The Wall Street Journal reports that the pay gap between CEOs and rank-and-file workers at big American banks has narrowed in recent years. However, the leaders still made 124 times the average worker’s salary in 2014. The heads of five top banks made $18.5 million on average.
The huge pay packages of major players in the corporate and financial worlds are the subject of a lot of outrage, but they’re also a matter of great interest to economists and management researchers. Why would for-profit organizations, which generally try to keep costs as low as they can, pay so much to an individual employee?
In a 2004 paper for Organization Science, business administration researchers Henry L. Tosi and Thomas Greckhamer write that most studies of CEO compensation have been based on US companies. These may have interesting findings—for example, one paper found that the pay of compensation committee members predicted CEO pay better than factors like firm performance, suggesting that social comparisons might matter more than economic variables. But, since they make comparisons mainly among American corporations, these studies can’t look at the effects of US culture on pay packages.
Tosi and Greckhamer went looking for ways that cultural differences between countries could account for differing CEO pay levels. They used the work of Dutch social psychologist Gerard Hendrik Hofstede to quantify several cultural variables for different countries. For example, the US is highly individualistic while Japan is much more collectivist, and France is much more accepting of power differences between people than Israel or Sweden. Controlling for national wealth, tax rates, and laws on corporate governance, the researchers mapped the cultural data and CEO compensation levels from 23 countries.
Tosi and Greckhamer found that strong individualism and high acceptance of power differentials both predicted high total CEO pay. They suggest that companies in more individualistic nations may focus more on rewarding individual achievement and assign more responsibility for success or failure to the CEO. Meanwhile, organizations in societies that accept large power differences are likely to be more hierarchical, and CEOs in these societies may have a greater psychological need for power, as manifested in greater wealth.
Both acceptance of power differences and “masculinity”—how much value a culture places on assertiveness, focus on achievement, materialism, and sex differentiation in jobs—predicted large pay gaps between CEOs and low-level employees. Tosi and Greckhamer suggest that more masculine cultures value ego goals over social goals, making big differences in pay more acceptable.
The biggest takeaway from this paper may not be the specific links between particular cultural characteristics and CEO pay but the fact that these connections exist at all. If culture is demonstrably important to compensation, crude popular-economic models in which compensation is set by the magic of the free market are missing a lot of what’s going on.
