The story of shareholder democracy is really the story of the invention of the limited company — one of the greatest conceptual innovations of all time — and one that also shifted the economic power base in ways it was hard for its early adopters to imagine.  Your losses as a shareholder became limited to the amount you originally invested. You would, of course, not want the company to fail — and would keep a close eye on those hired to run it (the directors). But if it were to fail, as a shareholder your only problem would be the loss of your stake. That its debts might not be paid back in full would be a problem for those who had lent to it (a risk they understood when they made the loan). This might sound like a small change. But it wasn’t. With losses capped, investors could take on more overall risk — investing in more companies and creating economic growth along the way. This changed everything. Without the structure and the organisational capacities of companies, says Financial Times columnist Martin Wolf, ‘the unprecedented economic development seen since the middle of the nineteenth century would have been impossible.’ Who would have put up the money for, say, the then-crazy-sounding ideas of the original railway entrepreneurs, the internet start-ups and companies such as Tesla if they thought they could lose their house in the process? No one. But knowing only the original stake could be lost made it much more attractive. If you are looking for the key invention that created the modern world, the limited liability company might be the one to go for.

Not everyone was enthusiastic  about the limited liability idea. Early observers thought it scandalous that investors might be able to walk away from losses as well as being protected from any negative consequences activities they had facilitated. They also worried the structure would cause conflict between shareholders and company managers: if they were to want different things, who would prevail? Adam Smith in his wonderful book The Wealth of Nations, published in 1790 (and a bestseller at the time) did not seem completely convinced:

The directors of such [joint-stock] companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own … Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.

Smith was right to worry about what became known as ‘managerial capitalism.’ He would, I think, have approved, then, of the shift in the 1970s to what we now know as ‘shareholder capitalism,’ the idea that companies should be run less to humour the whims of their employed managers and more to make money for their shareholders, and the creation of incentive systems to make sure this happened. He may not have been so keen on the latest shift in the dynamics of listed company ownership.

We live today in a world not so much of managerial capitalism, but of money manager capitalism. This is a type of shareholder capitalism in that control over corporates is still wielded by big shareholders. But the shareholders who matter are not the beneficial owners of companies — the world’s investors — but huge institutional fund managers.  Forty years ago not many people owned shares (in the UK about three per cent of the population). But those who did owned them directly (they had share certificates that gave them all the rights shareholders should have). Today, the majority of people in most developed countries own some shares — in the UK, for example, nearly 80 per cent of those employed are auto-enrolled into a pension scheme. However they rarely hold them directly — rather, they are in  a collective fund (often a passive one) managed by a big fund management company. And when I say big, I mean big.

Fund management is an industry increasingly dominated by giants. In the US, the three largest asset management firms, BlackRock, Vanguard and State Street, together manage around $20tn of assets. That’s one-third of all the assets managed worldwide; and 80 per cent of all assets under management in the US. Even 30 years ago, it would have been unusual for any one firm to hold more than one per cent of shares in a big company. Today in the US, one of the Big Three is the top shareholder in 495 of the companies in the S&P 500 — the benchmark index of America’s biggest firms. All in all, they control, on average, a staggering 20 per cent of 495 companies in the index. How is that for an oligopoly? And this pattern is not unique to the US — BlackRock, run by long term chief executive Larry Fink, is now the largest asset manager in the UK. The Big Three held an average of seven per cent of the average FTSE 100 company ten years ago. Today, it’s 12 per cent. BlackRock and Vanguard control over ten per cent of more than two-thirds of the 100 largest listed UK companies. BlackRock is the number one shareholder in 41 of those firms. Vanguard is a top ten shareholder in 98 of them.

Given the general lack of interest when it comes to voting among other shareholders, this situation gives the big fund managers enough clout and voting rights to demand a company does pretty much anything it fancies. This is a huge change from the past. Shareholder capitalism should be, and is in theory, hugely democratic: one share equals one vote. But if the majority of these votes rest with fund managers rather than individuals, that changes. In the days of managerial capitalism, the worry was that one person would have too much control over one company. Today, the issue is similar yet in very different form: a small group of people have close to effective control over pretty much every large listed company in the world.

‘We have a new bunch of emperors,’ said Charlie Munger, the vice chair of Berkshire Hathaway, in the summer of 2022, ‘and they’re the people who vote the shares in the index funds. I think the world of Larry Fink, but I’m not sure I want him to be my emperor.’ Herein lies the problem. If a group of powerful asset management chief executives can ask companies to do whatever it is they want, we must pay attention to what it is that they want. For the last six to seven years they have  been interpreting the phrase environmental, social and governance (ESG) investment — and the rise in interest in it — as mandate to reshape the world as they see fit. to make sure the companies they own parts of — (the vast majority of firms) — take responsibility for the wellbeing of not just their shareholders, but their customers, employees, suppliers, communities, and the environment. This, these top three men tell us, is a win-win. ESG investing makes the world a better place. It also makes investors more money — well run companies with an eye to the future and the welfare of the world do better than others. ‘Good’ companies (as defined by ESG criteria) do better than ‘bad’ ones. Between May 2005 and May 2018, ESG was mentioned in fewer than one per cent of earnings calls according to analysis by asset manager Pimco, reported in the Financial Times. By May 2021 it was mentioned in almost a fifth of earnings calls — and had become one of the main topics in conversations between fund managers and companies. Fink has been ESG’s chief evangelist. He has barely been off stage (any stage) in the last five years, and his annual letter to the companies in which Blackrock invests have made it very clear what he expects from them.

