CEOs: agents in turbulent monopoly markets

Gravity-defying CEO pay is not a payment for talent. It’s not looting by the executives, either. It’s the outcome of principal-agent relationship in a market where new technologies combined with regulatory dereliction have created a lot of winner-take-all situations.

More of that, and a few links, below. But first, what prompts this, is seeing Brad deLong ask a question that needs asking:

why … do Steve Kaplan and Joseph Ruah write that CEOs are riding the tide of:

technological change, particularly in information and communications, [which] can increase the relative productivity of highly talented individuals, or “superstars”… [as they] become able to manage or to perform on a larger scale, applying their talent to greater pools of resources and reaching larger numbers of people…. Other explanations of the rise in inequality have been offered… managerial power has increased… social norms against higher pay levels have broken down… tax policy affects the distribution of surplus…. We believe that the US evidence on income and wealth shares for the top 1 percent is most consistent with a “superstar”-style explanation rooted in the importance of scale and skill-biased technological change… less consistent with an argument that the gains to the top 1 percent are rooted in greater managerial power or changes in social norms about what managers should earn

Yes, there is a superstar economy–of entertainers like Oprah Winfrey and J.K. Rowling, and of entrepreneurial visionaries like Steve Jobs and Sam Walton. But what has this to do with the career ladder-climbing heads of large bureaucracies? The CEO pay fact looks to be broadly separate from the superstar economy fact, which looks to be broadly separate from the education premium fact.

De Long puts his finger on what makes the “market for talent” explanation for skyrocketing pay implausible. CEOs are “career ladder-climbing heads of large bureaucracies”: the number of top executive jobs doesn’t change much, the supply of credible candidates for these jobs is restricted by a set of career filters. Unless big companies have become miraculously better at picking the most talented and speeding them through the filters using the carrot of untold riches, it’s hard to buy the “cost of talent” explanation. At the same time, the common view that corporate executives are simply looting the companies and that high executive pay therefore represents a failure of corporate governance, doesn’t fit well with the fact that in aggregate, shareholder and executive fortunes have risen together since 1980. High executive pay is not due to a corporate governance failure – as I said in the Guardian eleven years ago, for shareholders high CEO pay is a feature, not a bug, and the complaints of “shareholder activists” about unearned pay are a kind of theater.

As Peter Skott and I argue, you can understand the rise in executive pay if you ask how technological change and deregulation have interacted. Information-based products and processes have increasing returns properties, and stronger intellectual property rights have made more of these returns privately appropriable, making for more winner-take-all markets; poorly regulated network markets – Microsoft’s software, web applications like Facebook, Amazon, telephone services, and so on – have a similar effect (network technologies of an earlier generation had a similar effect during the Gilded Age: by the mid-twentieth century they were either strictly regulated or under public ownership); rapid technological change means that much of the market power gained in these winner-take-all markets is short-lived, so it is not surprising that since the 1970s firm–specific financial volatility (whether measured in the stock market or in fundamentals such as value added) has risen sharply. All of these changes aggravate the information asymmetry between corporate executives and shareholders, and raise the value of executives’ inside information about company prospects. In any principal-agent model, this is a recipe for rising executive pay. These models were, of course, pioneered as normative apologia for high executive pay, but that is no reason to eschew their positive uses.

All of this is taking place in a world where executives are viewed as agents of shareholders – a much different world from the managerial capitalism of postwar years. That the managers paid themselves less when they were supposedly unaccountable to anybody tells you that you have to look more closely at what accountability in a managerial corporation meant. A useful way of looking at it is Aoki’s model which has the executives acting as mediator between workers and shareholders (in one of the later chapters of the book, he makes an argument for the sub-optimality of the shareholder-led model). The shift from managerialism to shareholder primacy dates from pension reforms in the 1970s which created a mass political constituency for the rights of minority shareholders; these reforms, themselves, owe something to the rise in firm-level volatility, which undermined employer pension schemes. For more of this argument, see my paper with Peter Skott.

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One thought on “CEOs: agents in turbulent monopoly markets

  1. I have taught something related in my social history classes: every new technology returns us to the primitive until it finds its place through regulation, customs, and defined limits. A small example is not knowing how to use some new device, such as a copy machine, combined with breakdowns in the device which make us think we were better off without the new invention. Another example is the toll in human life taken by new and more powerful machines. On railroad fortunes, however, the evidence is emerging that the railroads went bankrupt repeatedly while the entrepreneurs lined their pockets, and that the entrepreneurs did not in fact practice even elementary accounting. Sarah H. Gordon

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