Huge salary imbalances between CEOs and the people who work for them can send bad vibes throughout an organisation, weakening loyalty and eroding the talent pool. Every year the same ritual is played out in the business press: compensation figures for the highest paid chief executives evoke predictable gasps about overpayment.

Although economists find that many CEOs are worth every penny, social scientists are looking more closely at the effects of executive pay on corporate life. Among them is Charles O’Reilly, the director of the Centre for Leadership Development and Research at Stanford Graduate School of Business, who, by using data from 120 large public companies over a five-year period, tracked five levels of senior managers from vice-president to division general manager.

He found, for example, that in one firm in which the CEO was overpaid by 50 per cent compared with the industry norm and the general managers were underpaid by 50 per cent, turnover among the general managers was 18 per cent higher than at firms whose CEOs were equitably paid.

The turnover of such seasoned managers, O’Reilly argues, has a corporate cost because it robs the firm of valuable internal experience that new employees will take years to develop. Although the study tracked only lower levels of senior management, it suggests that the negative consequences of CEO overpayment are likely to trickle down.

“The CEO gets a huge bonus, but the company is not doing well and workers feel comparatively underpaid. What is the likely impact? Workers may decrease their effort and increase allegiance to the union.” He also found that if the CEO was overpaid, the executives under him tended to be overpaid, too – magnifying the cost to shareholders. For example, in a case where the CEO was overpaid by 64 per cent compared with the norm, executives a step below were overpaid by 26 per cent. However, the generosity wore off at lower management levels.

Wage gaps may also increase the tendency for individuals to perceive more inequity than actually exists, which can amplify the dysfunctional effects. More boards of directors should start looking at executive pay as a social, and not purely economic, corporate issue, O’Reilly says.

Extracted from Big CEO-Worker Pay Gap Costs More than Money. www.gsb.stanford.edu/ knowledgebase

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