Executive Compensation, Fat Cats and Best Athletes

Abstract

The income gains in the top 1 percent are the primary cause for the rapid growth in U.S. inequality since the late 1970s. Managers and executives of firms account for a large proportion of these top earners. Chief executive officers (CEOs) in particular have seen their compensation increase faster than the growth in firm size. We propose that changes in the macro patterns of the distribution of CEO compensation resulted from a process of diffusion within localized networks, propagating higher pay among corporate executives. We compare three candidate explanations for diffusion: director board interlocks, peer groups, and educational networks. The statistical results indicate that corporate director networks facilitate social comparisons that generate the observed pay patterns. Peer and education network effects do not survive a novel endogeneity test that we propose and estimate. A key implication is that local diffusion through executive network structures explains the changes in the macro patterns of income distribution evidenced in the inequality data.

Keywords: Executive Compensation, Social Comparison, Social Networks, Endogeneity, Chief Executive Officers, Income Distribution