Finance & Accounting Economics Policy Jul 5, 2011

Today’s Ris­ing One-percenters

The grow­ing gap between the very rich and everyone

Based on the research of

Steven Kaplan

Joshua Rauh

Few under­stand how the gap between the wealth­i­est 1 per­cent and the rest of the Unit­ed States’ pop­u­la­tion has grown so enor­mous in the last few decades. In fact, it has not been clear who these one-per­centers are. In the ear­ly 2000s, scruti­ny turned to the grow­ing salaries of top exec­u­tives at pub­licly-trad­ed com­pa­nies such as Home Depot and Ora­cle. But accord­ing to econ­o­mists Joshua Rauh, an asso­ciate pro­fes­sor of finance at the Kel­logg School of Man­age­ment, and Steven Kaplan, a pro­fes­sor at the Uni­ver­si­ty of Chica­go, it is worth tak­ing anoth­er look. After all, top exec­u­tives of Main Street” com­pa­nies com­prise only 5 per­cent of the top .01 per­cent wealth­i­est peo­ple in the Unit­ed States — a divi­sion whose mem­bers earned indi­vid­ual salaries of at least $7.2 mil­lion per year in 2004.

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Instead, Wall Street” employ­ees — includ­ing invest­ment bankers and man­agers of hedge funds, mutu­al funds, and pri­vate equi­ty funds — have become increas­ing­ly com­mon mem­bers of the rich­est class­es. Accord­ing to Rauh and Kaplan’s report on who con­tributes to the rise in the nation’s high­est incomes, the com­bined year­ly income of the top 25 hedge fund investors exceeds the com­bined income of the top five hun­dred exec­u­tives list­ed in the S&P 500 index. That sum was $6.3 bil­lion in 2004 and it has been ris­ing ever since. Rauh says, By 2007, the top five investors like­ly made more than the com­bined five hun­dred exec­u­tives at pub­licly-trad­ed com­pa­nies in the U.S.”

Thus, the intense focus on Main Street exec­u­tives has not been entire­ly jus­ti­fied. S&P 500 exec­u­tives — Main Street CEOs — have tak­en quite a beat­ing in terms of pub­lic per­cep­tion of their com­pen­sa­tion,” Rauh says, but when you look over time, their share of top incomes has been pret­ty con­stant, where­as groups on Wall Street have increased in a dra­mat­ic way.”

Track­ing Down Wealth 

Details on the salaries of Wall-Street high-rollers have always been dif­fi­cult to obtain. While pub­licly-trad­ed firms report exec­u­tive salaries to the Secu­ri­ties and Exchange Com­mis­sion, invest­ment banks report lit­tle infor­ma­tion on employ­ee compensation.

The authors used care­ful data analy­sis com­bined with sta­tis­ti­cal mod­els to esti­mate how much man­agers on Wall Street earn. They looked at com­pa­ny reports to find out how much a firm paid out in total com­pen­sa­tion as well as the num­ber of man­ag­ing direc­tors. Through inter­views, Rauh and Kaplan learned that man­ag­ing direc­tors at invest­ment firms typ­i­cal­ly make upward of $500,000 per year, and at least a quar­ter of man­agers earn over $2.5 mil­lion per year, one of many facts they used to cal­i­brate their esti­mates. They used sim­i­lar meth­ods of analy­sis for cal­cu­lat­ing the salaries of oth­er high-earn­ing pro­fes­sion­als, name­ly cor­po­rate lawyers, ath­letes, and celebri­ties. They esti­mat­ed cor­po­rate lawyer salaries by fig­ur­ing out the prof­it of the law firm and divid­ing that among part­ners and non-partners.

Col­lec­tive­ly, top CEOs, ath­letes, and cor­po­rate lawyers make far more mon­ey than they did a decade ago, beyond increas­es expect­ed from inflation.

