Restricting Pay Gap Backfires: The Case of Bank Misconduct

Abstract

This study examines the effect of the executive-employee pay disparity on bank misconduct. Using the 2014 “Pay Ceiling Order” mandated by the Chinese government as an exogenous shock, we find that banks with higher pre-reform pay gaps substantially reduced the pay gap to comply with the order. These banks engage in significantly more misconduct activities afterward. This effect is driven by banks with weaker governance structure, and is more prominent for remotely located bank branches, suggesting that the policy-induced decline in pay gap weakens the monitoring mechanisms inside banks.