How are responsible investors helping to reduce income inequality without losing their own shirts in the process?

How are responsible investors helping to reduce income inequality without losing their own shirts in the process?

Did you know that the average Top 100 CEO in Canada earns as much in four hours as the average Canadian makes in an entire year — about $46,0001?

I am deeply concerned about about social inequity, and in particular income disparity. When it comes to investment I feel conflicted: I still want to make money with my investments, but I’m also not willing to do so at any cost.

My concern on this issue comes from a fundamental discomfort with injustice. I also recognize, like many others that income inequality is bad for business, and bad for financial systems as a whole. In finance, this is called systemic risk, and it is the risk of collapse of an entire financial system or entire market. Indeed, the World Economic Forum identified severe income disparity as the fourth greatest systemic risk in their Global Risks 2014 report. (The related issue of structurally high unemployment/underemployment comes in as the second greatest risk.)

Responsible investment offers various ways of reducing income inequality and the social fall-out that it engenders. There are at least two effective ways that responsible investors try to address income inequality: local and international microfinance (micro-loans to the poor), which I will address in a future blog post, and shareholder engagement, which I’m going to write about today.

Shareholder engagement is a responsible investment strategy whereby investors use their influence and rights as share owners to dialogue with companies, submit shareholder resolutions and exercise their voting rights to improve the governance as well as the social and environmental behavior of the companies for which they have shares. (For more information, see www.ethiquette.ca/en/strategies/engagement/).

Some funds and some responsible shareholder rights groups are using their influence as shareholders to discuss and ask companies to disclose their pay ratios — the ratio between the CEO’s compensation and the median employee’s compensation. This type of data is not generally gathered or measured by publicly traded companies. Disclosure on pay ratios is a first step, and will help investors evaluate the reasonableness of executive compensation by giving it greater context. (Currently, this is the only context that is generally offered as a comparison to other CEOs in the industry.)

In the United States, disclosures on pay ratios in shareholder voting material within fast food companies reveal that the ratio was 1,000 times higher for the CEO in 2013, and that this was, in fact, down from the ratio in 2012 when the CEOs pay was 1,200 times the earnings of the average fast food worker.2 A responsible investor will see this enormous gap as a risk in the long term, rather than as an opportunity to make a lot of money in the short term and will encourage the company to explore the risks that such a discrepancy presents.

Switzerland has taken a stab at setting a maximum salary for top executives. The country held a referendum in 2013 on the idea of capping salaries for top executives at 12 times the company’s lowest salary, but the measure was defeated by slightly less than two-thirds of voters.

Given their small numbers and relative influence, responsible investors in Canada have not yet made great inroads on income inequality in Canada. The issue of pay ratio measurements between CEOs and bank tellers has been discussed with Canada’s five largest banks, and shareholder proposals to disclose information on this gap were filed with the banks in 2012, 2013 and 2014. All the banks were asked to, disclose this information, in recognition of the systemic nature of the risk, and the competitive challenge for one company to act if peers do not. The proposals were withdrawn when each bank agreed to explore the issues raised. Responsible investors will be monitoring what the banks do on this issue, and taking further action if the proposed measures are judged inadequate.

Disclosure on pay ratios comes at a time when shareholders are also finally getting to give their say on executive pay. Over the past few years, 80% of TSX-60 companies (60 large companies listed on the Toronto Stock Exchange) have adopted “say on pay” policies a term used for a rule in corporate law whereby a firm’s shareholders have the right to vote on the remuneration of executives). Overall, at least 127 mostly large Canadian companies have adopted say on pay policies and 120 held say on pay votes in 2013.3 While these votes are voluntary, generally non-binding and don’t go so far as to compare CEO compensation to median employee pay (like what may soon be required by law in the United States and the EU4), they are a small but important step in the right direction. The problem remains that most investors are still not responsible investors. Most investors, rather than evaluating the reasonableness of the compensation, are blindly rubber-stamping the company’s management recommendation to accept the CEO pay.5

Albeit through a lengthy process, responsible investors can influence income inequality. And they need to do so not just because it’s the right thing to do, but because it makes long-term financial sense. If more investors were responsible investors, positive change would no doubt accelerate. To find out how to invest in a world we want to live in, see www.ethiquette.ca/en/taking-action/.

 

4 Companies in the U.S. may soon be obliged by the Securities and Exchange Commission (SEC) to publish CEO compensation, median employee compensation and the ratio between the two. The European Commission is proposing the adoption of rules requiring certain publicly traded companies to report CEO pay ratios as well.

 

 


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