51 Pages Posted: 6 Feb 2017
Date Written: February 4, 2017
Pay inequality between executives and workers accounts for a substantial fraction of overall pay inequality in the United States. We develop a general equilibrium model that delivers realistic fluctuations in pay inequality -- both between executives and workers, and among executives in different firms -- as a result of changes in the technology frontier. In our model, executives add value to the firm not only by participating in production decisions, as do other workers in the economy, but also by identifying new investment opportunities. The economic value of these two distinct components of the executives' job varies with the state of the economy. Improvements in technology that are specific to new vintages of capital raise the return to managers' skills for discovering new growth projects, and thus increase the compensation of executives relative to workers. When most of the dispersion in managerial skills lies in the ability to find new projects, disparities in pay across executives in different firms also increases in response to these embodied technological shocks. Our model implies that, controlling for firm size, compensation is higher in fast growing firms. In addition, it implies that pay inequality increases as investment opportunities in the economy improve. Both predictions are consistent with historical and modern data on executive pay.
Keywords: inequality, technology, executive compensation
Suggested Citation: Suggested Citation
Frydman, Carola and Papanikolaou, Dimitris, In Search of Ideas: Technological Innovation and Executive Pay Inequality (February 4, 2017). Sloan Foundation Economics Research Paper; Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=2911649