Monday, May 28, 2007
From the Archives: On Gabaix and Landier on Executive Pay
by Tom Bozzo
Here's what I said about the working paper version just about a year ago:
A lesson you might draw from this is that while a published study like this may be assumed to be substantially free of direct errors (and there are plenty of papers that don't rise to that standard), that doesn't rule out blindspots of such magnitude that you (like, say, Kevin Drum) might reasonably wonder what world it is that is under study. Neoclassical and frictionless markets for corporate executive services? Riiight.
It's also almost the one-year anniversary of the verdicts in the trial of the late Kenny Boy Lay and Jeff Skilling , and that led me to take another whack at G&L:
Via PGL at Angry Bear, I see that Gabaix and Landier's paper "explaining" CEO pay dispersion as a function of market capitalization has made its way to the Quarterly Journal of Economics. No accounting for taste.
Here's what I said about the working paper version just about a year ago:
My two cents is that this paper (which would-be clickers through should note uses a fair amount of math) presents some interesting results derived from fantasy fundamentals — you read a sentence like "Our [CEO] talent market is neoclassical and frictionless" and try to resist the urge to snort...Read the whole thing, as you like.
[U]sing alternative measures of firm size, the "fundamentals" don't support the magnitude of the CEO pay increase as obviously as Gabaix and Landier suggest. The authors wave their hands around the connection between the present value of profits and firms' measured market values, and in fact offer that profits could be an admissible measure of market size. In the aggregate, though, corporate profits adjusted for inflation (as measured by the BEA) have increased by a factor of three; the leadoff comment at Marginal Revolution also highlights the excess growth of CEO pay relative to corporate earnings and the potential dissconnection between profits and market valuations.
This points to a second, and arguably bigger, problem. Even if you were to accept market capitalization as the appropriate benchmark, the growth of market capitalization reflects various factors that are not causally attributable to CEO talent or effort. Investors' willingness to pay more for a dollar of earnings than they were in 1980 (for the time being, anyway) is Exhibit A.
A lesson you might draw from this is that while a published study like this may be assumed to be substantially free of direct errors (and there are plenty of papers that don't rise to that standard), that doesn't rule out blindspots of such magnitude that you (like, say, Kevin Drum) might reasonably wonder what world it is that is under study. Neoclassical and frictionless markets for corporate executive services? Riiight.
It's also almost the one-year anniversary of the verdicts in the trial of the late Kenny Boy Lay and Jeff Skilling , and that led me to take another whack at G&L:
If you believed the compensation committees and compensation consultants, all of the CEOs are above average. What's worth explaining is the collection of CEOs who joined their companies long before the firms should have been shelling out for top executive talent and subsequently rode the market cap rocket to riches without their boards replacing them with someone more talented along the way. There are reasonable explanations for that, of course, but frictionless sorting of CEOs by talent in the labor market isn't one of them.
Labels: Economics, High Finance, The New Gilded Age
