Why do celebrities get a pass on their pay compared to CEOs?

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Why do celebrities get a pass on their membership of the top 1%?

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% Australian top incomes from wages, salaries and pensions since 1954

Australia has had a working rich for a long time now. Australian top income earners are top wage earners. They are athletes, celebrities, business executives and in the professions.

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Source: The World Wealth and Income Database.

% US top incomes from wages, salaries and pensions, 1913 – 2015,

The rich in the USA long ago became a working rich; most top incomes are from wages and salaries.

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Source: The World Wealth and Income Database.

Creative destruction in top ICT company pay

I am surprised to see that Yahoo is in business much less competing for top talent. Microsoft is in decline too. Apple does not pay people as much as everybody else.

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Source: Paysa Company Rank | Paysa.

Some other colours seem to duplicate so you will have to work out which is which by when they exploded in hiring top talent.

@Economicpolicy shows that top CEO pay has been a miserable rollercoaster for 15 years

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Are CEOs denied their labour surplus?

Bang Dang Nguyen and Kasper Meisner Nielsen looked at how share prices reacted to 149 cases of the chief executive or another prominent manager dying suddenly in American companies between 1991 and 2008.

If the shares rise on an executive’s death, he was overpaid; if they fall, he was not. Only 42% of the bosses studied were overpaid. Those with the bigger pay packages gave the best value for money as measured by the share-price slump when they passed away unexpectedly.

Share prices do speak to the value of the company and the contribution of its CEO. The share price of Apple went up and down by billions on the back of rumours about the health of Steve Jobs.

In terms of splitting of what some call the labour surplus increase from a firm hiring an executive, these employees retain on average about 71% and their employer keeps 29%. Others call this rent sharing.

71% going to the CEO might initially sound high, “but it’s not like he’s taking home more than he produced for the company,” says Nguyen.

The exploitation of CEOs gets worse when you consider the extensive use of promotion tournaments by their employers when setting their wages. They are thrust into rat races. Promotion tournaments are an integral and often invisible part of their workplaces.

Executive level employees are often ranked by their employers relative to each other and promoted not for being good at their jobs but for being better than their rivals. These promotion tournaments sent one employee against another – one worker against another – to the  profit of the owners of the firm.

The rat race set up by the owners of the firm are so cutthroat that in competitions to determine promotions the capitalists who own the firm may find that their employees discover that the most efficient way of winning a promotion is by sabotaging the efforts of their rivals.

Lazear and Rozen’s tournament theory of executive pay has stood the test of time. The key to this rat race is the larger is your boss’s pay, the bigger the motivation for you as an underling to work for a promotion. As Lazear wrote in his book, Personnel Economics for Managers

The salary of the vice president acts not so much as motivation for the vice president as it does as motivation for the assistant vice presidents.

Why hasn’t the Occupy Wall Street movement protested against this?

The occupations of the top 1% and the top 0.1%

"You didn’t build that" – which of sport superstars, celebrities and top CEOs earn their pay more?

Defenders have also pointed to the pay of pro ballplayers or Hollywood stars, but they do not determine their own pay (as CEOs do) and are paid based on performance. Once they begin to fail, they are dumped. By contrast, CEO pay isn’t tied to performance in any meaningful way.

Bruce Murphy – The Incredible Rise of CEO Pay

It’s a big concession to say that athletes and celebrities earn their pay but top CEOs don’t. Most of all, that concession changes the case against the top 1% from inequality to just desert – a big shift in theories of distributive justice. It’s also a big risk to base the argument for greater equality and a 80% top tax rate not only on the excesses of CEOs but on the very specific and testable hypothesis that these CEOs determine their own pay.

if we are to look at CEOs, top athletes and Hollywood celebrities, it is the athletes and celebrities who benefited the most from the windfall of been able to service huge markets through the global media market.

Figure 1: CEO pay and share market performance

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Source:  Economic Policy Institute.

