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 Bottom-line difference: (0.03)x($4 billion) = $120 million Suppose Cornell’s Skorton was 3% better at fundraising than the 2nd-best candidate.

“Obscene” Executive Pay? CEOs of large US corporations earned ten times the average worker’s salary in times the average worker’s salary in 2000

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. And so on all the way down the income ladder. That, in turn, shifts the frame of reference for those next below. This shifts frame of reference for those just below them, who also spend more.

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 long commute times Growth in divorce rates Growth in bankruptcy 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 ConsumptionMarginal Tax Rate 0 - $39,99920 percent $40,000 - $49,99922 percent $50,000 - $59,99924 percent $60,000 - $69,99926 percent $70,000 - $79,99928 percent $80,000 - $89,99930 percent $90,000 - $99,99932 percent $100,000 - $129,99934 percent $130,000 - $159,99938 percent $160,000 - $189,99942 percent $190,000 - $219,99946 percent $220,000 - $249,99950 percent

Taxable Consumption Marginal Tax Rate $250,000 - $499, percent $500,000 - $999, percent $1,000,000-$1,999, percent $2,000,000-$3,999, percent $4,000, 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?