When the gap between the salary of a CEO and an average worker is seen as unfair, employee resentment can harm a company's productivity, according to a report from Boston-based Harvard Business School.
In response to this issue, Ethan Rouen, PhD, an assistant professor at Harvard Business School, is exploring connections between wage disparity and company performance in a working paper titled "Rethinking Measurement of Pay Disparity and its Relation to Firm Performance."
Since 2018 is the first year public companies in the United States are required to disclose pay ratios between the CEO and employees, Dr. Rouen noted companies have a particularly important responsibility to justify the salary disparity.
Here are four takeaways from the report.
1. Dr. Rouen studied 931 companies in the S&P 1500 between 2006-13 using data from the Bureau of Labor Statistics. The data included total employee compensation and workforce composition. He found CEOs took home an average annual paycheck of $5.8 million while the average employee earned $42,000.
2. Dr. Rouen then determined the ratio of CEO compensation to mean employee compensation and analyzed how these measures of pay disparity affected future firm performance. He found companies with an unusually high unexplained CEO to average employee pay ratio saw their performance drop by as much as half when compared to peers with low levels of unexplained pay disparity.
3. As a result of these unexplained pay ratios, companies can suffer weak corporate governance, lower sales and higher employee turnover. "You have this high turnover, and that is incredibly costly because you have to search for new people and train them, plus you have a short-term decline in productivity," Dr. Rouen said. "If you're not making your employees happy and creating an environment where they're doing their best work, your firm is not going to succeed."
4. The study found as compensation at a company moved closer to expected levels based on economic factors, company performance increased. Dr. Rouen said companies should outline economic justifications for their pay ratios to investors and employees. Companies can indicate whether factors such as geography are contributing to pay differences. For example, an employee in New York City will be paid significantly more than a worker in rural Alabama due to cost of living differences.