Larry Fink Wants Companies to Talk More About the Future
One way I like to think about the stock buyback debate is that it's a debate over who should get to allocate capital to projects. Some people think that if the manager of a company is skilled enough to make money for that company, she should get to hold onto it and invest it in new projects. After all, she has shown that she is able to make money. Other people think that she should give the money back to the shareholders, so they can invest it in new projects. After all, it is their money, and they have shown that they are able to invest it profitably. Neither of these views is unassailable, and for roughly the same reasons: Past success, in business and in investing, only weakly predicts future success. But there the money is, and someone has to decide what to do with it.
This debate is sometimes described as one about long-termism versus short-termism, with long-termism meaning that the managers get to keep the money for a long time and short-termism meaning that they don't. Larry Fink, the chief executive officer of BlackRock, is one of the best-known advocates of long-termism, and a member of the secret club of investors that we talked about this morning, which meets to plot ways to make companies more long-term-oriented. Yesterday, Fink sent a letter to more than 500 companies saying that they should keep their money, but tell investors how they're going to spend it:
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.
Fink's letter has gotten a lot of attention for its call for companies to "move away from providing" quarterly earnings guidance: "Today’s culture of quarterly earnings hysteria is totally contrary to the long-term approach we need." But its vision of how companies should be managed is also revealing.
Fink thinks that companies should be managed by their managers. This doesn't sound especially revolutionary, when you say it like that, but of course there is a competing view. Lots of investors think that they have some pretty good ideas for how companies should be managed -- buybacks are often involved -- and aren't shy about proposing them. Sometimes those proposals are appealing, even to long-termers, and BlackRock sometimes backs them. "Nevertheless," writes Fink, "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."
It's useful to keep the capital-allocation-debate model in mind as you read this letter. Fink's message to managers is that they, rather than activist investors, should take the lead in deciding what projects should get funded. But Fink is very different from the average activist investor. In particular, he doesn't have a concentrated portfolio of high-impact activist bets. He runs a company that is really good at index funds and exchange-traded funds. At least on the equities side, BlackRock's business model is about diversified ownership of many companies. And it doesn't have much of a choice: BlackRock manages $4.6 trillion, and the long-term investors' club combines for more than $12 trillion, which comes to more than two-thirds of the entire value of the Standard & Poor's 500 Index. BlackRock, and the long-term club generally, basically own the whole market, because they have to.
If you own the whole market, capital allocation isn't the source of joy and outperformance that it might be for Carl Icahn or Bill Ackman. If a company's management, in an exercise of discipline and self-negation, decides not to reinvest its profits but instead hand the money back to you, what can you do with it? You have already put your money everywhere; where else can you put it?
If you own the whole market, you are unlikely to get a lot of performance by choosing the best projects to invest in, or to develop any particular skill set in doing that. You're choosing all the companies, with all the projects. You're much more likely to get performance by letting the managers of all those companies discover new projects and allocate capital to them. If they give the capital back to you, you're just going to index it anyway. You're not going to make the wild bets on the future. You're relying on corporate managers to do that.
Plausibly, life is different for more concentrated investors. There is perhaps a connection to what I have called the Azar-Schmalz critique of diversified investing, that it discourages competition among firms owned by the same set of diversified asset managers. Diversified investing does rather require leaving the capital-allocation decisions to managers, and leaving decisions to managers is, in the Azar-Schmalz theory, how managers end up not competing too hard against each other.
But Fink doesn't argue that managers should be left alone to manage however they want. Instead, he says they should tell investors how they plan to manage. "One reason for investors’ short-term horizons," he writes, "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." So he wants CEOs to "lay out for shareholders each year a strategic framework for long-term value creation":
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.
This proposal is partly tactical, a way to combat activism rhetorically. For all the criticism about short-termism, activists typically do come to companies with a plan for the future, and they tend to do best at companies where the future is the murkiest. That is why Yahoo is tripping over activists. Companies with their own clearly articulated plans for the future might take away the opportunity for activists to define it for them.
But also, I mean, if you are an investor, you might want to know your company's plans, no? It is odd that corporate disclosure is so backward-looking; like so much in corporate life, it is probably due mostly to the fear of litigation. Of course quarterly earnings guidance is forward-looking, and tends to be larded up with disclaimers out of just that fear of litigation. Perhaps Fink's idea -- less earnings guidance, more long-term-plan disclosure -- offers sort of a conservation law of litigation risk: If you stop worrying about whether you'll be sued because your earnings guidance turned out wrong, you can spend more time worrying about whether you'll be sued because your long-term plan turned out wrong.
