One of the defining social issues of our time is the persistent earnings inequality in the U.S. between men and women and between white and minority workers. Many factors contribute to this inequality, but two stand out: (1) pay gaps, i.e., the difference in compensation between men and women or between white and non-white workers working in the same job category, and (2) job segregation, i.e., the overrepresentation or underrepresentation of women and certain minorities in particular occupations and industrial sectors.
Title VII of the Civil Rights Act of 1964 prohibits pay discrimination by race, color, religion, or national origin, and The Equal Pay Act of 1963 proscribes wage discrimination based on sex. Yet, in 2024, women earned, on average, 84 cents for every dollar a man earned, and Blacks and Hispanics/Latinos earned, on average, 77 cents and 73 cents, respectively, for every dollar a white worker was paid. Prior studies examine the fundamental determinants behind the persistence of these pay gaps, attributing, for example, family obligations, age, flexibility of working conditions, education, and racial discrimination as some of the driving forces. Other papers document some of the macroeconomic consequences of these pay gaps, such as their detrimental effect on overall GDP or individual wealth accumulation.
In a new paper, we examine two lesser-known aspects of pay gaps: (1) the extent of variation across companies and industries, and (2) whether investors view these pay gaps as net value-enhancing or -diminishing to individual firms. By understanding the first issue, firms, social-minded activists, and regulatory bodies can turn their attention to tackling wage inequality more efficiently. For example, if pay gaps are more concentrated in certain industries, then we need to pay closer attention to firms in these industries. By understanding the second issue, solutions for reducing gender and racial/ethnic pay inequities may become more apparent. For example, if pay gaps are perceived by investors to enhance firm value, then we should not turn to capital markets for solutions.
Following standard definitions, we define a firm-specific pay gap as the difference between what a firm would pay an all-white male workforce and what it pays its actual workforce. Our demographic data come from the release of Type 2 EEO-1 forms by the U.S. Department of Labor for over 19,000 public and private U.S. contractors from 2016 through 2020. These forms contain standardized, detailed demographic breakdowns of companies’ workforces by 10 job categories. Our pay data also are from the EEOC, which previously released compensation data for the same demographic and 10 job categories by state and industry.
Using these data, we estimate pay gaps for 927 public firms and over 10,000 private firms.
Variations in Pay Gaps Across Firms and Industries
Public firms, on average, save over $49 million a year, or $6,069 per worker. How significant are these savings to the firm? In relative terms, the average pay gap is 8.12 percent of its total compensation costs, suggesting that the average public firm saves over 8 percent of its total labor costs by systematically underpaying women and minority workers. Using financial accounting data as reported on the firm’s Form 10-K, the mean labor cost savings is 6.96 percent of total selling, general, and administrative expenses (SG&A), implying that the average public firm saves almost 7 percent of its operating costs by having a more diverse workforce. In terms of revenues and assets, the mean ratio of savings over revenues is 1.44 percent, and the average ratio over total assets is 0.83 percent.
As measured by the total number of employees, private firms are, on average, much smaller than public firms. As such, their average pay gap is just under $6 million per year. However, in relative terms, the average pay gap for private firms surpasses those for public firms in two ways. First, the average per-worker pay gap for private firms is $6,928, which exceeds the average for public firms by 14 percent. Second, the mean pay gap as a percentage of total compensation is 11.52 percent, which is larger than the 8.12 percent for public firms. Thus, private firms benefit more from pay inequities per employee and per dollar spent on labor costs than public firms.
Pay gaps vary dramatically across industries, with finance, consumer non-durable goods, and healthcare having the largest pay gaps, and utilities, chemicals, and oil, gas & coal showing the smallest gaps. These variations are reflections of the varying demographics of an individual industry’s workforce as well as differences in pay gaps among different job categories. For example, in the private healthcare sector, women comprise almost 75 percent of a firm’s workforce, and many of these women work as “professionals,” as categorized by the EEOC. As documented by the EEOC, “professional” women in healthcare, on average, earn significantly less than white men – thus contributing heavily to the industry’s large pay gap. In contrast, utilities employ a relatively large number of white men, thus minimizing the pay gap but simultaneously making the industry’s workforce less diverse.
Do Investors View Pay Gaps as Value-Enhancing or Value-Reducing?
We further exploit the public release of EEO-1 forms by examining the market reaction to their release, conditional on the size of the firm’s pay gap. Finance theory predicts that if the data in these reports provide new information about a firm, and if investors can calibrate these measures within a valuation framework, then the market reaction around the release date will tell us how investors viewed and valued this new information. Stated differently, we propose that investors used the release of the EEO-1 forms in the same way we did – by calculating estimated pay gaps for the sample of publicly-traded firms – and then using these estimations to update their firm values.
The valuation effect of pay gaps is unclear. Pay gaps lower labor costs, thus increasing net income and potentially firm value. On the other hand, systematic pay inequities can lower employee satisfaction, potentially hurting firm value. We answer our question empirically by regressing the immediate stock market reaction for each firm in our sample around the release of the EEO-1 report on the relative size of its pay gap. A positive coefficient is consistent with investors placing a net positive valuation on a firm’s pay gap; a negative coefficient suggests an opposite interpretation of the net value of a firm’s pay gap.
We present strong and consistent evidence of investors viewing pay gaps as net value-enhancing. Our results hold after controlling for workplace diversity, the industrial organization (IO) structure of the firm, the state in which the firm’s headquarters is domiciled, industry classification, and other effects. We also present evidence that the rise in stock price holds after controlling for firm productivity, employee satisfaction, and seniority or talent of managers.
Our findings should inform stakeholders about the size, determinants, and perceived value of pay gaps. Our research highlights the importance of examining a firm’s equity, the “E” of DEI, when evaluating a firm’s DEI initiatives. That is, increased diversity without equity in pay does little to ameliorate earnings inequality in the U.S. Our market-reaction findings also suggest that capital markets may not be the appropriate place to address systematic pay inequities.
This post comes to us from Ferdinand Bratek and April Klein at New York University and Yanting (Crystal) Shi at HEC Paris. It is based on their recent paper, “The Market Value of Pay Gaps: Evidence from EEO-1 Disclosures,” available here.