A Watershed Moment on Wall Street?
January 22, 2018
On January 16, 2018, Larry Fink, founder and CEO of investment firm BlackRock wrote a letter to the CEOs of the world’s largest publicly held corporations calling upon them to benefit not only their investors, but society as a whole.
In his letter, Fink (2018) observes many governments failing on issues such as retirement, infrastructure investments, and automation.
“As a result, society is increasingly turning to the private sector and asking that companies respond to broader societal challenges. […] Society is demanding that companies … serve a social purpose. To prosper over time, every company must not only deliver financial performance, but also show it makes a positive contribution to society” (Fink, 2018).
A company’s activities need to benefit all stakeholders not just its shareholders. In today’s environment:
“…these stakeholders are demanding that companies exercise leadership on a broad range of issues”. […]. A company’s ability to manage environmental, social and governance matters … is essential to sustainable growth” (Fink, 2018).
According to Fink, BlackRock’s clients – investors – are calling on firms to demonstrate the leadership and clarity driving not only the returns on their investment but also “…the prosperity and security of their fellow citizens”.
A Sense of Purpose
In his letter, Fink contends that companies will “succumb to short-term pressures to distribute earnings”, sacrifice investments needed to ensure long-term growth, and risk losing their license to operate from key stakeholders if they do not have a clear “sense of purpose”.
When Fink calls on firms to develop a clear “sense of purpose”, he is inviting them to confront fundamental questions such as: Why does our firm exist? What is the contribution our organization wants to make? In essence, an organization’s purpose is the definitive statement about the difference it is trying to make. A clear statement of purpose holds the organization together and provides long-term direction.
Argue to Mackey & Sisodia (2014):
“When the purpose is clear, leadership can make quicker and better decisions. Clarity of purpose also leads to bolder decisions. Rather than adjusting decisions according to the winds of public opinion or changes in the competitive environment, decisions in a purpose-driven company take those things into consideration while also being informed by something more soulful and sturdy. This leads to superior overall performance” (2014, p. 49).
Importantly, purpose and profits are not opposites. They need each other. Profits are essential to the survival of the firm. In fact, one could argue that it is socially irresponsible to run a business without consistently generating profits. But, a firm’s focus on profits should be long-term and not short-term. According to Mackey & Sisodia (2014):
“Companies can become obsessed with trying to raise their numbers for the next quarter so that they will look good in the analysts’ financial models and receive a good grade. […] But those grades do not always reflect the best long-term positioning of the business. That approach may work in the short term, but in the long term, it can cause companies to move away from fulfilling their purpose and creating long-term value for all its stakeholders. (2014, p. 105)
Similar to Mackey and Sisodia, Fink laments the excessive focus of companies on short-term (quarterly) performance. He calls on CEOs to become much more explicit about their long-term growth strategy and “publicly articulate its strategic framework for long-term value creation”. A company’s long-term strategy should describe its path to financial performance. However, to sustain its financial performance, a company needs to understand the societal impact of its business. According to Fink, companies need to ask themselves questions such as:
“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?” (Fink, 2018).
From now on, BlackRock will hold firms accountable for its impact on society as it will formally integrate into its investment process issues such as a company’s ability to manage environmental, social, and governance matters.
Doing Well by Doing Good
In his letter, Fink is also making the case that doing well will lead to doing good. He recognizes that it is in the firm’s best (financial) interests to consider the societal consequences of its actions. Businesses are better off when they are concerned about our communities. Having a clear social purpose is inextricably linked to a company’s ability to sustain its profits.
Business and society are not opposites but in the past they often have been pitted against each other. Indeed, it has often been hypothesized that firms who invest in stakeholder relations and improve their social performance will be penalized by investors who are only interested in financial returns. Investments in social performance are believed to impose constraints on firms. These constraints will raise firms’ costs and reduce profits. Social performance investments are therefore widely seen as an irresponsible use of shareholder money. In this view, business “contributes to society by making a profit, which supports employment, wages, purchases, investments, and taxes” (Porter & Kramer, 2011, p. 66).
Recently however, the idea that businesses can be better off (i.e. enjoy a competitive advantage leading to superior profits) when they take on society’s problems is gaining ground. Much of Fink’s argument about the social accountability of firms rests on a fundamental change in perspective about the relationship between business and society, a perspective which Porter and Kramer (2011) have called ‘Creating Shared Value’. The concept of shared value can be defined as all “…policies and operating practices that enhance the competitiveness of a company while simultaneously advancing the economic and social conditions in the communities in which they operate” (Porter & Kramer, 2011, p. 66). The concept of shared value recognizes that economic value can be created in a way that also creates value for society. Businesses acting as businesses are a powerful force capable of solving many of society’s most pressing challenges. With governments increasingly failing to address societal challenges, Fink calls on businesses to build long-term strategies that generate sustainable profits while making “a positive contribution to society”, i.e. to create shared value.
Exit Friedman (1970)?
Fink’s letter to CEOs seems to call into question the long-standing argument that a firm’s sole responsibility is to its shareholders. Nobody has argued the primacy of shareholders better than Friedman in his famous 1970 New York Times essay “The Social Responsibility of Business is to Increase its Profits”.
In this essay, Friedman was trying to debunk the notion that corporations have a ‘responsibility’ to increase social welfare. Interestingly, Friedman did not argue that businesses should never engage in activities that increase social welfare; in fact, he submits that free-market capitalism itself increases social welfare.
