Tuesday, April 15, 2008
The Bad Penny
by Tom Bozzo
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.
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.
Labels: Economics, The New Gilded Age
Monday, April 07, 2008
The Last Worthwhile Part of the Old Firm is to be Destroyed
by Ken Houghton
These are the workers one would see every day, working hard and getting their jobs done. Many of them long predate my first time there, in the early 1990s.
And none of them ever made thousands or millions or even billions of dollars of shareholder value go away.
Stick a fork in it; one way or another, Bear Stearns is gone.
Even Jimmy Cayne didn't screw this one up, but Jamie Dimon plans to ruin the one Unarguably Good Thing they did:
JPMorgan Chase...wants to dismantle the firm's jobs program for people with disabilities, according to sources familiar with the matter.
That means about 40 Bear workers with disabilities who were given jobs at the firm over the years will likely be laid off.
These are the workers one would see every day, working hard and getting their jobs done. Many of them long predate my first time there, in the early 1990s.
And none of them ever made thousands or millions or even billions of dollars of shareholder value go away.
Stick a fork in it; one way or another, Bear Stearns is gone.
Labels: The New Gilded Age, The Old Firm
Thursday, December 13, 2007
Defining the Middle Class Up
by Tom Bozzo
A lot of Googlers used to find their way here searching for definitions of "upper-middle class." As far as I recall, we never really provided a definition, though my informal economist's take is that the upper-middle class is basically the upper-working class. That is, in contrast with the "rich," the upper-middle class depends on a flow of wage income to maintain its standard of living, etc. For instance, the 95th percentile net worth in the 2004 Survey of Consumer Finances data, $1.43 million, would buy a $57,300 joint life annuity with some inflation adjustment for a 50-year-old and spouse at the terms offered by the Thrift Savings Program; that's roughly a 65th percentile income.
It follows directly that Harvard's more generous financial aid policies only benefit the upper end of the income distribution, since the Harvard endowment isn't going so far to remedy the institution's "Upstairs/Downstairs" problem as to put the keys to late-model BMW M cars into the hands of kids from actual middle-income families. [*] That is, students from families with incomes under $60,000 get nothing more than before, and that's roughly the median income for families whose heads are old enough to send kids to college. [**] The real action is between the 85th to 95th percentile of the general income distribution and still a lofty slice of the families-with-college-age-kids distribution.
A W$J article (no link) reported that about half of Harvard's undergrads receive grant aid, and about a third of those get the under-$60,000-income free ride. So the national median (or maybe a bit better) income puts a kid at the 17th percentile or so of the Harvard undergrad distribution, and the 90th-95th percentile nationally is something like the Harvard median. So while Megan McArdle may not be quite on the money in characterizing the beneficiaries of the new policy as "actual" "working and middle class students," I can't disagree with her that the implied distribution is interesting if maybe not surprising.
The issue may be one of scale as much as anything — in a population the size of the U.S., being in the top percentile of something puts you in an exclusive club of some three million members. [***] So out of the top couple of deciles of U.S. households by income — the top 25 million or so — there will be smart teenagers far in excess of Harvard's modest undergrad enrollment. Of course, the same goes for the bottom half. In this regard, Felix Salmon is right to say, "I simply don't buy this idea that there's a limited pool of 'top students' which all top universities want." At least, if that's how elite schools' admissions officers view things, then they should sharpen their pencils.
In any event, I can hardly object to more generous aid terms, even though a really bold policy could spend a little more of the Harvard endowment's returns to a more conspicuously anti-elitist effect. If they wanted to do so, they could afford to match the income distribution of the general public.
The AMT discussion is less innocent. This morning, as many others recently, I've groggily heard NPR announcers telling me how an unfixed AMT will ensnare 22-point-something million "middle income" taxpayers. For actual middle-income taxpayers (q.q.v.), it takes very special circumstances to end up with an AMT bill of any size. The typical AMT relievee, in fact, looks quite a bit like me — decent income, couple dependents, relatively large deductions for state and local taxes — and I could not tell you with a straight face that it would cause substantial hardship to pay another grand or two to the Feds.
