When Larry Fink, the CEO of investment-management firm BlackRock, sent a letter to corporate America’s CEOs explaining that “without a sense of purpose, no company either public or private can achieve its full potential,” he joined a decades-long conversation about what the function of a business should be. Should the “purpose” of any corporation be entirely to maximize shareholder value, to the exclusion of any social objective its shareholders, employees, or other stakeholders might have? Could engaging with social issues, rather than diminishing shareholder value, help ensure its long-term growth?

To explore these and related questions, Booth’s Rustandy Center for Social Sector Innovation and George J. Stigler Center for the Study of the Economy and the State hosted a panel discussion of Fink’s letter and the broader subject of “the business of business” (with this panel excerpt edited for brevity). Moderated by Chicago Booth’s Robert H. Gertner, the panel included BlackRock cofounder Sue Wagner as well as Booth’s Luigi Zingales and Marianne Bertrand.

Gertner: We have seen greater discussion, both within and outside of academia, about the role of corporations. It has come from consumers, from employees, from the government, from academics, and from investors. Perhaps this letter from Larry Fink may go down as a sort of cornerstone of this discussion. Sue, can you tell us about BlackRock’s view on the responsibilities of business, the decision to issue this letter, and where BlackRock has been and where BlackRock is going with respect to its investment-stewardship policies?

Wagner: I find it somewhat interesting that the letter has received the attention that it has, because I don’t find it as some sort of a marker that something has changed. Really nothing has changed in my view.

The idea of maximizing shareholder value and the ideas articulated in this letter are not, to me, inconsistent. The letter explains that if you are an index manager, you are going to hold positions with particular companies for as long as those companies are in the index. You are, by definition, a long-term investor with patient capital. You have to express your views on the companies through engagement and voting, which are fairly limited modes of expression. The most efficient way to express your views of the company would be to vote with your feet and sell the stock, but you can’t do that if the company continues to be in the index in the same proportion.

So, what is different about saying to companies through this letter that your purpose matters, that the way you think about developing and engaging your talent matters, that your long-term strategy matters? If I’m a long-term investor, all of those things are fairly obvious. If you, the companies, execute your strategies well, you’re going to drive value over the long run.

Are profits passé?

Gertner: Luigi, you’ve written a paper recently with Harvard’s Oliver Hart about shareholder-value maximization versus shareholder-welfare maximization. What’s your thinking about these issues?

Zingales: I think there is a demand for a deeper discussion of what the objective of the firm is. This topic has been dominated by a piece Milton Friedman wrote many, many years ago. Friedman is extremely elegant and extremely clear, and he gives a very clean answer that’s very easy to sell: the only social responsibility of business is to make more profits.

But there are two things about that piece that people tend to overlook. First, Friedman adds that corporations have to respect the norms and laws of society, so that’s a big qualifier. But more importantly, Friedman recognizes that most people, when they invest, look not only at their financial returns but at other dimensions of their investment. However, he also makes an assumption that social activity and business activity are completely separable.

That assumption holds true in the case of donations. If you want to donate a lot of money to your alma mater, you can do it directly through the corporation, or you can distribute the money to shareholders and let the shareholders decide if and how they want to donate it. There is no value destroyed by the donation being made at the shareholder level, and because there is more flexibility in that route—and because I have a different alma mater than many of my fellow shareholders, and we all have different ideas about where our money should go—it is better to push that decision down to the shareholder level rather than doing it at the corporate level. So, if the only social activity we were talking about were corporate donations, Friedman’s principle would be absolutely correct.

However, for most social activities, there are some synergies to decision-making at the corporate level. For example, let’s say I really care about the environment, and I am willing to sacrifice some of my profits to have better management of oil spills. Sacrificing profits at the corporate level to prevent oil spills is not equivalent to allowing the oil spills to happen in the first place, making more profits, then sending the money to shareholders, who can pay to undo the oil spills. It costs much more to manage oil spills at the shareholder level than at the corporate level.

So maximizing shareholder value and maximizing shareholder welfare are not the same thing. People care about more than just money, and there are things for the sake of which people are willing to forgo some money. The big puzzle for BlackRock is, what do you do about that? Marianne’s tastes are different than mine, and we are probably both shareholders in the same S&P 500 companies, so if you are BlackRock and in charge of voting for Marianne and me, that seems like a big, complicated problem.

