Equity Market Reaction to Pay Dispersion: Evidence from CEO-Worker Pay Ratio Disclosure

Starting in 2018, U.S. public companies are required to disclose the ratio of CEO to median worker pay, providing the first opportunity to examine equity markets’ reaction to within-firm pay dispersion. We find a negative market reaction to firms disclosing high pay ratios. Additional evidence suggests that equity markets “dislike” high pay dispersion independently of high CEO pay or low worker pay. In the cross-section, firms whose shareholders have stronger prosocial preferences experience a significantly more negative market response to high pay ratios. Consistent with investors’ prosocial preferences moderating the initial market reaction, we find that during 2018 investors with stronger prosocial preferences rebalance their portfolios away from high pay ratio stocks relative to other investors. Overall, our results suggest that investors’ prosocial preferences, in particular with respect to within-firm pay dispersion, is a channel through which high pay ratios negatively affect firm value.