Companies that have a low gap between their highest paid executives and the average worker’s salary have higher-than-average profit margins, according to research from global index provider MSCI.
MSCI’s recent report on executive/worker pay gaps points to the benefits of ESG/SRI investing.
MSCI‘s “Income inequality and the intracorporate pay gap” report, which observed 591 companies between 2009 and 2014, shows that companies with smaller, more equitable pay gaps between the highest and lowest paid workers tended on average to have superior profit margins.
The data comes amid increased interest in SRI (Socially Responsible Investing) and ESG (Environmental, Social & Governance) investment approaches, which typically incorporate an assessment of executive compensation and remuneration imbalances within their methodologies.
The index provider reported last month that it has seen record revenue growth in its ESG research and indexing business, highlighting the emerging importance and increasing adoption of values-based investing.
Another, related area of ESG that is gaining the attention of investors is the impact of gender diversity. According to a 2015 MSCI study that explored global trends in gender diversity on corporate boards between December 2009 and August 2015, companies with at least three female board members outperformed others in overall return on equity by more than 36 percent.
SSGA recently launched a gender diversity ETF in the US that invests in companies that are leaders in advancing women through gender diversity on their boards of directors and in senior leadership positions. The ETF tracks the SSGA Gender Diversity Index, is composed of approximately 144 stocks from the largest 1,000 listed companies in the US, based on the presence of women at the CEO, board or senior leadership levels.
This result comes despite economic findings from organisations such as the IMF, OECD and S&P suggesting that over the long term, income inequality may perpetuate, exacerbate, or precipitate other, possibly significant, economic and social events.
According to the paper; “The International Monetary Fund’s paper Inequality and Unsustainable Growth: Two Sides of the Same Coin? stated that, while some inequality is integral to market functions and incentives, too much may be destructive, and periods of long economic growth “are robustly associated with more equality in the income distribution.”
The OECD similarly suggested that “income inequality has a negative and statistically significant impact on medium‐term growth.” By their estimate, a rise of 3 GINI points represented a cumulative loss in GDP over a 25 year period of 8.5%. Even Standard & Poor’s more recent research suggested “extreme income inequality drag[s] on long‐run economic growth.”
However, MSCI’s findings suggest that intra-corporate pay gaps paralleled country‐level income inequality between 2009 and 2014.
According to the GINI index, a measure of income distribution of a nation’s residents, the pay gap increased in 63% of countries around the world from 1980 to the current decade and has continued to expand since the crash in 2008.
The OECD also estimates that growing inequality has cumulatively shaved almost nine percentage points from growth of gross domestic product in the U.K., Finland, and Norway, and between 6-7% in the U.S., Italy, and Sweden between 1990 and 2010.
In other findings, in the US the highest gap in intra-corporate pay was in the Consumer Discretionary sector, which is likely to be impacted by movements advocating for adjustments to minimum wage in certain countries.
However, labour productivity, which was measured by sales per employee, was lower – on average – for companies with higher intra-corporate pay gaps.
Other findings showed that it was the labour force that usually bore the brunt of company initiatives to maintain or improve profitability. Notably in turbulent markets, this was through cuts in benefits, raises, or jobs. At the same time, executives were rewarded for short‐term performance, both through market returns on equity and equity options and increases in performance‐linked pay.
The report stated: “Using our sample, we note that the highest executive total summary compensation at a company grew on average by a 20% compound annual growth rate (CAGR) from 2009 to 2014; in contrast, compensation for the average employee grew at only 2% CAGR during this time period….However, what is clear is that the reward received by executives during this time period far outpaced that received by most of the workforce.”
The research was based on the ratio between top executive total compensation and that of the average worker over a period between 2009 and 2014 for 591 companies included in the MSCI ACWI Investable Market Index (IMI) with a total market capitalization of USD 6.9 trillion as of December 14, 2015. It specifically investigated the possible links between macroeconomic income inequality and intracorporate pay gaps.
Investors interested in ESG and SRI have an ever-growing number of ETFs at their disposal. In Europe, UBS are among the leaders in this space with a extensive suite of MSCI-linked SRI ETFs, offering exposure to various country and regional markets.