CEOs actually have to run large complex companies to earn their pay, which is why their compensation tracks the share market relatively closely. Athletes and celebrities don’t do that what they do any better than in the past. They simply do it in front of a global media market. Since the late 1970s, the ratio of average pay of CEOs of large public companies to the average market value of those companies has stayed relatively constant: CEO pay grew hand in hand with corporations.

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Steven Kaplan and Joshua Rauh make a number of basic points backed up by detailed evidence about CEO pay:

  • While top CEO pay has increased, so has the pay of private company executives and hedge fund and private equity investors;
  • ICT advances increase the pay of many – of professional athletes (technology increases their marginal product by allowing them to reach more consumers), Wall Street investors (technology allows them to acquire information and trade large amounts more easily), CEOs and technology entrepreneurs in the Forbes 400; and
  • Technology allows top executives and financiers to manage larger organizations and asset pools  – a loosening of social norms and a lack of independent control of CEO pacesetting does not explain similar increases in pay for private companies–  technology explains it;

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To put it simply:

If the reason for growth of incomes at the very top is, say, managerial power in publicly owned companies, then one would expect the increases in income at the top levels to be much larger for that group.

But the breadth of the occupations that have seen a rise in top income levels is much more consistent with the argument that the increase in “superstar” pay (or pay at the top) has been driven by the growth of information and communications technology, and the ways this technology allows individuals with particular skills that are in high demand to expand the scale of their performance.

As for the turnover argument, that underperforming athletes and celebrities are dropped, prior to the GFC, CEO turnover was already on the rise:

Turnover is 14.9% from 1992 to 2005, implying an average tenure as CEO of less than seven years. In the more recent period since 1998, total CEO turnover increases to 16.5%, implying an average tenure of just over six years.

Internal turnover is significantly related to three components of firm performance – performance relative to industry, industry performance relative to the overall market, and the performance of the overall stock market.

Only 21.3% of CEOs in 1992 remained in that role in 1999; only 16.35% of CEOS on the job in 2000 were there in 2007. In any given year, one out of six Fortune 500 CEOs loses their jobs, compared to one out of 10 in the 1970s.

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Dirk Jenter and Fadi Kanaan in a study of of 3,365 CEO turnovers from 1993 to 2009 found that:

CEOs are significantly more likely to be dismissed from their jobs after bad industry and, to a lesser extent, after bad market performance. A decline in industry performance from the 90th to the 10thpercentile doubles the probability of a forced CEO turnover.

In another study, Kaplan found that average CEO pay increased substantially during the 1990s, but declined by more than 30% from peak levels reached around 2000.

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In addition, private company executives have seen their pay increase by at least as much as public companies. Private company executives with fewer agency problems have increased by more than public company executives. To close with another quote from Kaplan:

The point of these comparisons is to confirm that while public company CEOs earn a great deal, they are not unique. Other groups with similar backgrounds–private company executives, corporate lawyers, hedge fund investors, private equity investors and others—have seen significant pay increases where there is a competitive market for talent and managerial power problems are absent.

Again, if one uses evidence of higher CEO pay as evidence of managerial power or capture, one must also explain why these professional groups have had a similar or even higher growth in pay. It seems more likely that a meaningful portion of the increase in CEO pay has been driven by market forces as well.

The impact of top tax rates on the migration of superstars

Emmanuel Saez is leading a literature showing how sensitive migration decisions of superstars are to top marginal tax rates. Specifically, he and his co-authors studied Spain’s Beckham’s law.

Cristiano Ronaldo moved from Manchester United to Real Madrid in 2009 partly to avoid the announced 50% top marginal income tax in the UK to benefit from “Beckham Law” in Spain. Beckham’s Law was a preferential tax scheme of 24% on foreign residents in Spain. When David Beckham transferred to Real Madrid, the manager of Arsenal football club commented that the supremacy of British soccer was at risk unless the U.K.’s top marginal tax rate changed.

A number of EU member states offer substantially lower tax rates to immigrant football players, including Denmark (1991), Belgium (2002) and Spain (2004). Beckham’s law had a big impact in Spain:

…when Spain introduced the Beckham Law in 2004, the fraction of foreigners in the Spanish league immediately and sharply started to diverge from the fraction of foreigners in the comparable Italian league.

