February 5, 2018

Does Wall Street Finally Care About Sustainability?

(This re-post is a bit delayed after some technical difficulties. It's about a letter
that the CEO of Blackrock, Larry Fink, sent to the CEOs of the S&P 500 companies. In short, he pressed them to think long-term and "serve a social purpose." Of course there was backlash -- an op-ed in the Wall Street Journal accused Fink of wanting "lower returns" for the sake of corporate social responsibility...which was pretty much exactly backwards. Fink is saying that purpose and sustainability drive value, not destroy it. And the only thing he said about "responsibility" was about his fiduciary responsibility and boards' responsibility to understand long-term value. Anyway, the debate rages on over whether Milton Friedman was right 40 years ago to tell companies to focus only on today's shareholders. I think you know where I stand. And apparently I'm joined by a guy with $6 trillion behind him.)

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I’ve been attending conferences on green or sustainable business for more than 15 years, and I’ve worked closely with senior executives at multinationals on sustainability strategy. Through it all, I hear a common refrain: Even though climate change is already creating material risks and opportunities for companies, and expectations from stakeholders about social responsibility are clearly rising, investors aren’t asking CEOs about their sustainability performance.

But could that finally be changing?

Last year there was significant movement by the financial community to push companies to look harder at climate change in particular, but also at other factors that matter to long-term performance, such as LGBT rights, economic inequality, and boardroom diversity. Then 2018 started with a bang — one that could indicate a further shift in investor priorities.

In his annual letter to S&P 500 CEOs, Larry Fink, CEO of BlackRock, made a full-throated defense of both long-term value creation and corporate purpose. And it’s powerful stuff, especially coming from the world’s largest asset owner. Fink points out that governments seem to be failing to prepare for long-term issues and that “society is increasingly turning to the private sector” to step up on societal challenges. (Interestingly, Apple CEO Tim Cook used remarkably similar language about the role of business in society last summer).

But the money quote from Fink was this:

Society is demanding that companies, both public and private, serve a social purpose. To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society.

Andrew Ross Sorkin, financial reporter for the New York Times, wrote a glowing reportand summed up Fink’s message as “contribute to society, or risk losing our support.”

It’s good news. But before I get too excited, I pause to remind myself that we’ve been here before. This is the fourth straight year that Fink’s letter has made the pitch for long-term thinking and sustainability. The language this year is even broader, but he’s been hitting these themes for a while:

Fink has used the phrase “long-term” 20 or more times every one of these years. Throughout these letters, and other pronouncements, BlackRock has made clear that managing issues like climate change and diversity creates business value. But have the letters made much of a difference? It’s not clear.

I’m not remotely suggesting that Fink isn’t serious. But there’s a critical structural problem here. Most of BlackRock’s trillions are “passive” investments, sitting peacefully in index funds (and even BlackRock points out that passive funds have limited impact on equity prices). So, BlackRock can’t move capital around based on its assessment of how well companies do at managing long-term value, even though it owns a chunk of every large company and hold assets “on par with Japan’s GDP.” In essence, the company is a bizarre, oxymoronic blend of unprecedented clout and powerlessness.

It’s also not clear how much attention CEOs pay to these letters. On the day that this year’s letter came out, I spoke to a client of mine, an S&P 500 CEO. He gave me a kind of shrug. As he saw it, leaders that get the value of sustainability to their core business are already doing what BlackRock wants, so it’s moot. And those that don’t buy it may not be rushing to change, since the capital won’t leave their stock.

So, what can BlackRock do to step up the pressure? I asked Ross Sorkin this question on Twitter. After he pointed out that index funds can’t move capital, he said, “They can vote directors off of boards.”

And here’s where it perhaps gets more interesting. The idea of shifting board composition used to be a fairly weak threat, but the rise of activist investors has made companies much more nervous. That said, could low-risk, index investor BlackRock really get more aggressive? Well, Fink did say in this year’s letter, “We must be active, engaged agents on behalf of the clients invested with BlackRock, who are the true owners of your company.” That sounds like it could be read as a veiled threat. After all, “active” is pretty darn close to “activist.”

And last year BlackRock did vote against two ExxonMobil directors while supporting a shareholder resolution to force the oil giant to “report on the impact of global measures designed to keep climate change to 2 degrees centigrade.” BlackRock, Vanguard, and State Street Global Advisors helped swing the resolution with their combined 18% of the company’s shares. These once “passive” voices became a lot more active.

It’s worth pausing to note the financial logic of supporting a resolution like this. The U.S. may have, in essence, pulled out of Paris climate accord, but every other country in the world is still in. And the prospects for oil are dimming. Big countries are banning gas and diesel vehicles, and Ford just announced an $11 billion investment in electric vehicles. So, yeah, global measures to slash carbon emissions will have a direct impact on ExxonMobil’s value. Stranded assets are not worth much.

BlackRock and other investors are in this for the money, as always. They are serving their fiduciary responsibility well. And thus I’m optimistic that action will continue, as the social responsibility argument increasingly lines up perfectly with the financial one.

Fink’s intentions and his letters do matter. But votes matter more.

(This article first appeared in Harvard Business Review.)

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