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The determinants and effects of CEO–employee pay ratios

Author

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  • Faleye, Olubunmi
  • Reis, Ebru
  • Venkateswaran, Anand

Abstract

We study the determinants and effects of the relative compensation of top executives and lower-level employees. First, we show that CEO–employee pay ratios depend on the balance of power between the CEO (relative to the board) and ordinary employees (relative to management). Second, our results suggest that employees do not perceive higher pay ratios as an inequitable outcome to be redressed via costly behaviors that lower productivity. We do not find a negative relation between relative pay and employee productivity, either in our full sample or in subsamples where employees are well-informed about executive pay and are protected against career retributions. Rather, we find that productivity increases with relative pay when the firm has fewer employees who are well-informed, and when promotion decisions are predominantly merit-based. We also find that firm value and operating performance both increase with relative pay. We conclude that ordinary employees appear to perceive an opportunity in higher pay ratios but the extent to which such perception incentivizes them depends on the likelihood of success in a series of sequential promotion tournaments.

Suggested Citation

  • Faleye, Olubunmi & Reis, Ebru & Venkateswaran, Anand, 2013. "The determinants and effects of CEO–employee pay ratios," Journal of Banking & Finance, Elsevier, vol. 37(8), pages 3258-3272.
  • Handle: RePEc:eee:jbfina:v:37:y:2013:i:8:p:3258-3272
    DOI: 10.1016/j.jbankfin.2013.03.003
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    Cited by:

    1. repec:eee:chieco:v:44:y:2017:i:c:p:186-202 is not listed on IDEAS
    2. Lin Ma, 2014. "Globalization And Top Income Shares," Working Papers 14-07, Center for Economic Studies, U.S. Census Bureau.
    3. Newton, Ashley N., 2015. "Executive compensation, organizational performance, and governance quality in the absence of owners," Journal of Corporate Finance, Elsevier, vol. 30(C), pages 195-222.
    4. Ethan Rouen, 2017. "Rethinking Measurement of Pay Disparity and its Relation to Firm Performance," Harvard Business School Working Papers 18-007, Harvard Business School.
    5. Dai, Yunhao & Kong, Dongmin & Xu, Jin, 2017. "Does fairness breed efficiency? Pay gap and firm productivity in China," International Review of Economics & Finance, Elsevier, vol. 48(C), pages 406-422.

    More about this item

    Keywords

    Employee incentives; Productivity; Pay ratio; Executive compensation;

    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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