Moreover, exploiting the specific eligibility rules in the Beckham Law, we show that the extra influx of foreigners in Spain is driven entirely by players eligible for the scheme with no effect on ineligible players.

Suez also found evidence from tax reforms in all 14 countries that the location decisions of players are very responsive to tax rates. Suez in another paper with Thomas Piketty wants the top tax rate to be 80%. However, their work on taxation and the labour supply supports a much lower rate:

First, higher top tax rates may discourage work effort and business creation among the most talented – the so-called supply-side effect. In this scenario, lower top tax rates would lead to more economic activity by the rich and hence more economic growth. If all the correlation of top income shares and top tax rates documented on Figure 1 were due to such supply-side effects, the revenue-maximising top tax rate would be 57%.

Suez and Piketty then go on to argue that the pay of chief executives of public companies, a subset of the top 1% and top 0.1%, may not reflect their productivity but that is a much more complicated argument about agency costs and the separation of ownership and control which they make rather weakly.

Much of their other work on top incomes is about the emergence of a working rich whose top incomes are wages earned by holding superstar jobs in a global economy. It would be peculiar and perhaps overzealous to organise the entire taxation of high incomes around the correction of agency costs arising from the separation of ownership and control of some of the companies listed on the stock exchange.

Figure 1: Percentage of national income (including capital gains) received by top 1%, and each primary taxpayer occupation in top 1%, USA

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Source: Jon Bakija, Adam Cole and Bradley T. Heim “Jobs and Income Growth of Top Earners and the Causes of Changing Income Inequality:  Evidence from U.S. Tax Return Data”.

There is a long history showing how the labour supply of sports stars is highly sensitive to top marginal income tax rates. For a very long time, boxing was the only really big-money sport for athletes:

The 1950s was the era of the 90 percent top marginal tax rate, and by the end of that decade live gate receipts for top championship fights were supplemented by the proceeds from closed circuit telecasts to movie theatres.

A second fight in one tax year would yield very little additional income, hardly worth the risk of losing the title. And so, the three fights between Floyd Patterson and Ingemar Johansson stretched over three years (1959-1961); the two between Patterson and Sonny Liston over two years (1962-1963), as was also true for the two bouts between Liston and Cassius Clay (Muhammad Ali) (1964-1965).

Then, the Tax Reform Act of 1964 cut the top marginal tax rate to 70 percent effective in 1965. The result: two heavyweight title fights in 1965, and five in 1966. You can look it up.

Ufuk Akcigit, Salome Baslandze, and Stefanie Stantcheva found that the migration of superstar inventors is highly responsive to top marginal tax rates.

Ufuk Akcigit, Salome Baslandze, and Stefanie Stantcheva studied the international migration responses of superstar inventors to top income tax rates for the period 1977-2003 using data from the European and US Patent offices.

our results suggest that, given a ten percentage point decrease in top tax rates, the average country would be able to retain 1% more domestic superstar inventors and attract 38% more foreign superstar inventors.

Emmanuel Saez and co-authors also found that a preferential top tax scheme for high earning migrants in their first three years in Denmark was highly successful in attracting highly skilled labour to that country:

…the number of foreigners in Denmark paid above the eligibility threshold (that is the group affected by the tax scheme) doubles relative to the number of foreigners paid slightly below the threshold (those are comparison groups not affected by the tax scheme) after the scheme is introduced.

This effect builds up in the first five years of the scheme and remains stable afterwards. As a result, the fraction of foreigners in the top 0.5% of the earnings distribution is 7.5% in recent years compared to a 4% counterfactual absent the scheme.

This very large behavioural response implies that the resulting revenue-maximising tax rate for a scheme targeting highly paid foreigners is relatively small (about 35%). This corresponds roughly to the current tax rate on foreigners in Denmark under the scheme once we account for other relevant taxes (VAT and excises).

This blog post was motivated by a courageous tweet about Tony Atkinson saying that increases in the top tax rate have little effect on the supply of labour! Not so.

