Above Board: BlackRock's 2021 Stewardship Report

MoFo Perspectives Podcast

30 Aug 2021

In this episode of the Above Board podcast, Morrison & Foerster partner and host Dave Lynn speaks with Arden Phillips, Vice President, General Counsel and Chief Compliance Officer of Tahzoo, a global user experience consultancy that provides digital content solutions to Fortune 500 clients, on corporate governance and board-related topics raised by BlackRock’s recently-issued 2021 stewardship report.

In the report, BlackRock focuses on five engagement priorities, including board quality and effectiveness, incentive pay alignment, climate and natural capital, company impacts on people, as well as strategy, purpose, and financial resilience. Here, Arden and Dave examine the report from a board governance perspective to determine ways boards may enhance their effectiveness and thereby improve the chances of favorable voting outcomes.


Speaker: Welcome to MoFo Perspectives, a podcast by Morrison & Foerster, where we share the perspectives of our clients, colleagues, subject matter experts, and lawyers.

Dave Lynn: Hello, I’m Dave Lynn, and I’m a partner at Morrison & Foerster based in the Washington D.C. office. And I’m pleased to be joined today by Arden Phillips. And we’re going to talk about corporate governance and board-related topics that are raised by BlackRock’s recently issued 2021 stewardship report. Arden Phillips is a vice president, general counsel, and chief compliance officer of Tahzoo, which is a global user experience consultancy providing digital content solutions to Fortune 500 clients. Arden has advised boards of directors throughout his career working at Fortune 200 companies, as well as mid‑market publicly traded companies on matters ranging from risk oversight, to fiduciary duties, to succession, executive compensation, SEC disclosure, and regulatory inquiries, as well as dealing with communication strategies in response to shareholder activism. And Arden is also the past chair of the Association of Corporate Counsel’s Corporate and Securities Law Committee and has said several leadership positions within the Society for Corporate Governance. Arden, thanks very much for joining me today.

Arden Phillips: Well, thanks for having me, and I appreciate the nice intro.

Dave Lynn: Great. Today, we wanted to talk about the BlackRock stewardship report and maybe the best place to start off. What is BlackRock and what is the stewardship report all about?

Arden Phillips: BlackRock is a multinational U.S. investment management corporation. It actually happens to be the world’s largest asset manager with just over 10 trillion in assets under management. Its 2021 stewardship report details how it voted shares and its engagement efforts to promote corporate governance practices consistent with encouraging long-term value creation for shareholders. So due to its size, BlackRock and a few other large institutional investors wield heavy sway in the corporate governance landscape.

Dave Lynn: Yeah, there’s certainly closely watched bellwether for many of the corporate governance issues that we pay attention to. What were your main impressions and takeaways from this year’s stewardship report?

Arden Phillips: Well, the report, I think, was almost 80 pages, so there’s a lot to take away, so I’ll try to streamline it. But the BlackRock 2021 report identifies several areas of focus and concern for boards. And BlackRock and other institutional investors believe that corporate governance and board effectiveness are tied to the performance of companies and have made it clear that boards will be held accountable for failing to focus on their core responsibilities. So in the report, BlackRock focused on five engagement priorities. One was board quality and effectiveness. Two was incentive pay alignment. Third was climate and natural capital. And a fourth area was strategy, purpose, and financial resilience. And the fifth area was company impacts on people. So I’m not, like I said, going to do a deep dive on how BlackRock voted on various issues raised in the report. Instead, I thought it would be good and helpful to examine the report from a board governance perspective to determine ways boards may enhance their effectiveness. So increasingly effectiveness improves chances for favorable vote outcomes for companies when they’re interacting with BlackRock and other institutional investors. And based on the report, boards need to make sure that they’re functioning in an independent, accountable, and effective manners. And aside from that, boards should ensure that their companies have comprehensive disclosures regarding longstanding governance issues like executive compensation, as well as emerging trends like climate change, diversity, and other ESG topics.

Dave Lynn: Yeah, I think BlackRock has really been at the front of the line in terms of pushing a lot of the issues that are of most interest to companies today and certainly has been a leader in terms of encouraging engagement with shareholders. What were some of the particular insights that stood out to you in the report?

Arden Phillips: Well, as I read the report, I was surprised to see how much of it encouraged companies to engage in what I considered to be just basic, sound corporate governance practices. So it wasn’t anything that was earth shattering. I think the takeaway is boards need to really focus on the fundamentals as well as some other things, and BlackRock’s report stress that good governance practices were necessary to deliver sustainable long-term value and sound corporate governance, especially supported by a capable, well-functioning board is critical in BlackRock’s view to the success of a company and protection of the shareholder’s interests and long-term shareholder value creation. And BlackRock and other institutional investors think that companies with engaged, diverse, and experienced board directors who actually actively advise and oversee management have a competitive advantage. And that is why board quality and board effectiveness remain top BlackRock engagement priorities.

