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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.
Here is the link, here is the non-gated version. 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.
Posted by Tyler Cowen on July 22, 2007 at 07:06 AM in Economics | Permalink
Comments
A very nice paper, with lots of information. The key table, in my opinion, is 8a. So, who are all the other people in these upper income brackets that are not executives, lawyers, athletes, or entertainers?
The groups that seem to be missing to me are doctors, private business owners and partners, private investors, non-executive employees. Am I missing any other important groups?
Posted by: Yancey Ward at Jul 22, 2007 2:28:07 PM
What is the impact of changes to tax rates? They dismiss the "social norms" explanation by talking about the minimum wage and unionization, but don't say anything about tax policy. Wasn't the capital gains tax rate basically cut in half between 1994 and 2004? I've seen some references that seem to indicate that tax policy hasn't had a huge impact on American income inequality over the past few decades but I imagine there are a fair number of really wealthy people whose income comes primarily from capital gains.
Posted by: Barbar at Jul 22, 2007 2:38:07 PM
I have mixed feelings on the hedgies. First, given their secrecy, they have all sorts of ways of making secret bribes to get political favors flowing their way.
Second, they have all sorts of ways of earning fat fees from suckering investors into moronic investments that have a high probability of high returns, and a low probability of total flaming disaster, to a point where the investment actually has poor expected value. I guess that aspect will prove self-correcting in time, but not before they've stolen quite a lot from gullible greedy investors. Maybe there's some justice, but that aspect is clearly socially wasteful.
Posted by: Keith at Jul 22, 2007 5:06:47 PM
Was inherited wealth considered? For example the Walton family is worth about $80 billion. They make the bulk of their annual income from stock dividends on Walmart.
Their ownership shows up as a footnote in the annual report since they own more than 5% of the outstanding stock, but I doubt they get counted by the usual methods of finding top earners. When they sell some of their shares this also wouldn't be seen using this analysis.
They are not unique there are a group of other families in similar situations, some are household names like Mars and Coors, but many are not.
The problem is that their wealth gives them exceptional political power. Just 18 of these families have been responsible for the bulk of the spending on abolition of the estate tax over the past decade or so. Collectively they have spent over $100 million funding think tanks, influencing politicians and through other indirect means. The Waltons alone stand to save $40 billion in estate taxes if the tax is repealed. This makes the return on their "investment" a good deal.
Populist resentment is being aimed at the most visible targets, but most of the nouveau riche don't get involved in self-serving policy making until they have amassed a big enough fortune. Their firms may, of course, be looking for political favors.
Posted by: robertdfeinman at Jul 22, 2007 7:35:47 PM
The fact that C-level execs are not the numerically dominant subgroup is pretty obvious. The whole link between exec compensation and inequality is a red herring (except in that it symbolizes our acceptance of winner take all economics).
I suspect that founders and early employees of successful private companies (startups) that have a liquidity event (i.e., an IPO or acquisition) are a large subset of the top AGI group. Note, though, that this population does not make it into the top tier (i.e., top 1 or .1%) with regularity, but rather only in a very successful year (the one in which they get their "exit"). Any decent tech IPO launches hundreds of employees into the top 1 or even .1%.
It is very important to know what fraction of the top group are there each year (doctors, lawyers, financiers) versus those for whom it is a one-time event (sold the business they carefully built over many years). If it is predominantly the latter it's hard to attribute an increase in top percentile earnings to unhealthy inequality.
Posted by: steve at Jul 22, 2007 8:56:41 PM
To be more quantitative: suppose there are 1M employees at private companies (not just in technology, but in other industries as well) who each have a 10% chance of participating in a liquidity event each year that raises their AGI to the top 1% threshold. That would add 100k additional top earners each year, and thereby raise the threshold to qualify for the top 1%. If there are 150M workers in the US then there are 1.5M in the top 1%, so this subset of "rare exit" or employee stock option beneficiaries would make up about 7% of the total each year (similar to the corporate exec number). But these people are clearly not part of the oligarchy, and if the increase in income inequality is due to their shareholder participation, why is that a bad thing?
Posted by: steve at Jul 22, 2007 9:50:53 PM
Perhaps also of interest:
Data on incomes by county covering the mid to late 1990's, from the government Bureau of Economic Analysis, shows an interesting geographical pattern. Most of the gains enjoyed by the top 1% came from a small number of counties. In particular, income increases at the top end in tech hotbeds Seattle and Silicon Valley, and finance capital New York City, account for almost all of the aggregate nationwide increase. If four counties in those regions are removed, there is almost no increase in inequality during that period.
So I guess it's not due to doctors and sports stars, and very likely (for startup employees), the payouts are not going to the *same* people each year.
http://infoproc.blogspot.com/2006/09/us-income-inequality-caused-by.html
Posted by: steve at Jul 23, 2007 12:25:20 AM
I keep hearing the explanation that much of the income inequality stems
from businesses going public and cashing out to realize large gains in one
year so I just took a look at the data.
