Transcript Will China Implode? Inequality and Social Stability

Team Production, Concentrated Rewards:
the paradox of work and pay
Richard B. Freeman, Harvard, NBER, and CEP, LSE
Green Templeton College, Oxford, Future of Work Oct 18, 2011
The Issue: increased importance of
team/cooperative work in economy coincident
with rising inequality in pay
This talk:
1- Evidence on team/cooperative and inequality in
science-engineering (paper authors), with side note on the
rise of supply chains
2- Evidence on group incentives vs incentives for top
executives.
3- What is fair/efficient division?
4- Toward a better world of work
The rising inequality in pay
The Wall Street Occupiers emphasis on the upper 1% is
wrong. In the US it is the upper 0.1%. Share of pretax
income earned by top 0.1% increased from 2.7% to 12.3%
(2007). Rest of upper 1% increased from 5.3% to 5.7%.
Who are the 0.1%? Two-thirds are executives, managers,
supervisors, financial professions + real estate
This means “income of 99.9% of Americans would have
increased by almost 10% if share of 0.1% was constant.”
Within the upper 0.1% ???, it is possible –likely? – we
would find similar fractal dimension of inequality – wealth
of billionaires in Forbes follows power law.
The World's Billionaires-- Forbes March 2011
Two hypotheses to explain phenomenon
H1: Efficient production. Modern ITC has expanded
role of coordination/span of control – superstars in
global Internet economy. “Masters deserve what
they get. Do what you’re told or the ship will sink.”
H2: Crony capitalism. Small elite has taken control
of business and government and extracted huge
economic rents as the purported residual claimants
on production.
Divergent views on the hypotheses
Crony? Are you kidding? I deserve my
billions. It’s hard battling Morgan
Stanley, Citicorps, and Goldman daily,
those unscrupulous sleazebags with all
their connections in the Beltway”
1.Teams in Science and Engineering
TEAM
Is there a payoff to multi-authored papers? YES
Analysis: Use five year forward citations to measure merit
of a paper (about 1/3rd of papers are never cited!). Based
on articles in ~22,000 journals from Thomson-Reuters
“Web of Science” data, 1950-2003.
Once about a time
Now
But power Laws for cites for individuals
Papers: mode is 0; 30-40% “never cited”;
competition between papers among and within generations
Science need instruments, equipment, data →
Grants. Compete in a tournament with peer
review. Guess who gets the grants?
I don’t do the research
or write articles, either, but
I raise the money
so I get the credit!
Paula Stephan, tabulated from Survey of Doctorate Recipients, for forthcoming HUP book
Does tournament structure affect supply?
Niederle &Vesterlund (2007) Experiment: add five 2-digit
numbers randomly drawn and presented in the following way:
21 35 48 29 83
Side note on Supply Chains and Fragmentation
Signs of Problems: postdocs organize
National Postdoc Association (“not a union”,
then unionize)
You work in for a Prof who you believe falsified data on a
grant application that covers your pay. What do you do?
In 2006 Science reported that after several months of debating, six graduate
students working in Elizabeth Goodwin's genetics lab at the University of
Wisconsin decided to tell university officials. A university investigation
subsequently found that Goodwin had falsified data. She resigned.
“When she resigned and the university forfeited her funding, her lab closed
down. That meant the students were out of work — no salaries, no tuition
reimbursement, and perhaps worst of all, no research. That would mean no
progress on their degrees, and starting over.”*
“One, Chantal Ly, had gone through 7 years of graduate school and was told
that much of her work was not useable and that she had to start a new
project for her Ph.D... Along with two of the others, she quit graduate
school. … (Another), Allen moved to a school in Colorado. Just two
students chose to stay at UW.” # One, Amy Hubert, got her PhD.
* John Allen Can of Worms, Wisconsin Alumni association,
# Jennifer Couzin-Frankel, Science Insider, June 28, 2010
2. Growth of incentive pay:
group incentives in US, 2002-2010
Associated with employee involvement (EI) committees,
teamwork: more likely to have EI if have group incentive
pay and conversely. Systems called high performance work
places. Compensation systems have local group incentives,
company-wide incentives, individual incentives, etc.
“Preponderance of Evidence” says group
incentives work
Reviews on employee ownership conclude that “two thirds of 129
studies [including both performance and attitude studies] on employee
ownership and its consequences found favourable effects relating to
employee ownership, while one tenth found negative effects”, and that
“research on ESOPs and employee ownership is overwhelmingly
positive and largely credible.” Meta-analyses that combine estimated
parameters from studies report a strong positive association between
inclusive capitalist modes of compensation and performance.
The UK Treasury commissioned Oxera (Oxford, London) in 2007 to
examine impact of tax breaks for individual employee stock
ownership, using confidential financial information. Estimating
production functions for 16,844 corporations, this study found that the
shared capitalism approaches increased value added per worker by
about 2.5% in the long run.
• A study of workers based on over 41,000
worker reports in 14 firms with some form of
employee ownership, profit and gain sharing,
and broad-based stock options finds that worker
co-monitoring helps overcome the incentives to
free ride because workers with a greater stake in
performance monitor each other more closely
and are more willing to intervene to reduce
shirking behavior than workers with less stake.
Workers in these firms perform better the greater
the depth of the incentive compensation system.
The systems increased employee attachment,
lowered turnover, prompted employee
suggestions for improvements, and worked best
with other “high performance” labor practices
and policies.
New Studies
Han and Ouimet (2011): Changes in wages and firm value following
ESOP adoptions are related to the ESOP size. When it is less than
5% of outstanding shares, both mean wages and firm values
increase. Since shareholders and employees are the two main
claimants of firm surplus, these changes suggest small ESOPs
increase productivity. But large ESOPs have neutral effects on
wages and shareholder value. Why the difference? Ownership
affects company culture in small but large ESOPs often are financial
gimmick not effort to improve group incentives and co-monitoring.
