한국생산성학회

It is not surprising that executives take more money than employees do. In recent years, however, great attention has been shown to the question of whether executive’s compensation is too much. Since the 1997 financial crisis, with the introduction of the U.S. compensation regimes, employees in Korean firms are expected to find the ever-increasing pay gap between executive and employees as unfair. So far, very little has been done in this direction. Therefore, this study’s main objective is to draw policy implications as to whether Korea’s pay gap is indeed justified and provides empirical evidence on employees’ incentives and behaviors with compensation-related managers, by examining how the pay gap between executives and employees affects firm productivity. In addition, by estimating managerial ability following Demerjian et al. (2012) and then exploring how the managerial ability affects the relationship between pay gap and firm productivity, this study investigates whether there are differences in employees’ perception over whether executives’ overpay is the pay they deserve. In light of the above, this study hypothesizes that pay gap between executives and employees makes a negative impact on firm productivity and that the negative effect is amplified in firms with low managerial abilities, and test the two hypotheses for firms listed on the KSE (Korean Stock Exchange) and KOSDAQ (Korean Securities Dealer Quotation). Using 17,731 firm-year observations listed on two Korean stock markets between 2002 and 2017, this study finds a negative relationship between pay gap (measured as the logarithm of the ratio of the annual average cash pay of executives to that of employees) and firm productivity (measured as sales per employees or total factor productivity). A tentative explanation for this result is that most employees in Korean listed firms believe that their executives’ pay is unjustifiably high. This sentiment seems to support the equity theory of Adams (1965) or the relative deprivation theory suggested by Crosby (1976) and Martin (1981) for Korean listed firms. Meanwhile, based on the managerial abilities of firms, this study reports that the negative effect of pay gap between executives and employees only occurs in low managerial ability firms. Employees in firms with low managerial ability may consider their executives’ overpay as unfair, while those in firms with high managerial ability accept the executives’ pay as deserving. This study conducts some additional tests. Two main findings remain robust in firm-fixed effect model to alleviate an endogeneity problem from omitted variable bias, in two-stage regressions using peer-firm pay gaps as an instrumental variable to consider a potential reverse causality, and in a dynamic panel data model of Arellano and Bond (1991) for controlling for inter-temporal persistence of firm productivity. Finally, this study tests whether main findings appear differently in subsamples divided into Chaebol and non-Chaebol firms and manufacturing and non-manufacturing firms. The negative effect of pay gap between executives and employees is pronounced for non-Chaebol firms or manufacturing firms than in Chaebol firms or non-manufacturing firms. Specially, this study finds the results that two hypotheses are supported in all subsamples except for Chaebol firms. This study first presents empirical evidence on the effect of pay gap between executives and employees on productivity of Korean listed firms. Furthermore, this study also contributes to useful evidence concerning the equity theory or relative deprivation theory by exploring how managerial ability is associated with the relationship between pay gap and firm productivity. The findings in this study may be used as reference for how pay for executives should be determined so as not to impede productivity and then as information to enhance productivity of Korean firms in pay-related decision makings considering managers’ abilities.