You might think this sounds like a good thing. And it could be. It does however come with a lot of problems. The first is that half of ESG’s promise is based on inadequate data. ESG portfolios did outperform non-ESG portfolios up until the end of 2021. But that turned out to have little to do with ethical actions and everything to do with the fact that most ESG portfolios were heavily weighted to growth stocks. When the growth story collapsed in late 2021 and 2022, so did ESG outperformance.

The second issue is that while ESG looks easy to define, it is actually very difficult. There was a reason we used to use long-term profits to judge companies — it was easy. Judge them using moral or ethical considerations, subjective by definition, and we can only fail. Consider defence — a key area that is beginning to make it clear that ESG as it stands is meaningless. Investing in defence has long been an absolute no-no for full-on ESG funds. It’s also been mainly verboten for most funds with a bit of an ESG overlay (almost all funds). After all, jets and tanks have a significant carbon footprint — and anything designed to frighten and kill is surely impossible to classify as a ‘good’ thing. But think a bit more carefully and it isn’t so simple. If you are only selling goods to so-called nasty dictators it’s hard to see how you could fit under E, S, or G. And investors wouldn’t want to buy shares in such firms anyway, as they would likely worry about governance issues the firm’s client base, meaning the fund manager would never get paid. War is nasty, the weapons that facilitate war are nasty, and buyers of those weapons aren’t always particularly steady clients. But if you supply weapons to the invaded underdog in an unprovoked fight, or to the countries backing said underdog, could we not file your activity under ‘S’, as a social good? As the Latvian deputy prime minister said this year: ‘Is national defence not ethical?’

You can make similar arguments for fossil fuels. Sure, they are a minus environmentally, but what about socially? All progress, and in particular great leaps forward, has been driven by cheap energy. Fossil fuels remain the driver of almost all economic activity globally — and, whether we like it or not, will be for decades to come. Rating them as ‘bad’ and divesting from them (as ESG funds tend to) limits exploration and production, and, it could be argued,  is part of what has got us to where we are today, a place where ordinary people’s living standards are being affected by high energy prices. It is also worth pointing out that Western fund managers not investing in oil companies does not mean less oil is produced or used. It simply means it is produced, and the profits received by different groups ­— and not always ones that give a fig for the environment. Thus, divesting can make things worse, not better. That’s not good socially or for governance. There is also an absurdity inherent in renewable energy investment. For example, ESG considers wind turbines a ‘good’ thing and an ESG fund will happily invest in these — but it might not invest in the producers of rare earth metals vital for energy transition (mining is dirty), and it certainly will not invest in coal mines, yet steelmaking mostly needs coal and turbines need steel. And what of governance in general? Our new emperors are very keen on environmental issues, but there was a point in late March when Russian-listed oil companies had higher ESG scores than some North Sea ones. I can’t be sure which companies were the most environmentally responsible at the time. But one would have thought North Sea firms would have won on the governance part of the equation alone.

Almost all our financial troubles today stem from the great financial crisis in 2008. ESG is no exception. Fund managers know they got off very lightly then (remember they were the shareholders who never asked the hard questions). This has been part of their rehabilitation — or deflection — attempt — depending on how you look at it. The worry is that in their efforts to look good — and take the easy route to doing so — they have sown the seeds of the next crisis. Investing in what is well-meaning rather than in what is useful and productive comes at a long-term price. By raising the cost of capital for fossil fuel firms for example, the big fund management companies have played a part in forcing them to cut back on exploration and production. The resultant supply crunch has contributed to the sharp rise in the price of fuel, and hence to the inflation crisis today engulfing the global economy.

There is good news however. The war in Ukraine has begun to show ESG up as the nonsense that it can be. There is a new awareness that environmental, social and governance issues can be in conflict with each other, that something that is something to everyone is also nothing — and crucially that profits and going concerns do matter. Money is flowing from the usual ESG-approved sectors to the sectors we need to finance (even if we must hold our noses as we do so). Vanguard has said it will now not stop new investments in fossil fuel projects. BlackRock has announced  it is likely to vote against some of the shareholder resolutions brought by climate lobbyists pursuing a ban on new oil and gas production. And at the same time there are hints that power will soon begin to shift from money managers to end owner. Individual investors are looking for ways to grab back some of the power they mistakenly (and unknowingly) delegated to fund managers — and fund managers are increasingly keen to let them do so (it turns out that being emperor isn’t always easy). Vanguard has, for example, said ‘it is committed to working with clients, policy makers, and others to help ensure long-term investor voices are heard,’ while Blackrock is, it says, keen to work ‘with members of Congress and others on ways to help every investor — including individual investors — participate in proxy voting if they choose.’  If things keep moving in this direction there is every chance a more rational form of ESG will emerge alongside a new form of shareholder democracy — something I suspect Adam Smith would very much have approved of.