Did BlackRock’s CEO Just Declare an End to Business As Usual?

Every year since 2012, Larry Fink writes a letter that starts “Dear CEO.” As the Chairman and CEO of BlackRock, he represents one of the largest shareholders in nearly every publicly traded company in the world – which makes Larry Fink a big deal and his letters a coveted read among Wall Street watchers. This year, Mr. Fink’s letter is causing more of a buzz than usual. Beyond the usual observations promoting long-term value creation, he also made one really bold claim: “The time has come for a new model of shareholder engagement.” If BlackRock and its peers are sincere about ushering in this new model, this letter will be looked back on as the clarion call for a needed reorientation of business as usual.

Fink begins his letter to CEOs by making it clear that he’s not just talking about operating with a clear conscience, he’s talking about good business.

The public expectations of your company have never been greater. Society is demanding that companies, both public and private, serve a social purpose. 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.

And I give credit to Larry Fink for not simply focusing on the acts of corporate citizenship – which can turn into marketing spin – but also drawing attention to the well from which all this good work springs. To make sure readers did not miss the point, he titled his letter “A Sense of Purpose.”

Without a sense of purpose, no company, either public or private, can achieve its full potential. It will ultimately lose the license to operate from key stakeholders. It 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.

Fink has long taken the mantle of Dutch Uncle, nudging his CEO peers to make more prudent use of investor capital. But in this letter, Larry Fink turns this mirror on himself and his peers.

Just as the responsibilities your company faces have grown, so too have the responsibilities of asset managers. We must be active, engaged agents on behalf of the clients invested with BlackRock, who are the true owners of your company. This responsibility goes beyond casting proxy votes at annual meetings – it means investing the time and resources necessary to foster long-term value.

Some of my shareholder advocacy coalition peers will argue that it’s too early to celebrate. It was only back in April 2016 when the talented Gretchen Morgenson penned her NY Times whip-lashing article BlackRock Wields its Big Stick Like a Wet Noodle on CEO Pay. But I believe this moment and this letter really are different. I believe this is different not only because of the clarity Fink has found as he writes on these issues but also because he commits to doubling his staff focused on shareholder advocacy over the next three years.

This letter comes at a time when passive investing strategies continue to dominate new money flows to the benefit of low-cost leaders Vanguard, BlackRock and State Street. Fink’s new model argues that passive investing is not a ticket to lazy shareholder advocacy efforts. In fact, I expect the time will come when asset managers who act as passive shareholders are viewed as breaching their fiduciary duty to care for the best interests of their clients.

Are Your Investments Perpetuating a Glass Ceiling?

Gender equity began as a social justice movement but momentum is picking up as engaged investors articulate the business case for eliminating the glass ceiling. Even as a growing number of investment management firms make gender equity a focus of their shareholder advocacy efforts, most firms continue to support the status quo.

According to a MSCI study, companies with strong female leadership generated a return on equity of 10.1% per year versus 7.4% for those without a critical mass of women at the top.¹ (For a humorous and insightful look at this issue, sociologist Michael Kimmel offers this TED talk to argue, “Why gender equality is good for everyone—men included.”)

Investors engaged on this issue typically use women serving on boards as a proxy for evaluating corporate commitment to gender equity. While board composition is undoubtedly incomplete, it is the best we can do right now. Corporations are not required to publicize data on the composition of their employees and so board composition has become the starting point for those who are looking to make progress in eliminating the glass ceiling.

Several countries, including Germany, France, Belgium, Iceland, and Italy have all created quotas of between 25% and 40%, of women on corporate boards. The United States is still a long way off from that. Almost 25% of all Russell 3000 firms have no women on their boards. The good news is that, in the last year, 96 previously male-only boards on the Russell 3000 added at least one female director. The bad news is that this still leaves an additional 642 firms in the Russell 3000 that continue to operate as an Old Boys’ Club.

Investor advocacy efforts in areas of gender diversity were historically led by socially progressive asset managers like Calvert Investments and Pax World. Now that mainstream investors have started to pay attention to gender diversity in corporate leadership, the largest Wall Street firms are responding. Index fund giant State Street Advisors voted against the reelection of board officers at 400 different companies this year because they had no females on their boards and no efforts to recruit for more diversity. To ensure that no good deed goes unnoticed, State Street installed the “Fearless Girl” statue in the heart of Wall Street to square off with the iconic charging bull.

BlackRock, the world’s largest asset owner, has made board diversity a strategic focus of its shareholder engagement efforts beginning this year. In the second quarter of 2017, they supported 8 of 9 shareholder resolutions focused on board diversity. This action marks a huge shift when compared to 2012 to 2016, when it only supported 2 of 98 such resolutions, according to Bloomberg.

Vanguard, the sleeper among the big three, has needed a bit more prodding to disclose its proxy voting record. Vanguard’s Investment Stewardship 2017 Annual Report cites three engagement stories, but offers no comprehensive statistics that would enable investors to measure the company’s efforts against their peers. Tim Smith of Walden Asset Management recently led a successful effort to encourage Vanguard to increase its transparency, and these investors expect more detailed reporting in future updates.

