Making better choices … Business leaders are waking up to the profitability of doing good, from Wall Street to Odense!

September 21, 2018

This year’s Thinkers50 European Business Forum focus on “Making Better Choices”. I will be hosting the event, Europe’s leading meeting of leaders and thinkers, and getting them to explore one of the big issues of our times. How can business do better for the world?

At last year’s EBF Michael Porter stood up and delivered the European Business Lecture about “shared value”, the need for business to look beyond profits and shareholders as their holy grail. To create value for society too, and potential by doing this to be more successful overall. The 400 leaders gathered had also challenged the prevalent obsession with tech and data, analytics and performance. To be more human, to open our eyes to a changing world, that is more than AI and robotics, but also about ethics and responsibility, diversity and equality, environment and climate, and much more.

New research by Ipsos/Mori shows that

  • 47% of consumers believe that ethically run businesses are better for the economy
  • 48% prefer to use or purchase from businesses that act ethically
  • 37% believe businesses should put social purpose ahead of making profits

Earlier this year BlackRock’s Larry Fink wrote a letter to all CEOs. The basic message of his landmark open letter was simple: if you want your firm to prosper, it needs a “social purpose” and it needs one fast. He even suggested that his company, one of the world’s largest investment firms, would only continue to invest in companies who could demonstrate they did good beyond profit.

Waking up to the profitability of doing good

As a new Raconteur report on Responsible Business puts it, this was groundbreaking stuff. Not so much the message itself. For the best part of two decades now, management gurus and business theorists have been arguing that corporations have to focus on more than just profit maximisation.

What’s remarkable about the letter is that it was written by the head of a multinational investment management corporation. This is no environmentalist fretting about saving the world’s forests. No, this is a man in charge of managing assets worth more than $6 trillion: a titan of hard-nosed finance, in other words.

The slow awakening of the financial mainstream to sustainability issues is as welcome as it is overdue. To quote the old adage, it proves that responsible business is as much about doing well as it is doing good.

Part of the argument for taking seriously non-financial issues centres around risk. Mega-trends such as climate change and population growth present huge threats to business as usual. Think of food manufacturers in a world of increasing droughts. Or transport firms in cities paralysed by gridlock.

But, as always with finance, there’s also the scent of juicy profits in the offing. Imagine the billions of dollars awaiting the company that works out how to tap methane from livestock, a major contributor to the greenhouse gas count. Or the fortunes in store for the firm that cracks global obesity?

Shifting the focus from shareholders to stakeholders

So far, so logical. But is the business world buying it? And, even if companies are genuinely trying to embrace sustainability, how are they getting on?

The verdict on both counts is mixed. On the upside, almost every chief executive these days is conversant on the importance of responsible business. Less positive is the gap between words and action, as events like the Volkswagen emissions scandal reveal only too clearly.

Stakeholder theory means putting employees, customers, communities, suppliers and the planet at the centre of business, rather than just shareholders. And this requires a total rethink, says Charmian Love, co-founder of B Lab UK, a pro-sustainability charity.

But it’s a rethink that more and more companies are seeking to make. “Around the world, we’re seeing the purpose of business being rethought so that it operates for people and planet as well as for profit,” she says.

Take Danone. With more than 100,000 employees and a market value of almost €70 billion, the French food giant is a business stalwart. Yet that didn’t stop its North American subsidiary recently qualifying as a B Corp, a certification issued by B Lab for companies practising stakeholder theory.

Other large-scale B Corps include the Brazilian cosmetics company Natura, which now owns Body Shop, and the iconic ice cream brand Ben & Jerry’s, part of Anglo-Dutch consumer conglomerate Unilever.

Moving businesses to stakeholder model not straightforward

Gaining a reputation for sustainability can help firms edge ahead with consumers. Survey after survey points to the growing importance that shoppers place on social and environmental issues.

But there are other business benefits to be had as well. Lower interest rates on loans, greater operational efficiencies and a more motivated workforce are just some of the positive outcomes cited by Danone’s chief executive Emmanuel Faber.