The Value of Steve Jobs

Organizations and Markets

| Peter Klein |

As you have likely heard, Steve Jobs is taking an indeterminate leave of absence from Apple to deal with his continuing health problems. How will this affect Apple? How important is one person — albeit the founder and CEO — to a diversified multinational company with tens of thousands of employees? Apple’s stock slipped slightly on the news of Jobs’ leave (down 2.3 percent today, the first trading day after the announcement), but Jobs’s health problems are well known and Apple’s stock price presumably already included a discount reflecting the possibility he’d step down. To estimate the value of a particular employee to the firm in this way, we need an unanticipated departure, one that isn’t a response to poor performance and isn’t expected in advance.

Sure, enough, there’s an app for that — I mean, there’s a literature on that. An influential 1985 paper by Bruce Johnson, Robert Magee, Nandu…

View original post 429 more words

Who among the top 1% and top 0.1% increased their share of income most between 1979 and 2005?

The members of the top 1% whose income increased the most between 1979 and 2005 were real estate professionals followed by financial professionals – see figure 1.

Figure 1: increase in share of national income (including capital gains) received by top 1% for each primary taxpayer occupation in top 1% between 1979 and 2005

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Source: Jon Bakija, Adam Cole and Bradley T. Heim “Jobs and Income Growth of Top Earners and the Causes of Changing Income Inequality:  Evidence from U.S. Tax Return Data”.

Figure 2 shows that the fastest-growing shares among the top 1% as in figure 1 are not necessarily the largest occupational group are those income earners. Moreover, their fortunes seem largely unrelated to each other.

Figure 2: Percentage of national income (including capital gains) received by top 1%, and each primary taxpayer occupation in top 1%
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Source: Jon Bakija, Adam Cole and Bradley T. Heim “Jobs and Income Growth of Top Earners and the Causes of Changing Income Inequality:  Evidence from U.S. Tax Return Data”.

The next members of the top 1% in terms of income growth were rather respectable group:professionals and scientists and arts, media and sports. The latter,arts, media and sports get a complete pass on their membership of the top 1% despite their great success in increasing their incomes since 1979 at the expense apparently on the bottom 99% if the Twitter Left is to be believed.

Figure 3: increase in share of national income (including capital gains) received by top 0.1% for each primary taxpayer occupation in top 0.1%between 1979 and 2005

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Source: Jon Bakija, Adam Cole and Bradley T. Heim “Jobs and Income Growth of Top Earners and the Causes of Changing Income Inequality:  Evidence from U.S. Tax Return Data”.

Arts, media and sports superstars are one of the fastest-growing members of the top 0.1% – see figure 3. Again, the arts, media and sports superstars get a complete pass on their membership of the top 0.1% from the Twitter Left. Most of the other occupations in the top 0.1% don’t strike me as anything other than working rich – see figure 3 and figure 4.

As with the top 1%, the top 0.1% of income earners are a mixed bag of occupations – see figure 4. Their fortunes are unrelated to each other terms of the forces driving there are increased incomes.

Figure 4: Percentage of national income (including capital gains) received by top 0.1%, and each primary taxpayer occupation in top 0.1%
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Source: Jon Bakija, Adam Cole and Bradley T. Heim “Jobs and Income Growth of Top Earners and the Causes of Changing Income Inequality:  Evidence from U.S. Tax Return Data”.

How much of the top 0.1% are now working rich in the USA, 1916–2013, and Canada, 1946–2007

Piketty and Saez (2003) concluded that a substantial fraction of the rise in top incomes was due to surging top wage incomes. They concluded that top executives (the ‘working rich’) replaced top capital owners (the ‘rentiers’) at the top of the income hierarchy.

That conclusion still holds for both the USA and Canada. The largest portion of the top 0.1% in both countries have become those earning wages. The top 0.1% are top wage earners who work for their livings founding, building or directing businesses.

Figure 1: percentage of top 0.1% with wages, salaries, pensions or entrepreneurial incomes, USA, 1916 – 2013

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Source: Alvaredo, Facundo, Anthony B. Atkinson, Thomas Piketty and Emmanuel Saez, The World Top Incomes Database.