Arden Phillips: So BlackRock looks to directors on key committees to ensure appropriate board composition, oversight of issues, independence from management, that they’re engaging in careful deliberation, and that, again, they are focused on the protection of shareholder interests. So when BlackRock thinks a company is not effectively addressing a risk that could impact long-term value, it will seek engagement as a means to hold directors accountable. And I believe this principle holds true for most institutional investors. That’s their way of operating. And therefore, I think a governance strategy or approach that puts a board on solid ground with BlackRock will also put it on solid ground with other institutional investors and their engagement efforts and priorities as well.

Dave Lynn: What advice would you give members of the board of directors to address this governance aspect of the report?

Arden Phillips: Yeah, well, like I said, a lot of it is very fundamental. So one is, I would just say stay one or two steps ahead of BlackRock and institutional investors. And by that, I mean, read the BlackRock voting guidelines around board effectiveness. Secondly, I’d recommend boards discuss the voting guidelines amongst themselves and with management. Third, I think boards should assess where their practices diverge from those investor guidelines, and next, determine what the board’s position is in relation to those particular guidelines because boards have to do what is appropriate for them. They can’t be obviously overly swayed by outside forces, but should always consider them. And then, fifth, and last, when the board actually comes away with a position and settles on one, they should be very clear in describing it in a proxy statement and stating why the board has decided to adopt a particular position because stating what you’ve done is I think just half the battle. The other half and the more important half is stating why it was done and explaining the justifications behind it.

Dave Lynn: Yeah. There’s some other specific takeaways in terms of actions that BlackRock took in 2021 that boards should be paying attention to?

Arden Phillips: Well, we could do a rundown of some of the elements of the report and then kind of get into what boards should be doing. I think that’s a good way to segregate it. So the report touched on a lot of issues, including how BlackRock votes on directors, again, their focus on board quality and effectiveness, their focus on independence and how they voted regarding disclosures, diversity, engagement, compensation, and ESG. And in the interest of time, I’ll do a high-level review of each of these before getting into the recommendations as to what I think boards could do now to address these. So regarding voting on directors, voting on the reelection of directors remains one of the most important ways that BlackRock and other institutional investors signal support for or a concern about a board’s oversight of management. And during the 2021 proxy year, BlackRock voted on more than 64,000 director elections, and BlackRock voted against one or more directors at 3,400 companies. Corporate governance concerns: including lack of independence, insufficient diversity, and executive compensation. Reasons: going to board quality and effectiveness.

Arden Phillips: We’ve talked about this a bit, but board quality, including composition, diversity, and accountability, remains a top engagement priority for BlackRock and a key factor in the majority of its voting decisions. And then when you go to board independence, lack of independence was the primary reason BlackRock withheld support for directors in the 2021 proxy season. So BlackRock did not support about 2,200 directors at approximately 1,300 companies over independence concerns, which was kind of surprising. I think by now independence has kind of been a longstanding, baked-in concept coming out of Sarbanes Oxley. I would figure more boards would have more independent directors involved on their board in a significant way, but BlackRock expects there to be a sufficient number of independent directors on the board to ensure that the interests of shareholders are protected and that the board is able to oversee management properly in delivering sustainable long-term financial performance. So in terms of the disclosure pieces that were in the report, I was able to take away that BlackRock wants companies to provide clear disclosures around the points we’ve talked about so far in other issues. This information helps BlackRock and other investors better understand the unique challenges each company faces and how they are appropriately addressing material risk and opportunities to deliver sustainable financial returns. So comprehensive disclosures on long-term strategy, milestones to achieving that strategy, and the governance and operational processes that underline their business are important for BlackRock to see.

Dave Lynn: You have mentioned two topics that I think are the most important. So in the minds of directors these days, and those were diversity and engagement with shareholders and stakeholders. What did BlackRock have to say on those topics?