From 1990 to 2006 the value of new stock issued in the US was equivalent to
between 1% to 2% of personal income each and every year. I do not have earlier data. The peak year was 2001 at $128.5 billion.
So while it looks like this played a role in the growth in income inequality it is
clearly inadequate to explain most of the 1990s growth in income inequality.
Posted by: spencer at Jul 23, 2007 9:32:15 AM
How are S corporations accounted for in income statistics like these?
Posted by: happyjuggler0 at Jul 23, 2007 10:15:19 AM
Spencer,
Is the figure you quoted (new shares issued) the amount of money raised in IPOs, or all new share issuance? The former would only be a small fraction of the liquidity generated. The implied market caps of post-IPO companies in 2001 may have been higher than $100B. Employee stock options, typically exercised long after the IPO, amount to selling additional shares into the market. The income generated is a portion of the total market cap of the public company, typically much larger than the amount raised in the IPO. For example, Google's market cap alone is now $160B.
Also, I don't know how payouts from acquisitions compares to IPOs, but they might be comparable.
As a fraction of personal income, how big is the shift in income to the top 1% in recent years? I would imagine it is only a few percent of total income, at most. For example, if the top 1% earns 20% of all income, and they increase their share by 15% while the rest are stagnant, that's an increase of 3% of total income going to the top 1% -- same ball park as the liquidity event numbers. These numbers are taken from the 2003-2004 data; see link below.
http://infoproc.blogspot.com/2006/07/more-income-inequality.html
Posted by: steve at Jul 23, 2007 2:32:16 PM
The figure I quoted is all shares, not just IPOs and obviously the value of IPOs would fluctuate much more than the total. But the point that the value of total shares is a consistent share of personal income as far back as the data goes -- the late 1980s -- implies that it is not a factor explaining the shift in income inequality. But to really demonstrate that I would need data from earlier periods.
What you are arguing is that the value of cash-outs through IPOs has increased significantly in recent years. The point that the market grew faster than GDP in the 1980s and 1990s would support that, but there is also good research that shows CEOs income stayed fairly constant as a share of stock market capitalization over this era.
My question is, are there any studies of the value of new cash-outs that would show how this has changed over time? In other words, do you have any data to support the thesis that cash-outs play a significant role in growing income inquality?
Posted by: spencer at Jul 23, 2007 3:21:20 PM
Spencer:
I think the Galbraith data for the late 90's is pretty persuasive -- he finds almost all of the *change* in income inequality is accounted for by the counties that include Seattle and silicon valley. I think post tech-bubble (after 2001, say) the financiers have probably taken up the slack from stock option payouts, but the data isn't available yet to show that. In other words, I suspect Galbraith's analysis performed on, say, 2003-2005 data would show that counties including NYC and Greenwich would account for most of the increased inequality.
A mathematical point: if a large number of workers participate in a lottery scheme (i.e., taking more of their compensation as stock options), that increases the volatility of incomes. In any given year some fraction of these people will pop into the top 1 or .1% of earners, but only for that year. If you look at inequality as income share of the top fraction, this phenomena will initially make inequality appear larger, when in fact the gains are being spread more evenly if averaged over many years (at least, spread within the pool of workers with stock options).
My basic question is whether it's the same people each year in the top income category, or is it primarily people who fluctuate in and out. The answer has a lot to do with whether *wealth* is being concentrated at the top as much as the income numbers (naively interpreted) might suggest.
I haven't yet seen any data which can determine the answer with precision.
Posted by: steve at Jul 23, 2007 4:02:46 PM
steve-- I'm not saying you are wrong. Just asking for the data.
On your last point, the question ought to be about wealth vs income. I'm sure the list of top wealth holders is much more stable than the list of top income receivers. But wealth is also much more concentrated than income.
But that is true of the entire debate on inequality. We use income because we have good data on income. But if we are looking at inequality shouldn't wealth be the more important variable.
Posted by: spencer at Jul 23, 2007 5:08:38 PM
Spencer,
I could very well be wrong -- I didn't take your comments as aggressive. :-)
The Galbraith (UT Austin) analysis of BEA data is what I linked to earlier:
http://infoproc.blogspot.com/2006/09/us-income-inequality-caused-by.html
He would claim that late 90's increases in inequality were due (looking at county by county numbers) to tech hotbeds. I think that (circumstantially) implicates stock options.
Again, post 2001-bubble I suspect financiers have been capturing an increased chunk of national income. (Liquidity glut and all that.)
Posted by: steve at Jul 23, 2007 5:34:12 PM
stock options & perks! did those two things get taken into account?
Posted by: j at Jul 24, 2007 9:39:45 AM
