Why have payouts by US corporations increased so much? Hanno Lustig, Chad Syverson and Stijn Van Nieuwerburgh * UCLA , University of Chicago and NYU September 24, 2007 Abstract Three of the most fundamental changes in the economy since the early 1970s have been (1) the increase in the importance of knowledge, or organizational capital, in production, (2) the increase in income inequality, and (3) the increase in payouts to the owners of firms. There is a unified explanation for these changes: The arrival and gradual adoption of information technology since the 1970s changed the nature of innovation and stimulated the growth of organizational capital in existing firms. The average firm became larger and size heterogeneity grew across firms. This change benefited the knowledge workers of large, productive firms, whose outside option improved, but not the workers of smaller, less productive firms. Hence the increase in income inequality. The owners of the firms partially insure their workers through long-term compensation contracts and bear all residual payout risk. Their payouts are highly sensitive to firm performance. As a result, owners captured a larger share of the organizational rents that were generated from IT. We document that US corporations have increased the fraction of value added that is paid out directly or indirectly to owners from 1.7% in the early 1970s to 9.4% in the early 2000s. We also document a 7 log point increase in between-firm within-industry wage dispersion. The model can generate both of these changes. It is also consistent with the observed evolution in labor reallocation rates, exit and entry rates, and firm valuation ratios. Finally, the same relationships between payout rates, valuation ratios, and reallocation rates hold also in the cross-section of firms. * Hanno Lustig, email: hlustig@econ.ucla.edu.edu. Dept. of Economics, UCLA, Box 951477, Los Angeles, CA 90095-1477, tel: (310) 825-8018. http://www.econ.ucla.edu/people/faculty/Lustig.html. Chad Syver- son: Department of Economics University of Chicago 1126 E. 59th St. Chicago, IL 60637. tel: (773) 702-7815. http://www.econ.uchicago.edu/~syverson. Stijn Van Nieuwerburgh, email: svnieuwe@stern.nyu.edu, Dept. of Finance, NYU, 44 West Fourth Street, Suite 9-190, New York, NY 10012. http://www.stern.nyu.edu/~svnieuwe. We are grateful to Scott Schuh and Jason Faberman for generously sharing their data with us. Lorenzo Naranjo and Andrew Hollenhurst provided outstanding research assistance. For helpful comments we would like to thank Andy Atkeson, Fatih Guvenen, Hugo Hopenhayn, Kjetil Storesletten, and participants at the UCL conference on income and consumption inequality, Duke finance, and NYU finance. This work is supported by the National Science Foundation under Grant No 0550910.