Do Board‐Level Employee Representatives Increase Pay Equity in Firms?

• Published date: 01 November 2024
• Author: Amirhossein Fard,Chune Young Chung
• Date: 01 November 2024
• DOI: http://doi.org/10.1111/corg.12608

Corporate Governance: An International Review, 2024; 32:1110–1132

https://doi.org/10.1111/corg.12608

Corporate Governance: An International Review

ORIGINAL ARTICLE OPEN ACCESS

Do Board- Level Employee Representatives Increase Pay

Equity in Firms?

AmirhosseinFard1 | C huneYoungChung2

1FIREL De partment, G. Brint Ryan Col lege of Business, Universit y of North Texas, Denton, Texas , USA | 2School of Busine ss Administration, C ollege of

Business and Ec onomics, Chung- Ang University, Seoul, S outh Korea

Correspondence: Chune Young Chung ( bizfinance@cau.ac.kr)

Received: 26 August 2022 | Revised: 19 June 202 4 | Accepted: 25 June 202 4

Keywords: board- level employee representation | CEO compensation | cor porate governance | employee wa ge | pay gap

ABS TRAC T

Question/Issue: This st udy investigates the role of board- level employee representatives (BLERs), a common corporate govern-

ance practice in Europe, in determ ining the pay ratio between CEOs and average employees.

Research Fi ndings/Ins ights: Using 15,34 0 firm- yea r observations from 17 European countr ies between 2001 and 2 019, we

find that BLERs prov ide greater bargaining power to the board for deal ing with CEOs and use this power to reduce the pay gap

between CEOs and employees. Subsa mple analyses indicate that bargaining power is more appar ent when BLERs are more so-

cially connected, have longer tenure, and hold more seats on the boa rd.

Theoretica l/Academic Implic ations: This st udy supports the role of BLERs in provid ing workers with more bargaining

power to create fairer wage d istribution in firms. Fur thermore, it supports the fair wage–ef fort theory, indicating a positive effect

of lower pay ratios on firm value following t he presence of BLERs.

Practit ioner/Policy Implicat ions: This study demonstrates the ef fects of a unique corporate governance practic e, the presence

of BLERs, on companies' wa ge distribution, with signi ficant policy implications. In pa rticular, the results indicate t hat when

presented with opportunities in a ffecting companies decision- making BLERs provide fairer environ ments for the workers who

they represent.

Fair pay within companies matter s; it affects

productivity, employee engagement and trust in our

businesses.

Joseph Stiglitz (The Price of Inequalit y,2012)

1 | Introduction

In the early 1970s, many Eu ropean countries began implement-

ing co- determination laws requiring the presence of labor (i.e.,

employee representatives) on boards of directors. Thes e laws

exist in various forms a cross European countries, ranging f rom

stringent regulations to voluntar y adoption based on mutual

agreements between employers and employees. Although the

extant literature has docu mented how board- level employee

representatives (BLERs) shape fi rms' financial levera ge (Lin,

Schmid, and Xuan2018), corporate payout policies (Ginglinger,

Megginson, and Waxin2011) and job security dur ing an indus-

try downturn ( Kim, Maug, and Schneider2018), their role is not

yet fully understood. Ba sed on this line of inquiry, we examine

how BLERs affe ct the pay gap1 between top executives and av-

erage workers2 by chan ging the power dynamics in pay negotia-

tions, thereby inf luencing firm value.

Recently, wide pay gaps between top executives and average

workers have triggered a public outcry,3 as employees often

use CEO compensation as a reference to measu re the fairness

of rewards for their workplace effort s (Wade, O'Reilly, and

Pollock 2006). According to Bloomberg, 4 in 2017, the United

States had a pay ratio of 265, the highest i n the world—on

This is an open ac cess article un der the terms of the Creat ive Commons Attribution Lic ense, which perm its use, distri bution and reproduction i n any medium, provi ded the original w ork is

properly cited.

© 2024 The Autho r(s). Corporate Gover nance: An Inter national Revie w published by John Wile y & Sons Ltd.

1110

average, CEO pay was 265 ti mes higher than that of an average

worker.5 As CEO compensation continues to grow fa ster than

average worker wages, concerned regu lators and politicians are

seeking ways to close thi s gap.

Using 15,340 f irm- year observations fr om 17 European countries,

we first test the inf luence of BLERs on pay structure. We conjec-

ture that BLERs , from either the governance6 or bargain ing power

standpoint, affect the pay gap. Hayes a nd Schaefer's(1999) labor

bargaining power the ory describes wage lev els as a function of

bargaining power bet ween contracting parties, given each part y's

power limitations. Wage dynam ics are the product of a power battle

between executives and the boa rd of directors. Strong labor power

in the boardroom can decre ase top executives' compensation, nar-

rowing the pay gap. For instance, De Angelo and DeAngelo(1991)

find reduced CEO compensation duri ng union negotiations with

firms. Banning and Chiles(2007) and Huang etal.(2017) also find

that powerful unions r educe executive compensation. Gorton and

Schmid(200 4) show that granting more board seats to BLER s ben-

efits employees, as evidenced by payr oll data and higher staff ing

levels.

