BlackRock CEO, Larry Fink: “We can tell a company to fire 5000 employees tomorrow, or tell a company to do something that maybe is bad for the environment, and if that maximizes return for the company, we did something well”
In 1970, Milton Friedman attracted the attention of the American public when he famously declared that the only social responsibility of business is to increase its profits. His statement has since become the standard framework for financial economists worldwide. But is it still valid, 46 years later? Should firms move away from focusing solely on maximizing shareholder value and take into consideration other objectives, such as environmental concerns or the welfare of their employees? Doesn’t the growing political clout of corporations negate Friedman’s assumptions about the positive effects of competitive markets on social welfare, as firms have started to actively change the rules of the game? Should there, in fact, be a limit on the ability of firms to pursue maximization of shareholder value?
These questions were the focus of a lively debate in January, hosted by the University of Chicago and the Booth School of Business at the World Economic Forum in Davos.
The panel featured BlackRock chairman and CEO Larry Fink, RBI Governor (and Distinguished Service Professor of Finance at Booth) Raghuram Rajan, Deloitte CEO Cathy Engelbert, Publicis CEO Maurice Lévy, and Luigi Zingales, the Robert C. McCormack Distinguished Service Professor of Entrepreneurship and Finance at Booth and the Director of the Stigler Center. The panel was moderated by Guy Rolnik, Clinical Associate Professor of Strategic Management at Booth.
The debate touched on such issues as short-termism, the question of “purpose over profit,”and the potential influence of powerful internet monopolies on democracy. Mostly, though, the panel focused on the social and political roles of corporations in the 21st century.
Asked about the letter he sent in April to S&P 500 CEOs, in which he urged fellow CEOs to avoid “shortsightedness,” Fink—who leads the world’s largest asset management firm, with about $4.5 trillion in assets—elaborated on the dangers of short-termism and the necessity of long-term planning. “We’re seeing a real reduction in long-term investing in so many different industries,” said Fink. “I do believe we have forgotten what our responsibilities are as business leaders.”
Fink continued to stress the importance of government incentives to longer term behavior, including capital gains tax reform, and pointed a finger at hedge fund activists. “In 1950, the average company was in the S&P 500 for fifty years. Today the average company is in for eighteen years,” he said, adding that “the growth in hedge funds had led to what I call aberrant behavior.”
Engelbert also spoke about the problem of short-termism, referring to what she identified as a dichotomy between the wishes of CEOs and CFOs to invest in the long term, and their inability to not focus on quarterly reports. “What creates some of the tension is the earnings guidance, the quarterly guidance. If you’ve been in any boardrooms lately, the first thing you hear is ‘How are you doing versus guidance?’ Business decisions shouldn’t be driven by the accounting, it’s the accounting that is driven by the business decisions. In our ADD society, we have a hard time following that mantra.”
Lévy too placed blame on activist investors, stating, “A lot of our clients are feeling not only huge pressure for short-term decision and short-term plans, but also, some stockholders who believe they are acting in the goods of the shareholders are pushing for short-term decisions—selling assets, breaking down companies—without taking into account the history of the company. This is good for the short term, but may impact the viability of the company in the long term.”
Lévy went on to warn that a focus on short-term gains might lead to public anger. “When you have solid fundamentals, you have a duty to build wealth for the future. You have duty to take into account all the stakeholders: the employees, the environment. You live in a city, you have a responsibility toward the city. When I see people slashing hundreds or thousands of employees, or moving from a city that had been very generous to them simply to save money on leases, maybe it’s a good short-term decision, but I am not sure that it’s good behavior.”
“This debate about short-termism is a bit schizophrenic,” said Zingales. “Have I seen short-term behavior when I sat on boards? Absolutely. The question is what forces this, and I don’t agree with Larry [Fink] that this is forced by the activist investors.”
“The vast majority of academic literature says that activist investors not only create value in the short term but also create value in the long term. There’s no evidence that they actually destroy value; if anything they create value. If anyone is putting pressure, it’s not the market, it’s the board. And who appoints the board? Larry,” said Zingales, referring to BlackRock’s status as a shareholding giant. (In 2012, according to a Michigan University study, BlackRock was the single largest shareholder of one in five US companies, and a major shareholder of 40 percent of all publicly-listed American companies.)
Zingales went on to suggest that, “Maybe we should change the way we appoint boards. Board elections these days are the closest thing to Soviet elections in the Western world: you have incumbents listing a bunch of names, you can vote ‘yes’ or withdraw your vote, and even if you don’t have a majority, you still get elected and you stay on the board.”
