by Cydney Posner
Asset management firm BlackRock (reportedly the largest, with $5.1 trillion under management) has identified its “Investment Stewardship” priorities for 2017-2018, intended to help companies prepare for engaging with BlackRock. Among the hot topics are governance (including board composition and diversity), corporate strategy for long-term value creation in light of shifting assumptions, executive pay linked to long-term strategy, climate risk disclosure and human capital management. According to BlackRock, its engagement process is designed to be constructive, and its goal is “to build mutual understanding and ask probing questions, not to tell companies what to do. Where we believe a company’s business or governance practices fall short, we explain our concerns and expectations, and then allow time for a considered response.” However, Blackrock’s approach is not limited to engagement; although, as a long-term investor, the firm will be “patient” as companies work to address concerns, in the absence of progress, BlackRock “will not hesitate to exercise our right to vote against management recommendations.”
To initiate engagement with BlackRock, companies are strongly encouraged to provide a “detailed agenda.” In determining whether to engage, BlackRock takes into account “a range of material factors including our thematic priorities, level of concern on specific governance issues, observation of market events, and assessment that engagement will contribute to outcomes that protect and enhance economic value.” Companies seeking some engagement time with BlackRock may want to consider addressing in their detailed agendas the priorities identified by BlackRock.
According to Reuters, the announcement of engagement priorities “marked a step-up in BlackRock’s advocacy with boards and executives, and comes after the fund giant was criticized by environmental and labor activists for not backing proxy resolutions dealing with climate change and other topics more often at shareholder meetings. BlackRock stopped short of pledging to vote more often against companies’ management. It said it still prefers private meetings with executives and casts critical proxy votes only as a last straw.” According to the BlackRock representative heading the engagement effort, the firm “can’t micromanage” its portfolio companies. Apparently, though, Reuters suggests, the move was enough to cause some shareholder proponents to withdraw a shareholder proposal calling for BlackRock “to review its proxy-voting process and record on climate change.” Notably, Reuters also reported that deposits in socially responsible or ESG-oriented funds have “been a rare bright spot for active fund managers lately.”
BlackRock’s Investment Stewardship priorities are discussed in more detail below:
Governance. According to BlackRock, “Board composition, effectiveness, and accountability remain a top priority. In our experience, most governance issues, including how environmental and social factors are managed, stem from board leadership and oversight.” The firm will engage with independent directors and examine board self-assessment processes, particularly with respect to “the skills and expertise needed to take the company through its future multi-year strategy (rather than the last one). In that context, we want to understand the board’s position on director turnover, succession planning and diversity.” Board gender diversity will be a particular focus: “over the coming year, we will engage companies to better understand their progress on improving gender balance in the boardroom. Diverse boards, including but not limited to diversity of expertise, experience, age, race and gender, make better decisions. If there is no progress within a reasonable time frame, we will hold nominating and/or governance committees accountable for an apparent lack of commitment to board effectiveness.” According to Reuters, the BlackRock representative observed that some companies mistakenly believe they already have diverse boards, but a “‘guy from Yale and a guy from Harvard does not count as diversity.’”
SideBar: Other asset managers have likewise expressed a more intense focus recently on board gender diversity. State Street Global Advisors, which manages $2.47 trillion in assets, announced, on the eve of International Women’s Day, that it is “calling on the more than 3,500 companies [in which] State Street invests on behalf of clients, representing more than $30 trillion in market capitalization to take intentional steps to increase the number of women on their corporate boards.” Although State Street’s preferred approach is also to encourage change through active engagement, it may use stronger measures as well, including voting against directors. (See this PubCo post.)
BlackRock states that it will also “encourage governance structures that enhance accountability (e.g. proxy access), limit entrenchment (e.g. annual election of directors and board evaluations), and align voting rights and economic interests (i.e. one share, one vote).” In addition, for companies in sectors that are significantly exposed to climate risk or where an individual company faces a material, business-specific climate risk, BlackRock expects the entire board to be “climate competent,” that is, “to have demonstrable fluency in how climate risk affects the business and management’s approach to adapting and mitigating the risk.” The firm will assess this competency “through corporate disclosures and direct engagement with independent board members, if necessary. Where we have concerns that the board is not dealing with a material risk appropriately, as with any other governance issue, we may signal that concern through our vote, most likely by voting against the re-election of certain directors we deem most responsible for board process and risk oversight.”
