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Rethinking Measurement of Pay Disparity and its Relation to Firm Performance

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  • Ethan Rouen

    (Harvard Business School, Accounting and Management Unit)

Abstract

I develop measures of firm-level pay disparity and examine their relation to firm accounting performance. Using comprehensive compensation data for a large sample of firms, I find no statistically significant relation between the ratio of CEO-to-mean employee compensation and performance. I next create empirical models that allow me to separate the components of CEO and employee compensation explained by economic factors from those that are not, and use these models to estimate explained and unexplained pay disparity. After validating my estimate of unexplained pay disparity as a proxy for pay fairness, I find robust evidence of a negative (positive) relation between unexplained (explained) pay disparity and future firm performance. Additional tests show that the negative relation between unexplained disparity and firm performance is driven by firms where both the CEO is overpaid and employees are underpaid, and is more pronounced for firms with weak corporate governance and high employee turnover.

Suggested Citation

  • Ethan Rouen, 2017. "Rethinking Measurement of Pay Disparity and its Relation to Firm Performance," Harvard Business School Working Papers 18-007, Harvard Business School.
    • Handle: RePEc:hbs:wpaper:18-007
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    Cited by:

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    2. Lan Guo & Theresa Libby & Xiaotao (Kelvin) Liu & Yu Tian, 2020. "Vertical Pay Dispersion, Peer Observability, and Misreporting in a Participative Budgeting Setting," Contemporary Accounting Research, John Wiley & Sons, vol. 37(1), pages 575-602, March.

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    Keywords

    pay disparity; pay ratio; CEO pay ratio; income inequality;
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