Of course, shifting to a model based on stakeholder theory is not without its challenges. Business strategists aren’t stupid. If the economic case for operating sustainably was so clear cut, every company would already be doing it. When the payback isn’t immediate or obvious, it’s often hard for internal change agents to get a hearing.

That’s where leadership comes in. Without exception, the corporations leading the sustainability charge have people on their boards who, whether for reasons of head or heart, are fully behind this new way of doing business.

Stepping out so boldly takes guts, especially for a listed company with fiduciary duties to its shareholders. The sheer size of most publicly traded companies also adds additional complexities. Like ponderous oil tankers, global corporations built on shareholder primacy often find it hard to change course.

Smaller firms ahead of the curve with stakeholder theory implementation 

For both reasons, the stakeholder theory trailblazers tend to be smaller firms under private ownership. As well as being more organisationally nimble, many are specifically founded to meet societal challenges. Unlike traditional companies, therefore, social purpose doesn’t have to be retrofitted, it’s there from the get-go.

The UK fairtrade chocolate brand Divine Chocolate provides just such an example. Established 20 years ago, the business was set up to better the lives of African farmers. Today, it pays a premium to its cocoa suppliers as well as reinvesting 2 per cent of its revenue in community projects.

Giving stakeholders a voice is critical to keeping Divine true to its mission, says Sophi Tranchell, the firm’s chief executive. As such, its board includes representatives from the Kuapa Kokoo co-operative in Ghana, which owns 44 per cent of the company and supplies the bulk of the cocoa for Divine’s chocolate bars.

“With representatives of Kuapa Kokoo on our board, we are supported and encouraged to do business differently with more long-term objectives,” says Ms Tranchell.

Let’s not kid ourselves, shareholders remain king. But the rise of stakeholder theory is eating into their rule. That’s good news for society at large. And, if Mr Fink is to be believed, it’s in shareholders’ economic interests too.

BlackRock CEO Larry Fink’s Letter to CEOs

“A Sense of Purpose”

Dear CEO,

As BlackRock approaches its 30th anniversary this year, I have had the opportunity to reflect on the most pressing issues facing investors today and how BlackRock must adapt to serve our clients more effectively. It is a great privilege and responsibility to manage the assets clients have entrusted to us, most of which are invested for long-term goals such as retirement. As a fiduciary, BlackRock engages with companies to drive the sustainable, long-term growth that our clients need to meet their goals.

In 2017, equities enjoyed an extraordinary run – with record highs across a wide range of sectors – and yet popular frustration and apprehension about the future simultaneously reached new heights. We are seeing a paradox of high returns and high anxiety. Since the financial crisis, those with capital have reaped enormous benefits. At the same time, many individuals across the world are facing a combination of low rates, low wage growth, and inadequate retirement systems. Many don’t have the financial capacity, the resources, or the tools to save effectively; those who are invested are too often over-allocated to cash. For millions, the prospect of a secure retirement is slipping further and further away – especially among workers with less education, whose job security is increasingly tenuous. I believe these trends are a major source of the anxiety and polarization that we see across the world today.

We also see many governments failing to prepare for the future, on issues ranging from retirement and infrastructure to automation and worker retraining. As a result, society increasingly is turning to the private sector and asking that companies respond to broader societal challenges. 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. 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. And ultimately, that company will provide subpar returns to the investors who depend on it to finance their retirement, home purchases, or higher education.

A new model for
corporate governance

Globally, investors’ increasing use of index funds is driving a transformation in BlackRock’s fiduciary responsibility and the wider landscape of corporate governance. In the $1.7 trillion in active funds we manage, BlackRock can choose to sell the securities of a company if we are doubtful about its strategic direction or long-term growth. In managing our index funds, however, BlackRock cannot express its disapproval by selling the company’s securities as long as that company remains in the relevant index. As a result, our responsibility to engage and vote is more important than ever. In this sense, index investors are the ultimate long-term investors – providing patient capital for companies to grow and prosper.

