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Rekenthaler Report

Larry Fink's Attack on U.S. Corporate Governance

Is Gordon Gekko becoming passe?

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In Praise of Avarice
In 1987's Wall Street, Gordon Gekko proclaims, "Greed, for lack of a better word, is good." (As with many movie quotes, the public edited the original, so that the most-famous line in Michael Douglas' career is now commonly remembered, incorrectly, as being "Greed is good." Score one for the wisdom of the crowd--the revision is cleaner, simpler, stronger.

The film was fiction, but the sentiment was not. Bruised by stagflation from the previous decade, and by the belief that American corporate dominance was fading, several influential parties in the 1980s--Wall Street stock analysts, fund managers, and business-school professors--urged corporate CEOs to reform. No longer should CEOs have multiple goals. Ultimately, their task was to please but one party: the shareholders. 

In other words, greed became good. By the new ethos, the stock market's heroes were those CEOs who worked tirelessly to increase their companies' share prices. They weren't primarily motivated by duty, or community spirit. Instead, they were driven by financial desire. Their motivation was beside the point, however. What mattered were the blessings that came from their actions. The new breed of CEOs transformed fat, inefficient firms into lean machines.

This tough-minded approach, went the argument, was for the best. To be sure, those workers who were axed so that companies could demonstrate their commitment to "cost controls" tended to view the matter differently, but the needs of the many must outweigh those of the few. Said Al Dunlap when running Scott Paper, "It doesn't make any sense to sacrifice 100% of the people at this company to save 30% of the people we have to let go."

Often, the argument was framed in moral terms. The best CEOs, as Wall Street defined them, weren't heroes solely because they made money for stock owners (and of course, for themselves). They were heroes because they made America better. In contrast, do-gooder CEOs who hesitated to make the hard decisions killed through their kindness. Nice guys finished last--and so, ultimately, did those who worked for them.

(Nobody played the moral card more enthusiastically than Dunlap, who entitled his book How I Save Bad Companies and Make Good Companies Great, and who said upon joining Scott that, under previous management, company shareholders "would have been abused less if they had been captured by terrorists." He lost something of his ethical high ground, however, after committing accounting fraud at his next stop, Sunbeam, which led to a 99% stock-price decline and a Chapter 11 filing.)

The Counterstrike
Last week, as discussed variously in the general media and by Morningstar's Jon Hale, BlackRock CEO Larry Fink attacked the prevailing model. Fink is scarcely the first to dissent, of course. Many prominent CEOs, including GE's Jack Welch, have complained that that the pendulum swung too far. However, Fink's comments carry more weight, because this particularly corporate boss oversees the world's largest money manager. No organization has more power over CEOs than does BlackRock.

So, when Larry Fink speaks, CEOs listen.

My guess is many are receptive to the message. Much of the appeal of the film Wall Street lay in its sense of time and place. It felt so very 1987, and so very American. Which it was. The rest of the world, by and large, did not accept the "cult" of shareholder value (to use Jack Welch's phrase). It advocated that CEOs satisfy a broader range of constituents. As foreign sales currently account for more than 40% of S&P 500 revenues, the CEOs of large American firms have become accustomed to hearing arguments that are similar to BlackRock's.

Indeed, Fink's comments would seem fully aligned with, for example, German corporate governance, which has traditionally scored CEOs on their ability to satisfy multiple constituents, as opposed to the single group of shareholders:

"We … see many governments failing to prepare for the future, on issues ranging from retirement and infrastructure to automation and worker training. As a result, society increasingly is turning to the private sector and asking that companies respond to broader societal challenge … Society is demanding that companies, both public and private, serve a social purpose. 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."

The italics are mine. They illustrate the heart of the issue--should CEOs be graded solely for their ability to increase shareholder value, or for how they fare across an entire curriculum?

Putting Theory Into Practice
The former task is straightforward. Measure the price of a stock when the CEO takes control, measure its price at future dates, and judge performance according to simple rules (generally based on benchmark comparisons). The latter is more complicated. Employee- and customer-satisfaction surveys leave off as much as they contain (if  Amazon (AMZN) did not exist, no customer-satisfaction survey would indicate how other companies were failing at meeting a need that consumers didn't realize they had), and gauging whether a company benefits its community is more difficult yet.

If BlackRock knows how it will be scoring CEOs, it is not tipping its hand. Its published comments are vague, leading one to suspect that Fink's statement is aspirational rather than a reflection of how BlackRock now operates. (The company's published statements about its proxy voting emphasize customary, noncontroversial topics, such as board structure, compensation policies, and so forth. Aside from some general language about environmental and social issues, the company's official comments don't openly conflict with the notion of maximizing shareholder value.)

My next column will address whether U.S. stock market investors should be worried, happy, or unconcerned about Fink's attempt to change U.S. corporate governance.

 

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.

John Rekenthaler does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.