Figure 2: percentage of top 0.1% with incomes from interest, dividends and rents, USA, 1916 – 2013

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Source: Alvaredo, Facundo, Anthony B. Atkinson, Thomas Piketty and Emmanuel Saez, The World Top Incomes Database.

Figure 3: percentage of top 0.1% with wage salary and pension incomes, business incomes  and professional incomes,  Canada, 1946 – 2007

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source : Alvaredo, Facundo, Anthony B. Atkinson, Thomas Piketty and Emmanuel Saez, The World Top Incomes Database.

Figure 4: percentage of top 0.1% with dividend, interest or investment incomes,  Canada, 1946 – 2007

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Source: Alvaredo, Facundo, Anthony B. Atkinson, Thomas Piketty and Emmanuel Saez, The World Top Incomes Database.

How to show the emergence of a working super rich while attempting to argue they are a rentier class

The Washington Centre for Equitable Growth in a review of Thomas Piketty accidentally contradicted their own arguments about the emergence of the top 0.1%. They quote Piketty:

on page 302 of his book that the rise in labour income “primarily reflects the advent of ‘supermanagers,’ that is, top executives of large firms who have managed to obtain extremely high, historically unprecedented compensation packages for their labour.”

according to the Washington Centre for Equitable Growth:

these supermanagers were being vastly overly compensated given their questionable contributions to productivity.

The Washington Centre for Equitable Growth then goes on the argue that in 1979, most of the top managers worked for large, publicly traded firms but by 2005 more were working in closely held firms.

I wish to explore this point about the biggest gains in both percentage terms and magnitude were among privately held business professionals and they are vastly overcompensated relative to their productivity. The key to the argument as explained in a link to a Robert Solow article by the Washington Centre for Equitable Growth is:

Piketty is of course aware that executive pay at the very top is usually determined in a cosy way by boards of directors and compensation committees made up of people very like the executives they are paying.

Piketty is equally direct about the ability of top managers to set their own pay:

It is only reasonable to assume that people in a position to set their own salaries have a natural incentive to treat themselves generously or at the least to be rather optimistic in gauging their marginal productivity.

Emmanuel Saez is less coy:

…while standard economic models assume that pay reflects productivity, there are strong reasons to be sceptical, especially at the top of the income ladder where the actual economic contribution of managers working in complex organizations is particularly difficult to measure. In this scenario, top earners might be able partly to set their own pay by bargaining harder or influencing executive compensation com­mittees.

When arguing that the optimal top income tax rate is 83%, Piketty, Saez, and Stantcheva push for that high top tax rate in part because top executives are more likely to bargain for higher pay when tax rates are lower and receive funds that might go elsewhere within the firm.

The only comment I could find on the increasing number of privately held companies that pay top executives so well is frustration by the Washington Centre for Equitable Growth that it complicates statistical collection. No other analysis is undertaken.

Xavier Gabaix and Augustin Landier found back in 2008 that what a major company’s CEO earns is directly proportional to the size of the firm that they are responsible for running. Executive compensation closely track the evolution of average firm value. During 2007 – 2009, firm value decreased by 17%, and CEO pay by 28%. During 2009-2011, firm value increased by 19% and CEO pay by 22%. Xavier Gabaix and Augustin Landier also found that compensation for executives has risen with the market capitalization. From 1980 to 2003, the average value of the top 500 companies rose by a factor of six. Two commonly used indexes of chief executive compensation show close to a proportional six-fold matching increase.

What intrigued me about this casual reference to the great number of super managers employed by privately held firms is the argument that they have a cosy relationship with their board of directors immediately collapses. That argument about executive pay is usually in the context of the separation of ownership from control. In large publicly held companies the executives are subject to less scrutiny by shareholders as few of them have a large enough individual stake in the company to gain from the extra effort of monitoring their pay packages.

When the pay packages of top executives is questioned, it is always pointed out that there is an easy way to test for whether top executives cheat shareholders by overpaying themselves.

