A Persian Cafe, Edward Lord Weeks

Tuesday, 9 February 2016

What Causes International Differences in CEO-to-worker Wage Ratios?

CEO-to-worker pay ratios vary massively across the developed world. In the US, the average CEO earns 354 times more than the average worker; by comparison, in Germany the figure is 147, in the UK 84, and in Denamrk only 48. This raises a puzzle for those of us who hold, however loosely, to the Efficient Markets Hypothesis: why is the marginal productivity of US CEOs so much higher?

I'm not going to be able to answer that here, but I will set out a few hypotheses and perhaps at some point try to establish which, if any, are correct.

(1) EMH is completely wrong or doesn't apply, and CEO salaries bear no relation to productivity.
This is possible, but fails to actually explain the key puzzle. Instead it just pushes us to the second question of why US investors are so uniquely unable to restrain salaries. (Or, perhaps, why US investors find it so useful to give rewards to CEOs in the form of salary).

(2) Tax distortion. Progressive income taxation may be expected to lead to higher pre-tax income inequality, since the incidence of income tax will almost never fall entirely upon the individual - instead they will on some margin demand higher pre-tax wages to compensate. This seems to make predictions which are opposite to reality, however - the US has relatively low income taxes, while Denmark is highly taxed.

(3) The US is bigger, tends to have correspondingly larger firms, and correspondingly higher payouts for CEOs. We could test this by comparing CEO-to-worker ratios of similar-sized firms across countries.

(4) Perhaps the corporate ladder is a tournament game, where the benefits of massive payouts to the winners (i.e. CEOs) come not from increased productivity by the CEOs, but instead through greater effort by those competing to become CEOs. If the competition to become a CEO is fiercer in the US - something which seems highly plausible (e.g. more competitors since everyone speaks English whereas relatively few people speak Danish, hence the US can import business-people more easily than Denmark) then we would expect to see higher payouts to winners of the US tournament.

(5) Cultural pressures towards income equality. These pressures need not be intrinsically egalitarian: for example, if being a CEO is highly respected, then we would expect to see CEOs receive lower wages than they otherwise would since they are in effect trading income for social status.

(6) Differences in the income of low-earners. I daresay that France would have a rather higher CEO-to-worker earning ratio were it not for its very high minimum wage. An economy in which almost all jobs involve the use of physical capital (e.g. an industrial manufacturing-based economy) would be expected to have higher wages than one based almost entirely around services. Eyeballing the figures I would guess that this plays at least a partial role - Denmark does have an unusually high average worker income, for example - but it cannot be the full story, given that the average US CEO earns almost six times the wage of the average Danish CEO.

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