Middle-income "victims" of the AMT are easier to find than family farmers put out of business by the estate tax, but again the issue is that the moderately-well-heeled are numerous in a big country. There's no doubt that politicians of both parties wouldn't care to annoy tens of millions of taxpayers from high-voting-rate demographics, but by and large the issue is an annoyance rather than an injustice. As it happens, the annoyance could be resolved justly by closing some prominent tax loopholes and modestly increasing rates for high-income taxpayers, but the Republicans who engineered the problem in the first place [****] have decided to circle the wagons around not raising any tax for any reason.
[*] Maybe tooling around Cambridge and Brookline in such vehicles is more of a BU thing. No matter.
[**] The income distribution shifts upwards with age, up to a point, reflecting the progress of typical career paths.
[***] So the answer to questions like "how many people can afford those megabuck lakefront houses and McMansions" is "more than you'd perhaps think," Big Shitpile issues notwithstanding.
[****] That is, the AMT problem was known when the Bush tax "cuts" were pushed through; taking away the cuts for upper-middle-income taxpayers was a means of keeping the official effect on the federal deficit small enough that fiscal conservatives could close their eyes and think of England while voting for it.
It's been interesting to see the Alternative Minimum Tax fix and the hoopla over Harvard's new undergrad financial aid policies framed as middle-class issues. This may be true in some technical sense, but it's misleading.
A lot of Googlers used to find their way here searching for definitions of "upper-middle class." As far as I recall, we never really provided a definition, though my informal economist's take is that the upper-middle class is basically the upper-working class. That is, in contrast with the "rich," the upper-middle class depends on a flow of wage income to maintain its standard of living, etc. For instance, the 95th percentile net worth in the 2004 Survey of Consumer Finances data, $1.43 million, would buy a $57,300 joint life annuity with some inflation adjustment for a 50-year-old and spouse at the terms offered by the Thrift Savings Program; that's roughly a 65th percentile income.
It follows directly that Harvard's more generous financial aid policies only benefit the upper end of the income distribution, since the Harvard endowment isn't going so far to remedy the institution's "Upstairs/Downstairs" problem as to put the keys to late-model BMW M cars into the hands of kids from actual middle-income families. [*] That is, students from families with incomes under $60,000 get nothing more than before, and that's roughly the median income for families whose heads are old enough to send kids to college. [**] The real action is between the 85th to 95th percentile of the general income distribution and still a lofty slice of the families-with-college-age-kids distribution.
A W$J article (no link) reported that about half of Harvard's undergrads receive grant aid, and about a third of those get the under-$60,000-income free ride. So the national median (or maybe a bit better) income puts a kid at the 17th percentile or so of the Harvard undergrad distribution, and the 90th-95th percentile nationally is something like the Harvard median. So while Megan McArdle may not be quite on the money in characterizing the beneficiaries of the new policy as "actual" "working and middle class students," I can't disagree with her that the implied distribution is interesting if maybe not surprising.
The issue may be one of scale as much as anything — in a population the size of the U.S., being in the top percentile of something puts you in an exclusive club of some three million members. [***] So out of the top couple of deciles of U.S. households by income — the top 25 million or so — there will be smart teenagers far in excess of Harvard's modest undergrad enrollment. Of course, the same goes for the bottom half. In this regard, Felix Salmon is right to say, "I simply don't buy this idea that there's a limited pool of 'top students' which all top universities want." At least, if that's how elite schools' admissions officers view things, then they should sharpen their pencils.
In any event, I can hardly object to more generous aid terms, even though a really bold policy could spend a little more of the Harvard endowment's returns to a more conspicuously anti-elitist effect. If they wanted to do so, they could afford to match the income distribution of the general public.
The AMT discussion is less innocent. This morning, as many others recently, I've groggily heard NPR announcers telling me how an unfixed AMT will ensnare 22-point-something million "middle income" taxpayers. For actual middle-income taxpayers (q.q.v.), it takes very special circumstances to end up with an AMT bill of any size. The typical AMT relievee, in fact, looks quite a bit like me — decent income, couple dependents, relatively large deductions for state and local taxes — and I could not tell you with a straight face that it would cause substantial hardship to pay another grand or two to the Feds.
