BlackRock is the largest asset manager on the planet, with $4.7tr of assets under management, 12,000 employees, 135 investment teams in 70 offices in 30 countries. Earlier this year, CEO Larry Fink sent his annual letter to the CEOs of the S&P500 and largest international companies urging them again to focus on the long-term, citing “today’s culture of quarterly earnings hysteria”. Few will argue with the sentiment. But short-termism persists driven by some investors, companies, and the media, and is a “red flag” to BlackRock’s fund managers and to many others.
In Europe, companies never jumped on the “quarterly earnings hysteria” bandwagon in quite the same way as the US. It is common for companies to report on a half-year basis, which we believe helps support longer-term investor thinking. In fact the UK’s Investment Association whose members run $5.5tr of assets is considering requiring companies to stop quarterly reporting altogether. This is in contrast to BlackRock who still want to see quarterly reporting, just not quarterly guidance.
However many European companies could do a better job of articulating their stories. Common investor complaints are confusing strategy and story, poor KPI disclosure, and difficulty in constructing a consistent historic record of the accounts (we have long urged companies to post their historic numbers all in one spreadsheet on their IR website, as Microsoft does). We have sometimes heard CEOs and CFOs react against clearer disclosure with “let the analyst do the work” which is entirely the wrong way to get more investors interested in your business given the constraints on their time. Companies that open up are rewarded in many ways.
We reproduce the full text of Larry Fink’s letter below, but it can be summarised into four key headings: explaining your long term value creation framework, educating investors about what you do, emphasising long-term over short-term, and attitude to environmental/social/governance issues.
1. Lay out a framework for long-term value creation
Annual reports and other shareholder communications are too backward looking and should more articulate a vision for the future. The board should explicitly review and endorse the CEO’s framework for value-creation, and this is something BlackRock looks for. Financial metrics to track progress should be disclosed, and used as part of long-term executive compensation.
2. Educate investors about your eco-system
Companies should be able to pivot, meaning change tactics or strategy in the face of a rapidly changing environment. Companies that have explained the eco-systems they operate in, the competitive environment, and how technology is impacting them, will find their investors are less short-term and more willing to accept necessary change.
3. Emphasise long-term vs short-term
Strong support for the long-term approach from the corporate sector is undermined by data – US companies are paying out the highest proportion of their earnings in dividends since 2009 (when earnings were depressed, unlike today) and share buybacks were up 27% in 2015. “We certainly support returning excess cash to shareholders, but not at the expense of value-creating investment.”
Absence of a long-term value creation strategy can lead to a management focus on the short-term. Blackrock will vote with activists who have a solid long-term value-creation idea. In 2015 Blackrock voted with the activist investor in 7 of the largest 18 proxy contests.
As companies do a better job of communicating their long-term value-creation plans, they should dispense with short term quarterly EPS guidance (already the norm in Europe). Long-termism is not an excuse for lower transparency, so quarterly reporting is still preferred, but managers should be explaining deviations from long-term plans, not a penny beat or miss to quarterly EPS.
4. Proactive attitude to environmental, social and governance (ESG) issues
“At companies where ESG issues are handled well, they are often a signal of operational excellence.” ESG is increasingly becoming part of the investment process at Blackrock and other fund managers. Investors, the media, and governments officials have their part to play here by thinking beyond the next election cycle which is usually the limit of their “long-term” thinking. But companies can continue to push for long-term beneficial policies in the areas of taxation and investment in government infrastructure, where BlackRock sees the US as suffering from chronic underinvestment in roads, sewers, and the power grid.
More investor red flags
In our next Insight we’ll go into more detail on the common “red flags” that turn-off investors. Oakhall was set up by former award winning equity analysts to help companies better internally analyse and articulate what they do. This is not about re-arranging a few lines of a press release but starts with an in-depth understanding of the business, then building a strategic planning model to help analyse the implications of that articulation. As equity analyst numbers continue to fall, the job of explaining what your business does to the busy investor is resting more and more on the shoulders of company executives. Contact us to discuss your strategic planning model.
Andrew Griffin spent almost two decades as a technology equity analyst before working in investor relations, corporate development and market intelligence for a UK listed software company. In 2015 he set up Oakhall to provide smart financial analysis and articulation for European public and private companies.
CEO letter full text
Over the past several years, I have written to the CEOs of leading companies urging resistance to the powerful forces of short-termism afflicting corporate behavior. Reducing these pressures and working instead to invest in long-term growth remains an issue of paramount importance for BlackRock’s clients, most of whom are saving for retirement and other long-term goals, as well as for the entire global economy.
While we’ve heard strong support from corporate leaders for taking such a long-term view, many companies continue to engage in practices that may undermine their ability to invest for the future. Dividends paid out by S&P 500 companies in 2015 amounted to the highest proportion of their earnings since 2009. As of the end of the third quarter of 2015, buybacks were up 27% over 12 months. We certainly support returning excess cash to shareholders, but not at the expense of value-creating investment. We continue to urge companies to adopt balanced capital plans, appropriate for their respective industries, that support strategies for long-term growth.
We also believe that companies have an obligation to be open and transparent about their growth plans so that shareholders can evaluate them and companies’ progress in executing on those plans.
We are asking that every CEO lay out for shareholders each year a strategic framework for long-term value creation. Additionally, because boards have a critical role to play in strategic planning, we believe CEOs should explicitly affirm that their boards have reviewed those plans. BlackRock’s corporate governance team, in their engagement with companies, will be looking for this framework and board review.
