“To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate.”
From the lips of the world’s largest investor, these words have created a shockwave across corporate America. In his 2018 letter to CEOs, entitled “A Sense of Purpose,” BlackRock CEO Larry Fink also observes that “[s]ociety is demanding that companies…serve a social purpose,” and argues that without such purpose, “no company…can achieve its full potential.”
While these sound bites and early media coverage of the letter may suggest that BlackRock suddenly prioritizes social issues over profits, BlackRock’s actual message is less controversial and more nuanced. The focus of the letter is BlackRock’s desire to create a new model for continuous shareholder engagement — in order to facilitate that engagement, Fink calls on companies to develop a clear long-term strategy that articulates a path to financial performance. In Fink’s view, in order for that financial performance to be sustainable in the current environment, companies “must also understand the societal impact of [their] businesses as well as the ways that broad, structural trends – from slow wage growth to rising automation to climate change — affect [their] potential for growth.” To that end, BlackRock places particular emphasis on environmental, social, and governance (ESG) matters because, in Fink’s view, a company’s ability to manage these ESG issues “demonstrates the leadership and good governance that is so essential to sustainable growth.” In other words, BlackRock’s emphasis on “social purpose” is fundamentally linked to creating sustainable long-term financial value.
BlackRock’s 2018 letter builds on the CEO letters issued by Fink in prior years, which have similarly called for a greater focus on long-term value creation, warned against short-termism, and implored companies to consider the economic, social, and political implications of globalization and income inequality. And yet, the tone of the 2018 letter undeniably takes a meaningful step beyond the prior BlackRock letters. While it is unlikely that the 2018 letter will immediately lead to a widespread shift away from the broadly accepted shareholder primacy doctrine that privileges financial returns ahead of other considerations, it nonetheless represents an influential, if incremental, step in legitimizing a more stakeholder-focused approach that encourages considerations of ESG and other matters BlackRock believes will ultimately result in more sustainable long-term value creation.
A few other takeaways from the 2018 BlackRock letter include:
- Shareholder Engagement: Citing its dissatisfaction with the current model of shareholder engagement that has “been too focused on annual meetings and proxy votes,” BlackRock is committed to creating a new model in which “engagement [is]… a year-round conversation about improving long-term value.” Given these statements, public companies that have not developed a program of continuous engagement should consider exploring doing so with experienced corporate governance counsel.
- Long-Term Strategy: To make engagement successful, BlackRock requests that companies “publicly articulate [their] strategic framework for long-term value creation and explicitly affirm that it has been reviewed by [their] board of directors.” BlackRock recognizes that such strategy statements would evolve over time and would be necessarily complex, but believes this disclosure is essential to “understanding a company’s actions and policies, its preparation for potential challenges, and the context of its shorter-term decisions.” Since the 2016 BlackRock letter asked companies to “lay out for shareholders each year a strategic framework for long-term value creation . . . [and to] affirm that their boards have reviewed those plans,” the number of companies disclosing strategic frameworks and the board’s role of strategic oversight in their proxy statements has grown significantly. However, BlackRock’s reiteration of this point in the 2018 letter suggests that there is room for public companies to continue to explore ways to provide more thoughtful disclosure on their strategic frameworks for long-term value creation.
- The Role of the Board: BlackRock places particular emphasis on the role of the company’s board of directors in developing long-term strategy and in remaining involved with overseeing such strategy on an ongoing basis, warning that “[d]irectors whose knowledge is derived only from sporadic meetings are not fulfilling their duty to shareholders.” These comments suggest that in addition to providing disclosure regarding the overall strategic framework, public companies should consider practical ways to demonstrate their directors’ engagement on these issues, including with respect to the number and general tone and topics of board meetings. While this type of voluntary disclosure may provide investors with more insight into the board processes, it will also need to be drafted carefully in order to avoid prematurely or incompletely disclosing sensitive board matters.
- Shareholder Activism: BlackRock believes proxy fights are “wasteful” and that activism has grown because of a failure of companies to be “explicit enough about their long-term strategies.” Fink emphasizes that when activists offer value-creating ideas, companies should begin discussions early and invite BlackRock, other shareholders, and other relevant stakeholders to the table. And when BlackRock is not satisfied with corporate performance, it is not afraid to use its sizable voting power to support activists: according to the New York Times, BlackRock sided with activists in approximately 19% of proxy fights during 2017, including in two of the most high-profile situations (ADP/Pershing Square and P&G/Trian). While every activist situation is different, companies will generally benefit from early and meaningful engagement with BlackRock and other large shareholders and emphasis on executing a previously articulated long-term strategy.
- Boardroom Diversity: In line with its own previous statements, those of other large institutional investors, and the McKinsey & Company report published earlier this month, BlackRock reiterates its view that diverse boardrooms are “less likely to succumb to groupthink or miss new threats to a company’s business model,” and “are better able to identify opportunities to promote long-term growth.” In making these statements, BlackRock joins other large investors and investor-related groups, including Vanguard, State Street and the New York City Comptroller and New York City Pension Funds, in signaling their intent to make boardroom diversity a significant priority. In light of this rapidly growing investor sentiment, public companies that have homogeneous boards should use 2018 as an opportunity to explore board refreshment options.
- The Ascendance of ESG: The 2018 BlackRock letter, together with recent pronouncements from Blackrock, Vanguard, State Street and other large institutional investors on diversity and environmental issues, puts corporate America firmly on notice that ESG issues are no longer relegated to the confines of obscure and unsuccessful Rule 14a-8 shareholder proposals. Instead, environmental, social and governance issues are quickly becoming an important benchmark utilized by institutional investors to evaluate board performance. BlackRock first addressed ESG issues in Fink’s 2016 letter, stating that “[o]ver the long-term, environmental, social and governance (ESG) issues — ranging from climate change to diversity to board effectiveness — have real and quantifiable financial impacts,” but other smaller investors have been calling for more significant ESG disclosure for years. Over the past ten years, the number of public companies providing voluntary ESG disclosure has risen significantly, but the expectations of investors and investor-related groups continue to outpace companies’ disclosures — for example, the activist hedge fund Jana Partners’ recently announced a new social impact fund and the firm also recently collaborated with CalSTRS to pressure Apple on matters relating to mental health impacts of technology overuse. As is always the case with providing voluntary disclosure, companies that are considering providing greater ESG-related disclosure should discuss their plans with counsel knowledgeable on the potential benefits and risks.