CEOs, Hedge Fund Partners, and Peak Income Inequality

Tyler Cowen says he has wanted to read this paper for quite a while:

Marginal Revolution: I've been waiting for a paper like this: Steve Kaplan and Joshua Rauh write:

We consider how much of the top end of the income distribution can be attributed to four sectors -- top executives of non-financial firms (Main Street); financial service sector employees from investment banks, hedge funds, private equity funds, and mutual funds (Wall Street); corporate lawyers; and professional athletes and celebrities.  Non-financial public company CEOs and top executives do not represent more than 6.5% of any of the top AGI brackets (the top 0.1%, 0.01%, 0.001%, and 0.0001%).  Individuals in the Wall Street category comprise at least as high a percentage of the top AGI brackets as non-financial executives of public companies.  While the representation of top executives in the top AGI brackets has increased from 1994 to 2004, the representation of Wall Street has likely increased even more.  While the groups we study represent a substantial portion of the top income groups, they miss a large number of high-earning individuals.  We conclude by considering how our results inform different explanations for the increased skewness at the top end of the distribution.  We argue the evidence is most consistent with theories of superstars, skill biased technological change, greater scale and their interaction.

How about this bit from the text?:

...the top 25 hedge fund managers combined appear to have earned more than all 500 S&P 500 CEOs combined (both realized and estimated).

This is important too:

...we do not find that the top brackets are dominated by CEOs and top executives who arguably have the greatest influence over their own pay.  In fact, on an ex ante basis, we find that the representation of CEOs and top executives in the top brackets has remained constant since 1994.  Our evidence, therefore, suggests that poor corporate governance or managerial power over shareholders cannot be more than a small part of the picture of increasing income inequality, even at the very upper end of the distribution.  We also discuss the claim that CEOs and top executives are not paid for performance relative to other groups.  Contrary to this claim, we find that realized CEO pay is highly related to firm industry-adjusted stock performance.  Our evidence also is hard to reconcile with the arguments in Piketty and Saez (2006a) and Levy and Temin (2007) that the increase in pay at the top is driven by the recent removal of social norms regarding pay inequality.  Levy and Temin (2007) emphasize the importance of Federal government policies towards unions, income taxation and the minimum wage.  While top executive pay has increased, so has the pay of other groups, particularly Wall Street groups, who are and have been less subject to disclosure and social norms over a long period of time.  In addition, the compensation arrangements at hedge funds, VC funds, and PE funds have not changed much, if at all, in the last twenty-five or thirty years (see Sahlman (1990) and Metrick and Yasuda (2007)).  Furthermore, it is not clear how greater unionization would have suppressed the pay of those on Wall Street.  In other words, there is no evidence of a change in social norms on Wall Street.  What has changed is the amount of money managed and the concomitant amount of pay.

There is a great deal of analysis and information (though to me, not many surprises) in this important paper.  The authors also find no link between higher pay and the relation of a sector to international trade...

Comments

[im1dc]

To Delong:

This is a Bimodal Fat Tail Distribution, yes?

Since you like numbers, and were not surprised by these, how about doing some research showing the average American worker and tax payer that "the rich are getting ricer and the poor are getting poorer," i.e., they are being played by way the fat cats at the top?

"...the top 25 hedge fund managers combined appear to have earned more than all 500 S&P 500 CEOs combined (both realized and estimated)."

[Hal]

From the Financial Times:

http://www.ft.com/cms/s/2a735dd0-3873-11dc-bca9-0000779fd2ac.html

Whether the politicians in the US will heed public opinion is not at all certain. They certainly haven't done so re Iraq.

[David]

im1dc,

It's admittedly hard to tell, but judging from the indent and the typeface I think it's *Cowen* who's not surprised by the numbers [and I'm not surprised that he isn't]. Brad's not talking yet.

[Robert Waldmann]

Paper seems to be a major hit in the blogosphere. Matt Yglesias linked to it too. Did you know that Steve Kaplan visited Weld hall in 1978 (he was a sophomore but not sophomoric).

[derek]

"Furthermore, it is not clear how greater unionization would have suppressed the pay of those on Wall Street."

Who is it that thinks unionization is supposed to suppress anyone's pay!? Unionization reduces income inequality by improving the pay of the workers (remember them?) who are the other side of income inequality.

[Hal]

There are many reasons why unions have grown so weak in the USA and none of these reasons can be easily repealed. The better way to go to reduce income inequality is through government redistribution of income. Tax the rich more and give it to those lower down on the income scale. It is simpler, faster, and more effective.

[Noumenon]

I think it's *Cowen* who's not surprised by the numbers [and I'm not surprised that he isn't]. Brad's not talking yet.

I wish he would. This idea is too big to go by without comment.

[Paul J. Reber]

Perhaps this is too close to home and too data-rich for JBD to be able to make a cursory comment on. But I hope some analysis/thoughts are forthcoming as this does seem very interesting.

I would not have guessed this:
"Non-financial public company CEOs and top executives do not represent more than 6.5% of any of the top AGI brackets (the top 0.1%, 0.01%, 0.001%, and 0.0001%)."

or this:
"...the top 25 hedge fund managers combined appear to have earned more than all 500 S&P 500 CEOs combined (both realized and estimated)."

This seems to imply that the rapid growth in inequality at the very top has been driven by financial-industry CEOs, fund managers and corporate lawyers. I'd be tempted to wonder if the "financial sharpies" who are best at their game have discovered how to fleece the biggest game in town, the capital markets themselves.

If so, why now? What created the sudden ability of these groups to explode in wealth? The quoted excerpt promises a theory based on "skill biased technological change," but I don't see that. I'd be inclined to wager on regulatory issues like tax or accounting dodges putting pressure on large scale transactions and producing huge wealth for the people who facilitate those transactions.

Nothing is mentioned about the entertainers (athletes) in relative proportion. I wonder how big a factor they are.

The issue of non-financial industry CEOs and unions seems pretty irrelevant. As always, it's good to tax the rich and boost the poor by redistribution and better labor barganing. But that doesn't seem to be the main story here -- who are these nouveau nouveau riche? And where did they come from?