26 January 2018 by Jimmy Nicholls
BlackRock’s chief demands that directors and investors engage for the long-term or face trouble
What is the business of business? To some the answer is obvious, but the decade since the financial crash has revived complaints that the economist Milton Friedman’s dictum of the business of business being business is not good enough.
The bailout of jeopardised banks in the wake of the crash, burgeoning executive salaries and the rising prominence of flexible work in the gig economy have all prompted protests from those that believe that businesses are evading their duties to society.
Intuition might not expect the chief executive of the world’s largest investment firm to side with the complainants. But in contacting the world’s largest public companies, Laurence Fink, chief executive of BlackRock, has done just that.
In a publicly-released letter, Fink warned that companies focused on short-term growth without thought for social impact will flounder.
‘To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society,’ he said. ‘Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate.’
The message of the letter is that a new model for governance, and particularly shareholder engagement, is needed. Fink wants directors to have a broader grasp of long-term strategy – which he claims is better for society – and he wants investors to engage outside of the regular pattern of annual general meetings.
“UK companies will rightly be sceptical of governance advice from someone with the job title chairman and chief executive officer”
‘BlackRock’s focus on the societal impact of companies in which they invest is key and the contribution of companies to the societies in which they operate remains critical to the rebuilding of public trust in business and to their continued licence to operate,’ said Peter Swabey, policy and research director at ICSA.
‘However, UK companies will rightly be sceptical of governance advice from someone with the job title chairman and chief executive officer, just as some were sceptical of the views on remuneration of someone reportedly paid $25 million in 2016. What Fink says in his letter is absolutely correct; the question is the degree to which BlackRock will practise what it preaches.’
The BlackRock chief is certainly not the first to wonder whether companies should care more about others beyond their investors.
Last year the Institute for Public Policy Research (IPPR) published its Corporate Governance Report, arguing that the British focus on shareholders was harming savers, companies and staff, as well as contributing to poor productivity and wage inequality.
Anger over investors’ fixation with short-term returns is a staple of business talk, with some companies opting not to issue public shares or creating multiple share classes precisely so they can focus on long-term growth.
As Fink put it, companies without a wider purpose ‘will succumb to short-term pressures to distribute earnings, and, in the process, sacrifice investments in employee development, innovation, and capital expenditures that are necessary for long-term growth.’
He added firms ‘will remain exposed to activist campaigns that articulate a clearer goal, even if that goal serves only the shortest and narrowest of objectives.’
Fink’s solution is that company’s publicly state their long-term strategy and confirm it has been reviewed by the board. He also wants directors to be able to ‘describe the board process’ for overseeing the company’s strategy.
‘Of course, we recognise that the market is far more comfortable with 10Qs [quarterly reports] and coloured proxy cards than complex strategy discussions,’ he wrote. ‘But a central reason for the rise of activism – and wasteful proxy fights – is that companies have not been explicit enough about their long-term strategies.’
George Dallas, policy director at the International Corporate Governance Network, said: ‘It is important for shareholders and company directors to recognise that long-term success requires both that companies pay attention to shareholder needs for sustainable returns, and that they address the needs of key stakeholders, such as employees, customers, communities, and the environment more generally.
‘In many ways this is not dissimilar to the current emphasis of the UK government and UK Corporate Governance Code consultation on the importance of stakeholder relations.’
“There is far too much evidence that many investors – and BlackRock have been cited as one – simply do not respond to company requests for engagement”
As part of BlackRock’s commitment to investment stewardship, Barbara Novick, vice chairman and co-founder of the firm, will now oversee the company’s approach to it, with the relevant team looking to double in size in the next three years. ICSA’s Swabey said that the latter move ‘is much to be applauded’ adding that ‘it would be great’ if other investment houses did likewise.
‘However, the proof of the pudding will be in how effective this increase is – will BlackRock be available when companies want to discuss issues with them?’ he said. ‘There is far too much evidence that many investors – and BlackRock have been cited as one – simply do not respond to company requests for engagement.
‘That is one thing when they have no issues and investors are supportive of the efforts of management, but all too often companies see votes against management resolutions from investors who have continually rebuffed attempts to engage.’
Others are more sceptical of the letter. Jamie Whyte, research director at the Institute of Economic Affairs, said: ‘Fink’s letter contains many familiar ideas – that the business world suffers from short-termism, that companies must not only profit their owners but make “a positive contributions to society”, and that boards perform better if they are diverse in gender and race.
‘He offers no evidence for these claims, and would find it difficult to do so. For example, the evidence that diversity enhances performance is weak to non-existent.
And the accusation of short-termism is difficult to sustain in the face of firms such as Amazon, most of whose market value is derived from expectations about its earnings many years from now.’
It might also be the case that Fink’s motives are more self-serving than they appear – a charge Friedman made around the time he came up with his dictum on business. As he wrote in a piece for The New York Times Magazine in 1970, ‘the doctrine of social responsibility is frequently a cloak for actions that are justified on other grounds rather than a reason for those actions’.
‘To illustrate, it may well be in the long run interest of a corporation that is a major employer in a small community to devote resources to providing amenities to that community or to improving its government,’ he said.
‘That may make it easier to attract desirable employees, it may reduce the wage bill or lessen losses from pilferage and sabotage or have other worthwhile effects.’
Such actions can be rationalised on grounds of ‘social responsibility’, he said. Citing the climate of opinion at the time ‘with its widespread aversion to “capitalism”, “profits”, the “soulless corporation”’ he noted that such tactics are ‘one way for a corporation to generate goodwill as a by-product of expenditures that are entirely justified in its own self-interest.’