Pay ratio and operational efficiency

Using a comprehensive US sample over the period 1995–2010, we examine the effects of CEO-to-employee pay ratios on operational efficiency. We have found evidence that the pay ratio is negatively associated with firm efficiency. This means that employees perceive higher pay ratios as an inequitable outcome that discourages their collaborations and leads to dissatisfaction with their working environments. We conduct a battery of tests to alleviate the endogenous nature of pay ratios and a variety of other sensitivity tests. We also find that the association is more pronounced when collaborative working environments are better, as in cases of: 1) firms with lower default risk; 2) firms with lower financial analysts’ attention; 3) firms with stronger less severe risk-aversion. Our paper provides significant evidence for the ongoing policy debate over pay inequality on firm operations.