Annual shareholder letters and other communications to shareholders are too often backwards-looking and don’t do enough to articulate management’s vision and plans for the future. This perspective on the future, however, is what investors and all stakeholders truly need, including, for example, how the company is navigating the competitive landscape, how it is innovating, how it is adapting to technological disruption or geopolitical events, where it is investing and how it is developing its talent. As part of this effort, companies should work to develop financial metrics, suitable for each company and industry, that support a framework for long-term growth. Components of long-term compensation should be linked to these metrics.
We recognize that companies operate in fluid environments and face a challenging mix of external dynamics. Given the right context, long-term shareholders will understand, and even expect, that you will need to pivot in response to the changing environments you are navigating. But one reason for investors’ short-term horizons is that companies have not sufficiently educated them about the ecosystems they are operating in, what their competitive threats are and how technology and other innovations are impacting their businesses.
Without clearly articulated plans, companies risk losing the faith of long-term investors. Companies also expose themselves to the pressures of investors focused on maximizing near-term profit at the expense of long-term value. Indeed, some short-term investors (and analysts) offer more compelling visions for companies than the companies themselves, allowing these perspectives to fill the void and build support for potentially destabilizing actions.
Those activists who focus on long-term value creation sometimes do offer better strategies than management. In those cases, BlackRock’s corporate governance team will support activist plans. During the 2015 proxy season, in the 18 largest U.S. proxy contests (as measured by market cap), BlackRock voted with activists 39% of the time.
Nonetheless, we believe that companies are usually better served when ideas for value creation are part of an overall framework developed and driven by the company, rather than forced upon them in a proxy fight. With a better understanding of your long-term strategy, the process by which it is determined, and the external factors affecting your business, shareholders can put your annual financial results in the proper context.
Over time, as companies do a better job laying out their long-term growth frameworks, the need diminishes for quarterly EPS guidance, and we would urge companies to move away from providing it. Today’s culture of quarterly earnings hysteria is totally contrary to the long-term approach we need. To be clear, we do believe companies should still report quarterly results – “long-termism” should not be a substitute for transparency – but CEOs should be more focused in these reports on demonstrating progress against their strategic plans than a one-penny deviation from their EPS targets or analyst consensus estimates.
With clearly communicated and understood long-term plans in place, quarterly earnings reports would be transformed from an instrument of incessant short-termism into a building block of long-term behavior. They would serve as a useful “electrocardiogram” for companies, providing information on how companies are performing against the “baseline EKG” of their long-term plan for value creation.
We also are proposing that companies explicitly affirm to shareholders that their boards have reviewed their strategic plans. This review should be a rigorous process that provides the board the necessary context and allows for a robust debate. Boards have an obligation to review, understand, discuss and challenge a company’s strategy.
Generating sustainable returns over time requires a sharper focus not only on governance, but also on environmental and social factors facing companies today. These issues offer both risks and opportunities, but for too long, companies have not considered them core to their business – even when the world’s political leaders are increasingly focused on them, as demonstrated by the Paris Climate Accord. Over the long-term, environmental, social and governance (ESG) issues – ranging from climate change to diversity to board effectiveness – have real and quantifiable financial impacts.
At companies where ESG issues are handled well, they are often a signal of operational excellence. BlackRock has been undertaking a multi-year effort to integrate ESG considerations into our investment processes, and we expect companies to have strategies to manage these issues. Recent action from the U.S. Department of Labor makes clear that pension fund fiduciaries can include ESG factors in their decision making as well. We recognize that the culture of short-term results is not something that can be solved by CEOs and their boards alone. Investors, the media and public officials all have a role to play. In Washington (and other capitals), long-term is often defined as simply the next election cycle, an attitude that is eroding the economic foundations of our country.
Public officials must adopt policies that will support long-term value creation. Companies, for their part, must recognize that while advocating for more infrastructure or comprehensive tax reform may not bear fruit in the next quarter or two, the absence of effective long-term policies in these areas undermines the economic ecosystem in which companies function – and with it, their chances for long-term growth.
We note two areas, in particular, where policymakers taking a longer-term perspective could help support the growth of companies and the entire economy:
• First, tax policy too often lacks proper incentives for long-term behavior. With capital gains, for example, one year shouldn’t qualify as a long-term holding period. As I wrote last year, we need a capital gains regime that rewards long-term investment – with long-term treatment only after three years, and a decreasing tax rate for each year of ownership beyond that (potentially dropping to zero after 10 years).
• Second, chronic underinvestment in infrastructure in the U.S. – from roads to sewers to the power grid – will not only cost businesses and consumers $1.8 trillion over the next five years, but clearly represents a threat to the ability of companies to grow. At a time of massive global inequality, investment in infrastructure – and all its benefits, including job creation – is also critical for growth in most emerging markets around the world. Companies and investors must advocate for action to fill the gaping chasm between our massive infrastructure needs and squeezed government funding, including strategies for developing private-sector financing mechanisms.
Over the past few years, we’ve seen more and more discussion around how to foster a long-term mindset. While these discussions are encouraging, we will only achieve our goal by changing practices and policies, and CEOs of America’s leading companies have a vital role to play in that debate.
Corporate leaders have historically been a source of optimism about the future of our economy. At a time when there is so much anxiety and uncertainty in the capital markets, in our political discourse and across our society more broadly, it is critical that investors in particular hear a forward-looking vision about your own company’s prospects and the public policy you need to achieve consistent, sustainable growth. The solutions to these challenges are in our hands, and I ask that you join me in helping to answer them.
(source Business Insider)