Curious.
Larry Fink, the chairman and CEO of BlackRock Inc. (BLK, Financial) has just released his annual letter to CEOs of the corporations in which his firm invests.
In it, he chides those CEOs for not doing enough to head off the ESG (environment, social and governance) activists, while at the same time telling them they need to do what the activists demand.
Corporations need to take care of the needs of all stakeholders, he says, and not just focus on profits for shareholders.
Here’s the curious part:
Many publicly traded corporations are now owned primarily by pension plans and mutual funds (including those of BlackRock), and the goal of almost all end-investors is to provide themselves with retirement income.
The Investment Company Institute, an organization representing the mutual fund industry, reports 92% of mutual fund investors are saving for retirement.
In the case of pension fund investors, the name says it all: 100% are investing for retirement.
And how deep is the penetration of retirement funds? Here’s a look at five very big corporations, with their percentages of institutional ownership:
- Walmart Stores Inc. (WMT, Financial): 32.69% (only 49% of shares in the float)
- Berkshire Hathaway Inc. (BRK.B, Financial): 36.00% (only 50% of shares in the float)
- Apple Inc. (AAPL, Financial): 62.15%
- Exxon Mobile Corp. (XOM, Financial): 51.90%
- McKesson Corp. (MCK, Financial): 90.53%
In each of these companies, institutional investors own the majority of shares (or more accurately, the float).
Is reforming society a primary goal of these institutional investors? Hardly. Vocal minorities may have environmental, social and governance objectives, but all indications are that these are lesser objective.
Finks said, “Society is demanding that companies, both public and private, serve a social purpose.” Has he missed the social purpose of providing retirement income?
He also said, “Companies must benefit all of their stakeholders, including shareholders, employees, customers and the communities in which they operate.” Yet, we know corporations are judged by their competence in turning the capital with which they are entrusted into additional value. They are not, and should not be judged, on how well they solve broad social programs. Nor should they be judged on how well they compensate for government failures.
Fink also argueed that if corporations fail to become good stewards for all stakeholders (as opposed to just shareholders), then they will “succumb to short-term pressures to distribute earnings, and in the process, sacrifice investments in employee development, innovation and capital expenditures.” Huh? He seems to say that if corporations do not capitulate to ideological trends, then they will head down the road to corporate perversion. Where’s the evidence for that?
It’s worth remembering Milton Friedman’s words, “There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”
Turning from the philosophical to the practical, there is one front on which Fink’s letter makes a valid point. He says BlackRock can choose which corporations it buys and sells, in actively-managed funds. However, it cannot choose when managing passive index funds, because it must buy all or none of a relevant index.
And convincing CEOs and boards may prove challenging. They have had such messages continually aimed at them for years now, and have often resisted to protect their shareholders. Of course, some will be on that pathway already, and will use Fink’s letter as further evidence they are doing the right things.
Fink calls his proposals a new model for corporate governance, but are they? They looks more like a repackaging of some old ideas that have not gained traction in the boardroom for good reason: They are not in the best interests of shareholders.
Fink also faces the challenge of walking the talk: BlackRock’s board and management team receives only middling scores in the ISS Governance QualityScore.
An organization boasting 1s and 2s would have more moral authority than one with 3s and 4s.
Also from a practical standpoint, it’s necessary to address the free-rider problem. If one corporation in a competitive industry is giving up profits to address society’s problems, what happens if competitors do not?
Next, how much should external stakeholders get, at the expense of shareholders (future and current retirees)?
Then, there’s the age-old confusion between demand and supply. The energy industry, for example, is driven by demand, yet many environmental groups believe cutting off supply will end society’s dependence. How are boards of petroleum companies to deal with such phantom realities?
Bottom line: Corporations that optimize their profitability serve an important social purpose. Profits produce retirement income that serves literally hundreds of millions of future and current retirees. And, of course, in optimizing profitability, they also produce jobs, taxes for governments, and provide numerous other social benefits.
Trying to convert corporations into ESG angels poses many practical challenges. If BlackRock wants to deal with the many thousands of companies in the indexes, it will need a small army of consultants who will have to identify lagging (in its eyes) corporations, work with the corporations to resolve perceived shortcomings, attend shareholder meetings, and so on.
What would all this activity do to BlackRock’s bottom line? It’s easy to see lots of costs piling on, but not much new revenue coming in. No doubt Vanguard is looking on with interest!
Most corporations and CEOs will likely nod and agree, then simply ignore the substance (what Fink called “rhetorical commitment” in his previous letter) while he goes off tilting at windmills.
Disclosure: I do not have shares in any of the companies listed, and do not expect to buy any in the next 72 hours.
