What the 2016 BlackRock Letter Means for Shareholder Engagement and Disclosure Practices

Ethan A. Klingsberg is a partner in the New York office of Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb publication by Mr. Klingsberg and Elizabeth Bieber.

In February 2016, Blackrock CEO Laurence Fink issued his annual letter to the CEOs of S&P 500 companies. In addition to repeating themes from prior years (the value of long-termism and the need for more thoughtfulness before allocating capital to buybacks and special dividends), this year’s letter had one notable omission and four of areas of specific emphasis that merit the attention of boards and managements.

Blackrock, with trillions of dollars of investments in equity markets, is the top stockholder for one in five U.S. public companies and the largest institutional investor in U.S. public stock markets. Moreover Blackrock has an in-house team prepared to engage with public companies directly on issues and assure that its influential votes are cast accordingly at stockholder meetings. The recommendations of ISS and Glass Lewis remain a variable, and institutional investors, including Blackrock, still subscribe to proxy advisory services and consider their views. However, institutional investment managers are increasingly independent thinkers when it comes to voting and Blackrock has publicly stated that it does not follow the recommendations of any single provider. Thus, consideration of the significance of the letter is worthwhile by both the recipients and other market constituents.

Notably absent from the 2016 letter is a call for CEOs or directors to have more direct engagement with stockholders. Letters over the past couple of years from Vanguard and Blackrock, as well as the alarmism of some advisors, have led to some overloading of the lines of communication between public companies and many institutional investors, especially during the second half of 2015. Despite packed agendas, direct engagement should still be a priority for a company with a foreseeable contested situation. Institutional investors will let companies know when a special meeting with directors or the CEO is advisable to support the usual IR check-ins.

The 2016 letter emphasized specific requests for:

  • Less Short-Term Guidance. Movement away from provision of quarterly EPS guidance.
  • Long-Term Plan Disclosure. Disclosure of clearly articulated, long-term strategic plans, including the financial metrics relevant to measuring the success of these plans and an express confirmation that the board has reviewed these plans.
  • Linked Compensation Metrics. Linkage of long-term compensation programs to the metrics cited as relevant to the long-term strategic plan.
  • ESG. Sharper focus on so called “ESG” (environmental/social/governance) matters.

Against the backdrop of the trends identified in the chart below surveying the approaches to disclosure over the last ten years by some large cap retailers, these requests give rise to the following considerations and expectations:

  1. Guidance. The ongoing pressure on IR departments from analysts will likely impede significant movement away from quarterly guidance. However, in recent years we have seen companies enhance their disclosures of short-term guidance by couching their expectations in the context of progress towards long-term goals, which is a nice way of bridging the hunger of analysts for short-term guidance with the demands of institutional investors, like Blackrock, for a bigger picture perspective; although it is far from clear that Blackrock views this approach as optimal. In addition, while quarterly guidance may be a distraction from long-term goals and, when missed, provide fodder for hedge fund activist campaigns, the continuation of quarterly guidance is unlikely to serve as a bar against support from Blackrock.
  2. Long-Term Plan Disclosure. Long-term plan disclosure has evolved in recent years from a theme underlying MD&A to becoming relevant to the contents of the annual proxy statement and a centerpiece of a number of investor relations websites with detail and color that goes beyond the typical investor power point deck containing historical and short-term details and non-specific long-term aspirations. However, the inclusion of long-term financial target numbers is most commonly seen in turn-around situations or where there is an imminent contested situation. Moreover, there is a sense among legal practitioners that the provision of quantified long-term targets puts unnecessary pressure on companies from a liability perspective due to the risk of “duty to update” claims, despite some protection under the Private Securities Litigation Reform Act and the inclusion of appropriate qualifying language. Nevertheless, as boards continue to position themselves preemptively against the risk of activist hedge fund attacks, we expect many companies to continue enhancing their long-term plan disclosure and starting to include more quantifiable targets. This movement will require attention to the “duty to update” risk, but may well enhance shareholder focus on long-term strategy, aligning companies more closely with influential institutional investors and help keep activists at bay.
  3. Compensation Metrics. The integration of the work of the compensation committee with the implementation of the strategic plan has been a theme for both hedge fund activists—for whom presence on the compensation committee is often a priority—and good governance types and has given rise to more innovative disclosure in annual proxy statements. Working through the relationship between the big picture strategic plan and the compensation plans and assuring clear disclosure on this relationship should be a focus of every board.
  4. ESG. Stockholder proposals on ESG matters rarely receive majority approval and we do not expect this trend to change. Many of the ESG shareholder proposals are either impractical or submitted to companies that have actually already done a decent job of taking into account the goals of the proposal. Nevertheless, even though approval of ESG proposals over management’s objections may not be a serious risk, the focus on ESG by boards and managements will continue to become more serious and necessary for positive stockholder relations. Much of corporate America has already gotten the message from Blackrock and other institutional shareholders that disclosing details of a company’s commitment to ESG matters is a way of signaling “operational excellence” or, as one investment manager recently stated to us, akin to having appropriate insurance policies and processes in place. Increasingly, investors see ESG matters as an enterprise risk that must be anticipated, assessed and managed.

The emergence of Blackrock and other index funds as active players on the shareholder landscape offers companies an opportunity to build relationships that function as a bulwark against threats of hedge fund activism. Consideration of the roadmap to their support, as provided by the latest Blackrock letter and analogous policy statements by other institutions, is an important component of being able to take advantage of this opportunity.

To view the full chart, please click here.

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