Compensation structure as a determinant of firm performance

Abstract

This study presents a theoretical model of firm performance as a function of wage dispersion with a causal relationship that explains most of the inconsistency of previous empirical research, which shows contrasting results from one study to the other. We can trace the shortcomings of empirical research in this field to narrow geographic or industrial sector settings, which limit the validity of the studies. In this study, effort is modeled based on equity theory and relative deprivation theory, within a systemic framework that considers interaction between hierarchical levels in the firm, and the interaction with the market, with a trans-disciplinary approach. The main results are: a) wage dispersion cannot increase indefinitely without causing operating margin to fall. The behavior of this financial indicator is non-monotone with respect to iv the degree of wage dispersion in the firm; b) large firms are more likely to benefit from a hierarchical wage structure, while small firms could experience some improvement in their fundamental financial indicators with a more compressed compensation structure. Firm size is measured in terms of number of employees; c) upper levels tend to apply more effort if the firm increases its wage dispersion with respect to a firm mimicking the labor market; d) a market with high income inequality affects the firm in that the former makes less attractive for the firm to make a move towards increased internal inequality. An ancillary result of this work is the proposition of a way to determine the weighing factor ? in Akerlof and Yellen's (1990) equation that models relative deprivation. I list the factors that affect that parameter