Equity Market Reaction to Pay Dispersion and Shareholders’ Prosocial Preferences

Do equity investors care about pay dispersion and income inequality? We address this question by examining equity markets' reaction and investors' portfolio rebalancing in response to the first-time disclosure by U.S. public companies of the ratio of CEO to median worker pay in 2018. We find that firms disclosing high pay ratios experience significantly negative abnormal announcement returns. Additional evidence suggests that equity markets “dislike” high pay dispersion rather than high CEO pay or low worker pay. In the cross-section, firms whose shareholders have stronger prosocial preferences experience a significantly more negative market response to high pay ratios. Consistent with investors' prosocial preferences moderating the initial market reaction, we find that during 2018 investors with stronger prosocial preferences rebalance their portfolios away from high pay ratio stocks relative to other investors. Overall, our results suggest that equity markets are concerned about high within-firm pay dispersion, and investors' prosocial preferences with respect to income inequality are a channel through which high pay ratios negatively affect firm value