Wage Gap and Stock Returns

37 Pages Posted: 18 Aug 2018 Last revised: 29 Aug 2018

See all articles by Ingolf Dittmann

Ingolf Dittmann

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE); Tinbergen Institute; Erasmus Research Institute of Management (ERIM); European Corporate Governance Institute (ECGI)

Maurizio Montone

Luxembourg School of Finance

Yuhao Zhu

Erasmus University Rotterdam (EUR)

Date Written: August 1, 2018

Abstract

Is the difference in compensation between managers and workers related to the quality of the firm? We propose an asset pricing model with unsophisticated traders and short-sales constraints, in which the optimal wage gap increases with managerial effort. In equilibrium, we show that firms with lower wage gaps should be overpriced. Using a unique data set on German firms' employee compensation, we provide strong support for the model's predictions. We find that a long-short portfolio of stocks with high and low wage gaps, respectively, yields positive and robust risk-adjusted returns. We also show that the overpricing of low wage gap stocks is explained, at least in part, by the presence of inequality-averse investors. Overall, pay inequality within firms has nontrivial implications for stock prices, and seems to reflect fair compensation rather than agency issues.

Keywords: Wage Gap, Stock Returns, Asymmetric Information, Inequality Aversion

JEL Classification: G10, G12, G14, G32

Suggested Citation

Dittmann, Ingolf and Montone, Maurizio and Zhu, Yuhao, Wage Gap and Stock Returns (August 1, 2018). Available at SSRN: https://ssrn.com/abstract=3226225 or http://dx.doi.org/10.2139/ssrn.3226225

Ingolf Dittmann (Contact Author)

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands
+31 10 4081283 (Phone)
+31 10 4089165 (Fax)

HOME PAGE: http://people.few.eur.nl/dittmann/

Tinbergen Institute

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Erasmus Research Institute of Management (ERIM)

P.O. Box 1738
3000 DR Rotterdam
Netherlands

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Maurizio Montone

Luxembourg School of Finance ( email )

4 Rue Albert Borschette
Luxembourg, L-1246
Luxembourg

Yuhao Zhu

Erasmus University Rotterdam (EUR)

Burgemeester Oudlaan 50
3000 DR Rotterdam, Zuid-Holland 3062PA
Netherlands

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