Joshua D. Rauh

Wall Street and Main Street: What Contributes to the Rise in the Highest Incomes?

We consider how much of the top end of the income distribution can be attributed to four sectors -- top executives of non-financial firms (Main Street); financial service sector employees from investment banks, hedge funds, private equity funds, and mutual funds (Wall Street); corporate lawyers; and professional athletes and celebrities. Non-financial public company CEOs and top executives do not represent more than 6.5% of any of the top AGI brackets (the top 0.1%, 0.01%, 0.001%, and 0.0001%). Individuals in the Wall Street category comprise at least as high a percentage of the top AGI brackets as non-financial executives of public companies. While the representation of top executives in the top AGI brackets has increased from 1994 to 2004, the representation of Wall Street has likely increased even more. While the groups we study represent a substantial portion of the top income groups, they miss a large number of high-earning individuals. We conclude by considering how our results inform different explanations for the increased skewness at the top end of the distribution. We argue the evidence is most consistent with theories of superstars, skill biased technological change, greater scale and their interaction.

Capital Structure and Debt Structure

Using a novel data set that records individual debt issues on the balance sheets of public firms, we demonstrate that traditional capital structure studies that ignore debt heterogeneity miss substantial capital structure variation. Relative to high credit quality firms, low credit quality firms are more likely to have a multi-tiered capital structure consisting of both secured bank debt with tight covenants and subordinated non-bank debt with loose covenants. We discuss the extent to which these findings are consistent with existing theoretical models of debt structure in which firms simultaneously use multiple debt types to reduce incentive conflicts.

Public Pension Promises: How Big Are They and What Are They Worth?

We calculate the present value of state employee pension liabilities as of June 2009 using discount rates that reflect the risk of the payments from a taxpayer perspective. If benefits have the same default and recovery characteristics as state general obligation debt, the national total of promised liabilities based on current salary and service is

Explaining Corporate Capital Structure: Product Markets, Leases, and Asset Similarity

3.20 trillion. If pensions have higher priority than state debt, the present value of liabilities is much larger. Using zero-coupon Treasury yields, which are default-free but contain other priced risks, promised liabilities are

The economics of state and local pensions

4.43 trillion. Liabilities are even larger under broader concepts that account for projected salary growth and future service.

Fiscal Imbalances and Borrowing Costs: Evidence from State Investment Losses

Better measurement of the output produced and capital employed by firms substantially improves the ability to explain capital structure variation in the cross section. For every firm, we construct the set of other firms producing the same output using the set of product market competitors listed in the firms public Securities and Exchange Commission filings. In addition, we improve measurement of capital structure by explicitly accounting for leased capital. These two steps increase the explanatory power of the average capital structure of other firms producing similar output on a firms capital structure by 50% compared to using only the average unadjusted debt ratio of other firms in the same three-digit Standard Industrial Classification (SIC) code. We provide evidence that the large explanatory power of the capital structure of other firms producing similar output is related to the assets used in the production process. Our findings suggest that what a firm produces and the assets used in production are the most important determinants of capital structure in the cross section. Copyright 2011, Oxford University Press.

Cost Shifting and the Freezing of Corporate Pension Plans

This paper provides an overview of an economics-based perspective on the financial aspects of state and local public pensions in the U.S. Drawing on the research commissioned for an NBER research program on this topic, we discuss the large degree to which public pension liabilities exceed the assets set aside to fund them. We summarize issues related to the optimality of pre-funding, portfolio allocation, the discounting of liabilities, as well as how plans operate in practice. We also lay out an agenda for future research related to financial aspects of public pensions, retiree health plans for public employees, as well as issues related to plan design and labor market outcomes.

State Taxation and the Reallocation of Business Activity: Evidence from Establishment-Level Data

This paper examines the effects of losses in U.S. state pension funds on state borrowing costs. Since public‐employee pension obligations are generally senior to state general obligation bonds, increases in unfunded pension liabilities are a serious concern for municipal bond investors. During the 3 months ending December 2008, losses in state pension funds amounted to between 1% and 6% of annual gross state product, and between 9% and 48% of annual state revenue, depending on the state. Using this cross‐sectional variation, we find that over this period tax‐adjusted municipal bond spreads rose by 10‐20 basis points for each 1% of annual gross state product lost in pension funds by states in the lower half of the credit quality spectrum. A similar result holds for each 10% of annual state revenues lost. The effect is approximately constant over the yield curve, suggesting a constant upward shift in annual risk‐neutral default probabilities. These results are robust to controls for credit ratings and other measures of the state’s fiscal strength. They hold within credit rating categories and are strongest among states with the weakest ratings. We conclude that U.S. state borrowing costs will likely increase if unfunded state liabilities continue to grow, making state debt more expensive to finance.

Political Representation and Governance: Evidence from the Investment Decisions of Public Pension Funds

Many U.S. corporations have frozen defined benefit (DB) pension plans, replacing new DB promises with contributions to defined contribution (DC) plans. We estimate expected DB accruals from the age-service and salary distributions of a large sample of U.S. corporate pension plans with more than 1,000 employees. Comparing the counterfactual DB accruals to the actual increase in 401(k) and other DC contributions for firms that freeze, we find only partial compensation to employees for the lost DB accruals. Net of the increase in total DC contributions, firms save 2.7-3.6% of payroll per year, and over a 10-year horizon they save 3.1% of total firm assets. Workers would have to value the structure, choice, flexibility, or portability of DC plans by at least this much more to experience welfare gains from freezes. The forgone accruals and net cost effects are initially largest for older employees but over time become largest for middle-aged employees who plan to stay with the firms until retirement. Furthermore, the probability that a firm freezes a pension plan is positively related to the value of new accruals as a share of firm assets. While there are differences in the age-service distributions of firms that freeze versus those that do not, we find that the differential accrual effect is largely driven by differences in benefit factors and the relative importance of labor in the freeze firms production function. The results overall support the hypothesis that pension freezes affect overall compensation and therefore that they change compensation costs relative to a workers marginal product.

Financial Valuation of PBGC Insurance with Market‐Implied Default Probabilities

Using census microdata on multistate firms and their organizational forms, we estimate the impact of state taxes on business activity. For C corporations, employment and the number of establishments have short-run corporate tax elasticities of −0.4 to −0.5 and do not vary with changes in personal tax rates. Pass-through entity activities show tax elasticities of −0.2 to −0.4 with respect to personal tax rates and are invariant with respect to corporate tax rates. Capital shows similar patterns. Reallocation of productive resources to other states drives around half the effect. The responses are strongest for firms in tradable and footloose industries.