“There is substantial data showing improved financial performance by companies that pay and treat their workers better.”
Phase I: Private Equity
The first phase of this project entails the development of several new private equity fund prototypes that share more profits with workers in portfolio companies – profits that would otherwise mainly reward executives and fund managers. It is hypothesized that in addition to benefitting workers, such models have enhanced potential for stronger limited partner returns and can still offer attractive incomes to individuals working for asset managers.
The private equity asset class is an initial focus due to the significant compensation that large fund managers receive (e.g. approximate 2% management fees and 20% carried interest), as well as the ability for private equity managers to have more control and influence over their portfolio companies. For instance, in the private equity model, it may be possible to structure opportunities for workers to participate in “carried interest profit sharing pools.” Private equity firms also are well-positioned to structure models in which portfolio company workers can participate in equity ownership of their companies.
Predistribution or redistribution? Not mutually exclusive
Many assume that the best way to address high executive and financial service industry pay is through taxes. However, this redistribution of earnings does not address whether actors in the capital markets supply chain – particularly workers - are adequately paid for the value that they create in the first place. The Predistribution Initiative recognizes that there are currently inefficiencies in labor and capital markets and that investors are uniquely positioned to advocate for and structure improved compensation structures.
Predistribution empowers workers through helping them build their own wealth. Initiatives to close the wealth gap that only focus on redistribution can result in cycles of dependency on top-down social safety nets and imbalanced power dynamics. Moreover, if we were only to focus on redistribution, we would ignore the existing cycles of wealth creation that perpetually grow economic inequality, potentially undermining redistribution efforts.
The Predistribution Initiative seeks to develop empirical and transparent methodologies to inform improved compensation structures. In addition to key questions around how much value each actor creates and how much each puts at risk, exogenous factors such as market rates for labor, localized cost of living for various stakeholders, etc. are also being considered.
The Predistribution Initiative is a multi-stakeholder effort to co-create new investment fund prototypes - designed for mainstream markets with risk-adjusted returns - that narrow compensation ratios between actors in the “capital markets supply chain.”
What do we mean by the “capital markets supply chain?”
Generally, actors in this supply chain include asset owners and allocators, intermediaries and asset managers, and portfolio company executive and senior management, middle management, and workers.
In building companies and creating value, all of these parties contribute.
High corporate executive compensation receives significant attention in the environmental, social, and governance (ESG) investment community, but asset manager compensation is largely overlooked. Similarly, in the impact investing community, investors may be concerned with investing in products and services to support the underserved, or paying a decent wage in their portfolio companies, but often do not consider whether they are paying such extreme amounts to fund managers that could undermine positive impacts relating to economic inequality at the portfolio company level.
Potential for systemic change
Reform of the private equity industry has potential for systemic positive impacts. In terms of the sector’s scale and reach, the author and professor, Ludovic Phalippou, notes:
“Eight of the largest ten employers in the U.S. are private equity firms.”
“Eleven million people work for a private equity sponsored company in the U.S. (as of 2016).”
“Globally, private equity firms manage a fast-growing pool of assets which reached $5 trillion in 2017 – the equivalent of one-fifth of the total value of the U.S. stock market in that year.”
Does the Predistribution Initiative Take a Stance on Redistribution?
We recognize that much of our modern society is built on historical inequities that place today’s actors in the economy on unequal footing. Taxes, philanthropy, and impact investing can help level the playing field for historically disadvantaged communities and people. Taxes in particular are also critical for provision of public services and resources. While the Predistribution Initiative is supportive of efforts to advance certain redistribution strategies, it is not a focus on our work.