Middle-income "victims" of the AMT are easier to find than family farmers put out of business by the estate tax, but again the issue is that the moderately-well-heeled are numerous in a big country. There's no doubt that politicians of both parties wouldn't care to annoy tens of millions of taxpayers from high-voting-rate demographics, but by and large the issue is an annoyance rather than an injustice. As it happens, the annoyance could be resolved justly by closing some prominent tax loopholes and modestly increasing rates for high-income taxpayers, but the Republicans who engineered the problem in the first place [****] have decided to circle the wagons around not raising any tax for any reason.
[*] Maybe tooling around Cambridge and Brookline in such vehicles is more of a BU thing. No matter.
[**] The income distribution shifts upwards with age, up to a point, reflecting the progress of typical career paths.
[***] So the answer to questions like "how many people can afford those megabuck lakefront houses and McMansions" is "more than you'd perhaps think," Big Shitpile issues notwithstanding.
[****] That is, the AMT problem was known when the Bush tax "cuts" were pushed through; taking away the cuts for upper-middle-income taxpayers was a means of keeping the official effect on the federal deficit small enough that fiscal conservatives could close their eyes and think of England while voting for it.
Labels: Social Class, The New Gilded Age
Friday, December 07, 2007
QOTD (Waldmann vs. Worthless Democratic Strategists Edition)
by Tom Bozzo
Given who pays the Republicans' bills, they may have been operating a little bit short of political suicide, but they were clearly willing to spin the barrel for some Russian Roulette. Why the eagerness to snatch the guns out of their hands?
Robert Waldmann, who clearly would be a higher-valued recipient of the money paid to Democratic "strategists":
I do not understand why the Democrats didn't make the Republicans actually filibuster this one. Delaying the AMT patch and the mailing out of refunds to protect the interests of a small number of hedge fund managers and private equity partners can't be popular can it ? The Democrats seem to have just decided that they will be blamed if the Republicans block them from doing what the public wants. Given the rules of the Senate, if the majority makes it clear that it is willing to cave to get things done on time, the minority can become more powerful than the majority. I really don't see why Reid caved so quickly on this one. A few days of denouncing the Republicans for blocking the AMT patch to serve the super rich who pay 15% of their income in taxes would have made the claim that "we have tried every alternative possible," a lot more convincing.
Given who pays the Republicans' bills, they may have been operating a little bit short of political suicide, but they were clearly willing to spin the barrel for some Russian Roulette. Why the eagerness to snatch the guns out of their hands?
Labels: Econoblogs, The New Gilded Age
Friday, September 07, 2007
Question Hour
by Tom Bozzo
Q: A Googler from Swaziland asks:
This has been another MU version of "Simple Answers to Simple Questions."
(An occasional look at search terms that bring people to this blog.)
Q: A Googler from Swaziland asks:
Is the CEO labor market neoclassical and frictionless [?]A: No.
This has been another MU version of "Simple Answers to Simple Questions."
Labels: Economics, principal/agent problems, question hour, The New Gilded Age
Thursday, September 06, 2007
You Know What This Means...
by Tom Bozzo
The Rocky Mountain News (via) quotes a Corporate Library analyst calling the arrangment "ridiculous." A forthcoming report from this analyst on personal use of company jets shows only 28 out of 215 companies allowing such arrangements (not including Qwest).
Am I too cynical, or am I hearing the sound of 187 CEOs getting on the horn to the lawyers who handle their employment contract negotiations?
Bonus:
For the boards, at least, the better argument would be that paying someone a few thousand bucks an hour to cool their heels in a security checkpoint line isn't a great use of resources. But that argument probably only gets them into a Citation (and not the Citation X, either). Cue the Boogeyman to make the leap to the G550.
So Qwest shareholders and/or ratepayers will get to pay for the CEO's wife and stepdaughter to commute between Denver and their present California residence on the company jet (apparently a Falcon 2000).
The Rocky Mountain News (via) quotes a Corporate Library analyst calling the arrangment "ridiculous." A forthcoming report from this analyst on personal use of company jets shows only 28 out of 215 companies allowing such arrangements (not including Qwest).
Am I too cynical, or am I hearing the sound of 187 CEOs getting on the horn to the lawyers who handle their employment contract negotiations?