“I am not against activism”, said Fink. “We voted 40 percent of the time with activists. We never mentioned activists in my letter. The letter is about having better governance at the board.”
Lambasting the Department of Labor’s so-called “fiduciary rule,” which applies new fiduciary standards on brokers who work with retirement accounts, Fink said, “We live in a world where the Department of Labor gave us this guidance about what is our fiduciary responsibility as investors. We only have one responsibility as investors: to maximize return. That’s it. So basically we can tell a company to fire five thousand employees tomorrow, and if that maximizes return for the company we did something well. We can tell that company to do something that maybe is bad for the environment. There is nothing right now that guides, other than a maximization of return behavior.”
“If you invested large sums of money right now for environmental good, and if you lost two percent versus what you should have earned, you could get sued by the Department of Labor,” claimed Fink, to which Zingales said: “I asked lawyers, and they basically told me it’s impossible to sue on that ground. We had a meeting of academics with the top lawyers, because I was concerned about the same thing. No chance in the world someone would win a case like this.” Zingales was referring to a conference that took place recently at Harvard Business School, about which you can read in ProMarket.
Rajan added historical perspective to the question of value maximization. “What is supposed to be maximized has changed tremendously over history. Over time we changed our interpretation of what firms are supposed to do. But the view that shareholders value maximization works under some fairly constrained assumptions.”
“Essentially it is that the entire value that the firm contributes to society is made up of contributions by commodity suppliers, such as labor and other things. All of them can be exactly priced. Under those circumstances, maximizing shareholder value makes absolute sense. However, supposing you have a bunch of employees who contribute tremendous value to the firm, over time they get a share of the rents the firm generates. But when you look at what the shareholders are getting, it’s not that much. In fact, you can sell the assets, sell down the firm, and make more. It’s value destruction for society, because you’re ridding these workers of their share of the rents, but you’re benefitting their shareholders. The point that was made earlier about the environment was similar: there is a value to society which is not being captured by shareholders. If you’re just maximizing shareholder value, you’re actually doing the wrong thing for society,” said Rajan.
And Friedman? “I think Milton Friedman and others who proposed shareholder value maximization were essentially targeting a different kind of behavior,” said Rajan. “When a company gave away millions to the New York Philharmonic so that they could sit on the board, it was personal aggrandizement on the part of the CEOs. They [Friedman et al.] were against that. There are situations in which shareholder value maximization doesn’t work, and typically we need to understand what those cases are. [But] I wouldn’t go immediately to stakeholder maximization, because we need to define what those stakeholders are.”
“There are a lot of deviations from the theory. Raghuram mentioned one, one that can be fixed by better accounting, because this means we are not properly accounting the capital of the firm, and that human capital is not really taken into consideration,” said Zingales.
“Especially in a service economy, like the US, that is absolutely critical”, said Engelbert.
Zingales continued, “Milton Friedman, when he wrote his famous piece about the only source of responsibility for business being to increase profits, was very careful in saying as long as it operates in a competitive economy without fraud or deception. The part that is often ignored is ‘competitive economy,’ and the idea that the rules of the game are fixed. Companies are very good at changing the rules of the game in their favor.”
Then Zingales expressed concern about the excessive power of lobbying by big firms, and Fink insisted that it is well within the definition of maximizing shareholder value:
“If maximization to shareholders is the only priority we’re going to look [at], then lobbying is really good because it is maximizing shareholder value,” said Fink.
Zingales: “Do you think companies should not lobby?”
Fink: “I think everybody should have a voice, whether it’s conversation with regulators or public politicians. I don’t see a problem with that.”
Zingales: “Everybody has a voice, but someone has a voice with a $2 billion check, and someone has a voice but no check—it’s not exactly the same voice.”
Fink: “I don’t agree.”
Zingales: “Here’s an example: Disney makes a lot of profit by extending the copyright on Mickey Mouse every time it is due to expire. They exert a huge amount of lobby, and then they extend this copyright by twenty to thirty years.”
Fink: “As I said, if the sole purpose of a company is to maximize shareholder value, then Bob Iger has done a fantastic job achieving that.”
Zingales: “Maximize, as long as you don’t change the rules of the game.”
Fink: “Why are you making this limit? I agree that we need to raise the question of what is the definition of maximizing return.”
Zingales: “I am concerned that if you allow complete freedom to lobby, you have freedom in which one party has a billion dollar check.”
