Delilah Rothenberg, Co-founder of Predistribution Initiative (PDI), shares updates on their work on regenerative approaches to asset allocation and investment structures that narrow the wealth gap for an inclusive economy.
The time is now for moving from a financialized economy to one that supports real people everywhere, across both rural and urban communities, developed and developing countries, businesses of all sizes, and which produces products and services that sustain healthy, thriving societies. This vision is attracting broad support from conservatives and liberals alike. We have a long way to go, but are confident that we can achieve this vision together.
Oxfam’s recent report, “Inequality Inc.”, helps underscore the work ahead, pointing out that the world’s richest 1% own 43% of all global financial assets and that they emit as much carbon pollution as the poorest two-thirds of humanity. Since 2020, the fortunes of the five richest men globally have more than doubled, while nearly five billion people have seen their wealth fall. If each of these men were to spend a million US dollars daily, they would take 476 years to exhaust their combined wealth.
While there are a wide number of contributing factors that got us here – including numerous forms of discrimination – in this blog, we explore three broad overlooked contributors to inequality and how we might address them. These include:
- The structure of compensation;
- Market concentration; and,
- Underpinning the first two issues, interpretations of risk, return, and value.
The Structure of Compensation
When we first launched PDI in 2019, one of our initial projects was exploring how the private equity (PE) industry could do a better job of sharing more wealth and influence with workers, communities, and retirees. Research revealed stark imbalances between how PE executives are compensated and incentivized versus other stakeholders who take risk and create value. Workers take significant risk and create value in companies. Communities do the same, particularly in infrastructure and real estate project development. Yet, unlike executives and investors, workers and communities often do not share in meaningful wealth creation from the production to which they contribute. In 2022, CEOs of the largest US companies were paid 344 times as much as a typical worker vs. 1965 when they were paid 21 times as much. And as we note in our previous content, PE executives of the largest firms typically make significantly more in compensation than many corporate executives.
This imbalance has increasingly attracted the attention of the world’s largest asset allocators (e.g., pension funds, insurance companies, sovereign wealth funds, and endowments). For instance, Chris Ailman, the outgoing Chief Investment Officer (CIO) of the $327 billion pension fund, CalSTRS, recently said in an interview with the Financial Times: “It’s great they (PE firms) make money for our retirees – who are teachers and for other funds. But they also need to share the wealth with the workers of those companies and with the communities they invest in.” We agree and applaud Ailman for raising awareness about this important issue.
What got us here? Many look to companies to pay a living wage as a potential solution. Oxfam’s report notes that, “Just 0.4% of over 1,600 of the world’s largest and most influential companies are publicly committed to paying their workers a living wage and support payment of a living wage in their value chains.” Paying a living wage is a crucial baseline that will help bring workers out of poverty, recognize more of their value and risk taken, and which can – as The Shareholder Commons (TSC) highlights – reduce the systemic and systematic risks of inequality for the economy, markets, and diversified portfolios. If diversified investors were to factor these system-level risks into their financial analysis and investment decision-making, companies that pay a living wage might have much more attractive risk-return profiles (we will come back to this point later).
However, with gaps in inequality as wide as they are, paying a living wage to workers will only go so far when it comes to building meaningful wealth for workers. One of the key reasons why workers and communities most often don’t share in the benefits of this wealth is because they are typically not compensated in equity, as investors and corporate executives are. This helps explain the previously mentioned pay ratio between workers and executives and why in the US, from 1978–2022, top CEO compensation rose 1,209.2% vs. 15.3% increase in a typical worker’s compensation.
This approach in large part results from financial economists in the 1970’s seeking to address the “principal-agent” problem (with investors being the principal, and CEOs being the agents), concluding that the best way to align corporate executives’ incentives with those of investors would be to structure a significant part of executive pay as equity. This logic assumed investors should incentivize corporate executives to maximize their own companies’ near-term financial returns.
Unfortunately, this upside is often short-term in focus and comes at the expense of other stakeholders, like workers, communities, and the environment. Arguably, seeking to maximize near-term returns can put pressure on a company to not pay a living wage. PE fund manager executive compensation follows a relatively similar model (in the form of carried interest).
Yet from another angle, research implies that the principal-agent problem extends beyond relationships between investors and CEOs, and that companies may have stronger and more resilient long-term financial performance if workers' interests are also aligned with investors and CEOs, by including equity ownership or profit sharing in worker compensation as well. Moreover, this "shared ownership" approach can help workers (or communities in the case of real assets - for instance local communities sharing in equity of an infrastructure project) build wealth alongside executives and investors.
At PDI, we believe “shared ownership” is an important tool for narrowing the wealth gap. However, there is a risk that equity owners of all types – professional investors, corporate executives, middle management, workers, and communities – may then be incentivized, under the current paradigm, to each maximize their own return relative to other stakeholders. For instance, worker owners of one company might seek to maximize the value of their own equity by encouraging lower pay for workers in the supply chain in distant geographies.
