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September 10, 2013
The Dismal Science
Superstars of the Corporate World
by Adam Smith

America has always represented a country where if people work hard enough they can fulfill their dreams. This thinking has been criticized lately by politicians, protesters, and some in the media. The Occupy Wall Street movement that swept the country a couple of summers ago represents the backlash to the American way of life.

There was a huge kerfuffle about the 1% and the 99%. The 1% was taking all of the money and there just was not enough left for the rest of us. America had lost its way, and the 99% were being trampled by the 1% just as in the days of yore when there were few aristocracies and everyone else, impoverished, barely surviving, working 20 hour days, did the bidding of the lucky few.

Really. And these people were taken seriously. When you look at cities in the United States do you really see a small handful of people living in luxury and everyone else barely surviving? Even in the stagnant economy we have, most people have a good job (sorry, 23 million unemployed, the government is determined that you never work again) and cities are bustling with commerce (please take this moment to bow your head in a moment of silence for Detroit).

First, let’s examine the issue. At the core, the facts are that the 1% earned 10% of the wealth in 1979 and in 2010 it was 20%. This increase was stated to be the result of the board of directors of public companies lavishing too much salary, bonuses, and stock options on CEOs.

A board of directors is often comprised of other CEOs from other companies and they were each lining each other’s pockets. The fix was in. (For complete disclosure I also believe many CEOs are overpaid. The ones that are really good are underpaid.)

Well the first thing to consider is the stated facts. The above numbers are true; however, they are before taxes. After taxes the increase is from 7% to 11%. This is still a significant increase, but not quite as dramatic as the pre-tax increase.

In a recent paper, Kaplan and Rauh (2013), do some research to try and help us understand what is causing this increase. (The paper is available online for those that are really curious about this topic and the paper is not a heavy math paper.) Here is what they found in a very brief summary.

They looked at what type of salary increases had occurred in various business settings to see if this increase is unique (using the correct definition of the word) to public companies or if the increase is found in private companies, hedge funds, professional sports, or other places.

They found in all of these business settings there has been an increase in the income of the top earners. They attribute the increase to the impact of technology and globalization of the world economy (obviously these are not mutually exclusive).

To understand this concept, consider the economics of professional basketball. Professional basketball’s popularity is driven by its stars. Any time Lebron James or Kevin Durant steps into an arena, it gets sold out. This is not a new development. Magic Johnson and Larry Bird did the same. The difference is in the reach the stars now have into our everyday lives and around the globe.

Sports-dedicated television channels have multiplied, bringing sports into our homes whenever we want to see some competition. During the NBA seasons, you can watch any game any night you want if you are willing to pay.

We used to be lucky to see a few highlights of our favorite players when I grew up. Now you can watch them over and over on YouTube. With television and the internet, the reach of the NBA goes into many countries. Fans from Asia, South America, and Europe love NBA stars.

This extended reach makes the stars worth much more than they were before.

Now think about a CEO. A CEO that knows the global market can help steer his company to cheaper costs to produce product with less expense, and he will know where the company’s products will sell. A company leverages a star CEO over a larger market. And like the star NBA player, the star CEO will be very well paid. He will receive even more compensation than that of an equally capable CEO from the 60’s.

Consider Steve Jobs. When he came back to Apple, it was worth about $5 billion. In ten years, it was worth $500 billion. Steve Jobs made a lot of money, but not enough for the return he gave to Apple’s investors.

So there is no conspiracy between the boards and the CEOs to inflate compensation as believed by so many critics of capitalism.

One other point raised by the Kaplan Rauh paper. The people that comprise the 1% come from interesting backgrounds. Thirty percent of the 1% started life wealthy, 50% started life with some wealth, and 20% started out poor. America is still the place that people can raise to whatever level of success they aspire.

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