The Agenda

On the Composition of the Top 0.1%

As Matt Yglesias observes, the composition of the top 0.1% has changed in recent decades:

Finance professionals have increased from 11% to 18% and salaried, non-financial executives at widely held firms have declined from 32% to 14%.

And the relative share of executives and managers at closely held firms has increased relative to the share of executives and managers at publicly-owned firms. This has been going on for decades. [Note: I didn’t make this clear before — my apologies to readers!]

Given the explosion in the private equity sector, it seems as though these phenomena might be related. That is, part of the story could be that finance professionals are seeding a parallel economy of lightly-regulated closely held firms, and capturing the gains from the successes of said firms.

There has been a lot of debate around how the Sarbanes-Oxley Act of 2002 has changed the corporate landscape, and I don’t get the impression that we have any conclusive answers. (And again, note that much of the growth in compensation for executives and managers in closely held firms happened long before 2002.) A 2008 Kauffman-RAND study found the following [PDF]:

This article investigates whether the passage and the implementation of the Sarbanes-Oxley Act of 2002 (SOX) drove firms out of the public capital market. To control for other factors affecting exit decisions, we examine the post-SOX change in the propensity of public American targets to be bought by private acquirers rather than public ones with the corresponding change for foreign targets, which were outside the purview of SOX. Our findings are consistent with the hypothesis that SOX induced small firms to exit the public capital market during the year following its enactment. In contrast, SOX appears to have had little effect on the going-private propensities of larger firms. [Emphasis added.] 

In 2006, Hannah Clark reported on the narrowing gap between publicly held and privately held firms in Forbes.com:

The differences between private and public company CEOs have by no means disappeared. Privately held firms can hold on to the best parts of Sarbanes-Oxley while avoiding much of the paperwork and expense. While private, they can also avoid disclosing executive pay information. “Private equity people make a lot more money,” says Dennis Block, a partner in the mergers and acquisitions practice at law firm Cadwalader, Wickersham & Taft. “They’re not out there reading about it in The Wall Street Journal or Forbes.”

Private equity CEOs can take bigger risks without worrying about the short-term earnings hit, says Justin B. Wender, president of private equity firm Castle Harlan. They can also keep competitors from learning about their margins and market share. But the pressure rises to generate strong cash flow. Private equity firms generally take out large amounts of debt in order to finance a buyout, and managers must relentlessly service that debt. If they succeed, a major payout awaits, but if they fail, it could mean disaster. [Emphasis added.]

It is hardly surprising that private and public firms demand different sets of skills:

In the world of private equity, CEOs must be entrepreneurial, hard driving, decisive and confident, says Nick Young, who leads the private equity search practice at headhunting firm Spencer Stuart. In fact, he says, finding a good private equity CEO is “almost like finding a needle in a haystack.”

By contrast, public company CEOs need strong people skills, to communicate with shareholders, analysts, activists and other interest groups. “They’re almost two different gene pools,” Young says.

As Steven Kaplan of the Booth School of Business has observed, compensation of CEOs at S&P 500 firms peaked in 2000-2001. 

One gets the impression that new types of corporate organization, and a new kind of corporate leadership, has emerged as an entirely unintended consequence of a regulatory overhaul, and that this in turn has led to soaring compensation for the most effective executives and managers at closely held firms. Another way of looking at this is as a subset of the broader shift from a big-unit to a small-unit economy. As firms outsource all but their core functions, there might be a growing need for nimbler firms. And there is definitely a sense in which privately-held firms can maneuver more freely and aggressively than publicly-held firms. 

This story is less appealing to some than a story focused on politics. But it does seem as though industrial organization is playing a significant role. I’d be eager to hear thoughts from readers, particularly those working in private equity.

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