Wage Gap and Stock Returns
37 Pages Posted: 18 Aug 2018 Last revised: 29 Aug 2018
Date Written: August 1, 2018
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: Suggested Citation