Trends in Relative Earnings
By Arnold Kling
Only the top 10% of US earners have seen their incomes grow faster than productivity since 1966. Part of the top-earner income growth is driven by market forces (superstar economics); the only feasible pro-equality policy here is more progressive taxation. For top corporate executives, however, non-market forces (CEO-Board complicity in pay setting) are important, so other policies are warranted. Increased disclosure and improved corporate governance would distribute economic gains more evenly across society and boost firms’ value.
I wrote about superstar economics when I talked about billers and players. People who are compensated by the hour are billers. People who play in winners-take-most tournaments (fiction authors, athletes, would-be CEO’s, high-risk entrepreneurs) are players.
I think it is possible that Dew-Becker and Gordon are correct that high CEO pay reflects exploitation of shareholders by CEO’s. But there is at least one alternative story, which is that high CEO pay is an inducement to would-be CEO’s to perform loyally and effectively.
That is (I think this is Edward Lazear’s model), suppose that upper middle managers have only limited incentives to remain loyal and to perform optimally. However, they are participants in the tournament that determines who will be the overpaid CEO. The incentive to win that tournament induce better performance on the part of upper middle management than the other incentives.
For this story (and probably other stories) to seem plausible to me, you have to invoke diminishing marginal utility to rewards. That is, the reason that I can’t just offer a bonus to my chief marketing officer to get him to perform is that he has diminishing marginal utility of income. So I have to offer a huge marginal bonus. Any way I do that is going to spread the income distribution. But one way to offer a huge marginal bonus is to say that good performance increases the probability of getting promoted to CEO and being vastly overpaid in that position.
So one of the factors in the widening income distribution is diminishing marginal utility of rewards at the top. In income terms, the high pay is unbelievably high. In marginal utility terms, the additional income is not worth so much.
If that story is true, then the authors’ reforms won’t work. Corporate transparency won’t matter, because companies need to offer large marginal income rewards to upper management in order to get top performance. And higher marginal tax rates won’t work, because they will just force corporations to raise pre-tax compensation in order to get the same after-tax marginal incentives.
My preferred outcome would be the gradual demise of huge corporations, brought on by ruthless competition from smaller firms. I think that the CEO tournament produces a lot of dysfunctional behavior in addition to whatever constructive incentives it provides.