Executive compensation has gained increased attention from regulators and academia in recent years. Executive compensation is pivotal in mitigating agency problems and is considered agency cost in corporate governance (Edmans et al., 2017, Flammer et al., 2019). Jenter and Frydman (2010) and Goh and Li (2015) argued that CEO compensation has grown significantly and appears to be one of the significant drivers of intra-corporate pay disparities since the 1970s. Otten (2008) and Baeten et al. (2011) argued that executive compensation literature has three main parts: value, agency, and symbolic approaches. In the existing literature, corporate governance research mostly used the value and agency approaches to reflect on the executive role, pay levels, and structures (Dasgupta et al., 2021, Edmans et al., 2017). A symbolic approach that challenges the tournament and social comparison theories might provide a relevant framework to study the link between the CEO-to-Employee pay ratio, say on pay votes and CEO compensation. Amore and Failla (2020) found that executive pay dispersion worked as a double-edged sword. They further documented that more dispersion in variable pay leads to more innovation, while more in fixed pay leads to lower innovation.
The CEO is the most crucial figure in an organisation (Bebchuk & Fried, 2004). Drawing on the perspective of a socially constructed symbol (Otten, 2008), two theories can underpin the possible outcomes of the CEO-to-Employee pay ratio and say on pay votes and their associated effects on executive compensation. On the one side, the tournament theory (Lazear and Rosen, 1981) suggests that remuneration is the outcome of an internal competition to reach the firm's top, and CEOs are the ultimate winners. Their compensation reflects the intensity of the competition and demonstrates their superior ability and skills for the position. It also depends on the number of tournament participants (Eriksson, 1999). Consequently, pay is seen as a prize and reflects the tournament’s outcome (O'Reilly III et al., 1988).
The advocates of the tournament theory argue that compensation an(Bebchuk and Fried, 2004). Similarly, Baker et al. (1988) argued that compensation is primarily independent of performance, and traditional economic theory cannot expound it. (Amore and Failla, 2020)Under this perspective, the CEO-to-Employee pay ratio contributes to mitigating the agency problem by aligning the interests of shareholders with CEOs (Baeten et al., 2011, Waheed and Malik, 2019, Butt et al., 2022, Hashmi et al., 2023). Investors might not see the CEO-to-Employee pay ratio as a material indicator affecting the long-term health of the firm or pay gaps as fair because it is a natural outcome of an internal logic that rewards tournament participants based on their hierarchical position and contribution to the firm’s success (Bebchuk et al., 2011). Though there is no consensus in the executive compensation literature regarding the effects of the CEO-to-Employee pay ratio on firms, some scholars find that a high pay ratio has a positive impact on firms’ financial performances (Cheng et al., 2017, Faleye et al., 2013, Sinha and Shastri, 2023, Tripathy and Uzma, 2022). In addition, the existing literature on say on pay voting provides robust empirical evidence towards an increase of shareholder dissent votes when firms experience poor financial performances and following a reduction in CEO compensation (Ertimur et al., 2013, Ferri and Göx, 2018). These empirical studies help to apprehend the latent reaction of shareholders to pay disparities and propose that they might not have incentives to vote against the CEO compensation package, and the effect might not be observable in the CEO compensation the following year.
On the other hand, the social comparison theory proposes that members of the compensation committee design the executive compensation packages by comparing the CEO pay with their own and with one of the peer CEOs evolving in the same business environment (Otten, 2008). This approach is consistent with Festinger's theory of social comparisons that arises from humans having the drive to evaluate their opinions and abilities (Festinger, 1954). One possible way is to compare one's opinions and abilities with others with similar characteristics and who are considered slightly better or more expert (O'Reilly III et al., 1988). Consequently, executive compensation depends on normative judgment (Otten, 2008), mainly independent of performance and skills (Baker et al., 1988). Drawing on this perspective, a high CEO-to-Employee pay ratio can increase agency costs because of misaligning the interests of CEOs with shareholders. Therefore, excessive pay disparities might harm collaboration and trust needed for business success in the long run by undermining employees’ motivation (Behrens and Patzelt, 2018, Benedetti and Chen, 2018).
