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The need for coordinated decision making bears on the pay gap between a firm's CEO and its other top executives. A behavioral view suggests that because more equal pay promotes collaboration, greater coordination needs encourage smaller pay gaps, and the combination of greater needs and smaller gaps enhances firm performance. An economic view implies the opposite because larger gaps create tournament-like incentives that address monitoring problems associated with joint decisions. We found that although economic theory was a better predictor of the size of CEO pay gaps, there was a balance between the economic and behavioral views as predictors of firm performance.
Managers are usually paid more than their subordinates, even those who are outstanding managers themselves. Midlevel managers, for instance, are paid more than frontline supervisors, and CEOs are paid more than other senior executives. Behavioralists and economists have radically different views of such across-rank pay gaps, particularly when they look at contexts in which coordinated decision making is required. Behavioralists contend that large pay gaps undermine coordination by creating feelings of relative deprivation among subordinates (Cowherd & Levine, 1992; Martin, 1981) and by establishing strong temptations for subordinates to sabotage their coworkers to win promotion (Dye, 1984; Milgrom & Roberts, 1988). In contrast, economists focus on problems with shirking and free riding that arise when joint work efforts make it hard to distinguish individuals' marginal contributions. They contend that when substantial coordination is required, large pay gaps are beneficial because they provide strong, tournament-like incentives that retain their potency even though monitoring individual efforts is impractical (Lazear & Rosen, 1981; Rosen, 1986).
This study addressed these conflicting ideas about across-ranks pay gaps. First, we identified specific conflicts between the economic views embodied in tournament theory and the behavioral views embodied in theories of relative deprivation, organizational politics, and allocation preferences. Second, we developed several pairs of rival hypotheses that put those theories to a stringent competitive test. Other studies have discussed general tensions between economic and behavioral views (e.g., Bok, 1993; Main, O'Reilly, & Wade, 1993; Siegel, 1996), but none has rigorously tested them head-to-head. To do so, we believed that it was critical to assess multiple pairs of rival hypotheses to determine if (1) a clear, consistent winner emerged, (2) opposing...