Entrenchment or Efficiency? CEO-to-Employee Pay Ratio and the Cost of Debt

Abstract

Using new data on S&P 1500 firms’ CEO-to-employee pay ratios disclosed by mandate of Section 953(b) of the Dodd-Frank Act, we examine the effect of within-firm pay inequality on bond yield spreads. We find a significant negative relation between industry-adjusted CEO-to-employee pay ratio and yield spreads while controlling for covariates and endogeneity. This result is the strongest in financially constrained, labor intensive, and small-to-medium sized firms. The evidence supports the incentive-provision explanation of CEO-to-employee pay disparity, reflecting efficient CEO compensation rather than rent extraction. We also document selection bias in self-reported pay ratios, highlighting the efficacy of the Dodd-Frank provisions.

Keywords: CEO-to-employee pay ratio, Dodd-Frank Act, Pay disparity, Executive compensation, Median employee pay, Cost of debt

JEL Classification: G28, G30, G31, G34