BlackRock CEO Larry Fink’s recent annual letter to CEOs attracted much commentary in global governance circles. Fink proposed a new model of shareholder engagement between companies and investors, based on a year-round conversation and focus on long-term value creation.
Shareholder engagement, he said, has been too focused around annual meetings and proxy votes. There has been too much emphasis on quarterly company results and not enough on long-term strategy and the organisation’s social purpose.
Fink’s letter stressed the importance of organisations delivering financial performance and a positive contribution to society. Companies should benefit all stakeholders – shareholders, employees, customers and the communities in which they operate.
The BlackRock CEO also called out the increasing community demands on the private sector for action on ‘broader societal challenges’, as governments fail to prepare for the future on issues from infrastructure to automation.
BlackRock promoted Fink’s letter as a “new model for corporate governance”. It is far from that, although still an important contribution in the push for boards to have greater involvement in long-term strategy; Environmental, Social and Governance (ESG) issues; and investor relations.
Some commentators have noted that BlackRock’s bark will always be worse than its bite, given much of its stock market investing is through index funds. There is no doubt, however, that BlackRock is highly influential and increasing its focus on ESG expectations and outcomes.
I see five main implications for boards from Fink’s view of shareholder engagement:
1. Strategy formation
Fink repeatedly emphasised that boards should be engaged in developing and communicating their organisation’s long-term strategy. But the role of boards in strategy is complex.
Some boards are deeply involved in strategy formation. Others believe their job is to help and coach management on strategy as needed, test strategy and its assumptions, and assess strategy implementation and results.
Fink’s view ups the ante on boards and strategy. He emphasises long-term strategy and the importance of boards aligning that strategy with the organisation’s social purpose and risk-management framework.
“The statement of long-term strategy is essential to understanding a company’s actions and policies, its preparation for potential challenges, and the context of its shorter-term decisions. Your company’s strategy must articulate a path to financial performance,” writes Fink.
This view of strategy, and the role of boards within it, is a wake-up call for directors who are primarily focusing on compliance and risk management.
2. Strategy communication
Fink wants boards to articulate the organisation’s long-term strategy through sustained shareholder engagement. That is easier said than done. Strategy communication can be problematic for boards and is often too broad-brushed to be meaningful.
“In order to make engagement with shareholders as productive as possible, companies must be able to describe their strategy for long-term growth,” writes Fink. “I want to reiterate our request… that you publicly articulate your company’s strategic framework for long-term value creation and explicitly affirm that it has been reviewed by your board of directors.
This demonstrates to investors that your board is engaged with the strategic direction of the company. When we meet with directors, we also expect them to describe the board process for overseeing your strategy.”
Boards will need to consider how long is “long-term” in strategy? What is the risk of the CEO and chair commenting on strategy in different forums, and how can their communication roles be delineated? How much information about strategy can be disclosed before the organisation tips off competitors, and how are the risks of forward-looking strategy disclosures managed?
I agree with Fink that boards should be able to articulate the organisation’s long-term strategy to investors. The caveat being that investors understand and respect the board’s role in strategy formation and communication – and do not see shareholder-engagement meetings as a proxy for discussions with management on short-term company-performance issues.
Boards should outline the broad thrust, opportunities and risks of their organisation’s long-term strategy to create financial and social wealth; not the detail.
3. Social purpose
Governance commentators picked up on Fink’s push for organisations to have a clear social purpose and deliver community outcomes. Much of the commentary centred on Environmental, Social and Governance (ESG) issues, but social purpose is much more than that.
“Without a sense of purpose, no company, either public or private, can achieve its full potential,” wrote Fink in his 2018 letter, going on to warn that company lacking a sense of purpose will ultimately lose their licence to operate from key stakeholders.
By arguing that organisations should serve a range of stakeholders, not only shareholders, Fink challenges the shareholder primacy concept of governance. Boards that see themselves only as shareholder agents have a narrow and outdated view of governance under Fink’s model.
