Why Has CEO Pay Been Rising and What,
If Anything, Should We Do About It?
Robert H. Frank
EPI Forum on Executive Pay
May 4, 2010
The market for university presidents
Suppose Cornell’s Skorton was 3% better at
fundraising than the 2nd-best candidate.
Bottom-line
difference:
(0.03)x($4 billion)
= $120 million
CEOs of large US corporations earned
ten times the average worker’s salary in 1980
531 times the average worker’s salary in 2000
“Obscene” Executive Pay?
Adam Smith:
People of the same trade
seldom meet together,
even for merriment and
diversion, but the
conversation ends in a
conspiracy against the
public, or in some
contrivance to raise
prices.
Winner-Take-All Markets
Markets in which
reward depends not
just on absolute
performance but
also on relative
performance.
CEO pay grew six-fold between 1983 and
2000, same as growth in market capitalization
during that period.
Gabaix and Landier, 2006
Alfred P. Sloan, Jr.
CEOs with Fewer than Three Years Tenure When Appointed
Inequality matters because context matters.
In a poor country, a man proves to
his wife that he loves her by giving
her a rose, but in a rich country he
must give a dozen roses.
Richard Layard
Expenditure Cascades
• Top earners spend more because they
have more money.
• This shifts frame of reference for those just
below them, who also spend more.
• That, in turn, shifts the frame of reference for
those next below.
• And so on all the way down the income
ladder.
The cost of sending a child to a school
of average quality is linked to the price
of the average house in the community.
Median size of a newly constructed house:
1980: less than 1600 square feet
2007: more than 2300 square feet
Evidence for Expenditure Cascade Hypothesis
In 100 most populous U.S. counties, those
that experienced highest growth in income
inequality also experienced highest
Growth in bankruptcy rates
Growth in long commute times
Growth in divorce rates
Frank, Levine, and Dijk, 2010
In OECD, over time and across countries,
higher 90/50 ratios are linked with longer
hours of work
Bowles and Park, 2003
Charles Darwin: Traits
are selected because
of their impact on the
reproductive fitness of
individuals, not groups.
Traits that benefit
individuals often work
to the disadvantage
of groups.
Big Antlers: Smart for One, Dumb for All
Bigger Mansions: Smart for One, Dumb for All?
The Progressive Consumption Tax
Consumption + Savings = Income
Consumption = Income – Savings
Taxable consumption = Income – Savings
– standard deduction
Taxable Consumption
0 - $39,999
$40,000 - $49,999
$50,000 - $59,999
Marginal Tax Rate
20 percent
22 percent
24 percent
$60,000 - $69,999
$70,000 - $79,999
$80,000 - $89,999
26 percent
28 percent
30 percent
$90,000 - $99,999
$100,000 - $129,999
$130,000 - $159,999
$160,000 - $189,999
32 percent
34 percent
38 percent
42 percent
$190,000 - $219,999
$220,000 - $249,999
46 percent
50 percent
Taxable Consumption
$250,000 - $499,000
$500,000 - $999,999
$1,000,000-$1,999,999
Marginal Tax Rate
60 percent
80 percent
100 percent
$2,000,000-$3,999,999
$4,000,000+
150 percent
200 percent
If you were society’s median earner, which
option would you prefer?
1) You save enough to support a comfortable
standard of living in retirement, but your
children attend a school whose students
score in the 20th percentile on standardized
tests in reading and math; or
2) you save too little to support a comfortable
standard of living in retirement, but your
children attend a school whose students
score in the 50th percentile on those tests?