Pay Harmony? Social Comparison and Performance Compensation in Multi-Business Firms

Abstract

Our study presents evidence that social comparison influences both the level of pay and the degree of performance sensitivity within firms. We report pay patterns among division managers of large, multi-business firms over a fourteen-year period. These patterns are consistent with employees comparing pay against both their peers (horizontal comparison) and the CEO (vertical comparison) within their firm. Horizontal comparison also appears to reduce pay-performance sensitivity, in accord with prior theory proposing that performance pay can lead to perceived pay inequity among employees. Taken together, our evidence suggests that agency costs and social comparison jointly influence pay within firms. The evidence also supports the notion that managers of multi-business firms are constrained in the degree to which they can incentivize employees, given the firm-imposed reference group.

Keywords: Executive Compensation, Pay-for-Performance, Internal Labor Markets, Peer Comparison, Firm Geography

JEL Classification: J33, J44, M12, M52