Stock Options and Inequality

A comment on a previous post from reader "Bill" raises an interesting conjecture about how policy might affect the income of the very rich:

Krugman's main concern seems to be with the earnings growth enjoyed by the top .01 percent of the population-- roughly 10,000 taxpayers-- whose earnings have grown five-fold since 1980. Surely, income from executive stock options has been a big factor in the rapid growth of ultra-high incomes.

Two public policies greatly accelerated the issuance of employee stock options-- a Senate resolution pushed by Sen Lieberman in 1994 that warned FASB against requiring companies to expense stock options and the 1993 law allowing companies to deduct only the first $1 million of executive compensation unless such compensation was explicitly linked to performance. Stock options were thought to be clearly linked to performance, thus a clearly deductible form of compensation in amounts greater than $1 million.

The funny thing is, the stock option gain realizations in 2001-2006 are mostly from compensation awards made in the 1990s, since most option awards have 10-year terms. The good fortunes of the very-high end are still an echo from the 1990s stock market boom.

The decision by FASB to require companies to expense stock options will solve the problem of excessive stock option compensation and result in an eventual decline in the income share of the top .01%. But it will take several years for all of the extravagant awards from earlier years to be "burned off" and disappear from high-income tax returns.

Although I am not an expert on executive compensation, there are parts of Bill's analysis that seem right to me. For many at the top of the economic ladder, stock options are an important part of compensation. In addition, public policy toward executive compensation has been excessively politicized, to say the least, and it may well have distorted behavior in unfavorable ways.

On the other hand, whether these particular public policies have been quantitatively important to rising inequality is less clear. Although the stock market had some spectacular runs in the 1990s, average stock performance over the past decade has been about normal. So I am skeptical that the interaction of stock options with surprisingly good stock performance is a large part of the story of rising inequality.

But my first guess about this may well be wrong. If anyone knows of relevant research on the topic, please let me know.