case for Perpetual Dual-Class Stock, Professors Lucian Bebchuk and Kobi Kastiel argued that time-based sunset provisions (the forced unification of shares into one share structure with equal voting rights after a certain period of time) should be a mandatory feature of dual class share structures (classes of common stock with unequal voting rights). This article has recently been used as authority by the Council of Institutional Investors (“CII”) to petition to the NASDAQ Stock Market (“NASDAQ”) and the New York Stock Exchange (“NYSE”) to amend their listing standards. The requested amendments would require companies seeking to go public with dual class shares to include in their certificates of incorporation a time-based sunset provision that would go into effect no more than seven years after the initial public offering (“IPO”) unless minority shareholders vote to extend it up to an additional seven years. This delayed unification based on a shareholder vote is incorporated in Bebchuk and Kastiel’s argument. 

This Article, which is based on comment letters I sent in response to the CII’s petitions, argues that such a mandatory provision would be extremely unwise and harmful to our most important public companies and their shareholders, current as well as future. As a creation of private ordering, the absence of time-based sunset provisions in dual class share structures serves a significant value enhancing purpose. It prevents the risk that a premature and therefore sub-optimal unification of shares may occur. This risk has so far been ignored by those advocating for the implementation of a mandatory time-based sunset provision. As subsequently discussed, this risk has been ignored because their analysis lacks an appreciation for how the positive skewness in stock market returns negatively impacts the value of mandatory time-based sunset provisions.

In 2005, the perception that wealthy executives were being rewarded for failure led Congress to ban Chapter 11 firms from paying retention bonuses to senior managers. Under the new law, debtors could still pay bonuses to executives—but only “incentive” bonuses triggered by accomplishing challenging performance goals that go beyond merely remaining employed. This Article uses newly collected data to examine how this reform changed bankruptcy practice. While relatively fewer firms use court-approved bonus plans after the reform, the overall level of executive compensation appears to be similar, perhaps because the new regime left large gaps that make it easy for firms to bypass the 2005 law and pay managers without the judge’s permission. This Article argues that the new law was undermined by institutional weaknesses in Chapter 11, as bankruptcy judges are poorly situated to analyze bonus plans and creditors have limited incentives to police executive compensation themselves.