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Sweated Labour
Photograph by Hulton Archive/Getty Images

Income inequality: Blame your mediocre company

May 27, 2015

The reason you make less than your brother-in-law isn't because he's a CEO and you're only an executive VP. It's because he works for a great company, and your company is just okay.

That's one conclusion you can draw from a new research study, titled "Firming up Inequality," published this week by the National Bureau of Economic Research.

The authors of the study—two professors from Stanford, one from the University of Minnesota, and an economist at the Social Security Administration—describe it more dryly. They say income inequality is rising because of a growing disparity between what different companies pay their workers, not a difference in what individual companies pay. It's a problem of inter-company, not intra-company pay. Put another way, income inequality is not rising because the average worker at a company makes a lot less than her boss but instead because the gap between what bosses, and workers, at different firms are making is rising. And the authors of the study say the trend holds across industries, areas of the country, and firm size.

That, of course, runs counter to all the energy income inequality advocates exert talking about CEO pay. In fact, the authors of the study, who looked at wage data covering all U.S. companies from 1978 to 2012, found that the wage gap between the average worker at individual companies and the highest ranking executives (CEOs and other C-suiters) at those firms had only grown by a "small amount" in the past three-and-a-half decades. The Securities and Exchange Commission's effort, mandated by Dodd-Frank, to get companies to publish their ratio of CEO-to-average-worker pay may not have much of an impact on income inequality.

The logic of the NBER study is in keeping with how other economists have explained the rise in income inequality in the past. Cornell professor and economist Robert Frank, who wrote a book in the 1990s titled The Winner-Take-All Society: Why the Few at the Top Get So Much More Than the Rest of Us, made popular the belief that a big portion of the increase in the income gap has to do with the way a global market values its best performers, be they CEOs or athletes or actual performers. In a global market, superstars have a bigger reach, and will suck up more of the pay.

It looks like the winner-take-all explanation can be applied to firms as well. Last year, the 20 most profitable companies in the country accounted for nearly 37% of the total profits of the entire Fortune 500. That's up from 30% two decades ago. Apple is not just a player in the smartphone business, it's the dominant player. So it's not just that employees in the phone divisions of Samsung or Blackberry or Motorola get paid less. They get paid a lot less, especially in the case of Motorola, where they are likely out of a job. And that's true in all of the markets Apple competes in. The fact that many employees get stock compensation only accentuates the difference in pay between firms.

Another reason for the growing firm-to-firm pay gap, according to the authors of the study, could be that in the modern economy companies have become so specialized and lean that some attract high-skilled workers and others mostly lower skilled ones. But that doesn't explain why the pay gap between rivals in the same industries is growing.

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