Pay inequality and corporate divestitures

Research Summary: This paper analyzes how pay inequality influences divestiture decisions. Using detailed data on division manager compensation and divestiture activity, this study documents that firms are more likely to divest divisions when pay inequality among division managers is higher. To address potential bias in the measurement of pay inequality, we construct a “synthetic” measure that varies with regional and industry pay shocks that differentially affect division managers within firms. Post hoc analyses reveal that social comparison appears to explain, at least partially, the relationship between unequal pay and divestiture. These findings support the notion that pay inequality can be an important predictor of firm boundaries. More generally, they suggest that unequal pay may have significant strategic consequences as firms increasingly adopt performance‐based compensation to motivate employees. Managerial Summary: This paper analyzes the link between the degree of inequality in division manager compensation and the likelihood that companies divest businesses. We find that companies are more likely to divest when the pay of their division managers is more widely dispersed. Supplementary analyses show that this relationship is stronger when division managers are more likely to compare their pay to that of their peers, for example, within companies whose divisions operate in more closely related industries or in more proximate geographic regions. These findings show that pay inequality can predict when companies choose to exit businesses. As such, it is relevant for understanding how corporate strategy is influenced by performance‐based compensation policies, particularly as these policies become the norm in companies around the world.