Really nice article in the post on Sunday about where our increasing economic inequality is coming from. Short (and not very surprising) answer: economically unjustifiable increases in pay for corporate executives.
The evolution of executive grandeur — from very comfortable to jet-setting — reflects one of the primary reasons that the gap between those with the highest incomes and everyone else is widening…
Now a mounting body of economic research indicates that the rise in pay for company executives is a critical feature in the widening income gap.
The largest single chunk of the highest-income earners, it turns out, are executives and other managers in firms, according to a landmark analysis of tax returns by economists Jon Bakija, Adam Cole and Bradley T. Heim. These are not just executives from Wall Street, either, but from companies in even relatively mundane fields such as the milk business.
The top 0.1 percent of earners make about $1.7 million or more, including capital gains. Of those, 41 percent were executives, managers and supervisors at non-financial companies…
Other recent research, moreover, indicates that executive compensation at the nation’s largest firms has roughly quadrupled in real terms since the 1970s [emphasis mine], even as pay for 90 percent of America has stalled.
Does anyone actually believe that executives are four times more valuable to their companies than they were a generation ago? Of course not. Do you really have to pay $10 million in salary plus a corporate jet to find someone capable of running your company. Again, I don’t think so. There’s surely many, many well-qualified people who would and could do it for less. The big stumbling block, nobody wants to earn less than all the other overpaid CEO’s.
Once again, straight-up economics fails and behavioral economics (i.e., psychology) triumphs. In no sense is it rational for companies to waste so much of their resources over-compensating their CEO’s. The only reason shareholders put up with it is because “everybody does it.” Not really the most satisfying explanation for something. I get so tired of hearing about how the private sector is so efficient and free of waste compared to government. What could be more wasteful than spending millions of dollars for your CEO to have his own jet to travel where ever he wants on a whim? That’s a lot of $600 toilets. We’ve go the GAO (and the media) to keep government honest. Who’s keeping these corporations honest? Clearly not their Boards.
Anyway, back the the psychology. Ezra nails it in his response to the article:
Study after study shows that people would prefer a medium-sized house in a neighborhood of small houses to a big house in a neighborhood of much bigger houses. What people really want isn’t to have a big house, in other words, but to have a bigger house than their peers. Economists call products driven by this sort of status competition “positional goods.” The less-technical term for this sort of behavior is “keeping up with the Joneses,” and we all do it.
When you’re talking about changes in CEO pay, you’re not talking about changes in the money CEOs use to make ends meet. You’re talking about changes in a compensation package that has long since become totally abstract. Making $50 million is nicer than making $40 million, but the things it’s buying, and the things it’s saying about you, are, at that point, positional: it’s a display of worth, not the way you put food on the table. People sometimes ask what CEOs need with all this money. The answer is they don’t need it. But they need to not be making less money than other CEOs. If they are making less, then what does that say about them?
Short version: it’s all about CEO psychology, not marketplace efficiency. Of course, personally, I’m pretty sure I’d actually choose the big house in the neighborhood of bigger houses, but I’m actually pretty unusual (i.e., better than most people 🙂 ) that way.
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