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Human Resources

Employees behaving badly: how high CEO pay can encourage wider wrongdoing

Published 1 November 2021 in Human Resources • 6 min read

Research suggests that CEO stock option schemes combined with a large pay gap can encourage and motivate lower-ranking employees to commit illegal behavior. 

Why did managers at German automaker Volkswagen install software to cheat on emissions tests? And why did staff at US bank Wells Fargo create millions of fraudulent savings and checking accounts without customers’ consent? A proliferation of corporate scandals in recent years prompted Stephen J. Smulowitz, Term Research Professor at the IMD Global Board Center, and Juan Almandoz, a Professor in the Department of Managing People in Organizations at IESE business school to examine what drives people to commit wrongdoing. 

Previous research had considered how pay schemes that link compensation to stock market performance, particularly in the form of option pay, can encourage a CEO to take risks that might result in wrongful behavior. Likewise, in companies with particularly large pay gaps between the CEO and the rest of the top management team, disgruntled executives who perceive the pay policies to be unfair may be more motivated to steal from the organization. However, no research had asked the question: Can CEO pay drive other employees in the firm, not receiving the pay, to commit wrongdoing?  

Using a sample of US Bank Holding Companies (BHCs) from 2007 to 2013, Smulowitz and Almandoz examined whether there was a link between CEO option pay and the pay gap with the probability of individuals in the wider workforce committing wrongdoing. 

Publicly traded BHCs provided an excellent research context for several reasons. First, they use high amounts of incentive pay and are required to disclose compensation data, making it possible to compare CEO pay to the average pay in the organization. Second, the regulatory requirements and risk management schemes in the banking industry make it easier to detect incidents of wrongdoing. Indeed, between 2007 and 2013, more than 2,000 individuals were banned from working at a US bank by regulators due to alleged wrongdoing, such as embezzling funds, forging documents, or accepting bribes. Third, banks’ central role in the functioning of the economy, as shown by the 2008 financial crash, makes the study of wrongdoing in this industry particularly relevant. 

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