Sunday, April 27, 2014

High Pay

Piketty's book is mostly about increasing inequality in the distribution of capital (and hence in income from capital).  However income from labor is also becoming less equal.  One aspect of this is the emergence of a group of extremely high earners.  Piketty's explanation for this is as follows.  This group largely consists of highly paid top corporate executives.  They are in positions where they can strongly influence their own pay.  This gives them some ability to overpay themselves and the reduction in top marginal income tax rates gives them more incentive to do so.  The natural result is very high rates of pay, well above economic value. 

I agree that top corporate executives in general are currently substantially overpaid.  Piketty's  account certainly seems plausible and is probably part of the explanation.  However it is not the entire story as there are lots of high earners who aren't negotiating their pay with themselves.  Krugman brings this up in his review:

 ... Also, I don’t think Capital in the Twenty-First Century adequately answers the most telling criticism of the executive power hypothesis: the concentration of very high incomes in finance, where performance actually can, after a fashion, be evaluated. I didn’t mention hedge fund managers idly: such people are paid based on their ability to attract clients and achieve investment returns. ...

However I think Krugman is also confused in that it isn't actually any easier to evaluate the performance of hedge fund managers than the performance of corporate executives.  In both cases you can look at how well they have appeared to do in the past but this won't predict their future performance very well.  This is because how well they do is highly dependent on luck and other factors outside their control.  But people tend not to adequately allow for this.

So I think another part of the explanation for unjustified high pay is that employers have a natural tendency to overestimate their ability to predict future performance.  So they are willing to pay more to attract their preferred candidates than is justified by actual differences in expected performance.  As a result it is quite plausible that top corporate executives would be overpaid even if their pay was negotiated with truly independent boards of directors.  Just as hedge fund managers as a group are obviously overpaid even though their clients could readily obtain better expected performance (after fees) in low cost index funds.

No comments:

Post a Comment