by Cydney Posner
This year, in his annual letter to corporate CEOs, Laurence D. Fink, CEO of asset manager BlackRock, challenges companies to address the impact of significant political, economic, societal and technological changes on their current strategies for long-term value creation: “As BlackRock engages with your company this year, we will be looking to see how your strategic framework reflects and recognizes the impact of the past year’s changes in the global environment. How have these changes impacted your strategy and how do you plan to pivot, if necessary, in light of the new world in which you are operating?”
What are these changes? To Fink, dramatic changes — such as Brexit, global upheaval and the new administration in the U.S. — could affect assumptions underlying many companies’ long-term strategic plans, such as plans for continued international expansion. At “the root of many of these changes,” he contends, is the “growing backlash against the impact globalization and technological change are having on many workers and communities.” Although he continues to believe that, on balance, globalization provides benefits, “there is little doubt that globalization’s benefits have been shared unequally, disproportionately benefitting more highly skilled workers, especially those in urban areas.” In addition, technology, while creating new jobs for highly skilled employees, is eliminating millions of jobs for other workers, many of whom face “retirement with inadequate savings, in part because the burden for retirement savings increasingly has shifted from employers to employees.” The political and economic consequences of these dynamics, he asserts, “impact virtually every global company.”
But what is the responsibility of companies in this context? It’s particularly interesting to view this year’s letter through the prism of the debate about the purpose of corporations — whether the “social responsibility of business is to increase its profits,” as suggested by the “shareholder preeminence theory,” or whether corporations have a broader spectrum of interests that includes employees, community and society at large. (See this Cooley News Brief.) Notwithstanding BlackRock’s status as a major long-term shareholder, or perhaps because of it, Fink’s letter suggests that he views the corporation in a larger context with obligations, albeit perhaps not of the fiduciary variety, to a broader group of constituencies.
For example, larger companies, Fink urges, must “fulfill their responsibilities to their employees” by improving internal training and education so that employees can leap over the “skills gap” and increase their earnings potential, “helping the employee who once operated a machine learn to program it.” In addition, he encourages companies to addressing the “retirement crisis”: “companies must lend their voice to developing a more secure retirement system for all workers, including the millions of workers at smaller companies who are not covered by employer-provided plans” and assist employees in building their financial literacy and learning how to prepare for retirement.
SideBar: See this article in the NYT, which discusses efforts by employers, faced “with a skills gap” in the local workforce, to “increasingly [work] with community colleges to provide students with both the academic education needed to succeed in today’s work force and the specific hands-on skills to get a job in their companies.” A study by Ball State University cited in the article found that “nearly nine in 10 jobs that disappeared since 2000 were lost to automation in the decades-long march to an information-driven economy, not to workers in other countries. Even if those jobs returned, a high school diploma is simply no longer good enough to fill them. Yet rarely discussed in the political debate over lost jobs are the academic skills needed for today’s factory-floor positions, and the pathways through education that lead to them.” However, it appears that, in the last decade, investment in worker training actually declined. One academic study using survey data documented a 27.7% reduction in the incidence of employer-provided training from 2001 to 2009, described by the study’s author as a “‘significant disinvestment in the nation’s human capital.’ [The author] further discovered that the largest decline in employer-provided training took place prior to the Great Recession.” (See this PubCo post.)
Companies also need to be responsible members of their communities, Fink maintains, considering ESG factors such as “sustainability of the business model and its operations, attention to external and environmental factors that could impact the company, and recognition of the company’s role as a member of the communities in which it operates. A global company needs to be local in every single one of its markets.” Moreover, from a shareholder’s perspective, ESG factors “can provide essential insights into management effectiveness and thus a company’s long-term prospects.”
An established foe of short-termism, Fink also takes aim at many of its indicia, such as the “furious pace” of stock buybacks: “for the 12 months ending in the third quarter of 2016, the value of dividends and buybacks by S&P 500 companies exceeded those companies’ operating profit. While we certainly support returning excess capital to shareholders, we believe companies must balance those practices with investment in future growth. Companies should engage in buybacks only when they are confident that the return on those buybacks will ultimately exceed the cost of capital and the long-term returns of investing in future growth.”
In that context, Fink stresses the importance of investing for the long term — in research and development, technology and, “critically, employee development.” He also advocates changes in tax policy that would encourage a long-term view, such as extending the holding period for long-term capital gains treatment to three years, with a declining rate for each year thereafter. And, if tax policy is changed to favor repatriation of cash from overseas, Fink cautions, “BlackRock will be looking to companies’ strategic frameworks for an explanation of whether they will bring cash back to the U.S., and if so, how they plan to use it. Will it be used simply for more share buybacks? Or is it a part of a capital plan that appropriately balances returning capital to shareholders with prudently investing for future growth?”
SideBar: Much attention has been paid to the decline in spending on R&D and capital investments attributed to short-termist myopia. Hedge fund activists have been impugned for pressuring companies to return capital to shareholders in the form of buybacks and dividends at the expense of funding R&D and plant and equipment, thus curtailing innovation and long-term value creation to the detriment of shareholders and the U.S. economy. As reported in this post from Professor John Coffee, a recent study that looked at campaigns launched by activist hedge funds found “that even those targets that escape a takeover still are forced to curtail their R&D expenditures by more than half over the next four years.” (See this PubCo post and this PubCo post.) Although there are a number of factors that may have contributed to the decline in investment in employee development, one potential factor identified in this report from the Center for American Progress “is the growing pressure within boardrooms and among CEOs to generate short-term profits. Increasingly, the pressure for short-term earnings forces business leaders to forgo long-term investments in order to provide dividends and stock buybacks.” And, unlike R&D, which is at least reflected separately in the financials as a valuable investment, the argument goes, spending on human capital is just reflected as “an increase in general overhead, a measure that managers have shown a proclivity for cutting and whose reduction is often cheered by investors.” However, investment in human capital, the report argues, can pay off in enhanced productivity. For example, a 2010 economic study of data from Belgian firms showed that “training increased the productivity of an individual worker at a rate nearly twice that of the corresponding increase in wages. Another study used British panel data to analyze the effects of training on productivity at the industry level and found that a 1 percent increase in the share of trained workers is associated with a 0.6 percent increase in industry productivity and a 0.3 percent increase in hourly wages.” (See this PubCo post.)
Ultimately, Fink contends, “it is imperative that companies understand these changes and adapt their strategies as necessary” on a continuing basis, cautioning that BlackRock “will be looking to see how [each company’s] strategic framework reflects and recognizes the impact of the past year’s changes in the global environment.” Companies working on their annual reports or other communications may want to take the hint: in discussing their strategies for long-term value creation, companies may want to consider whether these recent changes in the global environment could have a strategic impact and, if so, how they might pivot to address it.