Com­pa­nies must talk more about the fu­ture

The Pak Banker - - OPINION - Matt Levine

ONE way I like to think about the stock buy­back de­bate is that it's a de­bate over who should get to al­lo­cate cap­i­tal to projects. Some peo­ple think that if the man­ager of a com­pany is skilled enough to make money for that com­pany, she should get to hold onto it and in­vest it in new projects. Af­ter all, she has shown that she is able to make money. Other peo­ple think that she should give the money back to the share­hold­ers, so they can in­vest it in new projects. Af­ter all, it is their money, and they have shown that they are able to in­vest it prof­itably. Nei­ther of th­ese views is unas­sail­able, and for roughly the same rea­sons: Past suc­cess, in busi­ness and in in­vest­ing, only weakly pre­dicts fu­ture suc­cess. But there the money is, and some­one has to de­cide what to do with it.

This de­bate is some­times de­scribed as one about long-ter­mism ver­sus short-ter­mism, with long-ter­mism mean­ing that the man­agers get to keep the money for a long time and short-ter­mism mean­ing that they don't. Larry Fink, the chief ex­ec­u­tive of­fi­cer of Black­Rock, is one of the best-known ad­vo­cates of long-ter­mism, and a mem­ber of these­cret club of in­vestors that we talked about this morn­ing, which meets to plot ways to make com­pa­nies more longterm-ori­ented. Yes­ter­day, Fink sent a let­ter to more than 500 com­pa­nies say­ing that they should keep their money, but tell in­vestors how they're go­ing to spend it:

While we've heard strong sup­port from cor­po­rate lead­ers for tak­ing such a long-term view, many com­pa­nies con­tinue to en­gage in prac­tices that may un­der­mine their abil­ity to in­vest for the fu­ture. Div­i­dends paid out by S&P 500 com­pa­nies in 2015 amounted to the high­est pro­por­tion of their earn­ings since 2009. As of the end of the third quar­ter of 2015, buy­backs were up 27% over 12 months. We cer­tainly sup­port re­turn­ing ex­cess cash to share­hold­ers, but not at the ex­pense of val­ue­cre­at­ing in­vest­ment. We con­tinue to urge com- pa­nies to adopt bal­anced cap­i­tal plans, ap­pro­pri­ate for their re­spec­tive in­dus­tries, that sup­port strate­gies for long-term growth.

We also be­lieve that com­pa­nies have an obli­ga­tion to be open and trans­par­ent about their growth plans so that share­hold­ers can eval­u­ate them and com­pa­nies' progress in ex­e­cut­ing on those plans. Fink's let­ter has got­ten a lot of at­ten­tion for its call for com­pa­nies to "move away from pro­vid­ing" quar­terly earn­ings guid­ance: "To­day's cul­ture of quar­terly earn­ings hys­te­ria is to­tally con­trary to the long-term ap­proach we need." But its vi­sion of how com­pa­nies should be man­aged is also re­veal­ing.

Fink thinks that com­pa­nies should be man­aged by their man­agers. This doesn't sound es­pe­cially revo­lu­tion­ary, when you say it like that, but of course there is a com­pet­ing view. Lots of in­vestors think that they have some pretty good ideas for how com­pa­nies should be man­aged -- buy­backs are of­ten in­volved -- and aren't shy about propos­ing them. Some­times those pro­pos­als are ap­peal­ing, even to long-ter­m­ers, and Black­Rock some­times backs them. "Nev­er­the­less," writes Fink, "we be­lieve that com­pa­nies are usu­ally bet­ter served when ideas for value cre­ation are part of an over­all frame­work de­vel­oped and driven by the com­pany, rather than forced upon them in a proxy fight."

It's use­ful to keep the cap­i­tal-al­lo­ca­tion­de­bate model in mind as you read this let­ter. Fink's mes­sage to man­agers is that they, rather than ac­tivist in­vestors, should take the lead in de­cid­ing what projects should get funded. But Fink is very dif­fer­ent from the av­er­age ac­tivist in­vestor. In par­tic­u­lar, he doesn't have a con­cen­trated port­fo­lio of high-im­pact ac­tivist bets. He runs a com­pany that is re­ally good at in­dex funds and ex­change-traded funds. At least on the eq­ui­ties side, Black­Rock's busi­ness model is about di­ver­si­fied own­er­ship of many com­pa­nies. And it doesn't have much of a choice: Black­Rock man­ages $4.6 tril­lion, and the long-term in­vestors' club com­bines for more than $12 tril­lion, which comes to more than two-thirds of the en­tire value of the Stan­dard & Poor's 500 In­dex. Black­Rock, and the long-term club gen­er­ally, ba­si­cally own the whole mar­ket, be­cause they have to.

If you own the whole mar­ket, cap­i­tal al­lo­ca­tion isn't the source of joy and out­per­for­mance that it might be for Carl Ic­ahn or Bill Ack­man. If a com­pany's man­age­ment, in an ex­er­cise of dis­ci­pline and self-nega­tion, de­cides not to rein­vest its prof­its but in­stead hand the money back to you, what can you do with it? You have al­ready put your money ev­ery­where; where else can you put it?

If you own the whole mar­ket, you are un­likely to get a lot of per­for­mance by choos­ing the best projects to in­vest in, or to de­velop any par­tic­u­lar skill set in do­ing that. You're choos­ing all the com­pa­nies, with all the projects. You're much more likely to get per­for­mance by let­ting the man­agers of all those com­pa­nies dis­cover new projects and al­lo­cate cap­i­tal to them. If they give the cap­i­tal back to you, you're just go­ing to in­dex it any­way. You're not go­ing to make the wild bets on the fu­ture. You're re­ly­ing on cor­po­rate man­agers to do that.

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