Introduction
Shareholder primacy
Incentive compensation plans
Comment
This PubCo post discussing the Business Roundtable's adoption of a new Statement on the Purpose of a Corporation concluded by observing (rhetorically) that the question teed up by the new BRT Statement was what all of the signatories would actually do to fulfill the commitments in the Statement. Apparently, some NGOs are now asking that question for real, and, ironically, one of the first recipients is a well-known leader of the pack on commitments to all stakeholders.
You might recall that, in August, the Business Roundtable announced the adoption of a new Statement on the Purpose of a Corporation, signed by 181 well-known, high-powered CEOs. Surprisingly, the BRT Statement moved "away from shareholder primacy" as a guiding principle and outlines in its place a "modern standard for corporate responsibility" that made a commitment to all stakeholders. According to the press release, the Business Roundtable has had a long-standing practice of issuing Principles of Corporate Governance. Beginning in 1997, those Principles advocated the theory of "shareholder primacy—that corporations exist principally to serve shareholders"—and relegated the interests of any other stakeholders to positions that were strictly "derivative of the duty to stockholders." The new Statement superseded previous statements and "more accurately reflects [the Business Roundtable's] commitment to a free market economy that serves all Americans. This statement represents only one element of Business Roundtable's work to ensure more inclusive prosperity, and we are continuing to challenge ourselves to do more."
Shareholder primacy was not always the prevalent theory, argues Professor William Lazonick in "Profits without Prosperity," published in the September 2014 Harvard Business Review:
"From the end of World War II until the late 1970s, a retain-and-reinvest approach to resource allocation prevailed at major U.S. corporations. They retained earnings and reinvested them in increasing their capabilities, first and foremost in the employees who helped make firms more competitive. They provided workers with higher incomes and greater job security, thus contributing to equitable, stable economic growth—what [he calls] 'sustainable prosperity.' This pattern began to break down in the late 1970s, giving way to a downsize-and-distribute regime of reducing costs and then distributing the freed-up cash to financial interests, particularly shareholders. By favoring value extraction over value creation, this approach has contributed to employment instability and income inequality." [emphasis added]. (See this PubCo post.) The shift to shareholder primacy has been widely attributed to the development of the "shareholder preeminence theory" by the Chicago school of economists, beginning in the 1970s, with economist Milton Friedman famously arguing that the only "social responsibility of business is to increase its profits." Subsequently, two other economists published a paper characterizing shareholders as "'principals' who hired executives and board members as 'agents.' In other words, when you are an executive or corporate director, you work for the shareholders." (See this PubCo post.)
In the new BRT Statement, the signatories committed to
- "Delivering value to our customers. We will further the tradition of American companies leading the way in meeting or exceeding customer expectations.
- Investing in our employees. This starts with compensating them fairly and providing important benefits. It also includes supporting them through training and education that help develop new skills for a rapidly changing world. We foster diversity and inclusion, dignity and respect.
- Dealing fairly and ethically with our suppliers. We are dedicated to serving as good partners to the other companies, large and small, that help us meet our missions.
- Supporting the communities in which we work. We respect the people in our communities and protect the environment by embracing sustainable practices across our businesses.
- Generating long-term value for shareholders, who provide the capital that allows companies to invest, grow and innovate. We are committed to transparency and effective engagement with shareholders."
A broader view of "corporate purpose" has been advocated for several years now by Laurence Fink, the Chair and CEO of BlackRock and one of the signatories to the new BRT Statement. Governments, in Fink's view, have not been up to the task of meeting key social challenges, with the result that "society increasingly is turning to the private sector and asking that companies respond to broader societal challenges…. To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate." [Emphasis added.] What does that mean in practice? According to Fink, among other things, a company should consider its role in the community, its management of its environmental impact, its efforts to create a diverse workforce, its ability to adapt to technological change and take advantage of new opportunities, its retraining programs for employees in an increasingly automated world and its efforts to help prepare workers for retirement. But these goals are not just goals in and of themselves; they have a larger purpose. (See this PubCo post.)