Just as the responsibilities your company faces have grown, so too have the responsibilities of asset managers. We must be active, engaged agents on behalf of the clients invested with BlackRock, who are the true owners of your company. This responsibility goes beyond casting proxy votes at annual meetings – it means investing the time and resources necessary to foster long-term value.

The time has come for a new model of shareholder engagement – one that strengthens and deepens communication between shareholders and the companies that they own. 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. 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.

BlackRock recognizes and embraces our responsibility to help drive this change. Over the past several years, we have undertaken a concentrated effort to evolve our approach, led by Michelle Edkins, our global head of investment stewardship. Since 2011, Michelle has helped transform our practice from one predominantly focused on proxy voting towards an approach based on engagement with companies.

The growth of indexing demands that we now take this function to a new level. Reflecting the growing importance of investment stewardship, I have asked Barbara Novick, Vice Chairman and a co-founder of BlackRock, to oversee the firm’s efforts. Michelle will continue to lead the global investment stewardship group day-to-day. We also intend to double the size of the investment stewardship team over the next three years. The growth of our team will help foster even more effective engagement with your company by building a framework for deeper, more frequent, and more productive conversations.

Your strategy, your board, and
your purpose

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, outlined in past letters, 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. This demonstrates to investors that your board is engaged with the strategic direction of the company. When we meet with directors, we also expect them to describe the Board process for overseeing your strategy.

The statement of long-term strategy is essential to understanding a company’s actions and policies, its preparation for potential challenges, and the context of its shorter-term decisions. Your company’s strategy must articulate a path to achieve financial performance. To sustain that performance, however, you must also understand the societal impact of your business as well as the ways that broad, structural trends – from slow wage growth to rising automation to climate change – affect your potential for growth.

These strategy statements are not meant to be set in stone – rather, they should continue to evolve along with the business environment and explicitly recognize possible areas of investor dissatisfaction. Of course, we recognize that the market is far more comfortable with 10Qs and colored proxy cards than complex strategy discussions. 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.

In the United States, for example, 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. 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. The U.S. tax bill is only one such example – 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.

Where activists do offer valuable ideas – which is more often than some detractors suggest – we encourage companies to begin discussions early, to engage with shareholders like BlackRock, and to bring other critical stakeholders to the table. But when a company waits until a proxy proposal to engage or fails to express its long-term strategy in a compelling manner, we believe the opportunity for meaningful dialogue has often already been missed.

The board’s engagement in developing your long-term strategy is essential because an engaged board and a long-term approach are valuable indicators of a company’s ability to create long-term value for shareholders. Just as we seek deeper conversation between companies and shareholders, we also ask that directors assume deeper involvement with a firm’s long-term strategy. 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. Likewise, executives who view boards as a nuisance only undermine themselves and the company’s prospects for long-term growth.

We also will continue to emphasize the importance of a diverse board. 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. And they are better able to identify opportunities that promote long-term growth.

Furthermore, the board is essential to helping a company articulate and pursue its purpose, as well as respond to the questions that are increasingly important to its investors, its consumers, and the communities in which it operates. In the current environment, these stakeholders are demanding that companies exercise leadership on a broader range of issues. And they are right to: a company’s ability to manage environmental, social, and governance matters demonstrates the leadership and good governance that is so essential to sustainable growth, which is why we are increasingly integrating these issues into our investment process.

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? Are we using behavioral finance and other tools to prepare workers for retirement, so that they invest in a way that will help them achieve their goals?

As we enter 2018, BlackRock is eager to participate in discussions about long-term value creation and work to build a better framework for serving all your stakeholders. Today, our clients – who are your company’s owners – are asking you to demonstrate the leadership and clarity that will drive not only their own investment returns, but also the prosperity and security of their fellow citizens. We look forward to engaging with you on these issues.


Larry Fink Signature

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