Unexplained Pay Disparity Costs 1.8% in Returns

1.8% Drag

Impact of "Unexplained Pay Disparity" on ROA

The Research

Is all income inequality bad for business? A Harvard Business School working paper argues that the *source* of the inequality matters. The study separated CEO pay ratios into "Economic" (merit-based) and "Unexplained" (fairness-based) components. The findings were stark: "Unexplained Pay Disparity"—where a CEO is overpaid and employees are underpaid relative to economic benchmarks—was statistically linked to lower future performance. A one standard deviation increase in unexplained disparity correlated with a **1.8% decline in Return on Net Operating Assets (RNOA)**.

https://www.hbs.edu/ris/Publication%20Files/18-007_182aaa61-979e-4f84-ac61-d7e3837779d6.pdf
Key Finding

Unexplained pay disparity is negatively associated with future firm performance (-1.8% ROA impact).

The Archalos Thesis

We distinguish between "Tournament Incentives" and "Looting." When a CEO earns more because they are driving massive value (Economic Disparity), the market rewards it. When a CEO earns more simply because of weak governance or rent-extraction (Unexplained Disparity), the market punishes it. We use this "Fairness Metric" to identify management teams that are hoarding capital rather than compounding it.

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