In Friedman’s view, executives – as agents acting on behalf of the principal (the shareholder)[i] - should not be spending “somebody else’s money” for general social interests. Thus, executives should not be making “expenditures on reducing pollution beyond the amount that is in the best interests of the corporation or that is required by law in order to contribute to the social objective of improving the environment” (Friedman, 1970). Such actions of ‘social responsibility’ would ultimately reduce the returns to shareholders. Executives who pursue a goal other than making money are “unwitting puppets of the intellectual forces that have been undermining the basis of a free society” (Friedman, 1970).
According to Friedman:
“A corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom. […] The key point is that, in his capacity as a corporate executive, the manager is the agent of the individuals who own the corporation […] and his primary responsibility is to them” (Friedman, 1970). [ii]
"There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game” (Friedman, 1970).
Fink challenges Friedman’s thinking when he contends that companies “must benefit all of its stakeholders, including shareholders, employees, customers, and the communities in which they operate” (Fink, L., 2018). In his letter, Fink seems to subscribe to Freeman’s (2001) ‘Stakeholder Enabling Principle’ which states that corporations shall be managed in the interests of its stakeholders defined as employees, financiers, customers, employees, and communities.
Fink’s contention accurately recognizes that a business does not operate in a vacuum. It requires investors to give it money, customers to buy its products/services, employees to serve its customers, suppliers to sell them its inputs, and a community within which it can thrive. If any of these groups are absent, the business cannot be successful. Businesses are part of a complex system involving multiple stakeholders. One of the best ways to maximize long-term profits is to create value for all stakeholders in the system.
The outcome Fink seeks for his clients is a healthy long-term return. He will not accept disappointing performance. The challenge he lays out in his letter “…is to simultaneously walk and chew gum, to find that magic resolution of the seemingly competing mandates: deliver financial returns and make the world better at the same time” (Horst, 2018).
Where do we go from here?
With $6.3 trillion assets under management, BlackRock’s call for companies to consider the societal impact of their business, is a welcome one. Coming from anyone else, such a plea would be summarily dismissed as naive. However, when a message like this comes from the CEO of BlackRock, it may very well get the hearing it deserves.
Fink’s letter is widely seen as a very important statement. Argues Yale School of Management professor Jeffrey Sonnenfelt: “It is huge for an institutional investor to take this position across its portfolio”. “[I have seen] nothing like it” (Sorkin, 2018). According to Peter Horst (former CMO of Hershey’s), Fink’s letter qualifies as a watershed moment. “Some events stand out as watershed moments that re-define the environment and re-direct the course of events. Bill Gates writing his “Tidalwave of the Internet” memo in 1995. Steve Jobs holding up the iPhone in 2007. I believe we’re seeing another such moment” (Horst, 2018).
While it’s too early to tell whether Mr. Fink’s letter will be more than rhetoric, the simple fact that the CEO of the largest investment firm in the world calls for firms to be more conscious of their impact on society can only be good news. Only time will tell whether BlackRock will in fact use its investments to stimulate companies to assume their societal responsibility.
IMM Global Executive MBA
Filip Caeldries is Academic Director of the IMM – Global Executive MBA program where he teaches the Strategic Management and Geo-Competitive Perspectives courses.The IMM –Global Executive MBA program is a partnership program with TIAS School for Business and Society (NL), Purdue University (USA), Central European University (Hungary), Tianjin University (China) and FGV-EBAPE (Brazil). In 2016, Poets & Quants named him as one of the ‘Favorite Professors of the Best and Brightest EMBAs’.
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Fink, L. (2018), “Larry Fink’s annual letter to CEOs: A sense of purpose”.
Freeman, R.E. (2001), “Stakeholder theory of the modern corporation”, General Issues in Business Ethics, 3, pp. 38-48.
Friedman, M. (1970), “The social responsibility of business is to increase its profits”, New York Times, September 13, pp. 122-124
Horst, P. (2018), “BlackRock CEO tells companies to contribute to society. Here’s where to start”. https://www.forbes.com/sites/peterhorst/2018/01/16/blackrock-ceo-tells-companies-to-contribute-to-society-heres-where-to-start/#2f4e6be971d6
Jensen, M.C. & W.H. Meckling (1976), Theory of the firm: Agency costs and ownership structure, Journal of Financial Economics, Vol. 3 (0ctober), pp. 305-360.
Mackey, J. & R. Sisodia (2014), Conscious Capitalism, Harvard Business Review Press, Boston, MA.
Porter, M.E. & M. R. Kramer (2011), Creating Shared Value, Harvard Business Review, Vol 89 (January-February), pp. 62-77.
Sorkin, A. R. (2018), “BlackRock’s message: Contribute to society, or risk losing our support”. https://www.nytimes.com/2018/01/15/business/dealbook/blackrock-laurence-fink-letter.html
[i] In a seminal academic paper (“Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure”) Jensen and Meckling (1976) echo (and ‘formalize’) Friedman’s focus on shareholder value maximization. In their article, the authors focus on the principal-agent problem. The shareholders are seen as the principals of the firm—i.e., they own it and benefit from its prosperity, while the executives are agents who are hired by the principals to work on their behalf. A principal-agent problem occurs because agents have an inherent incentive to optimize activities and resources for themselves rather than for their principals. Jensen and Meckling argued that the singular goal of a company should be to maximize the return to shareholders. In order to align the interests of principals and agents, the agents (executives) should be given stock-options.
[ii] Friedman’s statement that “the executive is the employee of the owner of the business” i.e. the shareholder is not entirely correct. Legally speaking, the executive is the employee of the corporation.