Arden Phillips: In regards to diversity, BlackRock believes that a diverse range of skills, experience, and demographic characteristics among directors is necessary for boards to be effective and to avoid group think. BlackRock asked that boards explain their approach to ensuring diversity among directors and how board composition aligns with the company’s strategy and business model. When disclosure is inefficient, in their opinion, BlackRock typically votes against the reelection of members of the committee responsible for nominating directors. And I noted from the report that insufficient board gender diversity was the top reason BlackRock voted against directors in the last proxy season. And there were about 61% of the votes BlackRock cast against directors were for lack of gender diversity‑related reasons. So going onto one of the issues they talked about, and really which was underlying the whole report was shareholder engagement. And I think BlackRock believes that companies that build strong relationships with their shareholders are more likely to meet their strategic objectives.

Arden Phillips: And BlackRock believes poor stakeholder relationships may create adverse impacts that expose a company to legal and also regulatory, operational, and reputational risks that might hurt the company’s performance and constrain growth, which goes against their proposition for long-term shareholder value creation. And one of the other issues that was pretty much highlighted in the report was the over boarding of directors, which again is an old issue that I thought wouldn’t be something BlackRock would be encountering much, but another key reason that BlackRock had voted against directors in the 2020–2021 season was over boarding. So director over boarding remains a key BlackRock focus given the increasing workload and range of matters on which boards are expected to advise and oversee management. So I think that’s really reasonable, but again, surprising. And like I said, I thought a lot of what I saw in the report was just basic fundamental, good corporate governance, but I think some boards are still struggling to raise themselves to certain standards that other companies and institutional investors are expecting these days.

Dave Lynn: Yeah. I think two things that were really in the spotlight this proxy season was in the alignment of pay with performance and ESG factors. BlackRock certainly, I suspect, had some views on those as reflected in the report.

Arden Phillips: Yeah, absolutely. Everyone always takes the opportunity to opine on executive compensation and have strong views from the management side, as well as the investor side. But from BlackRock’s perspective, executive compensation is an important tool. They believe that drives long‑term value creation by providing incentives and rewards for executives for the successful delivery of strategic goals and outperformance of the market. And BlackRock looks to a company’s board of directors to put in place a compensation structure that rewards executives against appropriate and rigorous performance goals and metrics. So that’s kind of the pay for performance that we’ve heard before. They want challenging metrics, not just show up to work, do your job, and get paid tons of money. They want to see these goals and metrics drive the company forward. And BlackRock also wants companies to be transparent about executive compensation structures and how those outcomes sought are aligned with the company strategy and shareholder interests. And further, executive compensation was one of the top reasons BlackRock voted against directors in 2020–21, unsurprisingly.

Arden Phillips: So BlackRock voted against the reelection of 931 directors at 453 companies, which was an increase over the prior year. And they speculated or basically stated that the increase in the against votes were largely due to COVID-19-related adjustments that management did to make rewards to executives despite the company missing financial performance targets, and also at the same time reducing their workforces or taking government financial support. So BlackRock opposed executive pay programs when companies were not able to explain how these adjustments due to COVID supported long-term sustainable value creation. And related to executive compensation is say on pay and BlackRock evaluates say-on-pay proposals on a case-by-case basis. So BlackRock supported management on 95% of say-on-pay proposals in the 2021 proxy year, which was the same pretty much as the previous year. And BlackRock’s main reasons for supporting management proposals include good disclosure and didn’t seem like their awards were linked to their long-term performance.

Arden Phillips: But again, they voted in favor of 95%. So that’s still a pretty high percentage and probably an indication that the threshold is pretty low as to when of BlackRock will go against the board and management’s judgment on when or how to pay their executives as long as it’s explained properly. So the last issue was just ESG. And in the 2021 proxy season, a number of companies incorporated environmental, social, and governance metrics in their executive compensation plans. And the BlackRock report stated that some companies received shareholder proposals asking them to report how the integration of specific ESG metrics into executive compensation programs was done. And these requests are likely to increase in the future as stakeholder scrutiny of executive pay plans continue to increase. And BlackRock believes that ESG performance metrics should reflect material business factors and be aligned with the company’s long-term strategy as most other metrics are as well.

Arden Phillips: And BlackRock also noted that it is important for companies using sustainability performance metrics in their executive compensation plans to carefully explain the connection between what is being measured and rewarded alongside business goals and long-term performance. So I think it’s important that sustainability-related performance metrics are also stretch goals and are well tested just as is the case for financial metrics tied to executive compensation. And also in the 2021 proxy season, several companies had proposals to approve a company’s climate action plan, which is commonly referred to as “say on climate,” and BlackRock voted on 28 say-on-climate proposals. Twenty‑two of those were put forth by management themselves. And these proposals received an average support of 97%, while the six shareholder proposals received an average of 33% support. So that’s a quick summary, very high level, of the incentive compensation alignment issues and ESG issues that were raised in the report.

