Research and Insights

A Company’s Ability to Operate Responsibly Can be Supported or Inhibited by Capital Structures, Time Horizons, and Ticket Sizes 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.

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.

Should we worry that non-financial corporate debt is at a historic high (both in absolute terms and relative to GDP)? Though in theory financial vulnerabilities should be of concern, there are reasons to think that alarm bells may not be ringing quite yet. In a recent opinion brief, Robert Armstrong has recently looked at this issue, and come out not “terribly inclined” to put corporate debt on his list of pressing worries. As a starting point, consider that non-financial corporate debt is low relative to the market value of corporate equities. Hans Mikkelsen, credit strategist with Bank of America, has highlighted that the ratio is currently at 25%, at the low end of the historical range. This leads him to some comfort that leverage ratios are not concerning given that “U.S. corporate bond investors have never been backed by more equity value”. Of course, this might simply indicate that stock prices have risen faster than levels of debt, which is, as Armstrong points out, hardly reassuring.

The narrow focus on corporate disclosures can result in an oversight of important activities since investment strategies can shift the risk to workers and lead to the deterioration of affordable goods and services writes Delilah Rothenberg.

A new report translates the difficult questions we have on sustainability into suggested investment changes […] “Predistribution Initiative’s ESG 2.0: Measuring & Managing Investor Risks Beyond the Enterprise-level tackles these systemic issues head on, providing a detailed analysis of problematic investment trends in recent years. The paper highlights the inherent contradictions of more ‘traditional’ ESG approaches to sustainable investing, applied commonly at the underlying enterprise or asset level, and the structural impact of asset allocation decisions at the level of the financial institution itself, particularly in relation to global economic inequality, increasingly recognised as posing systematic risk.”

Do environmental, social, and governance (ESG) and impact investing practices in their current forms provide investors with sufficient tools to play a meaningful role in “Building Back Better” following the COVID-19 crisis? Many investors, including those who identify as “Universal Owners,” often seek to manage ESG risk and opportunity through corporate governance interventions. However, certain investment structures can also have negative impacts relating to ESG goals and management of systematic risk. Furthermore, they can undermine the positive impacts sought by investors at the portfolio company-level.

ESG funds’ bias against workers is unintentional, but it is a feature rather than a bug […] A new paper by The Predistribution Initiative, ESG 2.0: Measuring & Managing Investor Risks Beyond the Enterprise-level, foregrounds potential negative impacts from capital structures themselves, not just portfolio companies.

According to a new report about the private equity (PE) industry, the majority of PE firms are not doing enough to take systematic risks seriously in both their business operations and investment portfolios. The report, “Private Inequity: How the Private Equity Industry Needs to Improve When Addressing Systemic and Systematic Risks,” analyzed how PE firms responded to the ongoing triple crises of climate change, the COVID-19 pandemic and racial injustice.

PDI advisor, Kim Leslie Shafer, has spent significant time and effort engaging with various investor, legal, academic, and civil society networks to aggregate and synthesize perspectives. As a true leader, she is generously sharing the knowledge she has developed to encourage widespread responses to the SEC.