Also, notice that Fink's list of "what investors and all stakeholders truly need" is exactly what isn't (for the most part) in companies' public disclosures. If you are a big investor, and there is a perspective that you "truly need," and you can't find it in a company's public filings, what do you do? Well, you call up the company, and you set up a meeting with the CEO, and you sit down with her and look her in the eye and ask her how she is adapting to technological disruption or developing talent or whatever. And she ... tells you, right? And you go off and buy stock. And you and she and everyone's lawyers are satisfied that this was legal: She didn't give you any "material nonpublic information," because after all she didn't tell you anything about next quarter's numbers, or anything that should be disclosed in a filing. It was just vague long-term qualitative stuff.
Obviously that isn't legal advice, but I think it goes some part of the way to explaining why investors like meeting with management teams so much, and why investors who do so outperform, and why those investors and managers don't get in trouble. And, conversely, why prosecutors tried to imprison Todd Newman for years because he found out that a company's gross margin for the just-closed quarter was going to be 17.5 percent instead of 18.3 percent. Everyone is supposed to get the short-term stuff at the same time. The long-term plans are squishier and less regulated, but at least some people think they're more important.
One more fun thing in Fink's letter is his view on the role of corporate managers in public affairs. He's got his own particular policy ideas -- a longer time horizon for long-term capital gains tax treatment, more infrastructure spending, etc. -- but of more general interest is his statement that "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." It is worth reading that with your Azar-Schmalz glasses on, and imagining Fink not as a guy at a keyboard with some ideas about politics but rather as the boss of hundreds of giant companies' CEOs. All those CEOs woke up today with a letter from the owner -- who they now know regularly meets with other owners to decide how companies should be run -- suggesting that maybe they should lobby for more infrastructure spending. Will they? Should they? Is the power of giant diversified asset managers maybe just the tiniest bit worrying?
I've written about this before, when I mentioned a simple descriptive model in which each company is good at one thing, and if it invests the profits from that one thing in other things, it will probably mostly squander them. "Companies are obsessed with having a second act," writes Bloomberg Gadfly's Shira Ovide, "and few can."
Of course, on the investor side the news isn't great either; the lack of persistence in outperformance is one of the best-established facts in finance. There are some exceptions, like Warren Buffett, but he's part of the Larry Fink long-termism cabal himself.
That's sort of a dumb way to say it, but a reasonable way to model it. Long-termism means that the managers are supposed to invest the money in projects that take a long time to come to fruition but that are very profitable; the investors have to have a certain amount of faith in the managers, because they can't directly observe the long-term payoffs while they wait. Short-termism (used as a derogatory term) means that managers are supposed to make short-term profits at the expense of long-term gains; the investors can observe these profits and, if they aren't sufficiently large, they can get mad at the managers and run proxy fights and so forth. So long-termism versus short-termism is about more than buybacks, but buybacks are in some sense the instrument of the fight.
Whenever one thinks about corporate governance and agency costs, one runs into the fact that the "investors" involved are pretty much always agents themselves. It's not the hedge fund managers' money, or not entirely; it's certainly not Larry Fink's $4.6 trillion. It is sometimes convenient to pretend that corporate managers are acting as agents for the managers of BlackRock, Fidelity, etc., but it is always worth keeping in mind that that's not true: The corporate managers and the BlackRock managers are both acting as fiduciaries for millions of dispersed investors, and the question is which of them are doing a better job.
That is, $4.6 trillion for BlackRock, $3 trillion for Vanguard, $2 trillion for Fidelity (plus another $3 trillion in non-managed customer assets), $1.7 trillion for JPMorgan and $1.1 trillion for Capital Group. Plus Berkshire Hathaway is worth $300 billion or so, though its two biggest non-Buffett investors are Fidelity and Capital so there is some risk of double-counting. The S&P 500 market cap is just a bit under $17 trillion. Obviously most of those firms' money isn't in S&P 500 equities, so it's not like they own two-thirds of the S&P. But as Bill Ackman points out:
Scroll through the ownership registry of corporate America and the top three holders are typically Vanguard, Blackrock, and State Street. As the biggest managers of index funds, they often cumulatively own 12%, and as much as 20%, of nearly every public company.
Not this year, but you know what I mean.
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