Corporate strategy for the long term. As reflected in the corporate governance letters of BlackRock’s co-founder and CEO, the firm has been decrying short-termism for a number of years. For example, in 2016, he advocated that companies not just articulate their strategic frameworks for long-term value creation but also explicitly affirm that their boards have reviewed those plans. (See this PubCo post.) This year, he challenged 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? In his view, 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. (See this PubCo post.)
As expected, BlackRock’s identified priorities for engagement also reflect that concern. The firm advises companies to recognize that “[m]any of the assumptions on which prior year strategies were based have shifted dramatically in recent months and may require companies to pivot.” In addition to understanding short-term goals such as quarterly performance, BlackRock expects to hear succinct explanations of long-term strategic goals, milestones and anticipated obstacles, refreshed each year “to reflect the changing business environment and how it might affect how a company prioritizes capital allocation, including capital investments, research and development, employee development, and capital return to shareholders.”
Compensation that promotes long-termism. In engaging on the issue of executive compensation, Blackrock will be looking to see whether boards have established performance metrics that link to companies’ long-term strategies, focusing on sustainable long-term returns, as opposed to short-term share price performance: “To this end, we’ll seek clarity on the company’s balance and prioritization between ‘input’ metrics that are within management’s control relative to ‘output’ metrics such as earnings per share or total shareholder return. Where pay seems out of line with performance, we expect the company to provide detailed justification in its public disclosures and may engage with independent directors where concerns persist…. We may vote against the election of compensation committee members in instances, including but not limited to, where a company has not persuasively demonstrated the connection between strategy, long-term shareholder value creation and incentive plan design.” Interestingly, BlackRock also indicates that, in context of setting executive pay, it might also raise questions regarding the board’s consideration of “internal pay equity and broader macroeconomic” trends.
Disclosure of climate risks. Having contributed to two papers on climate change as an investment consideration, BlackRock believes “that enhanced, meaningful disclosures are an important step towards building understanding of the impact on individual companies, sectors and investment strategies.” Moreover, participating in “[t]hat work enhanced our understanding of the complexity companies and investors face in relation to climate change and has informed our engagement with companies on the anticipated impact of climate change on their business models and operations over time.” BlackRock is advocating the development of consistent sector and global disclosure standards and reporting frameworks. As a participant in the Financial Stability Board Task Force on Climate-related Financial Disclosures (“TCFD”), the firm is encouraging adoption of the TCFD preliminary recommendations and roadmap for disclosure, which includes sector-specific supplemental guidance. Those recommendations center “around four thematic areas that represent core elements of how organizations operate – governance, strategy, risk management, and metrics and targets. This framework offers companies and investors a starting point to assess, report, and price climate-related risks and opportunities.” BlackRock plans to “engage companies most exposed to climate risk to understand their views on the TCFD recommendations and to encourage them to consider using this reporting framework as it is finalized and subsequently evolves over time.”
Human capital management. Because of the intense competition for talent, BlackRock views as a “factor in business continuity and success,” each company’s “approach to human capital management — employee development, diversity and a commitment to equal employment opportunity, health and safety, labor relations, and supply chain labor standards…. In light of evolving market trends like shortages of skilled labor, uneven wage growth, and technology that is transforming the labor market, many companies and investors consider human capital management a competitive advantage. In our engagement on these factors, we seek to ensure companies are adopting the sound business practices likely to create an engaged and stable workforce. As part of the engagement, we are interested to know if and how boards oversee and work with management to improve performance in these areas. Such engagement also provides a lens into the company’s culture, long-term operational risk management practices and, more broadly, the quality of the board’s oversight.” For example, issues such as “uneven wage growth” can affect the loyalty and engagement of the workforce: in her interview with Reuters, the BlackRock representative observed that “‘ [p]ay that doesn’t seem to achieve some sense of equity within a company is likely to make an unattractive place to work.’”
SideBar: This report from the Center for American Progress argues that one class of investment that has received only scant attention but has also been victimized by short-term thinking is investment in the human capital and skills of a company’s workforce. Investment in human capital, the report argues, can pay off in enhanced productivity. Nevertheless, it appears that investment in worker training has declined. One academic study using survey data documented a 27.7% reduction in the incidence of employer-provided training from 2001 to 2009. Although there are a number of factors that may have contributed to this decline, one potential factor identified in the Center report “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.” (See this PubCo post.)