Mark Thoma cites some new research on inequality and CEO pay, challenging the Gabaix and Landier result that CEO pay has risen broadly with the stock market. The main criticism is that the result does not hold pre-1970...
Gordon and Dew-Becker refer to "outsized" increases in CEO pay but scant attention is paid to the broader literature or to event studies. You don’t have to go as far as Jensen and Murphy (1.4 cents received for every $1000 of value created) to see that CEOs don’t capture the full value of their contribution to the corporation, or anything close to it. Read this survey, pp.33-38 in particular. That is, even in today’s "Gilded Age" successful CEOs are underpaid relative to their marginal product, or how much they affect the value of the firm.
What about pre-1970? The obvious interpretation is that "way back when" CEO compensation was held very low, relative to marginal product, by social conventions (and perhaps to some extent by the threat of law, especially in the 1930s and 40s). Once these social constraints were relaxed, CEO pay rose very broadly in step with the stock market. The elasticity of CEO pay, with respect to performance, has been rising sharply.
The citation of institutional factors may sound like a criticism of Gabaix and Landier, but nothing in their paper denies the influences of such forces. They simply point out a recent regularity between the value of what is controlled and how much one gets paid to control it. It’s a trivial point, but it stops being trivial when people start forgetting it.
We shouldn’t expect the elasticity of CEO pay to market capitalization, over most stretches of time, to be close to one, even if it is close to one for some time periods. I would expect fairly long lags at times and then lots of catch up, with an elasticity greater than one for those catch-ups; the data seem to show this. The CEOs, however productive they may be, are reaping rents relative to their leisure, and their ability to capture those collective rents need not fit any particular time path. (That said, when you do see a 1-1 ratio it makes perfect sense.) The data do indicate that a regime switch has led to much greater rent capture, bringing compensation closer in line with CEO marginal products but still falling short of marginal products.
So in my view the Gabaix and Landier results holds up quite well, especially if one is willing to admit the central role of cultural factors, pre-1970 or so, in limiting CEO pay.
I’m not persuaded by the Bebchuk-Grinstein result that observable factors explain only about half of CEO pay; in fact I am surprised that the observables explain as much as they do.
Here is more from Mark Thoma. Here is a post from Ezra Klein on same.
While I disagree with some of their interpretations, the Gordon and Dew-Becker paper is a very useful summary of much of the literature on income inequality.
Are these studies really attributing all created shareholder wealth to the CEO? That hardly seems justified.
The studies don’t assume what you are alleging, for their methods see pp.32-33 of the Murphy survey plus of course the pieces themselves. Isolating the CEO’s contribution is a difficult problem but under plausible specifications they remain way underpaid relative to marginal product.
Finally. Someone looking out for the little guy.
“Tyler, I’d take you more seriously if you could explain why CEO’s never hand back compensation when profits or marketcap declines. Marginal product cuts both ways.”
seer,
I’m no economist, but I’m guessing they don’t give back comp because they like money.
As for why their contracts don’t require such forfeiture, probably because:
a. It would make CEOs too risk-averse, which is one of the big problems that modern compensation packages try to avoid; and
b. In order for CEOs to accept a substantial chance of having to pay back 8 or 9 figures of compensation (after they’ve already used it to buy a house or a plane), you’d have to pay them even more money, on average.
10 Cents?
Considering 0.0016 to be significantly different from the error term is always interesting.
Robert Beard – If they’ve used it to buy a house or a plane, then how is that different from when I declare bankruptcy and everything gets repossessed?
“I’m not persuaded by the Bebchuk-Grinstein result that observable factors explain only about half of CEO pay; in fact I am surprised that the observables explain as much as they do.”
I read this as saying:
“No, we have absolutely no idea why CEOs make as much as they do”
which is a few logical leaps from:
“There is no reason why we shouldn’t tax CEO pay either, as we cannot establish a direct link between CEO pay and CEO performance in the short-run”
Prof. Cowen, as far as I can tell, neither the Murphy overview nor the Jensen & Murphy articles from 1990 (in Harv. Bus. Rev. and J. Pol. Econ.) discuss any attempt to isolate the CEO’s contribution to performance from the contributions of other managers and employees. The net-of-market corrections don’t address this problem. That said, the paper you linked to yesterday (“Do CEOs matter?” by Bennedsen, Perez-Gonzalez, Wolfenzon) certainly suggests that the CEO as an individual matters quite a bit.
[How exactly, or even approximately, do you measure the CEO's marginal product?]
and more fundamentally, what do you do about the aggregation problem – that when you’ve isolated everybody’s marginal products, the sum of them will typically be much larger than the total amount?
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