Hochberg and Lindsey (2010) Options granted broadly to nonexecutive employees exhibit higher subsequent operating
performance, with the implied incentive-performance relation
concentrated in firms with fewer employees and in firms with higher
growth opportunities.
Great Places to Work (Blasi, Kruse, Freeman, 2012)
1300 corporations applied in 2006-2008 for making the
Great Place to Work Institute 100 Best Companies list.
They filled out a management survey & had random
employees take anonymous surveys → 300,000 responses.
We merged with DOL 5500s and S&P Compustat.
1) Many of the 100 Best have some form of shared
capitalism: 17% have ESOPs, 10% are majority employee
owned, 16% give options to most employees.
2) More shared capitalism --> more high performance
work practices and higher Trust Index of workers.
3) As shared capitalism and the Trust Index go up
together, the market value of the firm rises relative to book
value of assets Tobin’s Q.
Elsewhere pay concentrates at top
USA TODAY, APRIL 1,
2011
Main reason? Top earners tap into capital income as
incentive pay seeks to resolve principal/agent issues.
The View that Huge Options to top executives are
critical for firm success assumes
1 – Key decisions in large organizations depend critically on
top person rather than whole organization or
2- That top person is irrelevant but the pay at the top
motivates other employees, and
3 – That the contracts give them “right” incentive rather
than opening ways to game the system, through chicanery or
financial manipulation.*
* US Supreme Court June 2010 decision on Enron said the law
the firms/public has an "intangible right of honest services” used
to prosecute Enron and some politicians is too vague opens door
for more legal gaming.
Do big incentives at top improve firm performance?
YES. CEO-appointed board bargains at arms-length with CEO
over contract to resolve principal-agent problem in efficient
market. Test? No need to test. Efficient market theory says it is so.
What if there is no correlation between incentive pay and future
share prices? Just what the theory predicts on the margin.
What if the relation is positive? Shareholders did not
appreciate the power of option incentives. Give more options.
What if the relation is negative? Negative! Why would they ever
do that?
NO. The incentives are rent-seeking. Executives extract $$ by
dominating boards through corporate governance procedures or by
gaming whatever option rules the board sets (Bebchuk &Fried;
Black, for bankers). Test?
What do we know about incentives and performance
StStudies (Hall & Liebman) show that when company does well
executives do well, especially in options.
Some studies find negative correlation between option $$ this
period and future share price. But current option is not incentive
for future. Could be firm is lucky in period one, options pay off,
and regresses to mean.
“Correct” analysis looks at derivative of value of option wrt share
price (Black-Scholes delta). Problems of backdated options,
manipulation of news, multiple option holdings. Our analysis
shows that corrected for backdating, multiple options, delta of
option package has 0 to modest negative effect on future
prices.
Interpretation: Options are way to skim random variation in share
prices/company performance for execs. Test is what happens
when options go under water.
Question: You are a top exec. Your options are
underwater. What does YOUR board do?
Nothing? On the notion that you failed the incentive and
they don't want to reward you for failing to meet
incentives. About 20%
Eighty-one percent take action to restore executive wealth:
Reprice the option? Common until FASB required
repriced options count as compensation expense, then
shift to “6 and 1” option to avoid new ruling.
Give you “unexpected bonus”
Give you “unexpected options”
(Balachandran, Carter, Lynch, 2004)
Question: You are still a top exec. Share prices fell
because Wall Street collapsed. What do you do?
3. What is Inequality-Output relation is an Inverse U
Lower inequality costs (raises) output if economy is to
the right (left) of I*
Outp
ut
I*
Fair
US current?
Inequality
The Maze-Solving Experiment
Groups of six.
Round 1 – everyone does piece rate; informed about
scores in group
Round 2 – high, medium, no inequality
Number of mazes per
person misreported at
given incentives
Reported output at
given incentives
19
18.5
18
17.5
17
16.5
16
15.5
15
14.5
equal pay
all incentives
top wins all
Source: Freeman and Gelber, 2010
4. Toward a Better World of Work
1) Distribution and efficiency are related: need inequality to
motivate people but too much is socially destructive by
generating rent-seeking instead of production.
2) Upper 1%, 0.1%, etc will not give up much of their
income/wealth without struggle,but they have/will overreach
as part of human nature.
3) Crony capitalism is endemic to market capitalism/human
nature, rather than being some developing country disease.
Cut our pay and power? Never!
4) The misalignment of working as team and dividing
rewards as lords and serfs is inefficient
5) Global problems (RD commons, global warming,
pandemics, etc) require group coordination
6) Efficient economies should triumph over inefficient
systems
So saith, the
Invisible Hand
But IH needs
help from
visible hands
Remember America's greatest thinker
Dr.Seuss: the Grinch Stole Christmas but
Horton and the Whos win in the end
Are you sure the whos can beat the
grinches in the real world?
Of course, I am sure. Economists know a lot.
Social science is never wrong. And I did some high-powered
computer simulations. And the computer is never wrong.
But, on the other hand, my simulations of the dynamic
general equalibrium of the interactions of grinches and
whos in Calibi-Yau space has an attractor of economic
feudalism.
If the physicists cannot solve multi-body problems and
string theory has millions of possible universes as
solutions, how could any social scientist be all that sure of
anything?
Hey, this looks like a chance to
make some money. Anyone
interested in credit default swaps
on the success of those whos?
And if you want to bet the other way, I got some
Madoff bonds that Goldman goes belly up.
Who goes down first? The US or the Euro?
Will the China bank system collapse under bad
loans? Will Italy ever get rid of Berlusconi? Will
Murdoch survive? I don't give a damn what
happens – the house always makes money.