Greg Mankiw, in his defense of the top one percent (pdf), notes that “the key issue is the extent to which the high incomes of the top 1 percent reflect high productivity rather than some market imperfection,” and quickly turns to a discussion of CEO pay. Mankiw’s got a point—so let’s discuss whether or not CEO pay simply reflects compensation for ‘talent’ and productivity.
Mankiw does not present any evidence on whether CEO pay reflects high productivity: rather, he offers an argument that corporate governance is not problematic, using research by University of Chicago business school professor Steve Kaplan as his evidence. In fact, the chief claim that CEO pay tracks that of other talented workers also comes from Kaplan, who has a paper (not yet public) in the forthcoming Journal of Economic Perspectives issue along with Mankiw’s contribution and a paper from me and my colleague Josh Bivens. In this post, as promised in a prior one on Mankiw’s data claims, I draw on the evidence presented in our paper to show that CEO pay has grown far faster than that of other very high wage earners (the top 1/1000th) and that the CEO advantage relative to other very high wage earners has grown more than the college wage premium. We also demonstrate that Kaplan’s own data series shows the same pattern. A fair-minded review of these data, in our view, leads to the conclusion that the spectacular growth of CEO pay does not simply, or even primarily, reflect the market for talent, or some imagined increase in CEO productivity.
Kaplan, in a July 2012 speech—the prestigious 2012 Martin Feldstein Lecture (pdf)—claimed:
“Over the last twenty years, then, public company CEO pay relative to the top 0.1 percent has remained relatively constant or declined. These patterns are consistent with a competitive market for talent. They are less consistent with managerial power. Other top income groups, not subject to managerial power forces, have seen similar growth in pay.” (page 4)
And in a follow-up paper (pdf) (September 2012) for the CATO Institute, published as an NBER working paper, Kaplan expanded this point further:
“The point of these comparisons is to confirm that while public company CEOs earn a great deal, they are not unique. Other groups with similar backgrounds–private company executives, corporate lawyers, hedge fund investors, private equity investors and others—have seen significant pay increases where there is a competitive market for talent and managerial power problems are absent. Again, if one uses evidence of higher CEO pay as evidence of managerial power or capture, one must also explain why these professional groups have had a similar or even higher growth in pay. It seems more likely that a meaningful portion of the increase in CEO pay has been driven by market forces as well.” (page 21)
To assess CEO pay relative to that of other high earners, take a look at the table below, from a new paper by me and Natalie Sabadish. The table presents the ratio of the average compensation of chief executive officers of large firms—the series developed by Kaplan (and thankfully shared with us)—to two benchmarks. The first benchmark is the one Kaplan employs: the average household income of those in the top 0.1 percent developed by Piketty and Saez (xls). The second is the average annual earnings of the top 0.1 percent of wage earners based on a series developed by Kopczuk, Saez, and Song and updated in the State of Working America (Mishel et al. 2012). Each is presented as a simple ratio and logged (to convert to a “premium”, the relative pay differential between one group and another). The wage benchmark seems the most appropriate one since it avoids issues of household demographics—changes in two-earner couples, for instance—and limits the income to labor income (i.e., it excludes capital income). Both the ratios and log ratios clearly understate the relative wage of CEOs since executive pay is a nontrivial share of the denominator, a bias that has probably grown over time simply because CEO relative pay has grown (see the paper for an explanation). For comparison purposes the table also shows the changes in the gross (not regression-adjusted) college/high school wage premium (using those with a four-year college degree but no further education).
Growth of relative CEO and college wages, 1979–2010
|CEO compensation to:||College to:||CEO compensation to:||College to:|
|Top 0.1% households||Top 0.1% wage earners||High school hourly wages||Top 0.1% households||Top 0.1% wage earners||High school wage earners|
Source: Authors' analysis of Kaplan (2012b) and Mishel et al. (2012, Table 4.8)
CEO compensation grew from 1.14 times the income of the top 0.1 percent of households in 1989 to 2.06 times top 0.1 percent household income in 2010, Kaplan’s metric to measure CEO pay relative to that of other highly paid people. CEO pay relative to pay of top 0.1 percent wage earners grew even more, from 2.55 in 1989 to 4.70 in 2010, a rise (2.15) equal to the pay of more than two very high earners. The log ratio of CEO relative pay grew roughly 60 log points from 1989 to 2010 using either top household income or wage earners as the comparison.
Is this a large increase? Kaplan’s Feldstein lecture (page 4) concluded that CEO relative pay “has remained relatively constant or declined.” Kaplan’s CATO paper (page 14) finds that the ratio “remains above its historical average and the level in the mid-1980s.” It may seem odd that the conclusions differ but it isn’t: Kaplan made a (still unacknowledged) computation error in the Feldstein lecture that was corrected in the later paper.
In both papers Kaplan concludes that CEO pay seems to track that of other high earners but never provides any metric to assess the magnitude of the changes in relative pay. The figure below, also from my paper on CEO pay, does so, by putting these series in historical context, presenting the ratios back to 1947. Kaplan’s ratio of CEO pay to top household incomes in 2010 (2.06) was nearly double the historical (1947–1979) average of 1.11, a relative gain roughly equivalent to each CEO adding the total income of a top 0.1 percent household to their relative pay. CEO pay relative to top wage earners in 2010 was 4.70 in 2010, 1.54 higher than the historical average of 3.08 (adding the wages earned by more than 1.5 high wage earners to CEO relative pay). As the data in the table show, the increase in the logged CEO pay premium since 1979, and particularly since 1989, far exceeded the rise in the college-high school wage premium (a measure which is widely and appropriately considered to have substantially grown). Other CEO pay series, such as the one produced by Frydman and Saks (pdf) would show an even larger gain. These metrics indicate that CEO pay relative to that of other high earners has grown considerably.
Comparison of CEO compensation to top incomes and wages, 1947–2010
|Year||CEO pay to top income||CEO pay to top wages||1947–79 average: 1.11||1947–79 average: 3.08|
Note: "Top wages" are annual wages of the top 0.1% of wage earners. "Top income" is average annual income of the top 0.1% of households.
Source: Authors' analysis of Kaplan (2012b) and Mishel et al. (2012, Table 4.8)
My new paper shows that CEO pay has grown even further since 2010, with CEO compensation (measured with options-realized) rising 14.6 percent by 2012. Unfortunately, data on the earnings of top wage earners for 2012 are not yet available for a comparison to CEO compensation trends. However, CEO compensation grew faster than the wages of top 0.1 percent earners over 2010–11, with CEO compensation rising 1.6 percent (options realized) and top 0.1 percent wages rising just 0.3 percent. If CEO pay growing far faster than that of other high earners is a test of the presence of rents (‘imperfections,’ in Mankiw’s terms), as Kaplan has suggested, then we would conclude that today’s executives receive substantial rents. So should Mankiw. The stark increases in CEO compensation do not simply, or even primarily, reflect an increase in their contribution to productivity.