Performance Consequences of Pay Dispersion within Top Management Teams: The Impact of Firm Collaboration Needs

Abstract

According to tournament theory, the compensation gap between CEO and the top management team members provides incentives for lower-level executives to strive for promotion. However, equity theory argues that large pay dispersion leads to perceptions of inequity and has negative side effects on the firm`s cooperative atmosphere and organizational performance. These two contradicting theories motivate us to investigate whether the incentive effect of pay dispersion among top management teams will be dependent on the degree of firm collaboration needs. In this paper, we employ two methods to measure pay dispersions among top management teams. One measure of pay dispersion is the coefficient of variation in compensation of top management teams, and the other is overpayment and underpayment of executives. Both measures show that the degree of firm collaboration needs has a negative impact on the incentive effect of pay dispersion. This result suggests that firms with higher collaboration needs should cautiously consider the negative impact of pay dispersion.