However, other large money managers like Fidelity, Goldman Sachs, American Funds (Capital Group), and many other smaller asset managers have made no detailed disclosures of their voting records that would help an investor understand their positions on issues like gender diversity, executive compensation, or climate change reporting. When this is the case, investors are left to assume that these asset managers merely support the status quo.

Many of these “quiet managers”—the big three (BlackRock, Vanguard, State Street) have only recently roused from their slumber—are hesitant to begin shareholder advocacy efforts on any issues because they don’t see how doing so helps their business profitability.

Investors can begin to influence corporate behavior by moving assets to investment managers who acknowledge their role in voting for a board of directors that make room for women. As momentum builds, it will become financially unsustainable to remain a “quiet manager.” Alternatively, the do nothing approach will continue to support the status quo.

¹Lee, Linda Eling, et al. Women on Boards: Global Trends in Gender Diversity on Corporate Boards, MSCI, November 2015

Photo by Ben Rosett on Unsplash

What Investors Need to Know About Stock Buybacks

Stock buybacks are deceptively complex. (Perhaps this mystery adds to their allure among CFOs!) Shareholders should be particularly concerned because a recent report suggests that buyback confusion also extends to the board room.

Ever since the SEC loosened its regulation on buybacks, companies have been changing the way they distribute cash to shareholders. By McKinsey’s calculations, share buybacks have increased to about 47 percent of the market’s income since 2011, up from both about 23 percent in the early 1990s and less than 10 percent in the early 1980s.

A recent report¹ sponsored by the IRRC Institute, highlights interviews with 44 directors serving on the boards of 95 publicly traded U.S. companies and their perspectives on stock buybacks. One concerning conclusion from this report is that directors may view share buybacks as a method of covering up the unfavorable aspects of stock options.

The report’s author, Richard Fields, shared that he was struck by how universally accepted the assumption is that equity compensation should be offset by buybacks. For example, one director reported, “I believe you always buy stock back to offset dilution that comes from granting options. You do not want to dilute the current shareholders.”

Wait—hold on. This is terrible reasoning. Buybacks don’t offset the dilution of share value (caused by granting options). Assume with me that ACME Corp. has two shares of stock before awarding its CEO one share of stock as a reward for hitting growth targets. In our overly simplified example, adding an additional share increases the total outstanding shares to 3 and reduces the value of each existing share 33%.

Here’s how buybacks work. Now assume that ACME Corp’s market value is $300 and the corporation uses excess cash to purchase one of the existing shares with the aim of destroying this share and reducing its overall shareholder count. After the repurchase is complete, there are two remaining shareholders and the corporation is worth $200 (after $100 was distributed). In this example, the remaining investors are no better or worse off than before the buyback. They still own one share of stock and each share retains its original $100 value. The purpose of the buyback is to enable ACME to slim down by distributing cash that’s not being put to productive use.

stock option and buyback

Equity compensation is a very effective tool, but it’s naive to believe that buybacks can shelter shareholders from its costs. Another director quoted in the IRRC study shared this: “If we are using hard dollars to offset stock dilution, we should treat those hard dollars as a compensation expense. Otherwise we are not recognizing what we are actually spending to compensate our people.”

Corporations have many good reasons to pursue an equity buyback strategy, but camouflaging executive pay isn’t one of them.

¹Buybacks and the board: Director perspectives on the share repurchase revolution

Senator Mark Warner Sees Market “Renters” and We Need “Owners”

warnerPolitifact found that Sen. Mark Warner’s comment that average stock holding periods have changed from over 8 years in 1960s to 4 months currently is “Mostly True.” After looking at NYSE data, it is a bit more accurate to say that the holding period during the 50s and 60s was closer to 6 years and today’s estimates come in around 6 months.

So what’s the big deal? Senator Mark Warner points out a related trend: Corporations now invest little of their profits back into their company. During the 50’s and 60’s, the reinvestment rate was closer to 50% and now 95% of profits go to dividends and an unhealthy infatuation with stock buybacks that also happen to boost executive bonus payouts.

It’s hard to convince management to focus on the long term when their owners are suffering with a bad case of short-termism. <cough, cough>


Photo by Alex Guillaume on Unsplash

10 Virginia Companies Make Fortune’s 100 Best Companies To Work

High trust culture isn’t just a feel-good perk. Great Places to Work reports that decades of research shows workplaces with high-trust cultures see higher levels of innovation, customer and patient satisfaction, employee engagement, organizational agility, and offer higher shareholder returns to investors. Great Places To Work teamed up with Fortune to recognize superior American companies. Here is the list of Virginia-headquartered companies who made the list:

#12: KPMG
#17: Capital One
#23: PwC
#26: Hilton
#29: Ernst & Young
#47: Navy Federal Credit Union
#50: Mars, Incorporated
#74: Rackspace
#77: Carmax
#88: Accenture

You can see Fortune’s entire list of 100 companies here.

Small and mid-sized Virginia companies (15 – 1000 employees) looking to assess their own employee culture should look to a free service. This “Best Places To Work In Virginia” survey is sponsored by the Virginia Chamber.

All of this analysis around trust is especially important during a time when the 2017 Edleman Trust Barometer reveals that trust is in crisis around the world.