Salary data for indi­vid­u­als out­side of the top five exec­u­tives of pub­lic com­pa­nies are not that easy to come by,” Rauh explains. We did a lot of mod­el­ing based on what we heard from com­pen­sa­tion con­sul­tants and by study­ing the dis­tri­b­u­tion of pay. The main thing we found at invest­ment banks and law firms was that there were increas­ing prof­its shared among a con­sis­tent­ly small num­ber of man­ag­ing direc­tors and part­ners, which means you have a num­ber of indi­vid­u­als mak­ing a lot of money.”

We were sur­prised by the results,” he adds. Of course we had a sense that peo­ple we knew on Wall Street were mak­ing a lot, but we had no idea that the top 25 hedge fund investors made more than the top five hun­dred CEOs in the S&500.”

How­ev­er, it is not as if CEOs at pub­licly-trad­ed com­pa­nies have moved into the poor house. About 3,500 top exec­u­tives at pub­licly-trad­ed com­pa­nies earn more than $1 mil­lion per year (as do near­ly 17,000 Wall Streeters).

Pulling Away

Col­lec­tive­ly, top CEOs, ath­letes, and cor­po­rate lawyers make far more mon­ey than they did a decade ago, beyond increas­es expect­ed from infla­tion. For exam­ple, the aver­age pro­fes­sion­al ath­lete earned $780,000 in 1995 com­pared to $1.85 mil­lion in 2004. While these high­ly-paid pro­fes­sion­als con­tin­ue to claim ter­ri­to­ry in the increas­ing­ly exclu­sive top .01 per­cent of America’s wealth­i­est, doc­tors, tri­al lawyers, and suc­cess­ful entre­pre­neurs appear to make up a small­er share of the top brack­ets. Where­as a per­son earn­ing $3.2 mil­lion was includ­ed in the top .01 per­cent in 1994, now that lev­el requires a salary of $7.2 mil­lion. And for the wealth­i­est .001 per­cent, the qual­i­fi­ca­tion for entry has grown from $13 mil­lion per year in 1994 to $31 mil­lion in 2004.

There are a num­ber of the­o­ries for how this rise in income came about in recent years,” Rauh says. Rather than focus on tax breaks, chang­ing salary lim­its, or work­er exploita­tion, Rauh and Kaplan sug­gest the growth has to do with a mix of improved tech­nol­o­gy com­bined with skill. The skills of tal­ent­ed ath­letes can be put to use in more prof­itable ways now,” Rauh explains. Alex Rodriguez’s skills as a base­ball play­er for the New York Yan­kees reach many more peo­ple than was ever pos­si­ble before, and he’s claim­ing a share of the prof­its of that.”

Rauh says the prin­ci­ple holds on Wall Street. Improved tech­nol­o­gy has allowed larg­er amounts of mon­ey to be man­aged by a team of indi­vid­u­als of a giv­en size and skill,” he says. While the num­ber of pro­fes­sion­als doing trans­ac­tions and man­ag­ing mon­ey has increased, the amounts of mon­ey being trans­act­ed and man­aged have grown far more.” This the­o­ry that tech­nol­o­gy allows skills to be applied to ever-larg­er pools of cap­i­tal and oth­er resources can explain why the top indi­vid­u­als in var­i­ous groups — lawyers, ath­letes, and invest­ment bankers — have all increased their income despite the dif­fer­ences in the way each con­ducts business.

If you’re ask­ing what con­tributes to the rise in the high­est income, it’s that indi­vid­u­als who are real­ly good at mak­ing mon­ey can now apply their skills to larg­er amounts of cap­i­tal,” Rauh says. That’s favored some groups more than oth­ers, and very clear­ly, it’s favored Wall Street most.”

Relat­ed read­ing on Kel­logg Insight

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Featured Faculty

Joshua Rauh

Member of the Department of Finance faculty between 2009 and 2012

<p>Joshua Rauh was a member of the <a href="" target=_blank>Department of Finance</a> faculty between 2009 and 2012.</p>

About the Research

Kaplan, Steve and Joshua Rauh. 2010. “Wall Street and Main Street: What Contributes to the Rise in the Highest Income.” Review of Financial Studies. 23(3): 1004-1050.

Read the original

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