What are the main reasons for the massive increase in CEO pay inequality over the last thirty years?

10

Using Switzerland as a paradigmatic case, the ratio of CEO pay to the worker with lowest pay increased from 6x in 1984 to 43 x in 2011 (source: The Guardian).

What specific policy or policies have either allowed or/and promoted such a jump?

Mozibur Ullah

Posted 2019-04-18T01:38:16.900

Reputation: 3 678

Do you mean an increase in inequality? I'll assume that you do, and that the numbers mentioned refer to the ratio between CEO pay and the pay of the average (median) worker. If either of these assumptions is incorrect, please comment. – Obie 2.0 – 2019-04-18T05:23:49.520

2Possibly better fit for economics.stackexchange? – pjc50 – 2019-04-18T08:02:29.953

@pjc50: I’m specifically looking at intersection where politics and economics meet, with the emphasis on politics. – Mozibur Ullah – 2019-04-18T08:46:32.753

@Obie2.0: your first assumption is correct; on the second, the ratio is to that of the lowest and not the median/average pay. – Mozibur Ullah – 2019-04-18T08:48:44.003

1Mmmm. Corrected. Anyway, while this question is clearly on-topic and not vague, as evidence by the fact that it doesn't have a single close vote, there's definitely a thread of "I already know (or believe) that this economic policy is responsible for the issue, here, let me tell you about it." I think the Q&A format is an important part of the site, and as such posting questions that take their answers as given kind of detracts from it. – Obie 2.0 – 2019-04-18T08:52:54.380

1For instance, concretely applied to this question, if a libertarian-inclined person wanted to post an answer that said that anti-competitive collusion among CEOs is actually responsible, and that this is contrary to the free-market philosophy promoted by neo-liberalism, asking "How did neo-liberal policies do this?" kind of disqualifies such an answer at the gate. Conversely, if a person wanted to write an answer saying "It's neoliberal policies, which have worsened income inequality," then the question essentially pre-empts that. – Obie 2.0 – 2019-04-18T08:55:19.280

@pjc50: I'm not convinced it would be. The short answer is Margaret Thatcher and Ronald Reagan, who durably steered the world into an era of supply-side economics, on a backdrop of receding union influence and execs getting rewarded with increasing amounts of stock options, and a widely held (albeit incorrect) view that companies should maximize shareholder value. In Thatcher's own words, her greatest legacy is Tony Blair and New Labor.

– Denis de Bernardy – 2019-04-18T08:57:32.733

@obie 2.0: I don’t see any reason to hide what I think on the question; however, I’m looking for specifics rather than the kind of speculations that you're Indulging in. – Mozibur Ullah – 2019-04-18T08:58:53.383

1I think this should be migrated to Economics, as its primarily an economic question. If the consensus on economics is that political decisions were a factor then that would be the basis of a more specific question back here. – Paul Johnson – 2019-04-18T08:59:47.167

1I'm voting to close this question as off-topic because it belongs on Econoimics.SE. – Paul Johnson – 2019-04-18T09:00:59.377

3Then it should be a question-answer pair. That's what self-answers are for. As you know, this isn't a forum. A question isn't the same thing as an answer. Like, if the only good answer to a question simply restates information that's in the question, that's not exactly good. It's supposed to look for information, not simply provide it. The site has chat for a looser format, but apparently virtually everyone would rather use the Q&A format for that. – Obie 2.0 – 2019-04-18T09:01:10.477

And I genuinely am having trouble thinking of what would be an answer to the question that wouldn't be e..g. a total contradiction of the premise (the libertarian example), restate the premise, or be obvious (e.g. "There's no law against CEOs having really high salaries"). – Obie 2.0 – 2019-04-18T09:04:39.627

@Obie2.0: I’m having trouble making sense of your comment. My question was quite specific. For example, if some-one said repealing the Glass-Steagall act that was put in force after the Great Depression then that’s part of the kind of answer I’m looking for. – Mozibur Ullah – 2019-04-18T09:10:07.270

I kind of see what you're getting at, there. Maybe I'll write an answer. – Obie 2.0 – 2019-04-18T09:10:50.703

Comments are not for extended discussion; this conversation has been moved to chat.

