What Business Schools Get Wrong
Are MBA-trained CEOs to blame for wage stagnation?
New study links business degrees to CEOs who prize profits and productivity over employee wages
Several weeks ago I listened to a very interesting podcast, Are MBAs to Blame for Wage Stagnation, with Freakonomics Radio host, Stephen Dubner and MIT economist Daron Acemoglu. The podcast discussed a working paper by Acemoglu, Alex He, and Daniel le Maire on the effect of a CEO’s education on the wages of their company’s employees that was recently published in the National Bureau of Economic Research (NBER).
In the podcast, Acemoglu noted that over the last few decades, wages have grown much slower than productivity — a development that has long puzzled economists. “If you look at the real wages of workers with a high school degree, it increased about 2.5% a year in real terms between1945 and the late 1970s — a remarkable increase,” he said. “Since 1980, it has been declining in real terms every year.
So a large fraction of the U.S. population has been becoming poorer and poorer, even as we are building the most amazing technologies, the largest companies humanity has seen,[and] the most modern economy.”
The labor share — that is, the share of GDP that goes to workers — declined from 63% in the 1980s to 58% in 2020. And during those same four decades, the share of U.S. firms that were run by a business manager — that is, an executive with an MBA or some other business degree — increased from 25% in the 1980s to over 40% in 2020. Were these two trends connected? “Did the professionalization of the managerial class cause the labor share to fall?” The answer wasn’t obvious.
To shed light on this question, Acemoglu and his collaborators analyzed U.S. and Danish data, including firm- and worker-level information. They chose Denmark, in addition to the U.S., because the country has very high-quality data that makes it possible to do a lot of analysis that would be harder to do with U.S. data alone. Their methodology was very simple. They essentially tracked what happens to the earnings of the same workers when there is a switch in the type of manager leading their company, i.e., from a business to a non-business manager and vice versa.
Business vs. Non-Business CEOs
The overriding finding in their paper is that when a non-business CEO is replaced by a CEO with a business degree, there’s a significant decline in the wages and labor share of the firm. Within five years of their appointment, wages decline by 6% and the labor share declines by 5% in the U.S., while in Denmark, both wages and labor share decline by 3%. “In neither country do we see any differential trends in the labor share, wages, employment, output, or investment before the term of the business manager begins. Nor do we detect much of an employment, output, investment, or productivity response, which suggests that
business managers are not more productive than their non-business peers.”
These findings account for 20% of the decline in labor share and around 15% of the slowdown in wage growth since 1980 in the U.S., and for 6% for the decline in labor share in DenmarkAT the same time, the appointment of a CEO with a business degree leads to a 3% increase in return on assets (ROA) in the U.S. and a 1.5% increase in Denmark; the stock market value of the company increases by about 5%; and all else being equal, managers with business degrees earn more than non-business managers.
What account for the differences in wages and labor share between companies led by business and non-business managers? The explanation lies in the different response to excess profits per worker. Companies led by non-business managers are more likely to share any excess profits with their workers: a 10% increase in profit per worker is associated with a 1% increase in wages. On the other hand, in companies led by business managers, an increase in profit per workers has no impact whatsoever on their wages.
Why are managers with business degrees less likely to share their companies’ profits? Is it because individuals who are more prone to take a hard line against labor are more likely to pursue business degrees, or is the practice of taking a hard line with labor acquired as part of a business education?
Based on their analysis of detailed Danish data, the authors demonstrate that the aversion to sharing excess profits with labor is mostly acquired in business schools. As further evidence they cite two major ideas propagated by business schools that have influenced business managers over the past four decades.
Maximizing Shareholder Value is Key
The first influential idea is that maximizing shareholder value should be the primary goal of corporate managers, first put forth by academic economists in the 1970s — most notably by University of Chicago economist and Nobel Prize recipient Milton Friedman. In a 1970 NY Times Magazine article, “The Social Responsibility of Business is to Increase its Profits,” Friedman wrote:
“In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.” Business concerns beyond making a profit — such as “promoting desirable social ends,” or “providing employment, eliminating discrimination, avoiding pollution and whatever else,” amounted to “preaching pure and unadulterated socialism.”
These views were widely embraced by the business community, including the Business Roundtable (BRT) — an association of CEOs of major U.S. companies. However, those views waned considerably after the 2008 global financial crisis. In 2019, the BRT released an updated statement on the Purpose of a Corporation which moved away from its previous commitment to shareholder primacy to now emphasize a “Commitment to All Stakeholders” and to “An Economy that Serves All Americans.”
The second idea is our obsession with economic efficiency and lean corporations. The belief that efficiency is fundamental to competitive advantage has turned management into a science, whose objective is the elimination of waste — whether of time, materials, or capital — wrote University of Toronto professor Roger Martin in “The High Price of Efficiency,” a January 2019 article in the Harvard Business Review. “Why would we not want managers to strive for an ever-more-efficient use of resources?” he asked. Of course we do.
But, we also know that an excessive focus on efficiency can produce startlingly negative effects.
The root of the problem is that over the past four decades, we’ve treated the economy as a kind of machine that can be broken up into its constituent parts, each of which can be optimized to create an optimally efficient whole. In principles, the model was intended to produce a big bulge in the middle — that is, a large middle class — with a tapering of outcomes on the upper and lower ends — corresponding to both richer and poorer families. The richer families would make investments and pay substantially higher taxes that would help everybody else, especially families on the poorer end.
But our economic machine hasn’t worked as expected, a point also made by Acemoglu in the podcast. From 1947 to 1976, the median income of U.S. families grew at over 2.4% CGR. As a result, the median family income doubled in one 30-year generation. But, from 1977 to 2019, median income has only grown at 0.6% CGR, meaning that the median family income has only risen by 31% over the past 42 years.
“To the extent that business schools were the vanguard of these ideas that became more widely held among managers and were further propagated by management consultants, our estimates should be viewed as lower bounds on the effects of these management practices,” noted the NBER paper. “If so, in both the U.S. and Denmark management practices prioritizing shareholder value and cost cutting may have contributed significantly even more to the decline in the labor share and the slowdown in wages than our range of estimates.”
Toward the end of the podcast, Dubner asked Acemoglu what he would say to business school students if invited to teach a course on the impact of business leaders and wage stagnation.
“I would suggest two sets of avenues for further thought,” said Acemoglu. “One is that however powerful a business leader may be — or even a political leader or a dictator — their power is embedded in the norms of society. If the norms of society are not permissive, you’re not going to be able to do this sort of thing. Emblematic of the forces that we’re talking about are people like Jack Welch. Welch was as powerful as any CEO could be, and he is an example of CEOs that have cut wages. But Welch would not have been able to do what he did if society — his friends and neighbors, his shareholders — were not accepting of the policies and management style that he brought.”
“And second, what is it that we really teach people in positions of power? We come back to subtle cues that people get in business schools, or in other similar environments, including perhaps in management consulting firms.”
It’s certainly food for MBA thought.