Bright Asante-Appiah on How Fair Pay Affects Firm Value

Image by iStock/Andrii Yalanskyi

In this episode of Lehigh University’s College of Business ilLUminate podcast, we are speaking with Bright Asante-Appiah about his research suggesting that paying employees fairly has a positive impact on a company’s long-term value.

Dr. Asante-Appiah is an assistant professor of accounting at Lehigh's College of Business. His research delves into how corporate governance mechanisms affect financial reporting and audit quality, firm value, ESG (environmental, social, and governance) risks and opportunities, and managerial myopia.

He conducted the study with College of Business colleague Tamara Lambert, who holds the Sue and Eugene Mercy, Jr. Professorship of Accounting.

Asante-Appiah spoke with Jack Croft, host of the ilLUminate podcast. Listen to the podcast here and subscribe and download Lehigh Business on Apple Podcasts or wherever you get your podcasts.

Below is an edited excerpt from that conversation. Read the complete podcast transcript [PDF]. 

Jack Croft: One of the main areas of focus of your research is ESG, or that broad umbrella of environmental, social, and corporate governance. From your perspective, how does this question of employee pay fairness fit within the context of ESG?

Bright Asante-Appiah: Anytime we have mentioned ESG, many people immediately talk about environmental issues. And that is understandable. That was their focus maybe a decade ago when this issue became predominant here in the U.S.

There is this poll conducted by IBD/TIPP. And they asked investors, "What is most important when investing in a stock? Return on investment or one of these ESG traits?" As you expect, the return on investment will be higher, right? But I've seen that, yes, return on investment probably ranges from 61 to 68 percent of the respondents when they say what is most important.

But when it comes to the ESG traits, it's very, very interesting. And this poll was in 2020. We see a shift from environmental issues to social issues, to things such as fair employee wages, to things such as workforce, management, diversity, and all those things. Yes, environmental commitment is still an issue for ESG investors and the rest, but we are seeing that increasingly they are also concerned about the social component. The most important thing they are concerned about the social component is fair employee wages. So pay fairness, I believe, is the key to achieving the “S” component of ESG.

Croft: For the study, you relied on what's known as the efficiency wage theory. Could you explain what that theory entails and what advantages it offers in looking at this issue of pay fairness?

Asante-Appiah: Efficiency wage theory suggests higher firm value will result from equity-based measures of pay fairness. What it predicts is that higher employee pay can induce higher productivity. And findings from several streams of research also support this view.

So my co-author and I thought, "Hmm, instead of using these parity-based measures, comparing average employee pay to, say, CEO pay that has been used in the prior studies, we think it will make sense to measure pay fairness based on equity-based justice, which is grounded in this efficiency wage theory."

Equity-based fairness involves attempting to arrange events so that each person's outcomes are proportional to his or her inputs. So the benefit of measuring pay fairness based on this approach is that the pay-to-productivity relationship will be directly tied to employee effort to perform. And we know that effort to perform is what affects firm value.

Croft: As you started looking at this question of pay fairness, what were some of the main reasons that firms do not pay their employees more fairly?

Asante-Appiah: I believe it is likely the result of managers viewing human capital as an accounting expense to minimize in the short term without recognizing it as an investment in the firm's value or future value. Managers are typically averse to investing in long-term equity building. The reason is … shareholders may misinterpret this and may not reward managers for that in the short term. So we believe this is potentially the reason why managers do not pay their employees more fairly.

Croft: I was wondering if you could explain the role of what's known as managerial short-termism in determining fair pay, starting with defining what managerial short-termism is and how that connects to not paying employees as fairly as perhaps companies should.

Asante-Appiah: The simple way of explaining this managerial short-termism is when corporate managers sacrifice long-term value creation in exchange for short-term gains. CEOs who are focused on the short term have an incentive to minimize employee pay. And this leads to this wage stagnation issue that we are talking about.

What we did in this study, we look at several proxies of managerial short-termism or corporate environments that breed managerial short-termism. And for each of these proxies that we used, we found an association between managerial short-termism and less fair pay.

In other words, when a firm's environment breeds or provides managers the incentive to engage in short-term profit maximization as opposed to long-term value creation, such firms are more likely to pay their employees less based on the measure that we developed.

Croft: One of the things your study addresses is CEO contracts and the way that they're structured and the role that that plays in both fair pay for employees and a firm's long-term value. So if you could explain what the issue is with the way that many CEO contracts are currently structured that leads to less fair pay for employees.

Asante-Appiah: Based on the findings that came from the study, we were concerned that, "Oh, so this is the issue. This is the reason that CEOs are reluctant to pay the employees fairly." Is there a corporate governance tool that the board of directors can use to incentivize CEOs to pay their employees more fairly?

And we came about this CEO contracting. Just a little bit of background. In the U.S., the board of directors decides whether the terms of the CEO's employment-- and when I say the terms of the CEO employment, I'm talking about things such as the duration of the employment and renewal options, authority and responsibilities, the CEO compensation and benefits, things such as restrictions on CEO outside activities, and so many things. The board of directors determines whether these things are governed by an explicit agreement.

It will interest you to note that most CEOs of American companies, including the most notable ones, they are employed at the will of the board of directors. They do not have explicit employment contracts. That means that they can be sacked at any time, right? So theory suggests that such explicit CEO contracting can motivate CEOs to pursue long-term, value-adding investments, such as human capital because explicit agreements offer protection from-- assuming there was a fallout from short-term performance. If you're a CEO with protection from explicit employment agreements, then you are not so concerned that you're going to be fired just because you failed to meet the short-term performance target.

We see a positive association between explicit CEO contracting and the equity-based measure of pay fairness that we developed. That means that firms that provide contract and explicit contracting to their CEOs are more likely to pay their employees more fairly. Another interesting thing that we noted is that this explicit CEO contracting and pay fairness interact positively on long-term firm value.

That means that if you have a firm that provides a CEO with explicit contracting and pays its employees fairly, such firms are more likely to create value in the long term. So we believe that this is a very, very important finding that the board of directors has a tool to motivate CEOs to pay their employees more fairly. Paying employees more fairly, as we find in the study, is associated with long-term fair value.

So it's a win-win situation for the board. It's a win-win situation for the CEO, and it's a win-win situation for the employees.