Now, as indicated in this press release, As You Sow has submitted a shareholder proposal to BlackRock asking for a report on how the company plans to fully implement the new BRT Statement. According to AYS, shareholders are demanding that "companies exercise leadership on a broader range of environmental, social, and governance issues. They want company actions to be integrated with the BRT statement, not contradict it." While BlackRock has been a leading advocate on many issues of corporate social responsibility, AYS contends that BlackRock's publicly reported proxy voting record does not appear to be aligned with its advocacy positions, revealing "consistent votes against virtually all climate-related resolutions. A recent New York Times article notes that Blackrock votes its proxies against shareholder advocates on 93 percent of all social and environmental shareholder resolutions filed. These actions are not aligned with the new 'purpose of a corporation,' but instead undermine the core principles of the statement."
Notably, however, the NYT column cited by AYS also provides the BlackRock counter-argument, which is that they take a nuanced approach with proxy voting as "only one tool in [their] toolbox"; they "have the largest investment stewardship team in the industry," and frequently engage with management even in the absence of shareholder proposals. In addition, they vote "against corporate directors when 'we do not see progress through engagement [and] support shareholder proposals that we believe will enhance the value of our clients' investments, but blindly voting for shareholder proposals is not a responsible approach to stewardship.'" It will be interesting to see how recipients, including BlackRock, respond to this proposal.
And while BlackRock's CEO has been among those publicly promoting a more inclusive corporate purpose that encompasses all stakeholders, other CEOs have been feeling the pressure. This article in the WSJ, "The Tricky Role of the CEO in a New Era of Social Responsibility," discusses the impact for CEOs of the shift in perspective, reflected in the new BRT Statement, from shareholder primacy to a broad group of stakeholders. According to the article, many CEOs have recently "concluded that this focus on profits and share price above all has helped to bring about some of our most serious environmental and social ills. And so now, the pendulum is swinging again," back to the approach employed pre-Milton Friedman. Korn Ferry 2019 survey data of 163 European CEOs showed that 56% believed that the CEO role in 2025 would become more focused on moral/ ethical leadership to a "great extent," while 38% thought the focus would shift only to "some extent." Similarly, 62% thought that CEOs in 2025 would shift focus to a great extent from a single focus of profit to a triple bottom line including profit, people and planet, while 33% thought there would be a shift to some extent. In both cases, only 5% thought there would be no shift in focus. As a result of these changes, the necessary CEO skill set has changed, according to a Korn Ferry representative, to include empathy, self-awareness, listening and communicating as "must-have" skills. The CEO of the BRT views the job of the CEO today as "'radically different from what it was 10 years ago….They now actually have to respond to a variety of stakeholders,' including employees who are apt to express needs and concerns 'beyond wages and working conditions.'"
Human capital is a significant component of the new focus, with many now recognizing that workers have largely not benefited from the increased profitability of corporations, notwithstanding their increased contributions to that profitability. One CEO commented in the article that, while most of the money earned by corporations has gone back to shareholders over the past two decades, the "vast majority of workers have not prospered." Citing data from the Economic Policy Institute, the article reports that, from 1979 to 2018, "Americans' hourly output went up about 70%, while the hourly wages and benefits of the typical worker essentially stagnated, increasing less than 12% after adjusting for inflation. A study published last month by the Brookings Institution showed that 44% of all U.S. workers ages 18 to 64—53 million people—now hold low-wage jobs, with median annual earnings of just $17,950." Although some companies have raised their minimum wages, some critics believe that the wage increase is not really enough. Representatives of a nonprofit critic quoted in the article maintain that CEOs "'genuinely believe they are doing everything they can for their front-line workers and therefore don't have a bad jobs problem…But they aren't and they do."
Some critics argue that CEO compensation may play a role in the typical CEO's perspective. The article reports that a WSJ analysis showed that, last year, median pay for CEOs in the S&P 500 rose to $12.4 million, up 6.6% from 2017. Critics of CEO pay, the article observes, suggest that such high pay levels "make it hard for CEOs to relate to the kinds of hardships with which many people are struggling, and this inhibits how far they're willing to go to enhance workers' wages or benefits." Former Delaware Chief Justice Leo Strine phrased the point differently: "'If you were a CEO in the 1960s, you lived in one of the biggest houses in town, but you didn't live in a different world.'"
What's more, the article reports, a large proportion (2/3) of CEO comp last year was in restricted stock and options, intensifying the focus on share price. But, according to the article, less than 15% of companies in the S&P 500 incorporate ESG performance metrics into their executive comp programs, generally involving "trivial" sums. Commentators attributed the low level of ESG metrics to the absence of recognized global standards.
