Salaries for those in upper management has been debated both publicly and politically, at times in light of particular real-world cases. The focus has largely been on moral questions, with virtually no thought given to the important role salaries can have on company performance. However, there is a substantial economic empirical literature on pay incentives, and American studies, in particular, have shown a correlation between salaries and company performance. It is thus not necessarily in owners' best interests to pay as little as possible.
Professor Nicolai Foss of Bocconi University and professor Jacob Lyngsie of the University of Southern Denmark have carried out an analysis for CEPOS regarding the relationship between management salaries and company performance, based on Danish register data. This analysis shows a very clear correlation: companies that have increased their management's salary one year have subsequently achieved better performance the next. The correlation is consistent across various measures of performance. Doubling pay to management is typically associated with a 2 percent performance increase. The correlation is positive regardless of whether we measure turnover, assets, rate of return, productivity, or employment.
The data show clear signs of so-called "tournament effects", where a higher variance in salaries is associated with better performance. Employees are encouraged to put forth greater effort, with a view toward earning a higher ranking in the salary hierarchy. Unlike e.g. in the United States, there were no signs of so-called "superstar effects", where very large companies pay extraordinarily high salaries: quite the opposite.
The analysis does not show that higher management pay automatically results in, or directly causes, better performance, nor that all payment contracts were necessarily optimal; rather, it indicates that owners generally pay management staff based on their worth to the business.
It underscores that upper management's pay is strictly between upper management and the company's owners. The owners are the ones who pay the price of inappropriate salaries, whether they be higher than necessary or give disproportionate incentives. There should thus exist a right to negotiate them freely, without political regulation. On the contrary, such regulation only risks reducing businesses' productivity.
The main conclusions from the analysis are reproduced in this research paper (for further details, refer to Foss and Lyngsie's working paper).
