Investors are increasingly aware of the system-level effects of their investments. In a previous post I have written about how the very large asset owners and asset managers have to consider whether their investments are making a positive or negative contribution to the financial, environmental, and social systems that support human life on Earth. Sudden shocks (e.g., the financial crisis of 2008) and steady and persistent degradations (e.g., from climate change) in these systems will make it impossible for investors to earn the returns expected by their ultimate beneficiaries—all of us.
The most prominent and frequently cited example of system-level risk is climate change. More recently, investors are recognizing that income inequality is also a system-level issue. They regard it as of equal magnitude to climate change but with effects that are being felt more immediately. World leaders, including former President Barak Obama, have reinforced the urgency of the situation, calling inequality “the defining issue of our time.” The United Nations has highlighted inequality in its Sustainable Development Goals as a global concern for which meaningful action is possible.
Addressing income inequality and promoting equity is challenging for institutional investors but efforts are already being made. For example, in 2016 Aegon Asset Management, with around $380 billion in assets under management, engaged with Grupo Mexico S.A.B. de CV, the third largest mining corporation in Mexico, regarding its labor relations. Others, like the Omidyar Network, a philanthropy and impact investment firm, promote debate and discussion about the importance of investing in underserved markets.
Despite the emphasis investors are increasingly putting on the importance of addressing income inequality and the diverse approaches being taken, agreement on how they can tackle the fundamental causes of this challenge has proven elusive. A new report by Steve Lydenberg, William Burckart, and Mackenzie Clark of The Investment Integration Project, and Michael Musuraca, an independent advisor—in collaboration with the Principles for Responsible Investment—aims to deal with this challenge, and examines the question Why and how can investors respond to income inequality?
The report calls attention to the potential risks of income inequality for investors — particularly to long-term investment risk management and the overall stability of societal systems and financial markets — and offers practical insights on how investors can contend with such a complex challenge. “Investors have unintentionally contributed to the rise in income inequality and its potentially destabilizing effects, but in recognizing their role in this, investors can also see the opportunities to shift practice towards a more equitable one,” said Burckart, a co-author of the report.
The report focuses on three themes that have had the effect of contributing to income inequality: (1) the erosion of labor standards, (2) the tilt toward tying CEO compensation to stock price performance, and (3) the trend away from the responsibility for paying a “fair share” of taxes. It examines these themes through the lens of “fissuring” —in effect assessing how equality has been lost through deteriorating relationships between corporations and their workforces, stockowners and other stakeholders in the firm, and companies and government.
In the context of labor, for instance, over the past four decades large, global corporations have increasingly sought to meet investors’ demands to focus on core competencies that drive shareholder value. As Professor David Weil points out in The Fissured Workplace, this has resulted in outsourcing work, whether to global supply chains in which forced and child labor are common, or domestically to contractors. The result diminishes corporations’ responsibility for the workers performing such functions by turning them into costs to be minimized through competitive contracting that can ultimately lead to lower wages, fewer benefits, and less job security.
In addition, disproportionate CEO compensation can demotivate employees who do not see comparable rewards, as well as raise concerns among customers, suppliers, and local communities. And aggressive tax avoidance not only primarily benefits the largest corporations and very wealthy, but it also creates a destabilizing sense of unfairness in a system where all are asked to pay their fair share.
“Investors have begun to recognize their role in fostering the rise of income inequality throughout the globe,” said Musuraca, a co-author of the report. “How they now act to help create greater equity will, in large part, determine how successful their efforts to help address any number of the world’s ills will be.”