Tuesday, April 15, 2008

The Bad Penny

by Tom Bozzo

Were it not for D-squared, I'd have to wonder how Xavier Gabaix and Augustin Landier managed to get published in the QJE and not the American Enterprise Institute working paper series. So it's maybe more a matter of a disappointing reminder that the peer-review system is the worst one apart from all the rest than a call to the barricades to see the NYT maintain its death spiral in part by telling me that Gabaix is shilling his and Landier's dubious little result on executive pay in the AEI house organ (without notifying me that it is the AEI house organ we're talking about).

The verdict from two years ago was that they derived some mildly interesting results from fantasy premises, starting with the idea that the CEO labor market is frictionless and neoclassical. From some perspectives on economics research methods — and sometimes to the annoyance of economics critics — that can be a feature and not a bug; it's a common research method to characterize how far reality departs from such flights of fancy. The problem here is that even The American's Laura Vanderkam can't help but recount a variety of gross features of executive pay (the heads-I-win, tails-you-lose arrangements, the divergence in compensation between the executive ranks and everyone else, the non-observability of talent, the factoid that investor willingness to pay more money for a dollar of earnings is a major driver of recent market cap increases) that are puzzles for if not grossly inconsistent with a model of a frictionless CEO labor market.

Anyway, the Davies model seems to me to be a rounder peg for this particular hole: economists of a couple generations ago did their duty by providing a plausible explanation why corporate executives were underpaid, certain frictions in the system did their bit, and belatedly-discovered holes in the theory have been non-neoclassically slow to be plugged.

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Michael Porter is still alive and well, and his minions are well-dispersed and well-placed.

I was going through some papers this afternoon, and came across an old James Tobin article (AER, Dec 1975; "Neoclassical Theory in America: J. B. Clark and Fisher") that seems to imply that "shilling" is the rule not the exception.
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