In May 2019, comp consultant Mercer conducted a spot survey of 135 companies, looking at the prevalence and types of ESG (environmental, social and governance) metrics used in incentive compensation plans, including metrics related to the environment, employee engagement and culture, and diversity and inclusion. The survey found that 30% of respondents used ESG metrics in their incentive plans and 21% were considering using them. Mercer observes that with the "growing expectations for organizations to operate in an environmentally and socially conscious way, [ESG] incentive plan metrics are increasingly being considered as effective tools to reinforce positive actions."
And efforts to link ESG factors to executive comp have been a common thread in a number of shareholder proposals. According to Alliance Advisors, as of March 31, 19 shareholder proposals that sought to link various social issues to compensation had been submitted. For example, a union pension fund requested that the comp committee of an operator of private prisons and immigrant detention centers incorporate into its senior executive pay arrangements "respect for inmate and detainee human rights." A socially responsible investment fund and others submitted proposals requesting that companies' comp committees prepare reports "assessing the feasibility of integrating sustainability metrics, including metrics regarding diversity among senior executives, into performance measures or vesting conditions that may apply to senior executives under the Company's compensation plans or arrangements." The proponent cited studies suggesting that companies that integrate ESG factors into business strategy "reduce reputational, legal, and regulatory risks and improve long-term performance." (See this PubCo post.)
Interestingly, the article points out that many CEOs have been outspoken on a variety of important social topics, but "they can be warier in taking on the issues that are most core to the business." One example given is the environment. The article reports that a "survey this year of 1,000 CEOs from around the world by Accenture discovered that just a third of them are willing to commit immediately to cutting greenhouse gases by amounts promulgated in the Paris climate agreement." Nevertheless, pressure to address sustainability is incoming from employees, recruits, consumers, citizen groups and even governments, as well as from many shareholders. For example, the article reports that one in four dollars ($11.6 trillion in assets) under professional management by U.S. money managers are in investments that address ESG criteria.
However, while pressure from some shareholders about sustainability can be intense, other shareholders are still firm believers in shareholder primacy. For example, the Council of Institutional Investors opposed the BRT Statement, contending that it "gives CEOs cover to dodge shareholder oversight." (See this PubCo post.) CII's executive director worries that companies will be addressing a lot of social objectives without being answerable for their activity: "'accountability to everyone means accountability to no one.'" And even long-term investment funds with corporate engagement departments that preach about ESG and pressure companies to "spell out how environmental and workforce matters translate into longer-term opportunity and risk" can still send "contradictory signals"—the "individuals actually in charge of portfolios are still often fixated on shorter-term financial gains," the article reports. (But see this PubCo post reporting on a meeting of the SEC's Investor Advisory Committee where the topic for discussion was how investors use ESG information in making investment decisions.) And even more menacing are activist investors who "threaten to oust the CEO unless costs are cut and more money is handed to those who own the stock," accelerating CEO turnover and shortening median CEO tenure from eight years in 2000 to five years now.
Some are looking to the regulators to straighten things out, for example, by establishing standardized disclosure requirements for ESG and other stakeholder information. And others are looking to boards of directors or to "everyone up and down the ranks to weigh the broader impacts of the company's activities." Right now, however, it appears that CEOs will continue to be key players in facing the challenges of corporate social responsibility.
Don't count on rulemaking from the SEC that would require standardized ESG disclosure any time soon. When it comes to mounting calls for standardized ESG disclosure rules, SEC Chair Jay Clayton has been less than enthusiastic: "My view is that in many areas we should not attempt to impose rigid standards or metrics for ESG disclosures on all public companies. Such a step would be inconsistent with our mandate, would be a departure from our long-standing commitment to a materiality-based disclosure regime, and could effectively substitute the SEC's judgment for the company's judgment on operational matters." Instead of imposing marketwide ESG regulation, Clayton has favored the application of "the 'materiality' based approach to disclosure regulation. This has been the commission's perspective for 84 years and it has served our investors and markets very well. Keeping that perspective in mind is critical to our mission." (See this PubCo post.) One exception to Clayton's reluctance to impose any new regulatory mandate is disclosure about human capital management, which the SEC has proposed to address. (See this PubCo post.)
For further information on this topic please contact Cydney Posner at Cooley LLP by telephone (+1 415 693 2000) or email ([email protected]). The Cooley LLP website can be accessed at www.cooley.com.
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