The following, by Robert C. Pozen, first appeared on Fortune.com on Feb. 9.
Should public companies focus on earning profits for their shareholders, or should they serve broader societal needs? Larry Fink, the head of BlackRock, the largest fund manager in the world, recently issued a letter to company CEOs stating: “Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate.”
Yet the same letter tells public companies that they should adopt a strategic plan with “a path to achieve financial performance.” The letter reconciles these potentially conflicting objectives by pushing companies to pursue “long-term value creation” rather than short-term profits. In other words, they can enhance their long-term financial returns to shareholders by serving the needs of other stakeholders—even if this lowers short-term profits.
While BlackRock was trying to sensitize companies to their social responsibilities, the letter could undermine the accountability of corporate directors to their shareholders. CEOs could hypothetically justify any decline in annual earnings by claiming they were serving all stakeholders in hopes of increasing long-term financial results. How will shareholders later assess whether these stakeholder-focused policies actually resulted in higher financial returns? And does the long term mean five, 10, or even 20 years?
To operationalize BlackRock’s approach in a meaningful way, corporate directors should adopt a strategic plan with key performance indicators for the actual impact of stakeholder-focused policies (and any short-term tactics) on long-term financial returns over specific time periods. To promote accountability, corporate boards should then base a significant portion of the compensation of top executives on whether they meet these key indicators within the relevant periods.
Let’s begin with serving the interests of a company’s workers. After the passage of the recent tax act, several large companies raised wages for their employees, thus lowering their short-term profits. Was this driven by fairness considerations—distributing some of the rewards from a lower corporate tax rate to their employees as well as their shareholders? Or was this a response to a tighter labor market—the need to pay more to attract and retain higher-quality workers? Companies should publicly articulate their reasons for raising wages and identify metrics for assessing their long-term impact.
Similarly, a public company may decrease short-term profits by making substantial expenditures designed to attract more consumers in the long term. For example, a company could replace artificial components of food products with natural ingredients in the hope of increasing its sales to certain customers. Or a business could spend more than the law requires on waste disposal in order to project a better image to environmentally conscious consumers. In either case, the company should announce what revenue increases over what time periods it expects to result from these substantial expenditures.
A company’s efforts to serve its local community are more complex. Large U.S. companies have manufacturing and marketing facilities in a number of locations, including some in foreign countries. Therefore, it may be impossible to serve the interests of all of these communities at the same time. If a multinational company moves a factory from Mexico to Michigan, it will help the residents of one community as it undercuts the economy of another.
Nevertheless, public companies should articulate the expected positive impacts of its significant community efforts to the maximum extent feasible. For example, most large American companies make charitable donations to support projects and programs of local governments and non-profit groups. Perhaps these donations are made by companies for altruistic reasons. Alternatively, they may be made to help pave the way for local approvals of company expansion projects such as a new pipeline or office complex. To be held accountable, a company should explain publicly what it hopes to achieve by its major community investments, along with its measures of success.
After a company articulates its objectives and success metrics for stakeholder-focused policies as part of its long-term strategic plan, the company’s board should utilize these metrics as compensation criteria for its top executives. As a result, these executives will take seriously a company’s efforts to link its stakeholder-focused policies to its financial performance. And they will expand their time horizons to match the company’s definition of the long term, which will vary for different policies and different companies.
In short, the BlackRock letter should stimulate a healthy discussion about the extent to which public companies should serve the interests of employees, customers, and their communities. However, to avoid specious justifications for short-term declines in profits, corporate boards should publicly report each year on how stakeholder-focused policies are contributing to better financial performance in the long term—with success metrics for specific time periods.
Robert C. Pozen is a senior lecturer at the MIT Sloan School of Management and former president of Fidelity Management & Research Company.