Income inequality in S&P 500 companies

Abstract Income inequality in the United States has grown significantly in the last decades and has been drawing a lot of attention from the media, public, and academia. One important argument on this epidemic is that executive compensation and financial-sector pay have driven the income inequality. In this paper, I create a simple metric to calculate the CEO-to-worker compensation ratio, called the “Pay Ratio”, and examine its relation to the firm performance and pay-performance sensitivities (PPS). I also evaluate the impact of CEO ability on such associations, which is frequently used as a justification for high pay ratios. The findings suggest that the Pay Ratio and firm performance are positively associated, however only when you pay more to a high-ability CEO. In addition, PPS and Pay Ratio is also positively associated, again only with a high-ability CEO. Interestingly, I find that PPS weakens when a low-ability CEO is paid more. Also, the positive association between Pay Ratio and firm performance weakens with a chair-CEO, proving the value deteriorating impact of expropriation. Findings promise to shed light to the ability-entrenchment question in the executive compensation literature. Overall, I suggest that how much more CEOs are paid compared to the workers actually matters and CEO ability plays a key role on how the ratio affects the firm.