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| The Intra-Firm Pay Gap and the Adjustment of Human Capital |
| YANG Wei,KONG Dongmin
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School of Business, East China University of Science and Technology;
School of Finance, Zhongnan University of Economics and Law;
School of Economics, Huazhong University of Science and Technology |
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Abstract Summary: Although human capital theory was a revolutionary and controversial concept when it was first proposed in the 1960s, it has evolved into one of the most universally accepted research objects in economics and other social sciences.The research on human capital and economic consumption has mainly been conducted at the theoretical or macro levelusingfactors such as economic growth, the wage contract, and life cycle. In contrast, studies from a micro perspective focus on the returns from investments in private education and health. As a result, little firm level research is available. Moreover, in recent years, the pay gap between executives and employees has attracted significant attention from the media, the public, and the government. For example, in January 1, 2015, the Chinese government implemented a salary reform scheme for central enterprise principals, targeting around 200 executives from 72 SOEs.This reform reducedthe executive-worker pay ratio to about eight times. However, further research is needed on the economic consequences of the intra-firm pay gap between executives and employees.
In this paper, we examine the impact of the pay gap between executives and employees on the human capital structure of firms. Research has shown that the intra-firm pay gap has a significant influence on firm performance and productivity, and that this influence originates from the incentive effect of the pay gap on different levels of employees.We argue that the firm pay gap can affect the human capital structure of a firm by altering the incentives of both managers and employees. We use two competing theories to describe the economic incentives of pay gaps: tournament theory and comparison theory.In addition, we usethe economic theories of matching and managerial talent to explain some of our results. Practically, firms match the various abilities of managers by designing different pay policies. Moreover, different compensation contracts provide different choices for employees with different levels of education. Therefore, it is important to investigate how the pay gap affects the human capital structure of firms.
We manually collect education data on the employees of Chinese listed firms from 2000 to 2015. Specifically, we classify human capital into three types: high education employees, medium education employees, and low education employees. We use the ratio of the average managers' compensation to the average employees' salary to measure the intra-firm pay gap. We obtain financial data and corporate governance information about the listed firms from the China Stock Market and Accounting Research (CSMAR) database and the WIND database. We also exclude firms from the financial industry.Our analyses generate the following findings. First, a firm's pay gap reduces the ratio of bachelor degree employees, and increases the ratio of employees with low education. Second,using an instrumental variable approach and a scenario analysis of the global economic crisis, we find that the pay gap has a causal impact on the human capital structure of firms. Third, for firms with a small pay gap,enlarging a firm's pay gap significantly increases the ratio of employees with a low education, whereas it reduces the ratio of employees with a mid-level education. A possible explanation for this is that employees with different levels of education have different degrees of bargaining power. However, for the firms with a high pay gap, increasing the pay gap has a positive effect in attracting employees with a high level of education who maybe future managers. Fourth,the relation between a firm's pay gap and the changes in the human capital structure are more salient in firms that are large or employ young executives. Finally,human capital has a significant mediating effect on the relationship between a firm's pay gap and innovation, which suggests thata high pay gap increases the ratio of highly educated employees and thus leads to more innovation.
This paper makes three contributions to the literature. First, we measure firms' human capital using their employees' educational data, and thus are able to provide direct evidence of firms' human capital. Second, we examine the effects of the intra-firm pay dispersion on the structure of human capitalat the firm level, which provides a relatively new angle for uncovering the economic consequences of the intra-firm pay gap. Third, our findings provide clear policy implications by showing the relationship between the pay gap and a firm's human capital structure.To match the human capital structure to the development of firms, policy makers need to designan effective compensation system.
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Received: 22 August 2017
Published: 27 June 2019
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