Bonus:
"I don't have a problem with a board saying, 'We think there are security issues here,'" [Corporate Library analyst Paul] Hodgson said.Bah. Corporate aviation departments have pretty good safety records, but they're no better than Part 121 airlines. Nor is it very credible to suggest that there's a significant threat to corporate managers and/or their families between airport curbsides and gates beyond the indignities of shoe removal and the occasional frisking.
For the boards, at least, the better argument would be that paying someone a few thousand bucks an hour to cool their heels in a security checkpoint line isn't a great use of resources. But that argument probably only gets them into a Citation (and not the Citation X, either). Cue the Boogeyman to make the leap to the G550.
Labels: conspicuous consumption, The New Gilded Age, Trains Planes and Automobiles, Unintended Consequences
Tuesday, June 19, 2007
Adventures in Spelling, Beachside Edition
by Anonymous
So, does the bottom sign contain an extra "N" or an extra "H"? Or, perhaps the second "N" should be a "G" -- see Making Light's discussion of whinging vs. whining.
In Santa Cruz, CA, where modern hippies, dot com millionaires, and modern hippie dot com millionaires live side by side (not always comfortably), it's anyone's guess. Perhaps the person who ordered the sign suffered from the same uncertainty.
(the street address on the top sign is edited to protect the guilty.)
So, does the bottom sign contain an extra "N" or an extra "H"? Or, perhaps the second "N" should be a "G" -- see Making Light's discussion of whinging vs. whining.
In Santa Cruz, CA, where modern hippies, dot com millionaires, and modern hippie dot com millionaires live side by side (not always comfortably), it's anyone's guess. Perhaps the person who ordered the sign suffered from the same uncertainty.
(the street address on the top sign is edited to protect the guilty.)
Labels: just life, The New Gilded Age
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
Tuesday, April 24, 2007
Annals of Excessive Compensation
by Tom Bozzo
Quote of the Day honors go to J-Brad. [*]
From the industry side, Jim Dunn of Wilshire Associates is quoted as saying he's happy to pay for 'alpha,' the return independent of the 'market' that hedge fund managers supposedly extract from thin air (justifying their extraordinary compensation).
Well, here's where #3 on the list ($1.3 billion in earnings last year) got his alpha, per the Times:
Kudos to Jenny Anderson and Julie Creswell of the NYT for reminding their readers that managers' compensation structure means that they can earn extraordinary compensation in return for middling returns on large funds. We remain mystified as to why massive entry hasn't competed away the obvious excesses of the traditional hedge fund fee structure. Maybe Susan Athey can answer that one.
[*] Should we economists give each other nicknames like that? Uh, maybe not.
To crack the ranks of the top 25 hedge fund managers in 2006, you would have needed to take home $240 million. The top dog made $1.7 billion.
Quote of the Day honors go to J-Brad. [*]
“There is some question as to what the hell they are doing that is worth” that kind of money, said J. Bradford DeLong, an economist at the University of California, Berkeley. “The answer is damned mysterious.”Darn straight.
From the industry side, Jim Dunn of Wilshire Associates is quoted as saying he's happy to pay for 'alpha,' the return independent of the 'market' that hedge fund managers supposedly extract from thin air (justifying their extraordinary compensation).
Well, here's where #3 on the list ($1.3 billion in earnings last year) got his alpha, per the Times:
Mr. Lampert ... has $11 billion of his $14.6 billion ESL fund in the retailer Sears Holdings. Last year, Sears stock rose and with it, Mr. Lampert’s fortune by about $1.3 billion.Can someone explain to me why that isn't just a canny stock pick? Who's paying hedge fund fees for let's bet the farm on Sears?!
Kudos to Jenny Anderson and Julie Creswell of the NYT for reminding their readers that managers' compensation structure means that they can earn extraordinary compensation in return for middling returns on large funds. We remain mystified as to why massive entry hasn't competed away the obvious excesses of the traditional hedge fund fee structure. Maybe Susan Athey can answer that one.
[*] Should we economists give each other nicknames like that? Uh, maybe not.
Labels: hedge funds, The New Gilded Age