Before having to leave early, Fink acknowledged that firms’ behavior is a driving factor behind some recent political tumults. “I believe what is happening in Spain with Podemos and what’s happening in the United States with Trump is all reflective of society raising questions. I think this is real. That is why I am raising the question of what is our responsibility.”
“We are doing a lot of big data research to try and get better insight into how we invest, and what we found is that when companies are perceived to be good companies, especially by their employees, those shares do better than companies that are perceived to be bad employers. Better-run companies that employees like do better than companies employees don’t like working in, or that have a bad reputation,” he added.
When asked about lobbying and political balance, Rajan said: “Obviously if one party has excessive power, it creates a skewed structure that distorts decision and is bad for society in the long run. It does not necessarily follow that in every society the bar is skewed towards the corporations. Sometimes we have strong unions, sometimes we have other strong organizations. Societies that have skewed systems tend to exacerbate all the things that we worry about: inequality, unfair treatment, et cetera.”
Lévy added that “any rule which is taken to the extreme is a wrong rule. When you take a rule like maximizing shareholder value and consider it the only metric, I consider it a bad rule, because it’s not the only metric.”
Regarding firms growing out of their exclusive focus on shareholder value maximization, Engelbert referred to the influx of millennials into the job market as a potential reason why this shift might be inevitable. “They want purpose over profits. This whole ecosystem of value and purpose is going to be very important to retain this generation.”
Engelbert mentioned the growing talk of a “quadruple bottom line”: financial performance, environmental performance, social performance, and treatment of employees. “With the influx of millennials into the workforce, you can’t forget about the fourth bottom line. What’s going to happen is companies will participate in this ecosystem, and they’re going to have to partner and invest in the longer term to create that value, whether it’s social value, environmental value, or financial value.”
When asked about the increasing power, both political and economic, of tech CEOs and their potential influence on democracy, Lévy—whose company has a number of high-profile internet firms as clients—was adamant. “Their focus is much more on how to make their platforms the best tool for their users. They’re not thinking about the political power they have. Can they use it? Yes. There have been some inquiries lately from the European Union—they were trying everything they could in order to avoid those. But are they going to use their strength to kill democracy? I don’t believe so, not at all. I have not seen a hint of this from them.”
Engelbert, on the other hand, was more ambivalent about the growing power of tech firms. “Many of them, especially on the social side, are building communities, and communications is power with these communities. I have a fourteen-year-old son who wouldn’t watch the [presidential] debates but goes and watches the YouTube videos of each of the candidates and forms an opinion. This is very powerful, and something to be watched. There is enormous power in building a community and having people communicate through that with no regulation.”
“I am not so worried about this aspect of communications. If there is misbehavior, this is something that is very easy to regulate,” said Rajan. “The problem is more with network economics, and how that concentrates wealth. Let’s say that the some of the alarmist visions about robots and software ruling the world come true. Somebody who wrote the software essentially owns all the property right to a network-based structure, which then implies that he has a monopoly for a long, long time. Are we satisfied with that?”
“We always say, ‘Don’t worry about tech, there is so much competition, it’s going to kill existing incumbents shortly.’ But that hasn’t happened with Microsoft, or Google, and may not happen with Facebook. There is something with these network economics that allows them to stay for a long time. ”
Zingales was less optimistic about the possibility of regulating tech giants. “Raghuram says eventually they will be regulated. The problem is many of these companies end up capturing the regulator. Google had an anti-trust investigation by the FTC. The internal memo was leaked out, and it turns out the experts said we should proceed, but five out of five commissioners voted no. It took European courts to pursue an anti-trust case against Google, not because Europeans are better, but because Google is American. Europeans are very good at enforcing competition on Americans, a little bit less when it comes to themselves.”
Summarizing the main points raised by the panel, and making a final observation, Rajan said: “I think the point this panel has been making is that if you go against what society believes in, you may not go very far. Companies can’t be too far outside without, on the one hand, losing human capital and, on the other hand, running against the preferences of society, which would come back to hurt you in terms of anger and hatred for your products. Society is broadly tolerant in the United States of shareholder value maximization, but not in Europe. Nevertheless, European companies are doing pretty well. American firms move faster, but it’s not clear that European companies are destroying a significant amount of value that American firms are creating. I think it’s complicated, and we need to figure out how to do this right. This is the new project, to some extent.”
Disclaimer: The ProMarket blog is dedicated to discussing how competition tends to be subverted by special interests. The posts represent the opinions of their writers, not those of the University of Chicago, the Booth School of Business, or its faculty. For more information, please visit ProMarket Blog Policy.