AAA Spark Meeting of the Regions

Investors’ Judgments of Vertical Pay Disparity: The Role of Executives' ESG-Based Compensation and Investor Orientation

• In Event: Environmental, Social, & Governance

Abstract

To incentivize their executives to focus on environmental, social, and governance (ESG) initiatives, many companies have started to incorporate these ESG initiatives, particularly initiatives related to diversity, equity, and inclusion (DEI initiatives), into their executives’ compensation plans. While advancing DEI initiatives may be favorably embraced, there is little evidence about how investors respond to increases in vertical pay disparity resulting from executives’ financial incentives to advance diversity. We draw on the theories of distributive fairness and corporate hypocrisy to predict that investors will respond negatively to a diversity initiative in CEO compensation if vertical pay disparity subsequently increases. Additionally, we predict that such effects will be moderated by investors’ perspective of whether companies are primarily responsible to only their shareholders or all stakeholders (i.e., shareholder versus stakeholder orientation). To test our predictions, we conduct an experiment in which we manipulate the type of initiative that the company includes in its executives’ compensation (DEI initiative, business initiative, or no initiative) and the resulting year-over-year change in the vertical pay disparity (increase or no change in vertical pay disparity). We find that investors respond negatively to increases in vertical pay disparity resulting from accomplishing DEI initiatives in CEO compensation. We also find that stakeholder-oriented (compared to shareholder-oriented) investors respond more negatively to increases in vertical pay disparity resulting from DEI initiatives than business initiatives in CEO compensation. This study extends prior research on vertical pay disparity by showing that the cause of pay disparity influences investors’ reactions. Our results inform companies about the unintended consequences of including ESG initiatives in executive compensation plans.

Authors

• Ling Lin Harris, University of Nebraska–Lincoln

• Bret Sheeley, University of Nebraska–Lincoln