Entrenchment or Efficiency? CEO-to-Employee Pay Ratio and the Cost of Debt

Abstract

Using new data on S&P 1500 firms’ chief executive officer (CEO)‐to‐employee pay ratios disclosed by mandate of Section 953(b) of the Dodd–Frank Act, we examine the effect of within‐firm pay inequality on bond yield spreads. We find a significant negative relation between industry‐adjusted CEO‐to‐employee pay ratio and yield spreads while controlling for covariates and endogeneity. This result is strongest in financially constrained, labor‐intensive, and small‐to‐medium‐sized firms. The evidence supports the incentive‐provision explanation of CEO‐to‐employee pay disparity, reflecting efficient CEO compensation rather than rent extraction. We also document selection bias in self‐reported pay ratios, highlighting the efficacy of the Dodd–Frank provisions