Research and Insights

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. 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: (1) the structure of compensation; (2) market concentration; and (3) underpinning the first two issues, interpretations of risk, return, and value.

The Predistribution Initiative (PDI) partnered with Oxfam America and Omidyar Network on a new discussion paper, "Getting Ahead of the Curve on Dynamic Materiality: How U.S. investors can foster more inclusive capitalism." This paper is designed to support U.S. investors in understanding how sharing more wealth and influence with workers and communities can correct imbalances and support early identification and mitigation of emerging risks. Specific tools and opportunities are highlighted that can foster more sustainable and responsible value creation, and ultimately a more inclusive and thriving economy. Examples include: grievance mechanisms, freedom of association and collective bargaining, human rights due diligence and FPIC, shared ownership models, and workers on boards.

This piece is based on remarks by PDI's Delilah Rothenberg during a meeting organized by the G20 focused on “the fight against hunger, poverty and inequality.” The meeting was facilitated by Brazil’s Ministry of Finance as part of Brazil’s role as host of this year’s G20 meetings. "Relying on redistribution to continuously address socio-economic inequality can result in the disadvantaged being dependent on handouts from the rich. Instead of production resulting in vast imbalances in wealth and power which require continuous remedy, workers and communities could have similar opportunities as executives and investors to share in financial gains and influence over investments."

Rising inequalities both between and within countries are fueling polarization and protectionist pressures, hampering social cohesion and political stability. Leading economists are calling for society to combat inequality, demanding better measurement and ambitious targets. Businesses and investors have significant roles to play. The private sector, through various practices, can contribute to inequalities, alleviate inequalities, and also face risks posed by inequalities... Diversified investors who sit at the top of the “capital markets value chain” – like pension funds, endowments, and sovereign wealth funds – have an incentive to reduce socio-economic inequality. Their portfolios are so broad across geographies, industries, and asset classes that their financial success is dependent on the health of the economy.

The paper -- "From Fragmentation to Integration: Embedding Social Issues in Sustainable Finance" -- aims to generate momentum within the financial system to tackle inequality and improve a common understanding of the social impacts of a market-based economy. Drawing insights from the climate agenda, it sheds light on how to catalyze action at the policy and regulatory levels through existing sustainable finance initiatives. Based on the collective expertise of several institutions and a global consultation, the paper provides key recommendations for governments, regulators, and financial institutions to: support research on the systemic risk of socio-economic inequality for financial stability; adopt and improve social disclosure standards and risk management tools; and rethink the macroeconomic determinants of sustainable finance.

Forum for the Future, a non-profit that works in partnership with business, government, and civil society to accelerate the shift toward a sustainable future, published an exciting new report that builds on much of PDI’s work reimagining the way the financial system addresses systemic risks. The authors of “Finance: an agent of change?” specifically call out the potential of system-level investing and highlight how “The Predistribution Initiative and Responsible Asset Allocator Initiative are together convening investors to explore how to strengthen alignment between investment and stewardship teams, and how to integrate external data on externalities into investment analysis and decision making, at a systems level.”

It can be difficult for companies to have positive impacts and avoid unintended negative consequences (risks) if those companies aren’t backed by supportive investment structures... Because capital structures, fund structures, and asset allocation strategies are so critical to responsible and regenerative investment, a meaningful change in practice will require stronger alignment between capital stewardship teams and investment “deal” teams at asset owners and allocators. We are encouraged by recent efforts by regulatory bodies globally, including in the US and Europe, to reduce greenwashing. But truly understanding greenwashing and what distinguishes a holistic approach to responsible investing from one only focused on portfolio companies requires a deeper evaluation of markets, the economy, and their impacts on the world.

Karen Kahn and Marjorie Kelly spoke with Delilah Rothenberg, co-founder and executive director of the Predistribution Initiative, about the ways in which the private equity model drives inequality. Delilah Rothenberg has been interested in Pete Stavros’ model for sharing equity with all workers for some time. A few years ago, when she first heard about it, she looked at KKR’s 2017 sustainability report, where KKR talked about several portfolio companies where they had distributed shares more broadly. When she did the math, she found workers were receiving equity grants averaging about $25,000 while KKR’s general partners were taking home more than $100 million each in annual compensation.

As the world emerges from the pandemic with high inflation, vast inequalities, and rising oil and gas prices, it seems timely to ask how much we can expect of investors and businesses in our current system. While individual investors — people and firms — are taking on climate change and other systemic risks like inequality and biodiversity loss, they are doing so in a system where the odds are stacked against them. The very nature of the system resists change in ways that non-financial disclosure and policy and regulation alone cannot solve. Financial decisions are based on financial analysis, and the current system lacks a mode for accounting for externalities in the calculation of returns. In our current economic system, companies and asset managers are expected to maximize their financial return to investors.

The Predistribution Initiative (PDI) is focused on ESG implications of investment structures and practices. There is growing concern that as institutional investors migrate up the risk-return spectrum for yield and allocate more to residential real estate (RE), they are driving up valuations and competing with potential individual homeowners, thereby exacerbating the affordable housing crisis. Institutional investors are typically not intentionally causing harm and likely want to avoid these negative impacts, so are there more regenerative investment structures that they can allocate to with exposure to residential RE and risk-adjusted returns?

A recent article by Nathaniel Bullard on Bloomberg.com noted that heady valuations and investor fear of missing out, coupled with the need to fund planetary-scale innovation has provided a tailwind for climate tech. As Bullard alluded to at the end of his post, despite the positive headlines, high return expectations typical of venture capital and private equity investors could compromise portfolio companies’ abilities to effectively deliver strong results, both in terms of financial performance and positive impacts. Moreover, so many investors competing for the same investment opportunities with high-return potential can drive up valuations — some companies may end up overvalued, while other well-deserving companies who have slower growth trajectories may see no capital at all.

High leverage is arguably making our economy more vulnerable to a solvency crisis in the event of a persistent increase in interest rates and/or should future increases in inflation prove difficult to control. It is also contributing to and compounding the various forms of systemic inequality trickling down to individuals and communities. This is why we are concerned that if the source of high returns for investors lies in leverage rather than fundamental factors, heavy portfolio allocations to certain securities in such asset classes (e.g. high yield bonds, collateralized loan obligations, leveraged buyout private equity) end up creating negative externalities that can systematically undermine institutional investors’ ESG and stewardship efforts.