However, evidence suggests that an incre ase in labor power leads

to higher CEO compensation. Lin, S chmid, and Xuan (2018)

show a tradeoff between CE O and employees. When em-

ployee representatives are added to a board , CEO compensa-

tion increases by a third , whereas employees can secure their

jobs. In the executive- worker- allia nce hypothesis, Paga no and

Volpi n (2005) descr ibe employees and executives as both ben-

efiting from higher wage s and job security, which is a common

interest that may motivate them to form an al liance. In this sit-

uation, the mutual preferences of BLERs and CE Os for higher

wages and job securit y may shift loyalty towa rd the CEO, in-

creasing agency issues b y giving more power to a rent- e xtracting

CEO at the cost of employees or shareholders (Bertrand and

Mullainathan 2003; Gorton and Schmid 2004; Pagano and

Volpi n 2005; Cronqvist et al.2009; Levine, Lin, and Shen2 015;

Dessaint, Golubov, and Volpin2 017). In th is scenario, the pay

gap may increase fur ther.

Notably, the presence of BLERs is critical in mitig ating the pay

gap by giving workers more bargai ning power and the abil-

ity to limit rent- seeking CEOs when designing c ompensation.

Confirmin g this argument, we show that the decline in the pay

gap is mainly due to a reduction in CEO compensation. T his

result is consistent with the idea that labor co - determ ination

creates a fairer working env ironment by reducing the pay gap.

This effect is strong er for firms operating in cou ntries exposed

to high expropriation risk (i.e., the risk a ssociated with CEO

overcompensation) and those with a culture in which boa rd

members are less inclined to challenge CE Os, implying a solid

bargaining and gover nance role for BLERs.7 Our s ubsample

analyses conf irm the importance of the ba rgaining power of

these directors and indic ate that the pay- ratio reduction is more

substantial when BLERs have a l arger social network and longer

tenure. Moreover, we show that as the concentration of BLERs

on the board increases, so doe s their effectiveness in reducin g

the pay ratio in firms.

Next, we test pay- structure value creation followi ng the addi-

tion of BLERs. Accordin g to the tournament theory, a high pay

ratio motivates employees to increase their ef forts for promo-

tion and earn correspondin gly higher compensation, leading to

strong firm perfor mance (Mueller, Ouimet, and Simintzi2 017).

According to this theor y, changes in the pay ratio owing to the

presence of BLERs positively af fect labor productivity and firm

performance. Contrar y to the tournament theory, the fair wage–

effort theory (Akerlof and Yellen1990) posits that employees do

not try to maxim ize productivity when they feel their wages fall

short of the anticipated fair wage level. Sim ilarly, equity theory

predicts that a less dispers ed pay structure within a fir m signifi-

cantly increases employees' workplace productiv ity and morale

(Adam s 1965). Other evidence suggest s that paying above-

average compensation to employees increases f irm productivity

(e.g., Cappelli and Chauvin1991; Propper and Van Reenen2010 ;

Mueller, Ouimet, and Simintzi2017).

The effectiveness of BLE Rs in shareholder value maximi zation

is controversial. BLER s may cause confl icts of interest, where

one group pursues the interests of shareholders and another rep-

resents employees' interests.8 Consistent with this v iew, Fa leye,

Mehrotra, and Morck(2006) show that employee power is neg-

atively associated with long- term investment, sales, employee

growth, and fi rm risk exposur e, given employees' preference

for prioritizing long- term f irm sustainability with steady prof its

over shareholder value maximi zation.

Nevertheless, some researchers (e.g., Fauver and Fuerst 2006)

present conflictin g evidence, finding a va lue- enhancing role

for employee representatives, given their production- related

knowledge. This positive ef fect is especially appa rent for firms

in industries that demand higher coordi nation and specialized

employee skills. We argue that the value- creating role of BLERs

arises from their support for employees. Notably, the presence

of BLERs (and their resulting effect on re ducing the pay ratio)

is positively associated w ith labor productivity and fir m value.

These finding s are consistent with the inequity- aversion theor y,

which predicts that an optimal pay rat io enhances firm per for-

mance by achieving bett er workplace fairness and increa sing

labor productivity and fir m value (Akerlof and Yellen19 90; Card

etal.2012).

Although we find clear ev idence that BLERs suppress the com-

pensation gap, our findings may be d riven by omitted vari-

ables and, hence, subject to endogeneity issues. We employ a

difference- in- differences (DiD) analy sis to address this concern.

In the DiD analysis , we use the adoption of a French security law

in 20139 as a qua si- natural exper iment. Following the passage of

this law, 33 French firms appointed BLER s for the first time.

Thus, using these fi rms as a treatment group and a matched

sample (using entropy matching) of control firms that were not

subject to such a regulation as a control group, we confi rm that

BLERs reduce the pay ratios with in firms.

Finally, we investigate a fra mework in which BLERs play a

more significant role in af fecting the pay gap and firm value.

In particular, we exam ine the effect of BLER in countr ies

that mandate single- tiered or double- tiered boards. From a

bargaining power per spective, we argue that t he presence of

BLERs on the board should af fect the pay gap and firm value

differently, given the single- vs. double- tiered boa rd structure.

In a double- tiered setup, BLE Rs are part of the super visory

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