Why Blackrock's Stakeholder Approach Won't Work
The more times I read Larry Fink’s (CEO of BlackRock) most recent letter to CEOs, A Fundamental Reshaping of Finance, the more concerned I become. As I now understand the letter, BlackRock is attempting to use its considerable amount of delegated shareholder voting power to dictate its own vision of what a public company’s (a company traded on a U.S. stock exchange or over-the-counter) stakeholder relationships should be. In my opinion, this is a fool’s errand.
For purposes of this writing, I am taking Larry Fink at his word when he says that BlackRock’s objective is to promote shareholder value. However, he is simply going about it in the wrong way—a dangerous way. As stated by law professor Emily Winston in her extremely insightful new article, Managerial Fixation and the Limitations of Shareholder Oversight, “while corporate attention to non-shareholder stakeholders can improve firm value, shareholder oversight of these stakeholder relationships will not succeed in having this effect.”
In a public company, stakeholders represent an enormous number of entities and individuals, including shareholders, directors, managers, employees, independent contractors, consultants, consumers, creditors, vendors, distributors, communities affected by the company’s operations, federal, state, and local governments, and society in general, when it is positively affected by the social value created by the company or negatively affected when the company generates third-party costs such as air or water pollution. The management of these relationships is complex and is usually placed in the hands of those who have the knowledge and expertise to manage them: the company’s management team, up and down the line.
As a means to implement its new form of shareholder empowerment, BlackRock will be requiring each public company that it invests in—virtually all public companies—to disclose data on “how each company serves its full set of stakeholders.” Moreover, noncompliance will not be tolerated. According to Fink, “we will be increasingly disposed to vote against management and board directors when companies are not making sufficient progress on sustainability-related disclosures and the business practices and plans underlying them.” This threat appears to be playing out in reality. During the first quarter of 2020, BlackRock was reported to have voted against one or more board recommendations at more than 30% of the 333 shareholder meetings it attended in North America, including approximately 120 board-nominated directors.
This approach is deficient on three counts. First, as I discussed in my recent op-ed BlackRock, Larry Fink, and a New Form of Shareholder Empowerment, BlackRock is extremely resource-constrained even to attempt getting involved in such an undertaking on a per-company basis. It will be Larry Fink and his approximately 20-member U.S. based investor stewardship team dictating required disclosures, business practices, and underlying strategies for the thousands of public companies that exist in the United States.
Second, the BlackRock desire for an increased management role in our public companies must be based on an assumption that public companies as a whole are not paying enough attention to stakeholder relationships in order to maximize the long-term returns of shareholders. This is definitely a flawed starting point. Efficiently and innovatively dealing with these critical relationships is what the work of corporate management is all about. Moreover, these relationships can change on a daily basis: consumers who have ever-changing tastes or are becoming increasingly sensitive to the negative externalities that the company may create; competitors that introduce new products; changing technologies; threats to global and domestic supply chains for key components and raw materials; credit and equity markets that require ever-changing terms; and competitive labor markets for skilled talent. A failure to deal with these stakeholder relationship issues in an integrated manner can lead a company to report mediocre financial results and eventual failure.
Finally, it is hard to understand how it ever will be possible for BlackRock to identify when a public company is doing a good job in managing its stakeholder relationships. BlackRock exists outside the day-to-day of its portfolio companies. Moreover, from an informational perspective, BlackRock and its passive index fund competitors such as Vanguard and State Street Global Advisors are in the worst possible position for getting involved in the management of a public company’s stakeholder relationships. According to law professor Charles Korsmo: “A large and growing share of institutional investment is in the form of “passive” index funds…. They seek to offer a market return and compete by offering the lowest possible fees to individual investors. As a result, they expend little or no effort seeking to value the firms they invest in. While these index funds are certainly ‘sophisticated’ investors in the sense that they understand the central lesson of modern portfolio theory [it is more efficient to have a properly diversified investment portfolio than to try to pick stock winners using only publicly available information] … they are not ‘sophisticated’ in the sense of knowing anything about the firms they invest in.”
In sum, BlackRock’s scheme of interfering in the management of a public company’s stakeholder relationships will lead to lower, not higher, shareholder returns by undermining the critical work done in this area by people with the knowledge and expertise to manage these relationships: the company’s management.