The Consequences of Pay Dispersion on Employee Perceptions and Productivity

The recent Pay Ratio Disclosure mandated by the SEC under the Dodd-Frank Act requires the calculation of the ratio of total annual compensation of the CEO to the total annual compensation of the median rank-and-file employee. The Pay Ratio disclosure is a novel source of information about firm-level vertical pay dispersion. Contemporaneous research on pay dispersion evaluates the direct relationship between pay dispersion and future firm performance or capital market reactions. This paper contributes to the literature by investigating whether employee perceptions are a potential pathway for the relationship between pay dispersion and firm performance. I find that high levels of vertical pay dispersion within a firm are negatively associated with employee perceptions of a firm and labor productivity. I find that higher performance-based variable compensation moderates the negative perceptions and reduced labor productivity associated with high levels of vertical pay dispersion. I also find support for the hypothesis that the Pay Ratio Disclosure is incrementally (and in some cases relatively) more informative than existing disclosures about Executive Compensation with respect to employees and therefore also for researchers interested in the effects of pay dispersion on employees