A dramatic evolution is underway in terms of how shareholders influence the strategy and social responsibility of the companies in which they invest.
In the not so distant past, investor activism fell on the activist side of the equation, with the likes of Carl Icahn and Nelson Peltz deploying the clout earned by large holdings to demand strategy and leadership changes, with an eye toward improving returns.
The latest trend: the rise of the passive investor. The average investor—far removed from the world of corporate raiders—may be saving for retirement, or bolstering their income stream, by putting their money in index funds, rather than specific companies. Unlike traditional activist investors, they supplement their hopes for short-term returns with a desire for long-term strategy. With strength in numbers, they also want “good,” if not “great” companies with diverse boards, an environmental conscience, and an appreciation for their workforce.
A leading voice on behalf of these engaged, passive investors is Larry Fink, founder, chairman, and CEO of BlackRock. In recent years, he has echoed their causes, amplified by his firm’s investment might, in a letter to the companies in which it invests.
In the firm’s latest letter, issued earlier in January, Fink assesses the current business climate as “a paradox of high returns and high anxiety,” in which companies face unprecedented responsibilities.
“Society increasingly is turning to the private sector and asking that companies respond to broader societal challenges,” he wrote. “Indeed, the public expectations of your company have never been greater. 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.”
Companies “must benefit all of their stakeholders,” including shareholders, employees, customers, and the communities in which they operate.
“Without a sense of purpose, no company, either public or private, can achieve its full potential,” Fink wrote. “It will ultimately lose the license to operate from key stakeholders. It will succumb to short-term pressures to distribute earnings and, in the process, sacrifice investments in employee development, innovation, and capital expenditures that are necessary for long-term growth. It will remain exposed to activist campaigns that articulate a clearer goal, even if that goal serves only the shortest and narrowest of objectives.”
Fink goes on to describe “a new model for corporate governance” that goes beyond casting proxy votes at annual meetings and means investing the time and resources necessary to foster long-term value.
“As regulators, we have mandated or suggested rule sets—including disclosure requirements and incentive-driving requirements and prohibitions—that have reduced the opportunities for misalignment between shareholders and managers. It is clear that governance has improved as a result.”
Jay Clayton, Chairman, SEC
“I have written before that companies have been too focused on quarterly results; similarly, shareholder engagement has been too focused on annual meetings and proxy votes,” Fink wrote. “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.”
In order to make engagement with shareholders as productive as possible, companies must be able to describe their strategy for long-term growth. “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,” Fink wrote. “This demonstrates to investors that your board is engaged with the strategic direction of the company.”
“We recognize that the market is far more comfortable with 10Qs and colored proxy cards than complex strategy discussions,” he added. “But a central reason for the rise of activism—and wasteful proxy fights—is that companies have not been explicit enough about their long-term strategies.”
Fink had some suggestions to spark investor engagement. Companies should explain to investors how the significant changes to tax law fit into their long-term strategy. What will you do with increased after-tax cash flow, and how will you use it to create long-term value?
“This is a particularly critical moment for companies to explain their long-term plans to investors,” he wrote. “Tax changes will embolden those activists with a short-term focus to demand answers on the use of increased cash flows, and companies who have not already developed and explained their plans will find it difficult to defend against these campaigns. Regardless of a company’s jurisdiction, it is your responsibility to explain to shareholders how major legislative or regulatory changes will impact not just next year’s balance sheet, but also your long-term strategy for growth.”
Other questions that Fink says companies must ask themselves: What role do we play in the community? How are we managing our impact on the environment? Are we working to create a diverse workforce? Are we adapting to technological change? Are we providing the retraining and opportunities that our employees and our business will need to adjust to an increasingly automated world?
Boards meet only periodically, but their responsibility is continuous. “Directors whose knowledge is derived only from sporadic meetings are not fulfilling their duty to shareholders,” Fink wrote, emphasizing the importance of a diverse board. “Likewise, executives who view boards as a nuisance only undermine themselves and the company’s prospects for long-term growth.
Targeting Xerox—a joint statement from Carl Icahn and Darwin Deason
We are the first and third largest shareholders of Xerox, beneficially owning collectively over 40 million shares of the company’s common stock, constituting over 15 percent of the outstanding shares. Because we are completely aligned regarding our views on the following subjects, we have agreed to act in concert and have formed a “group” with respect to the contemplated solicitation of proxies to elect four new individuals to the board of directors at the 2018 annual meeting of Xerox’s shareholders:
In light of the recent accounting scandal at Fuji Xerox, the joint venture should be terminated or renegotiated to make it more favorable to Xerox;
Xerox should immediately commence a process with new independent advisors to explore strategic alternatives;
Xerox should immediately disclose the agreements governing the Fuji Xerox joint venture;
CEO Jeff Jacobson, a member of the Xerox “old guard,” is incapable of creating long-term value for Xerox shareholders and should be replaced immediately; and
If the “old guard” directors are unwilling to make the tough decisions necessary to prevent the Xerox ship from sinking, then they must be replaced as well.
