Manager Salary: Size Matters, and So Exclusive

Since the 1980s, the salaries of superstar employees have risen sharply, which is closely linked to the performance of their hiring superstar companies. This column examines the contribution of monopoly power to a manager’s salary. As the size of firms increases, so does the manager’s contribution to a firm’s value, and firms are willing to bid higher to the best manager for smuggling. Top managers are unequally hired by companies with market power in their sector and they are rewarded for doing so because good managers help raise rents from market power.

Inequality has increased significantly, mostly in the top 1% of distributions (e.g. Piketty and Saez 2003) consisting of many superstars. The salaries of superstar workers have risen sharply since the 1980s. Whether they are professional athletes in football, basketball or baseball, computer coders at Bigtech firms, or top managers of corporations – they have all experienced pay rises. Figure 1 of Frydman and Saks (2010) shows the evolution of CEO pay since 1936, with a significant increase in the 1980s.

Figure 1 Average manager salary and markup

The salaries of superstar employees are closely linked to the performance of their hiring superstar companies. The question is, what makes these superstar companies so successful and why have top-performing corporations become more successful over time? A key insight from the literature on executive compensation is that size is important (Gabaix and Landier 2008 and Terviö 2008). Over time, top corporations have grown as new technologies allow them to produce higher volumes more efficiently due to their scale economy. The emergence of the digital age, with its central role in outsourcing and globalization, is strongly driving this growth.1

But in the digital economy this scale economy has at the same time increased the exclusive power. Large manufacturing companies also tend to be concentrated and, more often than not, influential companies in the world market. For example, digital platforms for retail (Amazon), trading (eBay), and social interaction (Facebook) have built-in network externalities that depend on the price of the product and service. Technology not only makes companies bigger but also allows them to make exclusive profits. And it affects manager pay. Figure 1 also shows the evolution of average markup, which shows an increase since 1980 that coincides with managerial pay increases.

The CEO’s job is like a dam in the labor market Ackerlef’s (1981) model. Only a dam can block such a lake, only one person can perform the top job. These situations create the functionality of who is chosen to be particularly sensitive. The bigger the potential lake, the bigger the dam you want to build. In the market for managers, the power of the binding manager. How well a manager performs depends not only on their abilities but also on the size of the firm. Gabaix and Landier (2008) and Terviö (2008) point out that as the size distribution of firms changes, so does the manager’s compensation, even if the manager’s powers do not change. As the size of firms increases, so does the manager’s contribution to a firm’s value, and firms are willing to bid higher to the best manager for smuggling. Strong size increase so behind manager salary increase.

However, companies also exercise monopoly power. And better managers are better at running the firm to hire customers. In our recent research paper (Bao et al. 2022), we identify a mechanism that allows us to digest the contribution of monopoly power to our manager’s salary. Good managers make a firm more productive and in a market with less competition, more productive companies make higher profits by creating more market power. The effect of strategic pricing from unfinished competition increases all profits, but it does more for the most productive firms starting before the director contributes. The result is that the most marketable companies will bid the most to get the best director. The best managers increase profits for high-market-power firms more than low-market-power firms.

Our results are summarized in Figure 2. As seen in Panel A, an average of 46% of manager’s salary is due to market power; The rest comes from the manager’s contribution to the firm’s growth. And this share is growing over time, from 38% in 1994 to 49% in 2019. The most notable, however, is the power of managers, varying in the contribution of market power across Panel B. For top managers, market power is 80%. Their salary in 2019!

Figure 2 Over time managers ’salaries (A) and (B) contribute to market strength and strong size for various skilled managers in 2019

Interestingly, firms hire less top managers because they are productive and therefore active in the larger sector and more because they are the top companies in the sector. For example, compare a sector of large firms like retail with a small firm sector like Biotech. Top retail firms and top biotech firms compete for top managers, while top and bottom large retail companies compete for top managers. It helps to explain the quantitatively important role that market forces play in creating profits and how the best managers contribute to the profits of the top companies in their market. Tim Cook is the superstar manager and Apple paid him around $ 100 million because he did not work for a large manufacturing company but allowed his firm to dominate the market and hire Tim Cook to dominate the firm. In fact, with 150,000 employees, Apple is much smaller than Walmart and Amazon in retail, Volkswagen and Toyota in car manufacturing and FedEx and UPS in delivery services.

Overall, top managers are disproportionately hired by market-driven companies, and they are rewarded for it – increasingly so. The main reason is that good managers help raise rents from market power. Or as Warren Buffett put it in 2007:

I don’t want a business that’s easy for competitors. I want business with trenches around it. … The managers of the business we run, I got a message for them, to widen the trenches.

References

Akerlof, G (1981), “Jobs as Dam Site”, Review of Economic Studies 48 (1): 37-49.

Amore, M, and S Schwenen (2020), “The Value of Fortune in the Labor Market for CEOs”, VoxEU.org, 9 August.

Bao, R, J De Loecker and J Eeckhout (2022), “Are managers paid for market power?”, CEPR Diction Paper 17182.

Bell, B., and J. Van Rinen (2016), “Increasing CEO Salary and Relative Performance Agreements: The Role of Governance”, VoxEU.org, 5 August.

Chaigneau, P, A Edmans and D Gottlieb (2021), “How CEOs should design pay packages”, VoxEU.org, 4 May.

Friedman, C., and R. Sax (2010), “Executive Compensation: A New Perspective from a Long-Term Perspective, 1936-2005”, Review of Financial Studies 23: 2099–138.

Gabaix, X, and A Landier (2008), “Why is the CEO’s salary so high?”, Quarterly Journal of Economics 123: 49-100.

Terviö, M (2008): “The Difference That CEOs Make: An Assignment Model Method”, American Economic Review 96 (3): 742–7.

Endnote

1 Other determinants include fate; See, for example, Bertrand and Mullainathan (2001), Bell and Van Reenen (2016), and Amore and Schwenen (2020). And the CEO has a great deal of literature studying the design of salary packages; See, for example, Chaigneau et al. (2021).

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