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I stumbled across the economics working paper Why Has CEO Pay Increase So Much? in late February:

This paper develops a simple equilibrium model of CEO pay. CEOs have different talents and are matched to firms in a competitive assignment model. In market equilibrium, a CEO’s pay changes one for one with aggregate firm size, while changing much less with the size of his own firm. The model determines the level of CEO pay across firms and over time, offering a benchmark for calibratable corporate finance. The sixfold increase of CEO pay between 1980 and 2003 can be fully attributed to the six-fold increase in market capitalization of large US companies during that period. We find a very small dispersion in CEO talent, which nonetheless justifies large pay differences. The data broadly support the model. The size of large firms explains many of the patterns in CEO pay, across firms, over time, and between countries.

The paper presents a ‘simple’ equilibrium model for CEO pay based on firm size. It’s certainly simple in theory, but I confess to stumbling a trifle when it came to the math.

I chose the paper to present to my 200-level Microeconomics Theory class, which I will do this coming Monday (10/22/2007).

If you have time, I recommend reading at least the introduction. If you don’t, allow me to summarize, in brief:

The paper uses the simplifying assumption that the market for CEOs is competitive; namely, that (1) CEOs have talent and companies can measure that talent (or, at the very least think they can estimate it pretty well), (2) CEOs impact firm value in some measurable way, (3) there are no industry-specific CEOs (e.g. the Harvard/McKinsey assumption), and (4) the market for CEOs is frictionless.

They demonstrate that most of the increase in CEO pay can be attributed to the increase in firm size – at least in the USA. This makes sense from a conceptual standpoint: assume that the impact a CEO has on a company is a percentage. The absolute value of a CEO’s contributions will depend directly on the size of the company; a larger company will receive a greater direct effect. If a company gives a percentage of the absolute gains in corporate value to the CEO as compensation, a CEO’s compensation will increase as firm size increases.

The truly interesting claim they make – based on empirical data – is that CEO compensation exhibits constant returns to scale in regard to firm size. There may be fluctuation in the short term, but over the long term CEO compensation will directly correlate with company size.

The paper doesn’t address – or try to – the entire increase in CEO pay. They also acknowledge that they are unable to make any concrete assumptions about international markets, mainly because the data is limited. Even assuming that everything in the paper is true, we still can’t know whether or not this is a US-specific phenomenon. This did not, for example, occur in Japan.

I like the paper, because it’s a good example of economics explaining a phenomenon without making moral judgments about how the world ‘ought’ to be. And, of course, if the paper is torn apart in peer review and later literature it’ll merely confirm the reputation of economists.

Tim Haab shows how absurd the claim that “investing in renewable energy will create jobs.”

That’s true. But somewhat absurd:

Where do new jobs come from?

If investment dollars are transfered from oil and gas to ethanol, then jobs will follow.  It’s the same as trying to tell the difference between economic impacts and economic welfare.  When a hurricane rips through the U.S. gulf coast, new jobs are created.  Should we tout the benefits of hurricanes as a policy option to battle unemployment? 

‘Conservation’ applies to a number of things. “Conservation of Energy” rings a bell; I also like “Conservation of Work.” In this case, I think “Conservation of Jobs” applies. Jobs are not “destroyed” and “created” so much as they are moved, from one industry to another, and from one location to another. It’s by all means possible to argue that outsourcing ‘permanently’ removes jobs from the economy, but other nations outsource to the US at the same time. The net result is negligible. Unemployment occurs, to a large extent, because these things – location and industry (skill set) – are “sticky.” They take time to change.

Certainly, investing heavily in renewable energy will create jobs. But will it create more jobs than the current energy industry? Will workers currently employed in the industry be able to transition over, or will they have to find other employment?

I am not certain how America, as a nation, can ignore the Iraq when things like this occur:

Iraq bomb in toy cart hits children in playground

BAGHDAD (Reuters) – A bomb hidden in a cart of toys killed two children and wounded 17 others in a playground in northern Iraq on Friday, the first day of a national holiday to celebrate the end of the Muslim holy month of Ramadan.

The attack came the day after U.S. forces killed nine children and six women in an air strike northwest of Baghdad targeting suspected al Qaeda leaders. The U.N. mission in Iraq urged U.S. forces to conduct a “vigorous” probe into the strike

I have read numerous arguments about why America should leave Iraq. They all very eloquently point to the evidence that America is failing to ‘win’ against the Insurgency, or how Americans are needlessly dying, and so on. Democrats oppose the war because Bush initiated it – and the reasons we went to war were terrible – while Republicans are hardly eager to extend the war a decade.

Unfortunately, I haven’t much examining the moral consequences of American’s actions in Iraq, and the ‘War on Terrorism’ in general. I would not want to live in a place where my child could be killed or seriously injured by an indiscriminate bomb in a school. And how, precisely, do we rationalize an estimated one million Iraqis dying post-US invasion? Can we realistically argue that Iraqis are better off without Saddam if this is the result? How do we justify torture, and imprisonment without charges, trial, or recourse to the legal system?

When did the threat of terrorism acquire the power to silence all moral, ethical, legal, and political criticism? And why is our response to the threat war, torture, assassination, and spying?

And: what do we do now? If we leave Iraq, what will happen? We cannot simply dismiss the issue as “not our problem:” it became our problem when we invaded, dismantled the Iraqi government, and killed 3% of their population. We bear responsibility for their situation, and so we bear responsibility for what becomes of it. Leaving may very well allow Iraq to settle down, but it’s not the key question.

I believe the best question is ask is: how do we ensure Iraq’s success, as a nation, in the years to come? How do we restore the damage we’ve inflicted on their infrastructure and their people, and help them become a modern, healthy country?

We don’t exist in a vacuum, and it’s a mistake to think that the rest of the world doesn’t matter.