The Wall Street Journal recently reported that Xerox is in talks with Fujifilm regarding an array of potential transactions that may or may not include a change of control of Xerox.
We are not predisposed to approve or disapprove of any such transaction, whether with Fuji or any other party. But if Xerox is indeed exploring a transaction with Fuji that may result in a change of control (which to our view would make sense since we, like many others, believe consolidation in this industry is inevitable), then we implore the “old guard” directors—who have historically lacked the intestinal fortitude to challenge and demand accountability from Xerox management—to not do us all the tremendous disservice of allowing Jeff Jacobson to lead the negotiations. He is neither qualified nor capable of successfully running this company, let alone negotiating a major strategic transaction that will do more than save his own job.
Unfortunately, we have little faith that Xerox’s “old guard” directors will listen to us, which is why real change is needed now more than ever. Every day that the “old guard” remains in power—feebly overseeing the company’s steady decline—is a waste of time that could inevitably erode the value of our investment down to nothing. We simply cannot wait any longer for things to change. We must act before it is too late.
Stay tuned, fellow shareholders. This is just the beginning.
—Carl C. Icahn; Darwin Deason
“Boards with a diverse mix of genders, ethnicities, career experiences, and ways of thinking have, as a result, a more diverse and aware mindset. They are less likely to succumb to groupthink or miss new threats to a company’s business model.”
Fink’s letter, by coincidence, dovetailed with a daylong panel on shareholder engagement at New York University’s Salomon Center for the Study of Financial Institutions.
Matthew Mallow, BlackRock’s general counsel and a member of its global executive committee, said that his firm’s views are shaped by upwards of 15,000 face-to-face meetings with directors each year on “mission, purpose, strategy, and holding boards accountable.”
Darla Stuckey, president and CEO of the Society of Corporate Secretaries & Governance Professionals, says that there are two general responses to Blackrock’s outreach: “ ‘Who died and made Larry Fink god?’ some ask. Nevertheless, companies that don’t already have a strategy and articulate it … well, they should. The shareholder engagement landscape has certainly changed.”
Where once companies would strike a defensive pose when confronted by shareholder demands, they are slowly becoming more receptive, says Aeisha Mastagni, an investment officer within the corporate governance unit of the California State Teachers’ Retirement System (CalSTRS), the nation’s largest teacher retirement fund.
“We are still doing the same activities we have always done, but the companies’ responses to those activities are more active,” she said.
Stuckey gave a recent example of modern shareholder activism. Investors pressured Apple to review the ill effects of children who are perpetually immersed in consumer technology and social media. CEO Tim Cook, rather than hide from the question, embraced it and expressed similar fears.
“It is surprising that Apple responded so quickly,” Stuckey says. The lesson: “You should respond, always, to your shareholders.”
“If you are a company with no women on your board, you had better answer and you had better talk to them,” she added of investor outreach. You had better have a plan for what you are going to do about it.”
Jay Clayton, chairman of the Securities and Exchange Commission, shared his views, as a regulator, at the forum.
“As regulators, we have mandated or suggested rule sets—including disclosure requirements and incentive-driving requirements and prohibitions—that have reduced the opportunities for misalignment between shareholders and managers,” he said. “It is clear that governance has improved as a result.”
He added, however, that “even proxy voting is costly to shareholders.”
There is: analyzing the issue up for a vote; the potentially varying points of view on that issue; formulating an opinion; and casting the ballot, all a series of actions that requires nuanced determinations possibly beyond individual shareholders.
“Even investment companies struggle. Because they frequently compete on fees, are funds tempted to understaff proxy voting, or to outsource it to a proxy advisory firm?” he asked.
“Activism may be evolving, but it is not going away,” Clayton conceded. “So, it is more important than ever for shareholders to understand and evaluate activists’ long-term impact on companies and shareholder value. In particular, to what extent do shareholder campaigns launched by activist investors create value for all shareholders? What is the effect of these campaigns on long-term value? To what extent does passive institutional ownership, and the involvement of proxy advisors, facilitate the growth in activist campaigns?”
“Activists themselves are not monolithic,” he added. “They may themselves have different tactics or different time horizons that may lead to differential outcomes with respect to this range of questions.”
Clayton urged all involved to keep in mind the needs of “Main Street investors.”
“If our system of corporate governance is not ensuring that the views and fundamental interests of these long-term retail investors are being protected, then we have a lot of work to do to make it so,” he said.