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In Search of Ideas: Technological Innovation and Executive Pay Inequality

51 Pages Posted: 6 Feb 2017  

Carola Frydman

Northwestern University; National Bureau of Economic Research (NBER)

Dimitris Papanikolaou

Northwestern University - Kellogg School of Management - Department of Finance; National Bureau of Economic Research (NBER)

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Date Written: February 4, 2017

Abstract

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

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

Carola Frydman

Northwestern University ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Dimitris Papanikolaou (Contact Author)

Northwestern University - Kellogg School of Management - Department of Finance ( email )

Evanston, IL 60208
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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