– Sam I am says Reinstate Monica – 2019-04-18T19:38:32.723

I've reopened this question because in it's current state, the call out of neoliberal economics is not present. If you edit it back in, we may close this question again. That would make it a textbook loaded question. – Sam I am says Reinstate Monica – 2019-04-18T19:45:40.187

@Sam I am: Correct me if I am wrong here, but generally the period since Reagan & Thatcher has been characterised as neo-liberal. I was taking that as a given and was asking specifically what policies in the neo-liberal era promoted such vast disparities. I’ll let it stand as is given the threat of a question closure, but I’m registering my disapproval. – Mozibur Ullah – 2019-04-23T08:12:32.833

Answers

7

This question has seen a massive amount of research. It appears that the question of the cause of increased CEO pay is not settled and there are many competing theories. Here are a few which I've found:

Mergers & Acquisitions

This argument, put forward in Why Has CEO Pay Increased So Much? (2006) by Gabaix and Landier, attributes the increase to increased market capitalization:

The sixfold increase of CEO pay between 1980 and 2003 can be fully attributed to the six-fold increase in market capitalization of large US companies during that period. We find a very small dispersion in CEO talent, which nonetheless justifies large pay differences. The data broadly support the model. The size of large firms explains many of the patterns in CEO pay, across firms, over time, and between countries.

The increase in market capitalization is of course caused by the large number of mergers and acquisitions. However, this argument has been disputed. See for example Understanding Piketty's Capital in the Twenty-First Century (p. 138) by Pressman:

Another counterargument to Gabaix and Landier is that CEO salaries are not rising to the same extent everywhere in the world. The extremely sharp increase in CEO pay in the US has not been replicated in Japan or in most of Europe; but CEOs have taken on more responsibilities and are doing more regardless of where company headquarters are located.

Ownership structure

An earlier article The effects of ownership structure on conditions at the top: The case of CEO pay raises (1995) by Hambrick and Finkelstein found:

In management-controlled firms—where no single major owner exists—results suggest an overarching pay philosophy: maximize CEO pay, subject to demonstration of face legitimacy of that pay. In externally-controlled firms—where a major (nonmanager) owner exists—results suggest a very different philosophy: minimize CEO pay, subject to the ability to attract/retain a satisfactory CEO.

Implying that changing ownership structure of firms is responsible for the increase in CEO pay.

Perceived scarcity of talent

It makes sense to reason that if there is a scarcity of qualified CEOs then their compensation must increase. In Why Is CEO Pay Rising? Maybe There Aren’t Enough Good CEOs Donatiello, Larcker and Tayan argues that this might be the case:

Perceived scarcity of talent is likely driving pay higher. A tight labor market for CEO talent might help to explain high compensation levels, particularly among the largest U.S. companies. If only a limited number of executives are qualified to run these companies—and if outstanding CEO talent is critical for their success—then it is reasonable to expect that boards will offer large sums of money to attract their top candidate or retain their current CEO.

The idea is that board members and others who controls CEO pay believes that qualified CEO talent is scarce and that it therefore must be compensated royally. Normally this situation would be regulated by the Law of the supply and demand - rising pay should lead to a larger pool of qualified talent, moderating compensation growth. The authors speculate that this does not occur because the "labor market for CEO talent might be inefficient."

Lower marginal tax rates

In the 1960s and 1970s, most Western countries had very progressive tax rates meaning that high income earners paid a larger fraction of their income in taxes than low income earners. Reaganomics and neo-liberal thinking changed that and today most tax systems are much less progressive. In fact, many tax systems are today strongly regressive, meaning that the top pays less in income tax than the median earners.

According to Thomas Piketty in his best-selling book Capital in the Twenty-First Century (pp. 655-656) there is a casual link between lower marginal taxes and higher CEO pay:

It is always difficult for an executive to convince other parties involved in the firm ... that a large pay raise ... is truly justified. In the 1950s and 1960s, executives in British and US firms had little reason to fight for such raises, ..., because 80–90 percent of the increase would in any case go directly to the government. After 1980, the game was utterly transformed, however, and the evidence suggests that executives went to considerable lengths to persuade other interested parties to grant them substantial raises. ... top managers found it relatively easy to persuade boards and stockholders that they were worth the money, especially since the members of compensation committees were often chosen in a rather incestuous manner.