A regenerative financial system that works for all requires rethinking risk, return, and value so that investors of all kinds recognize that the health of their financial portfolios are dependent upon the wellbeing and stability of others, as well. We were thrilled to be invited to speak about this at recent conferences including those held by the Rutgers School of Management and Labor Relations Institute for Employee Ownership and Profit Sharing and Neighborhood Economics. A big thank you also to Joel Skene, host of The Mindful Marketplace on BizRadio, who invited me to share reflections on his recent podcast on "Redefining Capital and Distribution."
As PDI continues to explore shared ownership models as one of several approaches to narrow the wealth gap and reduce negative externalities, we are pleased to release the Summary Report from our November 2023 convening, held with support from The Rockefeller Foundation and Ford Foundation, which highlights strong appetite for greater collaboration and sharing of lessons and best practices. We were thrilled to be joined by a great mix of investors, lenders, advisors, companies, academics, NGOs, and other practitioners for a collaborative discussion on how to advance different models for shared ownership. A Steering Committee of several attendees is now forming to build on this convening and maintain continuous programming.
As we progress with this work, we will encourage both shared ownership (worker and community ownership models), as well as approaches to rethinking risk, return, and value. We will also highlight the importance of paying a living wage and offering diversified retirement accounts wherever feasible, and supporting freedom of association and collective bargaining, with shared equity ownership as an additional benefit.
Market Structure: Another Piece of the Puzzle
While sharing equity ownership can be beneficial for workers and community members, what about entrepreneurs (not everyone is a worker, after all) and small-and-medium-sized enterprises (SMEs)? As we have highlighted in past work, it is increasingly difficult for entrepreneurs and SMEs to grow and compete, not only because of lacking anti-trust enforcement, but also given the evolution of banking and capital markets which limit their access to capital (market structure issues).
Oxfam’s Inequality Inc. report suggests an inflection point in how we think about the root causes of inequality: “A huge concentration of global corporate and monopoly power is exacerbating inequality...” On this point, for anyone seeking to better understand the dynamics between market concentration and stakeholder outcomes, we highly recommend PDI Board Chair, Denise Hearn’s, new publication with the Columbia Center on Sustainable Investment (CCSI), “Harms from Concentrated Industries: A Primer.” This piece helps explain how market concentration can lead to higher consumer prices, lower worker wages and bargaining power, less innovation and business dynamism, fewer start-ups, lower growth and productivity, greater inequality, and imbalanced power dynamics.
We also recommend the Groundwork Collaborative’s recent research on how corporate profits – often in concentrated industries – are contributing to stubborn inflation. Inflation Revelation: How Outsized Corporate Profits Drive Rising Costs found that 53% of the rise in inflation between April and September of 2023 could be attributed to rising corporate profits, with recent production costs rising much slower (even decreasing for some commodities and services) than inflation, leaving corporations with little excuse to continue to raise prices. Corporate profits as a share of national income have ballooned 29% since the pandemic and are hovering at an all-time high.
In addition to policy reform to address these issues, asset owners and allocators may find it useful to rethink the cost-benefit analysis of investing through smaller asset managers and in smaller companies, as well as considering new and emerging asset classes to do so (we cover this further in past work and newsletters).
Rethinking Risk, Return, and Value: Integrating Systemic and Systematic Risk into Financial Analysis and Asset Allocation
What systemic and systematic risks might result from market concentration for investors, both in terms of (lack of) diversification and too much capital chasing the same assets (potentially leading to asset bubbles), as well as inequality? Gillian Tett raises parallel questions about risks from concentrated ownership of assets in this excellent article. If investors were able to quantify these risks and integrate it into financial analysis, would investing in diverse and emerging managers and SMEs have more attractive risk/return profiles? As we discussed in our previous newsletter on the investment case for tackling inequality, the consequences of concentrated markets and wealth include not only inequality, but also polarization, barriers to climate action, reduced diversification, and systemic and systematic risks via debt crises and asset bubbles which threaten diversified investors’ portfolios.
Similarly, when we think about the "Global South," what is the system-level risk of not investing in these markets? If we were able to factor this into financial analysis, would the risk-return profile of these markets change, thereby reducing the cost of and access to capital for these regions? If we factor system-level risks into financial analysis, do previously considered concessionary investments come closer to having a risk-adjusted rate of return?
On this topic, we highlight a working paper by our partners at the Southern Centre for Inequality Studies (SCIS) and Krutham titled: “The Inequality—Financial Markets Nexus: Implications for Developing Metrics for Voluntary Disclosures.” The paper brings a Global South perspective to the development of proposed disclosure frameworks to reduce inequality and offers excellent insights relating to the importance of the informal sector, as well as issues relating to investment structures and market structure. We highly recommend this as a resource and anticipate facilitating investor discussions around topics raised together with SCIS and other partners.
Investigating overlooked root causes of both system-level risks and inequality has led PDI to focus on supporting investors to co-create reforms relating to investment governance, financial analysis, investment structures, and market structure. Upstream changes with these actors at the top of the capital markets value chain regarding interpretations of risk, return, and value can lead to more regenerative approaches to asset allocation and investment structures that share more wealth and influence with workers and communities.