Executive Pay Disparity and the Cost of Equity Capital

Executive pay disparity, as measured by CEO pay slice (CPS), is positively associated with the implied cost of equity, even after controlling for other determinants of the cost of equity. The difference in the cost of equity can explain 43% of the difference in the valuation effect attributable to CPS reported by Bebchuk, Cremers, and Peyer (2011). Further analysis shows that the positive association is stronger when agency problems of free cash flows are more severe and when CEO succession planning is more important. Our evidence suggests that a large CPS is associated with CEO entrenchment and high succession risk.

Keywords: executive pay disparity, CEO pay slice, implied cost of capital, succession risk, entrenchment

JEL Classification: G12, G3

Suggested Citation: Suggested Citation

Chen, Zhihong and Huang, Yuan and Wei, Kuo-Chiang (John), Executive Pay Disparity and the Cost of Equity Capital (March 1, 2012). Journal of Financial and Quantitative Analysis (JFQA), Forthcoming, Available at SSRN: https://ssrn.com/abstract=2195381