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UC Law Journal

Abstract

This Article examines internal pay disparities in American public corporations and argues that wide gaps between the top and bottom of the pay scale can, in certain circumstances, directly and adversely affect firm value. Further, this Article argues that corporate boards should be informed about these effects, and that they should, in many cases, reduce internal pay differentials to address them. In support of this thesis, the Article analyzes numerous empirical studies that illustrate the underlying premise that wide disparities in corporate pay scales can adversely affect firm value. These studies demonstrate that, at many types of organizations, as internal pay differentials grow, employees and lower level managers increasingly view their compensation as unfair in comparison to more highly paid top management. This perception adversely affects employee performance, productivity and willingness to work, and thereby reduces firm value.

This Article argues that Directors' duty of care requires that they consider the spread between the high and low end of the corporate pay scale in setting firm compensation levels and act in corporations' best interests to reduce it if necessary to maximize firm value.

Moreover, this Article points out that the primary cause of growing pay differentials are mega-grants of stock options. These large stock option grants are unjustified if their costs exceed their benefits. Virtually no research has shown that the benefits of stock options are greater than the costs. The director's duty of care necessitates a more thorough determination of whether these plans maximize firm value.

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