But it may not be that difficult. Thanks to technology, it is not cost prohibitive to poll every investor who holds a stake in a company. Now, it is very costly for each one of us to make all those decisions, because some of us don’t even spend much time thinking about how we’ll vote in the next presidential election, let alone how we’ll vote on every issue for each stock we own. So instead, why don’t we create index funds with transparent, nonpecuniary objectives?

There are plenty of funds that abstain from investing in certain stocks for reasons unrelated to financial return. Environmentally friendly funds, for instance, don’t invest in oil companies. But while investing in a fund like that might save your soul, it doesn’t save the planet. If everyone who cares about the environment doesn’t invest in a particular company, it will be controlled entirely by people who don’t care about the environment, and they’ll run the company in the most environmentally unfriendly way. If you care about the environment, why not create an environmentally friendly index fund that includes oil companies, and then go to shareholder’s meetings and vote for board members who care about the environment too?

Bertrand: At its core, I think the letter says something that Friedman would very much have agreed with. The letter makes an obvious point, which is that there has been a lot of focus on short-termism among corporations, for a set of reasons that have to do with the way we compensate management. It says that there are a set of shareholders, people investing for their retirement, who are really not concerned about variation in stock prices or profits from one quarter to the next, but are instead more interested in being patient and maximizing their retirement accounts. The letter simply says that these are our shareholders, we at BlackRock are their stewards, and what we expect from companies is that they have a focus on the long rather than the short run. Things like training workers and thinking about the community are often good for the value of the firm in the long run, and I don’t think that’s something that Friedman would have at all disagreed with.

The main thing that Friedman is worried about is that we would not want to be in an environment where the CEOs of companies, just because they happen to be the CEOs, are deciding for us as a society, as an electorate, which social objectives we care about and which we don’t. We hope that we have a political process in place where the preferences of the electorate about spending on schools or spending on alleviating homelessness would be expressed through the political system, but I think there is a concern that without some guidance as to what social goals companies should be pursuing, especially when those social goals are no longer fully aligned with long-term valuation, we might give corporations too much power.

You have a predetermined list of incumbents to choose from. You can vote yes or abstain. I think the Soviet Union was more democratic than the selection of corporate boards.

Luigi Zingales

It feels, to me, like Friedman is talking about a world where the government is in a separate sphere and has taken charge of fixing all of the market failures. Under that environment, the first welfare theorem tells us that yes, indeed, companies should be maximizing profits. But obviously we do not live in this world, and the letter talks about the government’s failures in addressing all of our social problems. I think businesses are, via the lobbying process and the influence of money in politics, playing a very large role in driving those government failures for a set of reasons that we could spend weeks on. That’s something that I would have liked the letter to speak a bit more about.

Gertner: I get the sense that everyone on the panel would agree that if you are thinking about long-term rather than short-term shareholder value, you will be thinking about things like reputation, the link to the community, employee satisfaction—things that are associated with greater social responsibility. But it also seems to me that the letter said it can’t be about shareholder value, even long-term shareholder value, but that companies need to be thinking more broadly. If you think about shareholder value as complicit in this, you become too short-term oriented. How should we make sense of this?

Wagner: Again, maybe we’re reading too much into the letter. I think that the reason you bring up social purpose is that it matters to your employees. That’s the first point Larry makes in the letter. You have to be able to clearly articulate your purpose as a company in order to drive the kind of alignment and engagement that will enable you to attract and retain the best talent, and the best talent is a precursor for achieving your strategies and maximizing shareholder value.

This is why I wonder, does the letter go as far as people seem to suggest? The clients that BlackRock is serving are mostly retirees. We have a looming pension crisis in this country and in other countries in the world. From an investment-stewardship perspective, that’s part of what creates the obligation to really engage with these companies to ensure that they are driving long-term value.

Gertner: Sue, you said that for nonindex funds, voting with your feet can be an effective way to make your disapproval of a company felt, but that as an index investor, you don’t have the option of using your feet, so you have to use your voice. Luigi said voice is more powerful than feet. Can we explore that?

