New Issue Brief: Index Funds Have Too Much Voting Power

The excessive influence of ESG in investing calls for legislative reform

New York, NY – Earlier this week, Exxon Mobil filed a lawsuit against two sustainable investment firms that had sponsored a shareholder proposal pushing the company to focus more on sustainability goals. This lawsuit is the latest in a broad pushback against environmental and social activism in financial markets, a movement analyzed in a new Manhattan Institute issue brief by senior fellow and director of legal policy James Copland.

Copland assesses the rise of two trends increasingly reshaping American investing: passive index investing by institutional investment firms such as Vanguard, BlackRock, and State Street, and the environmental, social, and governance (ESG) investing led by those same firms. After establishing the costs of ESG activism to individual investors and the public at large, Copland explores options for curbing the undue influence that institutional investment firms wield by way of their passively managed index funds.

Copland points to passive investing’s promise of broadly diversified stock market returns at a low investing cost as the central reason for its rise, while characterizing ESG as a new development in the “socially responsible investing” tradition. He argues that incorporating the latter into the former is in tension with passive funds’ rationale and risks an anti-democratic end-run – substituting the policy views of an increasingly concentrated cohort of institutional investment executives for the judgment of elected officials.

Copland analyzes two proposed legislative fixes to the problem, the 2022 INDEX Act and a draft bill circulated in the 2023 House Financial Services Committee. He argues that although the bills appear sensible on the surface, neither adequately resolves the concerns animating the pushback against ESG in passive index investing. The issue brief concludes with an alternative idea for reform: remove passive index funds’ shares from shareholder voting calculations altogether. The brief includes model legislation to that effect.

Read the full issue brief here.