This simple test is comparing the pay of large private companies and public companies with a large or a few share holders with public companies with diffuse share holdings. Private equity typically also pay its top executives very well, even though the capacity to dupe public shareholders are not a factor.

Privately owned companies and public companies with a few large shareholders can easily keep track of the pay packages of the executives and the board of directors hired to monitor them. Private equity ownership have high pay-for-performance but also significant CEO co-investment.

The standard argument for excessive compensation for CEOs is free rider problems prevent shareholders from  doing sufficient monitoring of executive compensation practices, and that the problems have been getting worse over time. For example, in a classic paper, Bebchuk and Fried (2004) argued that executive compensation is set by CEOs themselves rather than boards of directors on behalf of shareholders,

This argument does not apply to private companies with a few shareholders but they still offer large pay packages to their top executives. Companies, be they public or private that pay any employee more than they contribute risks takeover and loss of market share and failure through higher costs.

The burst of takeovers and leverage buyouts in the 1980s were partly driven by opportunities to profit from reducing corporate slack and downsizing flabby corporate headquarters of large publicly listed companies. Cleaning out the overpaid executives and overstaffing in the headquarters of large corporations was an express purpose of these takeovers and leveraged buyouts.

The response of the Left over Left of the day was support regulation to stop these mergers and takeovers rather than applauding them as giving lazy, overpaid top executives a kick up the backside and from the boot out the door. This regulation to make hostile takeovers more difficult undermined the market the corporate control rather than strengthened it as Michael Jensen explains:

This political activity is another example of special interests using the democratic political system to change the rules of the game to benefit themselves at the expense of society as a whole.

In this case, the special interests are top-level corporate managers and other groups who stand to lose from competition in the market for corporate control. The result will be a significant weakening of the corporation as an organizational form and a reduction in efficiency.

Central to the hypothesis of the Twitter Left of CEOs overpaying themselves is there is free cash within the business they pocket in pay rises, fringe benefits and lavished corporate headquarters rather than pay out in dividends or invest in profitable investments.

CEOs with high pay packages are now much more likely than 20 or 30 years ago to be employed in private companies where the shareholders have far greater opportunities to ensure they get value for money.

All modern theories of the focus in part or in full on reducing opportunistic behaviour, cheating and fraud in employment and commercial relationships. The market for corporate control, and mergers and takeovers realise large benefits from displacing underperforming manager teams. Premiums in hostile takeover offers historically exceed 30% on average. Acquiring-firm shareholders on average earn about 4% in hostile takeovers and roughly zero in mergers.

Another reason for high CEO pay in both public and private companies is CEOs tend to be more risk adverse than their shareholders. The shareholders in any one company has a diversified portfolio and protected by limited liability if the company fails because of a risky venture. Moreover, shareholders  receive nothing in dividends if the  company breaks even so they would prefer that managers pursue business ventures likely to do more than break even.

The agent principal conflict ears as long as the company breaks even, the CEO gets paid. Out of career concerns, a CEO does not want to be at the head of a company that fails because his re-employment prospects are quite grim. High-risk/high-reward ventures are less attractive to top executives because if they fail, their human capital that is specific to the failed company is worthless elsewhere.

To encourage CEOs to take risks, paying them were share options makes them more interested in risky ventures because their pay goes up in line with the risks they take which they would otherwise not take but for option being paid in options. Privately owned companies are well aware of this risk aversion among their chief executives which is why they pay them so well and often in share options and bonuses for taking risks.

The Washington Centre for Equitable Growth simply did not address the reasons for privately owned companies paying the top executives so well.

The incomes of executives, managers, financial professionals, and technology professionals who are in the top 0.1% is very sensitive to stock market fluctuations. This  volatility in the pay of CEOs is inconsistent with the notion that their pay is linked to their ability to form cosy relationships with the boards of directors rather than with their performance.

These top 0.1% CEOs are working super rich whose fortunes rise and fall with the businesses they direct. Top CEOs are paid so much more because they direct the fortunes of large enterprises. In such cases, a small amount of extra talent is worth because the benefits of that small amount of extra talent are spread over such a large firm.