a lot on what
Finally, to the extent that there is a market for corporate talent, who, exactly, are the buyers? Who determines how good a CEO is, and how much he has to be paid to keep another company from poaching his entrepreneurial know-how? The answer, of course, is that corporate boards, largely selected by the CEO, hire compensation experts, almost always chosen by the CEO, to determine how much the CEO is worth. It is, shall we say, a situation conducive to overstatement both of the executive’s personal qualities and of how much those supposed personal qualities matter for the company’s bottom line.
What all this suggests is that incomes at the top—the paychecks of top executives and, by analogy, the incomes of many other income superstars—may depend a lot on “soft” factors such as social attitudes and the political background. Perhaps the strongest statement of this view comes from Lucian Bebchuk and Jesse Fried, authors of the 2004 book
To the extent that this view is correct, soaring incomes at the top can be seen as a social and political, rather than narrowly economic phenomenon: high incomes shot up not because of an increased demand for talent but because a variety of factors caused the death of outrage. News organizations that might once have condemned lavishly paid executives lauded their business genius instead; politicians who might once have led populist denunciations of corporate fat cats sought to flatter the people who provide campaign contributions; unions that might once have walked out to protest giant executive bonuses had been crushed by years of union busting. Oh, and one more thing. Because the top marginal tax rate has declined from 70 percent in the early 1970s to 35 percent today, there’s more incentive for a top executive to take advantage of his position: He gets to keep much more of his excess pay. And the result is an explosion of income inequality at the top of the scale.
The idea that rising pay at the top of the scale mainly reflects social and political change, rather than the invisible hand of the market, strikes some people as implausible—too much at odds with Economics 101. But it’s an idea that has some surprising supporters: Some of the most ardent defenders of the way modern executives are paid say almost the same thing.
Before I get to those defenders, let me give you a few words from someone who listened to what they said. From Gordon Gekko’s famous speech to the shareholders of Teldar Paper in the movie
Now, in the days of the free market, when our country was a top industrial power, there was accountability to the stockholder. The Carnegies, the Mellons, the men that built this great industrial empire, made sure of it because it was their money at stake. Today, management has no stake in the company!…The point is, ladies and gentlemen, that greed—for lack of a better word—is good. Greed is right. Greed works.
What those who watch the movie today may not realize is that the words Oliver Stone put in Gordon Gekko’s mouth were strikingly similar to what the leading theorists on executive pay were saying at the time. In 1990 Michael Jensen of the Harvard Business School and Kevin Murphy of the University of Rochester published an article in the
Why, then, weren’t companies linking pay to performance? Because of social and political pressure:
Why don’t boards of directors link pay more closely to performance? Commentators offer many explanations, but nearly every analysis we’ve seen overlooks one powerful ingredient—the costs imposed by making executive salaries public. Government disclosure rules ensure that executive pay remains a visible and controversial topic. The benefits of disclosure are obvious; it provides safeguards against “looting” by managers in collusion with “captive” directors.
The costs of disclosure are less well appreciated but may well exceed the benefits. Managerial labor contracts are not a private matter between employers and employees. Third parties play an important role in the contracting process, and strong political forces operate inside and outside companies to shape executive pay. Moreover, authority over compensation decisions rests not with the shareholders but with compensation committees generally composed of outside directors. These committees are elected by shareholders but are not perfect agents for them. Public disclosure of “what the boss makes” gives ammunition to outside constituencies with their own special-interest agendas. Compensation committees typically react to the agitation over pay levels by capping—explicitly or implicitly—the amount of money the CEO earns.[13]
In other words Jensen and Murphy, writing at a time when executive pay was still low by today’s standards, believed that social norms, in the form of the outrage constraint, were holding executive paychecks down. Of course they saw this as a bad thing, not a good thing. They dismissed concerns about executive self- dealing, placing “looting” and “captive” in scare quotes. But their implicit explanation of trends in executive pay was the same as that of critics of high pay. Executive pay, they pointed out, had actually fallen in real terms between the late 1930s and the early 1980s, even as companies grew much bigger. The reason, they asserted, was public pressure. So they were arguing that social and political considerations, not narrowly economic forces, led to the sharp reduction in income differences between workers and bosses in the postwar era.
Today the idea that huge paychecks are part of a beneficial system in which executives are given an incentive to perform well has become something of a sick joke. A 2001 article in
Not surprisingly, executive pay in European countries—which haven’t experienced the same change in norms and institutions—has lagged far behind. The CEO of BP, based in the United Kingdom, is paid less than half as much as the CEO of Chevron, a company half BP’s size, but based in America. As a European pay consultant put it, “There is no shame factor in the U.S. In Europe, there is more of a concern about the social impact.”[16]
To be fair, CEOs aren’t the only members of the economic elite who have seen their incomes soar since the 1970s. Some economists have long argued that certain kinds of technological change, such as the rise of the mass media, may be producing large salary gaps between people who seem, on the surface, to have similar qualifications.[17] Indeed the rise of the mass media may help explain why celebrities of various types make so much more than they used to. And it’s possible to argue that in a vague way technology may help explain why income gaps have widened among lawyers and other professionals: Maybe fax machines and the Internet let the top guns take on more of the work requiring that extra something, while less
