Pay Gap Among Executives and Firm Value

Abstract

We simultaneously study the determinants of the pay gaps among top executives and their impact on firm value. We find that firms that require additional incentives to reduce shirking, such as the ones with high capital intensity and the ones with volatile stock performance, have higher pay gaps than other firms. On the other hand, firms that rely on efficient cooperation to survive and succeed, such as technology-intensive firms and firms with financial distress, tend to have lower pay gaps. We further find that firm value is impaired if the pay gap arrangements deviate substantially from the firm’s optimal range. Corporate governance can explain such deviation. CEO entrenchment is likely to lead to higher than optimal pay gaps. On the other hand, strong governance can result in lower than optimal pay gaps. We also document a substitution effect among various incentive mechanisms. When the alignment of interests improves, the pay gap level reduces and so does the effect of pay gap on firm value.