Our [Thomas Piketty, Emmanuel Seaz and Stefanie Stantcheva] findings suggest that skyrocketing executive pay is fairly well explained by the bargaining model (lower marginal tax rates encourage executives to negotiate harder for higher pay) ...

Finally, we found that variations in the marginal tax rate can explain why executive pay rose sharply in some countries and not in others. In particular, variations in company size and in the importance of the financial sector definitely cannot explain the observed facts.

Because they can / Are allowed to

Thomas Piketty in Capital (pp. 419-420) argues that CEO pay has sky-rocketted because executives have the power to set their own salaries:

It is only reasonable to assume that people in a position to set their own salaries have a natural incentive to treat themselves generously, or at the very least to be rather optimistic in gauging their marginal productivity. To behave in this way is only human, especially since the necessary information is, in objective terms, highly imperfect. It may be excessive to accuse senior executives of having their "hands in the till," but the metaphor is probably more apt than Adam Smith's metaphor of the market's "insivible hand."

According to him, CEO pay is largely driven by "societal norms":

Each society also imposes certain social norms, which affect the views of senior managers and stockholders ... as well as of the larger society. These social norms reflect beliefs about the contributions that different individuals make to the firm’s output and to economic growth in general.

Without a theory of this kind, it seems to me quite difficult to explain the very large differences of executive pay that we observe between on the one hand the United States ... and on the other continental Europe and Japan. Simply put, wage inequalities increased rapidly in the United States and Britain because US and British corporations became much more tolerant of extremely generous pay packages after 1970. Social norms evolved in a similar direction in European and Japanese firms, but the change came later (in the 1980s or 1990s) and has thus far not gone as far as in the United States.

Discredited theories

Of what I can find, it appears that the theory that CEO pay is driven by increased demand for CEO talent, this is, that CEO pay is "fair," is discredited. See for example the report CEO compensation surged in 2017 (2017) by Mishel and Schieder:

The argument that CEO compensation is being set by the market for “skills” does not square with the data. Bivens and Mishel (2013) address the larger issue of the role of CEO compensation in generating income gains at the very top and conclude that substantial rents are embedded in executive pay. According to them, CEO pay gains are not the result of a competitive market for talent but rather reflect the power of CEOs to extract concessions.

Another discredited theory is that CEO compensation is linked to company performance. See for example The Link between CEO Compensation and Performance (2011) by Nilsson and Tärnbo:

Our main finding ... is that CEO compensation in our data set is not related to our relative performance measure. We obtain a negative relationship between compensation and the relative performance ... It seems like compensation is not determined according to the agent-principal theory, ... Instead accounting measures such as EPS and other factors, e.g. market capitalization and bonus ratio play a vital part in determining the compensation levels for the CEOs studied.

Meta I reject the notion that CEO pay would be a non-political issue. Clearly, compensation is seen as the premier measure of the value of a persons work. One corroborating reason for higher CEO pay is likely that we as society nowadays tend to value their work higher. But why do we do that? Unless CEO pay is justified by market factors, economy alone cannot answer that question. Hence it is a question of politics.

Björn Lindqvist

Posted 2019-04-18T01:38:16.900

Reputation: 4 749

1The M&A point is interesting. The trend seems to have been towards consolidation in many markets, which are increasingly becoming dominated by a smaller number of players. That pushes up market caps; however, I would think that would actually reduce the demand for CEOs, since there are fewer companies that need leading. – Time4Tea – 2019-04-18T17:39:29.353

Btw, your answer seems to suggest that the main reasons are not really political. – Time4Tea – 2019-04-18T17:39:52.847

@Time4Tea: but the old CEOs are now 2nd layer management. They clearly cannot lose (much) during M/A. So a new CEO on top of them is needed. That new CEO of course also needs higher pay... Perfectly plausible outcome IMHO – cbeleites unhappy with SX – 2019-04-20T16:02:16.813

0

There are many reasons but mostly due to changes in corporatisation culture and deregulation. Bad CEO can now "rewards" themselves even they are doing a terrible job, as long as the activist shareholder allow them. There are tons of reason that activist shareholder pay millions for a CEO to intentionally run it down for the quick profit for those shareholder. A common tactics is "share buy back" by exhausting the company cash by the CEO, while the activist shareholder can reap the profit from non-production stock jack-up even it will definitely jeopardize the company in long run.

