Joshua Rauh: What the Forbes 400 List Says about American Wealth

With income inequality rising in the United States, there are two popular conceptions about which people make up the wealthiest 1 percent of Americans: that they were born into wealth or that they mainly include the CEOs of the largest public companies. Both of these are wrong.

New research from Joshua Rauh, professor of finance at Stanford Graduate School of Business, and Steven Kaplan, professor of entrepreneurship and finance at the University of Chicago Booth School of Business, finds that only a small fraction of America’s wealthiest fall into either of these two categories, and in both instances, the numbers are falling over time. Consider:

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Bill Gates, son of a lawyer, topped the Forbes 400 list in 2013. (Associated Press)

• In 1982, 60 percent of the people on the Forbes 400 list of wealthiest Americans came from wealthy families, compared with 32 percent in 2011.
• In 2004, top executives of publicly traded companies made up only 5 percent of the top 0.01 percent of the wealthiest people in the United States — a sliver of the population whose members earned individual salaries of at least $7.2 million per year that year. Another example: The combined yearly income of the top 25 hedge fund investors exceeded the combined income of the CEOs of the Standard & Poor’s 500 index in 2009.

What explains the shift? Technology and scale.

“The Forbes 400 of today also are those who were able to access education while young and apply their skills to the most scalable industries: technology, finance, and mass retail,” Rauh and Kaplan write in their most recent study, “Family, Education, and Sources of Wealth Among the Richest Americans, 1982-2012.”

The explosion of information technology has created an entirely new class of the very rich, many of them self-made. It’s no coincidence that three of the 10 wealthiest people in the United States — Bill Gates, Larry Ellison, and Michael Bloomberg — built their fortunes on information technology that barely existed in the 1980s. (Bloomberg’s fortune was built upon the “Bloomberg Box,” an advanced desktop computer running on a sophisticated data network.)

Drill down a bit more, and you’ll see that information technology is the foundation of 15 percent of the fortunes on the list, and that figure actually understates the importance of technology. Rauh and Kaplan found that on a weighted basis, roughly 25 percent of the businesses owned by the wealthiest people had a sizable technology component.

One sector grew even faster than technology as measured by its contribution to the incomes of those on the list: retail, including restaurants. Fifteen percent of the Forbes 400 fortunes are based on that industry. Retail is a sector in which technology and the ability to scale up operations has helped major players transform the landscape, making billions for entrepreneurs including Jeffrey Bezos of Amazon in e-commerce, and the Walton family with the more traditional Wal-Mart. The other growing sectors are medical technology, hedge funds, private equity, money management, and venture capital.

Meanwhile, old standbys, including real estate, energy, and media, have become significantly less important. Energy, for example, used to play a role in about 21 percent of the fortunes represented on the Forbes list; now it accounts for about half that much.

From Middle Class to Upper Class

It’s noteworthy that the technology billionaires did not inherit vast amounts of wealth, though they were hardly paupers. Microsoft founder Bill Gates, for example, grew up in an upper-middle-class household, his father a successful lawyer. About half of the Forbes 400 grew up in circumstances similar to Gates’, compared with about 30 percent in 1982.

Some of the people on the Forbes list did follow a conventional path (for the very rich, that is) of inheriting wealth and then taking over the family business. The 10 richest people on the list include David and Charles Koch, whose fortune is based on the energy industry, and the Walton siblings, members of the family that owns Wal-Mart.

Others took an entrepreneurial route, starting businesses that were far removed from what their parents had done. Kaplan and Rauh found that 69 percent of those on the list in 2011 started their own businesses, compared with only 40 percent in 1982.

CEO Salaries Dwarfed by Hedge Fund Compensation

There’s a tendency to link runaway CEO salaries with rising income inequality. But here, too, the truth is more complex, as Rauh and Kaplan discussed in their 2010 paper, “Wall Street and Main Street: What Contributes to the Rise in the Highest Incomes?” (The authors are conducting a research project that will update the 2010 paper. Some data from that work in progress is quoted in this article.)

In 2010, the median pay for CEOs was $10 million, down from a high of $18 million in 2000. But even their peak salaries are small change compared with the average compensation of $1 billion for the 25 highest-paid hedge fund managers in 2009, says Rauh. Behind that astronomical compensation is scale. Hedge funds are handling money on a scale that was never even thought of in the past, he says.

Now consider the fortunes of professional athletes like Buster Posey of the San Francisco Giants, who just signed a nine-year contract worth $167 million. How is that possible? It’s another example of scale, says Rauh. Baseball and other sports now reach tens — in some cases hundreds — of millions of people around the world, making the market for a professional athlete’s skills much richer than ever before. Athletes like Posey, the professor says, are using their skills to get a larger share of the increased profits.

Commenting on how economic and technological change has shaped the formation of America’s upper class, Rauh puts it this way:

“Being super rich no longer requires being born wealthy, but wealth does confer advantages, particularly in access to education,” says Rauh. “The new order is that those with some wealth and a lot of intellectual firepower and ambition can take their talent and apply it to a much larger pool of resources than in the past.”

And that, he says, makes them even wealthier.