A resolution for investors: you must engage on new forms of stakeholder capitalism
Delilah Rothenberg and Amanda Feldman on private equity, disclosure and rethinking the system
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Responsible Resolutions: This is the latest article in a series from sustainable finance practitioners about their hopes for the New Year.
Private equity is booming. According to McKinsey, assets under management in private markets hit yet another all-time high in 2018, at $5.8trn – and Private Equity International just reported that 2019 private equity fundraising shattered post-crisis records. The deal flow is also growing, with the value of private equity deals reaching a high in 2018 at $1.4trn. As institutional investors look to private markets for yield, they also have a strong opportunity to invest in companies that benefit all stakeholders – and contribute to the success of the Sustainable Development Goals.
Yet debates about negative impacts of private equity investment have also heated up. Senator Elizabeth Warren’s Stop Wall Street Looting Act, as well as organisations such as the Center for Popular Democracy, highlight “how Wall Street firms have been driving economic inequality in our country for decades”. Their concerns include, among others, excessive use of leverage and the resulting potential risks to workers in portfolio companies. As the Toys-R-Us bankruptcy recently highlighted, the use of leverage should be approached responsibly. Significant debt burdens can lead companies to bankruptcy and push risk down to workers, who can experience decreased pay and loss of benefits or even their jobs.
Similarly, short-term incentive structures, as well as pay gap ratios between average workers in companies and their CEOs have captured the attention of investors and policymakers alike. Yet data suggests that the compensation of fund manager executives can often be even greater than that of corporate executives. Furthermore, as a 2019 report from the UK Parliament notes, “it may be awkward, if not hypocritical” for fund managers “to criticise pay policies for prioritising short-term financial incentives.” It is not uncommon for even self-identified long-term investors to use valuation methodologies with inherent characteristics that promote short-termism, such as IRR, and evaluate investment professionals based on annual financial performance.
Investment structures should be tax-efficient, but domiciling funds in tax havens and lobbying for the protection of the carried interest loophole can have serious negative impacts on society and well-functioning systems.
Meanwhile, workers in portfolio companies invest significant parts of their lives, sometimes even putting their health and safety at risk, to make investments successful. They frequently do this without building any wealth of their own. In private equity, there is an opportunity to narrow these pay ratios and share more of the profits and rewards with workers. If capitalism is going to work for stakeholders more broadly, it is critical to ensure workers (and communities in the case of real assets) are being rewarded for the value they create and the risk they take, in addition to investors.
It is difficult to highlight stakeholder concerns about private equity without mentioning tax, particularly since Rutger Bregman rang the alarm bells at last year’s World Economic Forum. Investors have responded well to Bregman’s words, but solutions are mostly being applied at the portfolio company level, as opposed to also recognising that our own tax practices as investors could be resulting in negative externalities. Investment structures should be tax-efficient, but domiciling funds in tax havens and lobbying for the protection of the carried interest loophole can have serious negative impacts on society and well-functioning systems.
It is true that as investors embrace a new paradigm of doing business, there are promising solutions in the industry’s ESG and impact frameworks. However, we need to take this analysis beyond just the portfolio company level, and also focus on how funds are managed and investments are structured.
Why are investors not talking more about externalities – positive and negative – stemming from the structure and operational processes of our own investment firms? What role do our fund structures play in a push towards stakeholder capitalism? Investors are companies, too – the level of data and transparency around issues identified in Klaus Schwab’s reflections on the Davos Manifesto would be more complete and effective if asset owners and managers were included in the equation.
As the 2020 World Economic Forum continues, the Predistribution Initiative invites investors, labor advocates and civil society to workshop solutions together to develop stronger ESG and impact analysis at the investment structure and practice levels to avoid missing serious blind spots of our own. We can no longer afford to overlook positive and negative contributions of investors that contribute to systemic risks. Through self-reflection and careful listening to stakeholders, we can make sure our investment structures and practices are part of systemic solutions, not the problems.
Delilah Rothenberg is Founder and Director of the Predistribution Initiative, to which Amanda Feldman is an Advisor