Zingales: Voice is much more powerful than exit, in that exit might lead to the wrong outcome.

Gertner: But the US corporate governing system makes shareholder voice fairly muted, right? Basically, shareholders fundamentally have the right to elect directors.

Zingales: Do they? In principle they do. But in practice, you have a predetermined list of incumbents to choose from. You can vote yes or abstain. I think the Soviet Union was more democratic than the selection of corporate boards.

Gertner: And all of these proxy votes about social responsibility are all advisory—nonbinding under US corporate law. So, for this to work, does corporate law have to change?

Zingales: I think one particular thing that would be easy to change is the screening done by the SEC [US Securities and Exchange Commission], in terms of what it allows to come to a proxy vote. I know this may seem unpopular these days, but I believe in direct democracy, both at the corporate level and at the political level. You have to have some filter, and if you only have a handful of shares, you shouldn’t be able to put an issue on the ballot. But if you get some significant portion of shareholders—say 10 percent or 5 percent of a company’s shares—behind putting something on the ballot, I don’t know why it shouldn’t go on the ballot. The company ultimately is owned by the shareholders, and if they want to do something, especially something that isn’t at odds with profit maximization, why can’t they vote on it?

Wagner: Shareholder proxy access has been adopted in almost all US companies. I think it has changed a lot; proxy access has gotten much, much easier. Most of the proxy-access proposals that come are on social issues, and they’re most of the ones that make it through. So there are shareholders voting on them. I haven’t seen any pass.

So, actually, I think that these issues do come to a vote, and if anything, the SEC has backed off of screening. They are giving less guidance to companies on what they can and cannot set to the side, but overall guidance is that if it is part of normal corporate practice, your board can make a decision that it is not something that rises to the level of a shareholder vote.

Zingales: This outcome points to a government failure. Proxy access changed from the bottom up, with activists and shareholders pressuring for change. At the political level, all of these changes to proxy access have been blocked.

This is where I feel uncomfortable from a theoretical point of view. On the one hand, I recognize the gigantic failure of the political system, and so I would like corporations to do more. On the other hand, it’s a risky business because corporations, as Sue was saying, don’t represent all the people. They represent a subset of people. So, if we give them a huge amount of political power, I’m not so sure that they’ll fix the problems the right way.

Bertrand: That is exactly what I was trying to say. If the guidance about what social issues corporations take on doesn’t have the ultimate objective of maximizing long-term value, I worry about how much power a few individuals ultimately will have over the kind of society that we are going to be living in.

Shareholders and voters are not the same. Many of the neighborhoods on the south side of Chicago, where government resources are deeply needed, unfortunately don’t have many shareholders that could be expressing their votes via the direct-democracy mechanism Luigi has talked about. So we’re going to be representing them and speaking for them in a world in which we have given up on the government to actually address social problems.

Gertner: This discussion also pertains to philanthropy, where we see lots of wealthy individuals who are, to some extent, shaping social policy through their donations, and through leveraging those donations politically.

Sue, it would be great to get some insight into the real mechanics of the way voice works. My guess is if BlackRock feels there is a significant company in the portfolio, index or not index, that is too short-term oriented and inconsistent with what’s laid out in the letter, the first step is unlikely to be a proxy. Right?

Wagner: Yes. In general, the investment-stewardship team annually publishes its focus areas, or principles that they intend to reach out to companies with and talk to them about in a given year. Those don’t change dramatically from year to year. Their objective is to engage directly with companies on these points. So that means they don’t want to wait for a proxy. They don’t want to wait until there is a shareholder vote. They want to be as transparent as possible and engage in a discussion on the issues that matter.

The first instinct, always, is, “Sit down with us. Talk to us.” That’s how we are using voice. We want to give you our perspective before you’re writing your proxy so that you give some thought to, for example, how you are crafting your executive-compensation plan, and will it address our concerns about alignment with long-term value creation. That’s another example that is fairly common. And they look to other disclosures that are public: “It’s mentioned in here, in your letter to your shareholders . . .”

I think things are changing because of the set of global issues that we are facing.

