In our recent report, “Income Inequality: Market Mechanism or Market Failure?” we argue that unequal incomes are a normal feature of a free market economy. It is the extent of this inequality, coupled with stagnating wages and persisting poverty, which led us to focus on this topic.
Why We Chose to Write on Income Inequality
The debate over inequality datasets is ongoing; however, most mainstream economic and political institutions agree that income inequality in the US has been rising and reaching unprecedented levels since the early 20th century. The social, economic and political implications of this trend have been widely debated, but without its investment implications being systematically or directly addressed. We wanted to go beyond the political economy discussion and understand:
- How income inequality is linked to the investment process;
- What are the impacts of individual investment decisions on this macro trend; and
- Why should investors care about it?
Our hypothesis was that income inequality can impact financial performance, and is a topic that investors need to look into. The availability of macroeconomic data on income inequality – and of corporate socially-related KPIs – provided the necessary material for our framework.
How We Conducted Our Analysis
We provide investors with the background and new tools to assess income inequality:
- The most recent data and the main facts on what income inequality represents; and
- An economic analysis of the drivers and effects of this trend on markets and the economy as a whole.
We then dive into the micro level and look at how investment decisions impact – positively or not – income inequality. We also draw from existing research on this topic, as many of the issues at the nexus of social welfare and business performance have already been studied. Our focus brings this knowledge within investors’ insight, and offers a new perspective on income inequality.
Our analysis links income inequality and corporate performance at two levels:
- Internally, through human capital management and social policies. Better social performance is often associated with better management quality, and good financial performance.
- Externally, through the local economic impact of companies on supply chains, customers and the local community
A Closer Look at the Results
Investors can gain an understanding from our report on how their decisions impact income inequality. For socially responsible investors, that is an important concern. But we argue that mainstream investors, regardless of how much they care about social concerns, should examine these issues as well. Income inequality is bad for the global economy, and it can be bad for business. Companies that understand this, and have taken effective measures, are companies who maximize their value creation potential. For value-driven investors, that can be an important additional layer of their analysis of corporate performance.
We want to be pragmatic – and offer solutions. In our report, we provide two simple tools to assess to what extent investments in corporations increase, or on the contrary, reduce inequality. Those tools are focused both at the internal social performance of companies, and at their broader, external socio-economic impact. Our approach is complementary to traditional corporate performance analysis – as it offers specific insight into how investors can engage companies to tackle this issue.
Our report was made widely available to the public, and can be downloaded on Cornerstone’s website. We believe this issue is of great importance, and investors need to be aware that their investment decisions do have an impact on incomes and ultimately, on social welfare and economic growth. We provide examples of corporations which have embraced this issue and found workable solutions aiming to reduce inequality, and that also produce very good financial outcomes. We argue that reducing inequality is actually good for markets, and provide arguments to support this view.
Potential Barriers to Overcome
The link between the macro and the micro levels of income inequality is, in theory, easy to grasp, but in reality, it can be difficult for investment managers to effectively address this issue, especially in the short-term investment cycle.
Our experience shows that companies can also find it difficult to answer these questions; sometimes they haven’t even thought about them in this perspective. But if engagement doesn’t work immediately, investment managers can find some of the responses themselves – simply by linking the right social KPIs to sector averages – and with the rise of ESG data, this is increasingly feasible. There are also top corporate performers in the market – both in social and financial terms – that are establishing best practices in terms of reducing inequality. It might be only a matter of time before other mainstream corporations follow.
Investors need to see high income inequality as a defining feature of an unsustainable economy, one that is undermining its own growth potential and threatening its own stability. But when this issue is considered only as a collective good to mend, it can seem difficult for investors to individually engage in this enterprise. In reality, when properly designed and implemented, such a complementary approach to corporate performance evaluation can have a helpful contribution. Companies that work to reduce inequality, through a positive social approach, also increase their ability to produce better performance over the long term.
With the rise of sustainable investing, investors – companies’ dialogue on social matters will eventually become easier. It is not only about endorsing the investors’ responsibility related to this global challenge, but also about seizing the opportunities that the evolving corporate social practices offer in terms of increased value creation potential.Margarita Pirovska, PhD is the Policy & Sustainability Analyst at Cornerstone Capital Inc.