29
Nov
11

Enhancing shareholder value

Tyler Cowen loses patience with the econoblogosphere’s discussion of CEO pay and CEO value added — more specifically, with the discussion’s strenuous avoidance of the literature:

Read this paper by Kevin Murphy (pdf), especially pp.33-38.  Admittedly the paper is from 1999 and it won’t pick up the more recent problems with the financial sector.  But most of the data are from plain, ol’ garden variety CEOs.  In many of the estimations we see CEOs picking up less than one percent of the value they create for the firm, and all of the estimates of their value capture are impressively small, albeit rising over time.  Never is the percentage of value capture anything close to one hundred percent.  “One percent value capture” is an entirely plausible belief.

So perhaps the standard lefty meme that business executives are parasitic fat-cats being paid far more than they actually deserve should be consigned to the dustbin of history.  (And perhaps not: this is, according to Cowen, the uncontroversial consensus result in the literature, but one of the exciting things about research is that “the literature” is occasionally wrong.  Nevertheless, don’t bet on it.)  But even if CEOs really do earn — in the median — their Croesus-like* compensation, surely it’s only fair that they be taxed on it, right?

Hang on: That they be taxed on it?  It’s time to talk about tax incidence!  Discussions of tax incidence make the economummy cry… tears of joy:

Let’s turn to taxation of the top 0.1 percent, and focus on these CEOs.  If the tax rate on their income/K gains goes up, the firm will compensate by giving them more equity/options, to keep them working hard.  In other words, the tax rate on the top earners can be hiked without much effect on CEO effort because there is an offset internal to the firm.  At some margin the firm’s shareholders will be reluctant to chop off more equity/options to the CEO, but the marginal value created by maintaining the incentive seems to be very high, for reasons presented above, and so the net CEO incentives will be maintained, even in light of new and higher taxes on CEO earnings.

But here’s the problem, if that’s the right word.  The incidence of that tax is going to fall on shareholders in general and thus on capital in general.  These top CEOs could even get off scot-free, if the shareholders up the equity/options participation of the CEO to offset completely the effects of the new and higher tax rate.  This is also relevant to the Piketty-Saez-Stantcheva analysis that everyone has been talking about; they don’t see these mechanisms with sufficient clarity.

Moral of the story: it’s harder to tax the top earners than you think.

(Emphasis added.)

So raising taxes on very high CEO incomes (note: we’re taxing income here, not wealth) is likely to turn into a tax on shareholders in general.  That’s probably not what we want.

Andrew Sullivan comments:

The cost of this, of course, is still carried by the shareholders. But not quite so much by the tax-payer.

Really?

First of all, isn’t this pretty much false by definition?  We’re talking about the cost of a tax increase… how can that cost not be borne entirely by “the tax-payer”?

Of course, Sullivan isn’t claiming that the cost won’t be borne at all by “the tax-payer”, by whom I think we can imagine (without being uncharitable) he means “the general public” or even “We the People”: he’s just claiming that most of it will be carried by shareholders in companies that pay their CEOs a shit-ton of money.  But as Cowen notes, this turns into a general tax on capital, which affects the markets in general.  We’re back to the Bastiatan story of “what is seen” — presumably highly-touted tax increases on the top 0.1% — vs. “what is not seen” — jobs not created because that tax increase was passed on to shareholders, whereupon (at the margins) some shareholders decided they had better things to do with their marginal dollar than invest it at now-higher effective tax rates.

Now, you could argue that a CEO Tax Increase — even if it was actually incident on the capital markets — would be too small to cause such a distortion, and I might even agree.  (My intuition is that, even under a “fair” tax rate, the top 0.1% wouldn’t pay a noticeable amount of income tax when taken as part of gross tax receipts.)  But that makes any such proposed tax increase pure window-dressing: if it’s small enough in aggregate terms to not fuck with capital markets, it’s probably too small to make a dent in the deficit.

None of which is to say that we shouldn’t be looking at some form of tax increases as part of a plan to reduce deficits, and given that the marginal dollar of a 90th-percentile income is worth less than the marginal dollar of a 10th-percentile income I’d kind of rather that those tax increases be progressive.  But given the whole “recession” thing, especially considering the slow-motion train-wreck that used to be called the Eurozone, I’d really rather that those tax increases be as non-distortionary as possible.

——

* There doesn’t seem to be a good adjective for this.  “Croesian”?

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2 Responses to “Enhancing shareholder value”


  1. 1 TMI
    November 30, 2011 at 09:33

    Kantian. Jeffersonian.

    Croesusian.
    .

    • November 30, 2011 at 23:44

      I dunno, too many vowels and sibilants together. Scans better with the emphasis on the second syllable rather than the first, though.

      Faustus => Faustian. Croesus => Croesian?


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