Supermanager Compensation

I am currently reading Thomas Piketty’s book Capital in the Twenty First Century which has already spawned much commentary around the econoblogsphere, most of it along ideological lines.  Liberals are a little too effusive with the praise, meanwhile conservatives trot out the same tired arguments they always use to deny inequality, most of which are thoroughly refuted in Piketty’s book.  Of course, facts have never kept a bad conservative idea down.

Now a longer post about the book will be forthcoming once I finish it, but mostly I want to talk about his theory of why income inequality in the Anglo-Saxon countries has risen so dramatically, in particular among the 1% and higher fractions.  Piketty claims this is from supermanagers, the high level executives at large corporations with a 20% contribution from the finance industry.  The ratio of the CEO’s pay to the average worker at his firm is reaching ever greater heights, hundreds now instead of something like 40 in the 1960s.

Now some, like Larry Summers, have criticized this theory, but offered no other suggestions to explain the increasing divergence of labor income at the top of the scale.  What other profession could possibly be raking in enough money to even enter the top .1%?  Tech entrepreneurs get most of their income from the huge return on capital of their initial investment and labor, i.e. it’s not counted as labor income.  So who are these people earning insane incomes via their labor?

But lets let the question of plausible alternatives lie and look at Summers arguments against the supermanager theory and why he think executive compensation is actually fairly close to marginal product (i.e. what economics tells us a workers wages should be equal to).

1. Private equity firms pay their executives just as much as public firms and they aren’t as vulnerable to executives having control over their own compensation (via stacking the corporate Board).

2.  Modern economy is winner-take-all where the best at something accrues far larger returns than they they did in the past.

The first is of course true, private firms aren’t nearly as vulnerable to corporate corruption by their executives.  However, they still have to compete with public firms for executive talent and so must offer equivalent wages.

Secondly, I am not sure that this is actually the main reason executive pay is outsized.  It seems more likely that the problem is that nobody knows how much a CEO is worth and for very large firms even a few million to attract someone you think is only marginally better can easily pay for itself.  Now I find it unlikely that these supermanagers are not interchangeable, I mean French firms do fine with much lower paid executives, but if you disagree with me you should put your money on it.  And they do.

This argument is bolstered by the fact that in good economic times executive pay rises very quickly, I am assuming to compensate them for their good work.  Yet, it’s relatively easy to make money in good economic times and the true test is whether someone else could have made you even more.  However, that does not seem to be the metric used and one can only conclude that nobody can value executives properly.  I mean you can’t really run an experiment and there are so many exogenous variables that you couldn’t interpret it anyway.

Summer’s second argument begs the question.  It is only relevant if you already assume that executive pay is equal to marginal product.  If that is true then the fact that certain firms are winners with a high percentage of the revenue in a market then yes executive pay should also rise meteorically.  However, if executive pay has nothing to do with marginal product then hyperprofitable firms do not in any way explain exorbitant executive pay.

And all of this discussion is kind of incidental since the theme of Piketty is how inevitable extreme wealth and income inequality is and the structure of that, labor or capital, is relatively unimportant.  After all, all that money they accrue from labor will turn into capital income when they retire or pass on an inheritance.



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