Legislating John Rawls?

In his A Theory of Justice, philosopher John Rawls basically argued that a just society is one that minimizes inequalities among its citizens. In furtherance of that goal, Rawls devised his difference principle which declared that in order for any change to be accepted as an improvement, it must help the least advantaged representative person.

I suspect that Rawls would be happy to endorse the Income Equity Act of 2007, introduced by Rep. Barbara Lee (D-Calif.). The Act aims to limit the compensation of corporate executives in the name of equality. As the Progressive Democrats of America site explains the Act:

Amends the Internal Revenue Code to: (1) deny employers a tax deduction for payments of excessive compensation to any employee (i.e., more than 25 times the lowest compensation paid any other employee); and (2) require such employers to file a report on compensation paid to their employees with the Secretary of the Treasury.

But are corporate executives overpaid? Ralph Nader's Citizen Works offers a handy list detailing the pay of executives whose companies have recently lost a lot of shareholder value due to questionable activities.

On the other hand, George Mason University economist Tyler Cowen in his New York Times column cites research suggesting that executives are not overpaid. To wit:

…in a new paper, "Why Has C.E.O. Pay Increased So Much?," the economists Xavier Gabaix of the Massachusetts Institute of Technology and Augustin Landier of the Stern School of Business at New York University offer a contrarian view. They suggest that the higher salaries for chief executives can largely be explained by increases in the value of the stock market. Viewed as a whole, these salaries are a result of competitive pressures rather than the exploitation of shareholders.

Their core argument is simple. If we look at recent history, compensation for executives has risen with the market capitalization of the largest companies. For instance, 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 sixfold matching increase (the correlation coefficients are 0.93 and 0.97, respectively; 1.0 would be a perfect match).

So how does this argument work? Better executive decisions create more economic value. If the number of big companies is greater than the number of good chief executives, competitive bidding will push up pay to reflect the value of the talent.

Whole Cowen column here.

Discuss.