Dave Lynn: Great. Thanks very much for those insights. As we wrap up, what do you think the top five things that boards should be doing now in light of the 2021 stewardship report that BlackRock has provided?

Arden Phillips: I think the overall message would be to drill down on basics. So the first thought I have is just related around fundamental governance, like make sure you have independent directors, make sure they’re qualified board members who are not over boarded that have adequate timed meetings where you can have robust discussion and debate over particular issues. Secondly, around comprehensive disclosure. I think that’s very key. So you should use—I think directors should be key drivers in making sure that the company’s website and its proxy statement and as much as possible other SEC periodic reports, as well as the annual report, share a detailed and coordinated message regarding how compensation strategy is aligned with company goals and how these goals increase long-term shareholder value. I also believe the board should make sure that they discuss and justify any deviations from compensation design in any particular year in which compensation or incentives were granted when the company overall didn’t do well.

Arden Phillips: And that piece about comprehensive disclosures is not just related to executive compensation, but I think we have many different issues. Again, ESG issues that you can have a apprehensive plan to disclose through your proxy statement and other means to coordinate a message. It’s almost like having an internal or investor relations view of your SEC reporting that can really help you sell your message to shareholders. The third tip would be regarding making sure that you have a proactive engagement program. So certainly do shareholder engagement by reaching out to at least 70% of your shareholder base, which may be hard or not as hard depending on breakdown between your institutional and retail ownership. But in these calls that you arrange with these shareholders, make sure you have the chair of the compensation committee on these calls, which demonstrates that the board is actively engaged in the company’s compensation strategy.

Arden Phillips: And I think it also shows that the company is open to dialogue and to explain how certain compensation decisions were made. I found through experience that institutional investors like to see companies that are constructively engaged, receptive to shareholder feedback, and initiate change from within. And in those situations, BlackRock and other institutional investors are inclined to support management in those types of situations. So definitely focus on describing shareholder engagement in the proxy statement itself. So it’s not only important to do it, but it’s also important to describe and let your shareholders know that you’ve devoted a considerable amount of time and effort to the process. And where BlackRock has independently assessed that companies have not considered shareholder feedback and where BlackRock sees significant risk to long-term value, BlackRock has voted against management and board members. So I think a robust discussion in your proxy statement about your shareholder outreach efforts will go a long way.

Arden Phillips: And lastly, I would say, be ready, be receptive, and be responsive. So being ready means the board should be informed and knowledgeable. That kind of goes back to fundamental governance. They should know how the business operates, know its strategy, et cetera. So that’s like being ready and also being ready, knowing your responsibilities as a director, and really not only your responsibilities, but what the expectations and the growing expectations are for board members to do more and more seems like each proxy season. So be ready, have an attitude of being receptive, I think is helpful for the board, meaning be open to shareholder-initiated engagement, as opposed to being defensive or arrogant or resistant just by nature. Don’t slip into that posture because I’ve found that shareholders mostly just want to be heard and make sure that the lights are on and that someone at the company gets it.

Arden Phillips: And ultimately, they may not be so much concerned with having the company agree with their position 100%, as long as you’ve shown that there’s a considered rationale for why the company is doing what it’s doing and that they’re open to hear the concerns of particular shareholders. So the other part of that is just being responsive. So you go out, you do the shareholder engagement, but also follow up with any promised communication. Don’t let things fall through the cracks, make sure you close the loop on feedback, and, again, describe in the proxy statement the interactions and considerations and ultimate decisions that the board came up with so that these shareholders who have engaged with you feel validated basically. And again, I think that’s half the battle with them. They want to know that their mission has been accomplished, that they’ve spoken to someone at the company at the board level that’s respected and has shown them respect in some type of regard.

Arden Phillips: I think the worst move is to ignore shareholder concerns because they won’t go away, and most likely they’ll build momentum around their issues. So it’s better to address shareholder concerns early, before a larger campaign can be launched around it. And just one tweak to that is stakeholder engagement versus shareholder engagement. And I think the ESG concerns that we’ve seen lately coming to the fore are requiring boards and management to go beyond the typical traditional shareholder, but engage other parties to debate these ESG issues and what the company’s going to do, what they’re not going to do, how they’re going to do it, and how they’re going to disclose how they’re going about addressing some of these ESG issues that are more prominent, like climate and diversity, for example. So those are my wrap-up recommendations, Dave, and I just turn it over to you.

Dave Lynn: Great. Thank you, Arden, for all of those insights. Really appreciate you joining me today and giving us a rundown on BlackRock’s 2021 report.

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