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| The Internal Pay Gap and Firm Value:New Exploration Based on Life Cycle Theory |
| LIANG Shangkun, ZHANG Yu, WANG Yanchao
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| School of Accountancy / China's Management Accounting Research &Development Center, Central University of Finance and Economics |
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Abstract Firm operating efficiency is important to the whole economy, and clarification of the compensation distribution relationship between managers and ordinary employees under given resources has become an important issue.
There are two opposing theories on the relationship between the internal pay gap and firm value: tournament theory holds that expanding the internal pay gap is conducive to improved organizational performance (Lazear and Rosen 1981; Rosen 1986), whereas behavioral theory holds that this pay gap is not fully conducive to cooperation, and thus reduces organizational performance (Cowherd and Levine 1992; Carpenter and Sanders 2004). Arguments against and evidence for these two views appear in various studies (Pfeffer and Langton 1993; Williams et al. 2006; Lin et al. 2003; Zhang 2008; Liu and Sun 2010; Zhao 2012; Li and Hu 2012). This controversy prompts us to consider whether it is partly due to heterogeneous effects of the internal pay gap in different situations.
With this in mind, this study explores the question from the perspective of the firm life cycle. The life cycle is an important characteristic of a firm, and studies show that it greatly affects a firm's investments, financing, distribution, and other behavior (Anthony and Ramesh 1992; Bens et al. 2002; DeAngelo et al. 2006; DeAngelo et al. 2010; Hribar and Yehuda 2015). At different life cycle stages, managers and employees face different responsibilities and pressures; therefore, the same internal pay gap may produce different results.
Using a sample of A-share firms listed on the Shanghai and Shenzhen Exchanges from 2005 to 2014, we study the impact of firm life cycle on the relationship between the internal pay gap and firm value. We find that (1) the internal pay gap is conducive to overall firm value, which is consistent with tournament theory, (2) the promotion effect is strongest in the growing stage and weakens as the life cycle progresses, and (3) the main mechanisms are the importance of managers to firm performance and employee demand for equity. The above findings remain stable with other life cycle measurements.
The study makes three contributions. First, it shifts our understanding of the relationship between the internal pay gap and firm value from a static to a dynamic perspective. While examination of the internal pay gap and firm value has a long history, the literature has mainly taken a static approach (Zhang 2008, etc.), and ignored the dynamic impact of the internal pay gap at different stages of development. Based on the life cycle theory, this study predicts and finds that the internal pay gap has heterogeneous effects on firm value at different stages of the life cycle. It effectively links tournament theory and behavioral theory through the life cycle theory, placing them within a consistent discussion framework, with additional exploration of the mechanisms involved.
Second, although scholars have studied manager incentives in depth, this study emphasizes the importance of ordinary employees, who have received little attention in the past. Firm performance is a function of the productivity of both managers and ordinary employees, and the role of the ordinary employee should also be considered (Chen et al. 2015). Our findings show that in the actual compensation formulation, especially for mature firms and those in recession, the interests of ordinary employees need to be considered, and setting a reasonable pay gap is conducive to improved firm value. For the large number of firms newly listed on the Small and Medium Enterprise (SME) Board and Growth Enterprise Market (GEM) in China, managers should also be given sufficient reward for their efforts. Thus the findings of this study provide some theoretical references for the reform of income distribution.
Third, this study provides some guidance for research methods in future research. Unlike previous studies that rely on a single life cycle measurement method (Zhao and Sun 2005; Cao et al. 2010; Li et al. 2011; Li and Li 2012; Dong and Mao 2013; Luo and Li 2015), this study uses several life cycle measurement methods, including the comprehensive scoring method, retained earnings method, and enterprise-industry growth method, allowing for more stable conclusions and opening opportunities for future research in this field.
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Published: 29 April 2019
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