Marianne Bertrand

The nuclear option is voting the proxy. A lot has been written about the fact that index managers, and not just BlackRock, have principally not voted against executive-compensation packages. The logic behind it is the view that this is mainly a management and a board decision. But if, after repeated engagement or attempts at engagement, the issue is not addressed, the option of last resort is to vote no on “say on pay,” which is an advisory vote, and vote against reelection of the members of the compensation committee, for example, or all of the directors.

Zingales: I have to say I am a little bit concerned about this private engagement because BlackRock is also in the business of selling products to companies. It sells risk-management products, very good ones, to insurance companies. So, for example, if [Assicurazioni] Generali, an Italian insurance company, buys a product from BlackRock and then you go and engage about whether to vote with or against management, it creates the possibility that it’s not exactly a clean situation. How do you handle this problem?

Wagner: It’s not an unfair observation; but as a practical matter, it’s not usually an issue. The people involved in those decisions are completely different people, both on the BlackRock side and on the company side. Usually the investment-stewardship team is talking with a CFO, an investor-relations department, and sometimes a CEO. Whereas the people who are selling the product to Generali are usually talking to the investment office and CIO.

You can wonder whether or not the division actually works, but having been there for a long time, I never saw this conflict materialize inside BlackRock.

Zingales: I have no doubt that BlackRock does everything perfectly, but a lot of people are going to buy the BlackRock product just in case. Unless you go out of the way to advertise from the outset that there is no correlation between how we vote and whether you buy our product, I think you have to understand the expectation on the other side of the table.

Wagner: Imagine being in Larry’s seat. Do you know how many CEOs want to call and try to exert influence? He says, I have no influence. I am not the one telling the investment-stewardship team how to vote those shares.

Gertner: Is anything changing with respect to the role of corporations? Or is it just getting more attention than it used to?

Bertrand: I think things are changing because of the set of global issues that we are facing. The broad environment of increasing inequality and declining jobs, and in the United States in particular, the failure of government to actually deal with these issues, has changed the nature of the conversation. I also think we are a richer society that has more time to devote to these issues.

Zingales: I agree that things are changing. Not as fast as I would like. And part of the story, in addition to what Marianne said, is the sheer market power that some firms have. Think about Bitcoin and ICOs [initial coin offerings]. Facebook and Google decided not to let them advertise. Those two firms represent 63 percent of the online market. They are more effective regulators than the SEC.

On the question of ICOs, they may have done the right thing, but suppose the next time they decide who is and isn’t allowed to advertise an investment. That’s pretty scary. That’s why people are engaging in more activism.

Wagner: In less than a decade, there has been a significant shift on these types of issues, and it has come from a product-availability perspective. I can remember sitting on the board of another fine higher-education institution when we were dealing with student and faculty committees coming in and saying, “You have to divest our position in various companies.”

My response was that if you really want to drive change, our small endowment divesting is not going to change things. If the theory of selling and divesting is to increase the cost of capital for the company whose stock you sold, it is so difficult to trace that through and see that it actually has an impact. If you want to actually drive change, you need to get those principles in the indices, and then institutions or individuals can choose to invest in those products.

Those funds didn’t exist then, but in the last five to seven years, there has been a tipping point. Now everybody is talking about impact investing, and everybody is talking about using these ESG [environmental, social, and governance] products of various types.

Another board I’m on announced last year that they switched to ESG through the entire investment process, which amounts to about $180 billion of assets. I chair that committee, and we’re overseeing how they are implementing that. It’s not straightforward, and we still have to ask ourselves all the time, are we giving up returns? Is that an issue for our shareholders?

Bertrand: At the core, I think these changes on the supply side are manifestations of the demand changing, with more and more investors looking for those products. To me, it feels like the growth for impact investing is somewhat constrained because a lot of companies don’t want to talk about the possibility that, as a shareholder putting money in those kinds of funds, you might be making a trade-off between financial return and social impact. We could go many steps further were we willing to have those conversations with investors. Some people out there are really willing to leave money on the table if they think they can have an impact.

Wagner: Everybody assumes that you’re going to leave money on the table, but it’s not clear that you will. I think we have seen a lot of change, and that we will continue to see focus on these issues and further evolution.

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