Why Has CEO Pay Been Rising and What, If Anything, Should We Do About It? Robert H. Frank

Why Has CEO Pay Been Rising and What, If Anything, Should We Do About It?

Robert H. Frank

EPI Forum on Executive Pay

May 4, 2010

The market for university presidents

Bottom-line difference: (0.03)x($4 billion) = $120 million

Suppose Cornell’s Skorton was 3% better at fundraising than the 2nd-best candidate.

“Obscene” Executive Pay?

CEOs of large US corporations earned

ten times the average worker’s salary in 1980

531 times the average worker’s salary in 2000

Adam Smith:

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.

Winner-Take-All Markets

Markets in which reward depends not just on absolute performance but also on relative performance.

CEO pay grew six-fold between 1983 and 2000, same as growth in market capitalization during that period.

Gabaix and Landier, 2006

Alfred P. Sloan, Jr.

CEOs with Fewer than Three Years Tenure When Appointed

Inequality matters because context matters.

In a poor country, a man proves to his wife that he loves her by giving her a rose, but in a rich country he must give a dozen roses.

Richard Layard

Expenditure Cascades

• Top earners spend more because they have more money.

• And so on all the way down the income ladder.

• That, in turn, shifts the frame of reference for those next below.

• This shifts frame of reference for those just below them, who also spend more.

The cost of sending a child to a school of average quality is linked to the price of the average house in the community.

Median size of a newly constructed house:

1980: less than 1600 square feet

2007: more than 2300 square feet

Evidence for Expenditure Cascade Hypothesis

In 100 most populous U.S. counties, those that experienced highest growth in income inequality also experienced highest

Growth in long commute timesGrowth in divorce rates

Growth in bankruptcy rates

Frank, Levine, and Dijk, 2010

In OECD, over time and across countries, higher 90/50 ratios are linked with longer hours of work

Bowles and Park, 2003

Charles Darwin: Traits are selected because of their impact on the reproductive fitness of individuals, not groups.

Traits that benefit individuals often work to the disadvantage of groups.

Big Antlers: Smart for One, Dumb for All

Bigger Mansions: Smart for One, Dumb for All?

The Progressive Consumption Tax

Consumption + Savings = Income

Consumption = Income – Savings

Taxable consumption = Income – Savings – standard deduction

Taxable Consumption Marginal Tax Rate

0 - $39,999 20 percent

$40,000 - $49,999 22 percent

$50,000 - $59,999 24 percent

$60,000 - $69,999 26 percent

$70,000 - $79,999 28 percent

$80,000 - $89,999 30 percent

$90,000 - $99,999 32 percent

$100,000 - $129,999 34 percent

$130,000 - $159,999 38 percent

$160,000 - $189,999 42 percent

$190,000 - $219,999 46 percent

$220,000 - $249,999 50 percent

Taxable Consumption Marginal Tax Rate

$250,000 - $499,000 60 percent

$500,000 - $999,999 80 percent

$1,000,000-$1,999,999 100 percent

$2,000,000-$3,999,999 150 percent

$4,000,000+ 200 percent

If you were society’s median earner, which option would you prefer?

1) You save enough to support a comfortable standard of living in retirement, but your children attend a school whose students score in the 20th percentile on standardized tests in reading and math; or

2) you save too little to support a comfortable standard of living in retirement, but your children attend a school whose students score in the 50th percentile on those tests?