Several scholars found the adverse effects of significant pay gaps on performance (Rouen, 2020, Mahmoudian and Jermias, 2022), firm innovation (Amore and Failla, 2020) and employees morale, productivity and turnover (Benedetti and Chen, 2018, Georgellis et al., 2019). Kelly and Seow (2016) found that incrementally disclosing a higher-than-industry pay ratio (versus disclosing only higher-than-industry CEO pay) significantly decreases perceived CEO pay fairness. These empirical studies show that shareholders might have incentives to vote against the CEO compensation package, and the effect might not be observable in the CEO compensation the following year. On the other hand, the investors might see the CEO-to-Employee pay ratio as a material indicator affecting the firm's long-term health or perceive pay gaps as unfair because it results from a biased assessment of the CEO's contribution firm's success that might be financially detrimental to all stakeholders.
Hypotheses development
The existing empirical studies on CEO compensation and say on pay votes show that shareholders might react adversely to excessive CEO pay (Mahmoudian and Jermias, 2022). Ertimur et al. (2013) reported a positive relationship between CEO compensation and say on pay votes on a sample of S&P 1,500 companies. Similarly, Conyon (2015) reported a positive relationship between CEO compensation and, say on pay votes on a sample of S&P 1,500 companies. Nevertheless, little is known concerning their reaction to pay disparities between the CEO and employees. Crawford et al. (2021) explored the banking industry using different proxies to measure pay disparities. Their study shows the potential positive association between the CEO-to- Worker pay ratio and shareholder dissent votes. Though the approach of shareholder wealth maximisation has prevailed for more than forty years (Davis, 2005), this is now highly debated because it might narrow the quest of shareholder interests to maximise returns in the short term (Belinfanti and Stout, 2017). The scholars have proposed a shared value approach, where each stakeholder has equal importance, which might be more appropriate and profitable in today's business context (Porter and Kramer, 2011, Shaffer, 2009, Orazayeva and Arslan, 2022, Arslan and Alqatan, 2020). Scholars also argued that shareholders increasingly understand the adverse effects that environmental, social, and government issues could exercise on their investment, particularly income inequality, and the opportunities provided by shared value maximisation (Abeuova and Alqatan, 2021, Arslan, 2020, Grewal et al., 2016). Consequently, the shared value nascent stream is consistent with the social comparison approach, where the CEO-to-Employee pay ratio is a valuable financial metric to shareholders. Therefore, the following hypothesis is proposed:
Hypothesis 1
The higher the CEO-to-Employee pay ratio, the more shareholder dissent votes are likely to occur.
Kelly and Seow (2016)The existing evidence from management and organisation fields shows that value discordances between broader society and businesses could threaten the reputation and legitimacy of firms with subsequent financial effects (Dowling and Pfeffer, 1975, Zimmerman and Zeitz, 2002). In addition, the study of Kelly and Seow (2016) conducted a study by drawing a sample from 75 MBA students. They found that the pay ratio disclosure might shame firms with significant income disparities, pushing them to reduce their CEO pay. Consequently, significant pay disparities that affect the reputation and question the legitimacy of companies, are negatively seen by shareholders and may push them to vote against the executive compensation package the following year. Thus, we propose the following hypothesis:
Hypothesis 2
A higher Pay Gap Opposition, the ratio between shareholder dissent votes and the CEO-to-Employee pay ratio, will likely decrease future CEO compensation.
Shaffer (2009) and Arslan and Alqatan (2020) argued that the wealth maximisation goal of firms could emasculate the welfare of other stakeholders because corporations might try to influence policymakers to shape the legal framework in their interests. In addition, Marti and Scherer (2016) argued that theorists in the organisational theory and management fields claim that today's financial regulation only focuses on two pillars that are efficiency and stability while ignoring social justice and fairness. The CEO-to-Employee pay ratio disclosure rule has all the characteristics of an inclusive financial regulation by combining these three pillars. Porter and Kramer (2011) argued that this is consistent with a shared value approach that gives equal importance to shareholders and other stakeholders such as the employees and civil society.