While another way round is about how the CEO pick their board, to make sure the shared looting went unchecked, like in Enron case.

In the year prior to its December 2001 bankruptcy filing, Enron handed out $745 million in payments and stock awards to 144 of its senior executives. The company disclosed that these executives received $310 million in salary, bonuses, loan advances and other income. $435 million came in the form of exercised stock options and restricted stock packages. These figures include the $54.6 million in retention bonuses that were given to 200 executives in the days immediately preceding the declaration of bankruptcy.

Why all this happens, perhaps this transcript of Noam Chomsky interviewed by Laura Flanders shed some light.

LF: But you hear it all the time that under law, the CEO’s required to increase dividends to shareholders.

NC: It’s kind of a secondary commitment of the CEO. The first commitment is raise your salary. One of the ways to raise your salary sometimes is to have short-term profits but there are many other ways.

In the last thirty years there have been very substantial legal changes to corporate governance so by now CEOs pretty much pick the boards that give them salaries and bonuses. That’s one of the reasons why the CEO-to-payment [ratio] has so sharply escalated in this country in contrast to Europe. (They’re similar societies and it’s bad enough there, but here we’re in the stratosphere. ] There’s no particular reason for it.

Stakeholders — meaning workers and community – the CEO could just as well be responsible to them. This presupposes there ought to be management but why does there have to be management? Why not have the stakeholders run the industry?

mootmoot

Posted 2019-04-18T01:38:16.900

Reputation: 1 110

I'd like to point out the mechanism here is exactly the same as my answer, it's just made to sound a lot more sinister. The CEOs get high pay because the board expects it will get even more money. – Joe – 2019-04-18T17:29:16.010

1@Joe - "board expects it will get even more money"...And they expect this because the board member is voting to increase CEO compensation for that particular company and expects quid-pro-quo voting from the CEO who is a board member at the company the first board member is the CEO. IOW, incestuous voting. – Dunk – 2019-04-18T23:02:16.520

@Dunk Actually, most CEOs are hired externally, so incestuous voting cannot explain the phenomenon – Joe – 2019-04-19T02:13:49.493

@Joe Try explain Enron, Comcast, etc the list is endless. – mootmoot – 2019-04-23T07:23:22.267

-3

High CEO pay is caused by competition between large corporations for their skills, because they make those corporations lots of money

Being a CEO requires a lot of skills and experience that most people do not have. A successful CEO can potentially make a corporation many millions or billions of dollars more than it otherwise would have made, especially in terms of stock valuation. During the same period you mention in the question, the value of stock markets pretty much everywhere also increased by about the same amounts.

If CEO decisions can make a company hundreds of millions of dollars more than it otherwise would have made, then it’s a no-brainer to pay that person tens of millions of dollars a year. That is especially true if you want to stop that guy from working for one of your competitors.

What specific policy or policies have either allowed or/and promoted such a jump?

This is like asking “what specific policy or policies have either allowed or/and promoted Pokémon?” It presumes that the world is a tightly controlled and well-understood place, so anything strange that might happen is the product of some deliberate design that can be adjusted simply by changing a very specific law that must have allowed it to happen. That is not the case. In reality, the world is full of all sorts of behavior that emerges unexpected from a variety of factors that don’t involve a master plan enacted through specific government policy.

My actual attempt to answer that question is to say “all of the policies that allow corporations to make large sums of money,” but that’s not very specific. It’s impossible to give an answer that is both specific like you want and accurate, because this situation isn’t the result of a set of discrete policy decisions.

