A recent report by the London School of Economics (LSE) on executive pay has cast light on a rather forgotten corner of labour market theory – that of economic rent and transfer earnings. The wages of most workers can be divided into two different parts. The first part is the transfer earnings, or money which must be paid to the worker in order to persuade them to do the job. This can be thought of as the bare minimum the worker will accept. This may well be affected by such factors as the next best employment option open to them and the wages it might bring. The rest of their salary is known to economists as economic rent, or the extra they receive above their transfer earnings. This can be seen as the earnings equivalent of supernormal profits to a firm. It is extra payment which the worker does not really need in order to persuade them to do the job, but which they receive in any case.
The recent LSE report, prepared after extensive interviews with the headhunters who recruit CEOs, came to some interesting conclusions. The first is that the average annual salary for a FTSE 100 CEO is now £4.6m per year. It is often suggested that the for most of those individuals the vast majority of this money represents transfer earnings rather than economic rent. Why? Those of us who earn considerably less, which is statistically most of us, are told that there are very few who can actually do such jobs and that there is a global market for this limited supply of very talented individuals. If large UK firms do not pay these high salaries then these workers will go elsewhere, particularly the US. In other words, the opportunity cost for them in accepting a job with a UK firm is very high because of the other options open to them. Therefore, even if their salaries are in the eye-watering region of £4.6m, they are receiving little in the way of economic rent.
However, they LSE reveals that headhunters think differently. Firstly, they describe most FTSE 100 CEOs as “mediocre” and they comment that 100 people could have filled the job just as ably as those who actually are chosen. This suggests that these workers are not as limited in supply as they themselves would have us believe, and therefore that the opportunity cost for them of accepting a CEO post might not be as high as the picture they have painted because they would find it difficult to earn such a salary elsewhere. If much of their salary is, in fact, economic rent then labour market theory suggests it can quite safely be taken in the form of tax without altering their behaviour in the slightest and without affecting economic efficiency It is possible that Thomas Piketty could make some useful suggestions in that direction………..
Links to newspaper articles on the LSE reports can be found below: