Determinants and Performance Effects of Executive Pay Multiples

Disclosure rules for the Korean Stock Exchange require Korean firms to disclose average executive and employee pay. These disclosures provide a unique opportunity to examine factors influencing the executive pay multiple (executive-employee pay disparity) and its effects on performance. We find that a substantial portion of cross-sectional variation in the executive pay multiple is explained by the firm’s economic, governance, executive, and workforce-related characteristics. Consistent with the behavioral theory of pay disparity, our results also indicate that the executive pay multiple has a statistically significant negative relation with subsequent operating and stock return performance, suggesting that a higher (lower) pay multiple is associated with poorer (better) future performance. These results are robust to corrections for endogeneity. When we adopt a two-stage approach, however, we find strong evidence that deviations from the expected executive pay multiple, estimated using the first-stage determinant model, are associated with poorer subsequent performance. Additional tests provide some evidence that CEO (employee) turnover is positively related to executive pay multiples that are lower (higher) than expected, suggesting that deviations from the expected executive pay multiple negatively affect subsequent performance in part through their impact on subsequent executive and employee turnover.