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Rethinking Measurement of Pay Disparity and its Relation to Firm Performance

70 Pages Posted: 10 Nov 2016 Last revised: 24 Jul 2017

Ethan Rouen

Harvard Business School

Date Written: July 13, 2017

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.

Keywords: pay disparity, pay ratio, CEO pay ratio, income inequality

Suggested Citation

Rouen, Ethan, Rethinking Measurement of Pay Disparity and its Relation to Firm Performance (July 13, 2017). Harvard Business School Accounting & Management Unit Working Paper; Columbia Business School Research Paper No. 16-81. Available at SSRN: https://ssrn.com/abstract=2867041 or http://dx.doi.org/10.2139/ssrn.2867041

Ethan Rouen (Contact Author)

Harvard Business School ( email )

Soldiers Field
Boston, MA 02163
United States
617-495-6275 (Phone)

HOME PAGE: http://www.ethanrouen.com

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