Member Article

A large pay gap between executives and employees negatively affects firm performance

Too large of a pay gap between executives and the employees of a company negatively affects employees’ morale and therefore harms the firm’s performance, according to new research from Durham University Business School.

However, the study also found that higher executive pay relative to employee pay could encourage executives to work hard to improve corporate performance as well.

This research was conducted by Laurence Ferry and Guanming He, Professors of Accounting at Durham University Business School, together with Chang Yang, a visiting academic of the Business School. They investigated how executive pay and its gap with employee pay specifically influence corporate performance in the tourism industry.

In order to investigate this link, the researchers manually collected data on the executives’ and employees’ remunerations for tourism listed companies in Thailand and analysed its impact on corporate performance.

The researchers reviewed both short-term compensation - salaries and bonuses - and long-term compensation - pension and other deferred compensation which includes social security, provident funds, and retirement benefits.

For these tourism companies, the researchers found that the gap between executive and employee wages can have a huge impact, both positively and negatively, on firm performance.

The researchers describe the impact as a reverse U shape, showcasing that the gap can ensure executives work tirelessly to boost performance, but also that employees can hinder performance through their low morale and increasing conflicts.

“Compensation is an essential issue for corporate governance as it influences the performance and growth of a firm. However, offering executives the right level of compensation is a tricky balancing act,” says Professor Guanming He.

“On one hand, it acts as an incentive for talented executives to further contribute to firm performance, but on the other hand, it can negatively affect the employees’ morale, dedication, and creativity and thereby lower the productivity and performance of a firm.”

Managing employees’ wages and therefore their morale and motivation can be difficult for companies, and firm’s must constantly monitor, ensuring that they are making the right decisions to successfully boost firm performance, say the researchers.

“Fair compensation is a key dimension in measuring organisational culture, which is one of the most significant attributes for tourism companies’ success”, says Professor Laurence Ferry. “Ensuring that all employees have an appropriate salary will help a firm to build a harmonious organisational culture, which is more likely to ensure the company performs effectively.”

This study shows to boards of directors and compensation committees of tourism firms the importance of avoiding too large a pay gap between executives and employees, and ensuring all employees are considered when executive pay rises. While the pay for executives to incentivise them to serve their company better is crucial, it is also crucial to lift the pay for all employees as well, say the researchers.

This was posted in Bdaily's Members' News section by Durham University .