Pay disparity and firm performance in Korea

Abstract

This study investigates the effect of large pay disparity between executive and employee on firm performance and explore the underlying cause of the result. In this study conducted for Korean publicly traded companies, I find that pay multiple is negatively associated with subsequent firms operating and stock return performance. In general, there are a couple of main explanations on this result in prior literature. One is that large pay disparity harms employee morale and the other is that large pay disparity is a manifestation of management rent extraction. In this regard, I find that the relation between pay multiple and proxies for employee morale is statistically insignificant, suggesting that the first explanation is not supported empirically in Korea. As an alternative explanation, I examine whether the adverse effect of large pay disparity is because it implies the prevalence of management rent extraction. In result, I find that the level of executive pay is negatively associated with subsequent firm performance, and this result remains unchanged when replacing the level of executive pay with excess executive pay. To ascertain the robustness of the result, I additionally examine how the predicted component of executive pay arising from governance structure affect firm performance following Core et al.(1999). Consistent with the result of main test, I find that the predicted executive pay arising from board structure is negatively associated with subsequent firm performance. Taken together, my findings imply that to address the adverse effect of large pay disparity in Korea, regulators and corporate sector should focus on mitigating the agency problem rather than simply decreasing the pay gap itself.