Firms should resist short-termism, create long-term value

OVER the past several years, I have written to the CEOs of leading US companies urging resistance to the powerful forces of short-termism afflicting corporate behaviour. 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 long-term goals, as well as for the entire global economy.

While I'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 per cent over 12 months. We certainly support returning excess cash to shareholders, but not at the expense of value-creating investment.

LONG-TERM VALUE CREATION FRAMEWORK

We are asking that every CEO lay out for shareholders each year a strategic framework for long-term value creation. In addition, 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.

We recognise 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 a company will need to pivot in response to the changing environments it is 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.

ACTIVISTS' PERSPECTIVE

Without clearly articulated plans, companies risk losing the faith of long-term investors. Companies also expose themselves to the pressures of investors focused on maximising 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 destabilising 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 US proxy contests (as measured by market cap), BlackRock voted with activists 39 per cent 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.

REPORTING PROGRESS

Over time, as companies do a better job laying out their long-term growth frameworks, the need diminishes for quarterly EPS (earnings per share) 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 behaviour. 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.

ENVIRONMENTAL AND SOCIAL IMPACT

Generating sustainable returns over time also requires a sharper focus not only on governance, but also environmental and social (ESG) factors. Over the long-term, ESG issues - ranging from climate change to diversity to board effectiveness - can 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.

STAKEHOLDERS TO BUY IN

We recognise 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 also have a role to play in changing the culture of short-term results.

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 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 companies' prospects and the public policy they need to achieve consistent, sustainable growth. The solutions to these challenges are in our hands, and I ask that CEOs join me in helping to answer them.