His view suggests companies should have a conversation and accountabilities with communities, not only investors.
Also, that boards should be willing to sacrifice short-term results if it is in the organisation’s long-term interests. Directors should be custodians for organisation sustainability and long-term performance.
This push for a clearer “social purpose” is challenging.
Social purpose and ESG are intertwined but not the same. To my thinking, ESG is fundamentally about risk management and enhancing the organisation’s social licence to operate; for example, understanding how climate change will affect long-term earnings, or the role of corporate social responsibility in attracting top talent and strengthening the organisation’s brand.
Social purpose is more than ESG, company mission or values. It’s about organisations being clear on outcomes they want to deliver for communities and measuring the progress. But too many organisations have vague social purposes based on hard-to-measure goals.
If investors and communities want to see social purpose, organisations need to better define, communicate and measure it. Does the community know or understand the social purpose of our banks, telcos or resource companies? What are the outcomes of those social purposes and how do they align to the organisation’s long-term strategy, values and risk-management framework?
Addressing these questions in strategy formulation and communication will be an increasing focus for Australian boards.
4. Investor relations
Fink rightly argues that too much shareholder engagement is based around annual general meetings and proxy votes. He wants a year-round conversation that focuses on long-term value creation, and companies to pay more attention to activists who have good ideas.
“If engagement is to be meaningful and productive – if we collectively are going to focus on benefitting shareholders instead of wasting time and money in proxy fights – then engagement needs to be a year-round conversation about improving long-term value”, writes Fink.
That is fine in theory. In practice, it implies boards spending extra time on investor relations – a trend that is well underway in the United States and increasingly in Australia. As more investors want to talk about strategy and ESG issues, demand for meetings with boards is rising rapidly.
Some chairs of ASX 50 companies I know now attend up to 30 investor meetings in the lead-up to their company’s AGM, from about 10 meetings a few years ago – a trend I am reporting on for AICD Company Director Journal in the April edition.
The upshot is boards, principally the Chair, having more meetings with investors on ESG topics and on long-term strategy.
Fink also argues that organisations should bring key investors to the table when activists offer valuable ideas, and begin those discussions earlier. That implies a more open, inclusive approach from organisations towards external stakeholders who want to shape strategy.
Under Fink’s model, boards will have to own part, if not all, of the investor-relations function within their organisation if investors want more meeting on shareholder engagement.
5. Board composition
The investment community’s focus on shareholder engagement, long-term strategy and social purpose suggests some boards will need to rethink their composition in coming years.
High-performing boards have generalist directors: those who govern across a range of complex areas and join the dots; not specialists with narrow expertise. But the current skillset of boards may need tinkering with to meet the model of corporate governance that Fink proposes.
For a start, most directors who have not been CEOs or chief financial officers of ASX 200 companies have no or limited investor-relations experience. The pool of directors of listed companies with deep communication skills in global financial markets is limited.
A greater focus on ESG and social purpose will also test board composition. If Fink wants boards to focus on the needs of a broader range of stakeholders, and for organisations to deliver community outcomes, directors will need to understand a wider set of corporate and community issues. Gender, skills, age and cultural diversity on boards, so that different stakeholder perspectives can be considered, are even more important under the Fink model.
“Boards with a diverse mix of genders, ethnicities, career experiences, and ways of thinking have, as a result, a more diverse and aware mindset,” argues Fink. They are less likely to succumb to groupthink or miss new threats to a company’s business model. And they are better able to identify opportunities that promote long-term growth”.
Boards of larger listed companies will need to ask: do we have sufficient skills to communicate with institutional investors and activists on topics ranging from long-term strategy, to climate change, human-rights issues in supply chains, sexual-conduct policies, occupational health and safety, organisation culture, diversity, digital disruption, employee turnover and so on?
In this brave new world of shareholder engagement, listed-company boards will need to be more engaged with investors on more topics. That means extra risk and work for boards– and, increasingly, a more intensive role for directors.