Is The Rise in Executive Pay A Market Failure?

This graph was taken from an article on the growth in executive pay by an economist from Oxford. He was pleased to hear the conservative Prime Minister declare that the growth in executive pay was due to market failure. There was no good explanation, however, regarding the source of the market failure.

One can't derive the sources of market failure from the graph, but we can make an effort to point in the right directions. Its pretty clear from the graph that the top 0.1% share of income reached a peak in every country just prior to the Great Depression. This was a period of rapid economic growth and also a period of rising stock prices. Those who benefited from the asset bubble in stock prices were also those who were in the top 0.1%. Their share of income dropped dramatically after the stock market crash and the start of WW II. It remained at that level for some time and then something happened. The income share of the top 0.1% remained flat for France and Japan, while it grew rapidly in the US and the UK until it reached the peak of the "Gilded Age" prior to the Great Depression. The problem is to explain why the US and the UK had such a different experience. I can't speak for the UK but there were several things going on the US that might be related to the boom. The cultural climate shifted in the US in a couple of ways. Corporate executives somehow were elevated in the public mind to super star status that was once reserved for movie stars and sports stars. It was also a period of transformation in the US. The movement from an industrial economy to a services economy also led to a decline in union membership, and the countervailing influence of unions on public opinion and legislation rapidly declined. There was also a change in the incentive system for corporate executives. Their compensation was increasingly based upon the award of stock options. This enabled them to benefit from the rise in stock prices. Executives were compensated much like the industrialists who founded industries in the Gilded Age. It didn't take long for a pattern to emerge in executive contracts, and how corporate boards determined executive compensation. Top executive hired lawyers to negotiate their contracts, and corporate boards hired executive compensation firms to assist them in setting compensation policy. This set the stage for the "Lake Wobegon Effect". Everyone's CEO was regarded as above average and compensation was set accordingly. This led to a ratcheting up effect in which each firms CEO would receive a higher raise each year than a CEO in a similar capacity. The financialization of the US (and the UK) economy also had an impact. Top performers on Wall Street receive a substantial share of top 0.1% income. That too was quite common in the Gilded Age. Perhaps we should call this the the return of the Gilded Age, but this time it is different. The Great Recession has had little impact on executive compensation and Wall Street executives are still a significant percent of the top 0.1%.