Corporate Stakeholders and CEO-Worker Pay Gap: Evidence From CEO Pay Ratio Disclosure

Mei Cheng is an Associate Professor of Accounting at the University of Arizona and Yuan Zhang is an Associate Professor of Accounting at the University of Texas at Dallas. This post is based on their article forthcoming in the Review of Accounting Studies. Related research from the Program on Corporate Governance includes Stealth Compensation via Retirement Benefits by Lucian Bebchuk and Jesse M. Fried.

In recent years, the ever-widening gap between chief executive officer (CEO) pay and worker pay has become a heated topic of public debate. Headlines such as “CEO compensation has grown 940% since 1978, while typical worker compensation has risen only 12% during that time” have sparked public debate and outrage over the growing pay gap (Mishel and Wolfe 2019). Given the economic and social significance of income equality and distributive justice, corporate stakeholders, especially non-shareholder stakeholders such as employees, communities, and governments who value pay equality, have become increasingly concerned about the high CEO-worker pay gap. We use the recently mandated disclosure of CEO and median worker pay ratio to capture the extent of CEO-worker pay gap and examine whether these non-shareholder stakeholders exert influence on CEO-worker pay gap.

Amid public concern about the widening CEO-worker pay gap, on August 5, 2015, the Securities and Exchange Commission (SEC) adopted a rule that requires listed firms to disclose the ratio of CEO compensation to the median worker compensation for fiscal years beginning on or after January 1, 2017. Before this mandate, firms were only required to disclose CEO compensation. Under the new mandate, firms must also disclose the median of the worker compensation and the ratio of CEO compensation to the median worker compensation. Thus, the mandatory disclosure of the pay ratios provides stakeholders a fresh and prominent signal to assess pay gap and potentially pay inequality. Ex ante, it is unclear whether the disclosed pay ratio will be associated with the subsequent CEO-worker pay gap. On the one hand, stakeholders are likely to be particularly sensitive to high pay ratios and attempt to influence firms with high pay ratios. On the other hand, high pay ratios across firms could stem from differing firm characteristics and strategies for attracting talent, and non-shareholder stakeholders may not have any influence on the underlying strategies and the resulting pay ratios. Additionally, the SEC rule itself allows discretion in determining the median worker pay, making interpretations of the pay ratios even more complicated.

Based on CEO pay ratio data for 1,444 individual firms in 2017–2019, we find significant and robust evidence that the change in the CEO-worker pay ratio in the next year is negatively associated with the current pay ratios relative to similar industry peers. This negative association is evident for both the high pay ratio group and the low pay ratio group. This suggests that, after disclosing the pay ratios in the previous year, firms with high pay ratios adjust their ratios down; however, perhaps not intended by the rule, firms with low pay ratios adjust theirs up.

More importantly, we specifically examine the influence of the following non-shareholder stakeholders: employees and public stakeholders (i.e., communities and governments), because of their strong advocacy for CEO-worker pay equality and their significant social impacts on compensation committees. We capture stakeholder influence using an aggregate index based on high-tech industry and R&D indicators as a proxy for employee bargaining power, county-level social capital as a proxy for community impact, and state employee minimum wage legislation as a proxy for government emphasis on labor compensation. We find that the negative association between the high relative pay ratio and the subsequent change in pay ratio is significantly stronger for firms with greater stakeholder influence.  Stakeholder influence, however, is not associated with pay ratio adjustments when the relative pay ratio is low. Further, we find that, when pay ratios are relatively high, firms decrease CEO pay and increase median worker pay and that greater stakeholder influence is associated with both changes. These results highlight the critical roles of stakeholders in monitoring and impacting firms with high pay gap.

Finally, we examine a specific and direct mechanism through which public stakeholders can influence the pay gap, namely, pay-ratio-related tax proposals, which can draw significant public attention to firms with high pay ratios and pressure these firms to adjust their compensation structure. Using seven states (i.e., California, Connecticut, Illinois, Massachusetts, Minnesota, New York, and Rhode Island) with such tax proposals as our treatment group, we find that firms with high CEO-worker pay ratios in these states reduce the pay ratio significantly more than firms with similarly high pay ratios in other states. Our findings suggest that state tax legislation can be a direct mechanism to curb the pay gap.

Given the flexibility the SEC allows in determining the pay ratios, many observers are skeptical of the informativeness and hence the real effects of the mandatory pay ratio disclosures (Bank and Georgiev 2019). Our paper documents significant economic consequences of these disclosures in prompting compensation committees to adjust the pay ratios (via both CEO pay and median worker pay) in response to stakeholder scrutiny and criticism. These results highlight the information value of the disclosures and support the view of Leuz and Wysocki (2016) that disclosure regulations can have real economic effects (e.g., Mas 2017).

More importantly, our novel perspective and findings on the influences of specific non-shareholder stakeholders underscore the importance of employee bargaining power and government and community emphasis on social welfare in curbing the high CEO-worker pay gap. With the growing importance of ESG performance, social issues such as CEO-worker pay disparity have never been more relevant. Yet researchers’ understanding of factors that influence over-time changes in pay ratios is limited. Consistent with Business Roundtable’s (2019) redefined Purpose of a Corporation that promotes an economy that serves all Americans, our study demonstrates that firms consider stakeholders’ perspective in making important corporate decisions like pay practices. Collectively, employees, communities, and governments can contribute to pay equality and distributive justice, eventually enhancing social welfare.

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