Joe

Posted 2019-04-18T01:38:16.900

Reputation: 12 229

3This is just ideological bumph, to be honest. Being a surgeon is a very specialized skill that most people do not have, that is very important socially, but is not paid at the rate of tens of millions of dollars a year. – Mozibur Ullah – 2019-04-18T11:30:16.353

4@MoziburUllah Surgeons don’t get paid tens of millions of dollars a year because the do not make the hospital hundreds of millions of dollars a year. Nothing ideological about that. – Joe – 2019-04-18T11:32:39.853

They could quite easily by going on strike and demanding those kinds of sums after all, everybody needs healthcare. They don’t, because it’s a regulated profession. I, personally don’t see why entrepreneurs can’t be seen as just another profession without buying into the myth of the entrepreneur. – Mozibur Ullah – 2019-04-18T11:38:00.970

2@Joe As if CEOs do... – M i ech – 2019-04-18T11:38:53.127

@Miech Yes, they do, or the boards that run them seem to think so. What do you know that they don’t? – Joe – 2019-04-18T11:40:29.743

@MoziburUllah Doctors are definitely allowed to go on strike in a number of legal jurisdictions; it’s actually been noticed that patient mortality decreases during doctor strikes: https://www.psychologytoday.com/us/blog/slightly-blighty/201510/why-do-patients-stop-dying-when-doctors-go-strike

– Joe – 2019-04-18T11:42:50.783

@MoziburUllah Also, not all CEOs are entrepreneurs. Most CEOs are hired externally from the companies that employ them. – Joe – 2019-04-18T11:44:06.747

@Joe: You’re missing the point, I’m saying that CEOs and entrepreneurs are professions like any other and shouldn’t be treated as some kind of exceptional case. – Mozibur Ullah – 2019-04-18T11:50:37.470

2@MoziburUllah I get that. You seem to think that the large sums of money paid to CEOs is an inherent property of them being CEOs. I think the large sums of money paid to CEOs is because they make their employers even larger sums of money, which is a general property of most forms of private employment. – Joe – 2019-04-18T11:53:44.157

@Joe: You’re making unjustified and unbalanced claims. They also have lost a great deal of money - look at the Great Depression and the most recent Great Recession. Furthermore, the US ran with a top tax rate of 90% for two decades which shows that such levels of pay are not essential to a well-run economy; moreover, there was probably a very good reason why railroad and oil bosses during the early phase of industrial capitalism in the US were called ‘robber barons’. – Mozibur Ullah – 2019-04-18T11:59:52.247

1@MoziburUllah I never asserted it was necessary to have high paid CEOs to have a well run economy. I also never asserted that CEOs don’t ever lose money; the typical redress a corporate board seeks when their CEO loses money is to replace them with someone else who they think will make money instead. – Joe – 2019-04-18T12:03:28.927

@Joe: So you say; but the evidence appears otherwise ... – Mozibur Ullah – 2019-04-18T12:08:44.887

2I think part of the reason is that there is a perception among shareholders that this is the case. However, whether it actually is the case is much more debatable. You haven't provided links to any evidence to back up the claim. Also, you haven't explained why this supposed 'CEO effect' is so much stronger now than in 1987, that such a huge increase in executive salary would be justified. – Time4Tea – 2019-04-18T16:04:58.013

1@Time4Tea I explicitly said "A successful CEO can potentially make a corporation many millions or billions of dollars more than it otherwise would have made, especially in terms of stock valuation. During the same period you mention in the question, the value of stock markets pretty much everywhere also increased by about the same amounts." 5 minute Google search will tell you this increase in valuations has been going on since the late 70's. – Joe – 2019-04-18T17:27:59.303

2I'm not disputing the increase in market caps over that time period. However, you haven't provided any evidence that shows the increase in value is largely down to the actions of CEOs, rather than other factors, e.g. lower-level employees. – Time4Tea – 2019-04-18T17:35:46.137

1-1 "If CEO decisions can make a company hundreds of millions of dollars more than it otherwise would have made" that's an important if; sources supporting this would significantly improve your answer; without them, it's just a guess. And the current top-voted answer has some sources which seem to contradict this guess. – tim – 2019-04-18T20:26:53.340

1@Joe - I think your claim that stock markets increased by the same amounts since the 70s is proof that on average CEOs have little to no effect on company stock valuations. At least half of companies are led by less than average CEOs and yet the stock market continued to rise. Kind of implies that even with less than stellar CEO leadership stock prices will still go up. – Dunk – 2019-04-18T23:11:20.190