Too large a pay gap between leaders, workers impacts performance

'Offering executives the right level of compensation is a tricky balancing act'

Too large a pay gap between leaders, workers impacts performance

While there has been plenty of talk in the past about compensation gaps between executive and employee salaries, a new study out of the U.K. is proving that too large of a chasm will actually harm performance.

“It’s important for companies to not only pay well but to avoid too large a pay gap between the executives and employees,” says Guanming He, associate professor at Durham University in the U.K.

“This is not to say that we should not pay the executives well; we should pay the executives well but, in the meantime, try our best to avoid the pay gap. This will serve all the parties’ best interests.”

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 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.”

While higher executive pay relative to employee pay could encourage executives to work hard to improve corporate performance, too large a pay gap between executives and employees could impair employees’ morale and harm firm performance, find the researchers.

The study, “How do executive pay and its gap with employee pay influence corporate performance? Evidence from Thailand tourism-listed companies,” used both short-term and long-term pay structures including both salaries and bonuses and is running in the Journal of Hospitality and Tourism Insights.

What is ideal?

That optimal gap depends on many factors so it is extremely complicated to get correct, says He.

“How to define ‘too large’ really depends from case to case,” he says. “We can resort to some statistics to figure out what is optimal but this estimated optimality is inevitably subject to estimation errors.”

It is up to leaders to have a sense of what is too large, he says.

“Competent managers are supposed to be able to infer what level of the pay gap is regarded as too large for the firm that will harm their firm performance.”

Guanming He

When it comes to figuring out what to pay certain classes of employees, this will involve some negotiations, says He.

“When we measure the contribution, we see the past performance experience and their qualification and the ability, so on and so forth and also the outcome of the work could be evaluated. If the employees are in charge of sales, then we can use the volume of the sales, that is quite straightforward, there’s no controversy. But the controversy is how to share the pie between the sales managers and the sales employees; there’s some tricky points that are subject to negotiation.”

The message to boards of directors is clear, according to He.

“One thing is sure: If the gap is too large, the overall performance will decrease so the relationship between the pay gap and the firm performance firstly increases and then decreases. That is the qualitative message to the compensation committee and the executives.”

The tough labour market could equal to higher compensation in 2022, according to one survey and almost 90 per cent of workers asked in another survey said how they were treated as workers matters more than pay.

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