Effectively managing employee turnover is a primary concern for many companies, as they try to retain their most talented employees. Effective turnover management can be particularly important when it comes to the CEO’s top team, as their departure can often have a significant impact on overall company performance. A study of Standard & Poor’s 500 companies from 1994 to 2008 examined the impact of pay dispersion, pay disparity, and pay level relative to the market on executive turnover, and found that not only did these factors significantly impact turnover but that they interacted in interesting ways to increase or decrease turnover levels.
Key Topics: Executive compensation; Benchmarking; Pay disparity; Pay dispersion; Turnover
Title of Reviewed Article: Implications of Multiple Concurrent Pay Comparisons for Top-Team Turnover
Researchers: Jason W. Ridge (Clemson University), Aaron D. Hill and Federico Aime (Oklahoma State University).
Publication: Journal of Management, 2017, Vol. 43 No. 3, pp. 671 – 690.
Setting the Scene
Research indicates that employees compare their compensation with that of others, and their perceptions relating to the equitable distribution of pay affects their behaviour, such as that relating to motivation, performance, and intentions to leave (Messersmith et al., 2011; Shaw, Gupta, & Delery, 2002).
Top management reporting to the CEO have been shown to also be sensitive to these compensation comparisons, and studies have demonstrated that comparisons are made in respect to a number of referents, namely vertical referents (i.e. the CEO), internal horizontal referents (i.e. peers in the CEO’s top team), and external horizontal referents (i.e. peers in the external labor market) (Henderson & Fredrickson, 2001; Messersmith et al., 2011).
Given the importance of the CEO’s top team in company performance, these comparisons can have important ramifications. The present study examines how these three referral points affect turnover within the CEO’s top team, as prior studies have indicated that turnover can be sensitive to perceptions of compensation inequity (Carpenter & Sanders, 2004; Fredrickson, Davis-Blake, & Sanders, 2010).
Studies have generally shown that greater pay disparity relating to vertical referents can lead to reduced employee turnover (Lazear, 1989; Siegel & Hambrick, 2005), while greater internal and external peer pay dispersion can lead to greater turnover (Kepes, Delery, & Gupta, 2009; Wade et al., 2006), although how these factors interact and affect top management has received less attention.
The researchers examine a number of hypotheses relating to the perception of pay and turnover within the CEO’s top team:
Hypothesis 1 – “Pay dispersion within the CEO’s top team is positively related to turnover within the CEO’s top team.”
Hypothesis 2 – “CEO’s top-team pay disparity is negatively related to turnover within the CEO’s top team.”
Hypothesis 3 – “The relationship between pay dispersion within the CEO’s top team and turnover within the CEO’s top team will be moderated by CEO’s top-team pay disparity such that the positive relationship between pay dispersion and turnover within the CEO’s top team is weaker as pay disparity increases.”
Hypothesis 4 – “The relationship between CEO’s top-team pay disparity and turnover within the CEO’s top team will be moderated by the firm’s pay level relative to the market such that the negative relationship between CEO’s top-team pay disparity and turnover within the CEO’s top team is weaker as pay level relative to the market increases.”
How the research was conducted
Data for this study was collected from Execucomp in relation to compensation of CEOs and their top team from 350 companies in the Standard & Poor’s 500 from 1994 to 2008. Compensation data incorporated salary, bonus and long-term incentives.
For the purpose of this study, each company’s top team was categorised as the company’s four highest-paid non-CEO executives.
Further information relating to control variables, such as company size and CEO tenure, were sourced primarily from Execucomp and Compustat.
Based on the data collected, turnover of executives in the CEOs’ top teams was also assessed.
Pay dispersion was calculated by dividing the standard deviation of the CEO’s top team compensation by the average compensation of the CEO’s top team. Pay disparity was calculated based on the difference between CEO compensation and average compensation of the CEO’s top team.
Pay level was determined by comparing the average compensation of the CEO’s top team with average compensation of top teams in the focal company’s industry.
Key Research Findings
Pay dispersion was found to be positively related to turnover of members of the CEO’s top team, with higher pay dispersion leading to increased turnover. This finding supports Hypothesis 1.
Support was also found for Hypothesis 2, with the results indicating that pay disparity is negatively related to turnover among members of the CEO’s top team, such that a higher pay gap between the CEO and their top team leads to lower turnover amongst members of the CEO’s top team.
Higher levels of pay disparity were found to reduce the turnover effects of pay dispersion on top-team members, providing support for Hypothesis 3.
Support was also found for Hypothesis 4, with a significant moderating effect found in a company’s pay level relative to the market on the relationship between CEO’s top team pay disparity and turnover in the CEO’s top team.
The results of this study confirm that pay dispersion, pay disparity, and pay level relative to the market are all relevant factors in the turnover of senior executives. Higher pay dispersion related to greater turnover, suggesting that greater feelings of pay inequality with close peers led to dissatisfaction and on to turnover. Greater pay disparity with the CEO on the other hand led to reduced turnover, suggesting that the CEO’s top team view high CEO compensation as indicative of a bigger prize that they may receive if they were promoted to CEO, and therefore are more likely to stay.
Furthermore, these factors were found to interact in effecting turnover, indicating that executives use multiple pay referral points, both within the company and externally, when considering whether to leave their current company or not. Pay disparity, for example, was found to reduce the effect of pay dispersion on turnover, while higher pay levels relative to the market reduce the pay disparity effect on turnover. These results are consistent with prior research that indicated the interactive effect of pay level and pay dispersion (e.g. Messersmith et al., 2011).
Organizational and Reward Implications
This study highlights the complex and multifaceted relationship between executive turnover and compensation, and illustrates some of the challenges in designing appropriate compensation strategies for executives in order for companies to retain them.
In determining compensation for executives, companies should take account of direct internal and external peers, as well as those at the next level in the hierarchy, where these executives aspire to progress to. Not only do pay dispersion, pay disparity, and pay level individually impact turnover, but they also work together to affect the behaviour of executives, and failure to address these factors appropriately is likely to lead to greater turnover.
Furthermore, companies should consider these factors in the determination of compensation at other levels within their company, as similar behavioural mechanisms are likely to hold, with employees looking across a number of referral points in determining satisfaction with their own compensation. This study indicates that companies that minimize pay dispersion amongst peers, while creating greater disparity across hierarchical levels will likely gain the greatest employment stability.
This study illustrates the importance of multiple compensation referral points, both internal and external, in employee turnover, and due to the comprehensive nature of this study, the results are generalizable across multiple industries. While this study focused on turnover specifically, future research would benefit from examining the role of pay dispersion, pay disparity, and pay level in other employee behaviours, such as performance.
Source Article: Ridge, J. W., Hill, A. D., & Aime, F. (2017). Implications of Multiple Concurrent Pay Comparisons for Top-Team Turnover. Journal of Management, 43(3), 671 – 690.
Published by: Southern Management Association
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