The gap between CEO and worker pay in the U.S. has become a chasm. According to the Economic Policy Institute, the CEO-to-worker compensation ratio skyrocketed from 21-to-1 in 1965 to a staggering 344-to-1 in 2022.[1] This widening disparity has spurred a search for whether changes to corporate governance could offer solutions. Since the board of directors ultimately determines executive pay, its composition is a key area of focus. This raises an important empirical question: Can board gender diversity (BGD) curb excessive CEO pay ratio? The theory is intuitive, as a growing body of research suggests that women, on average, may have a stronger aversion to inequity than men. Yet, the evidence is conflicting; other studies find different results, showing that women’s social preferences can be highly sensitive to context. In a recent study, we aim to provide evidence to help answer this question.
We examine three questions:
- What is the causal effect of BGD on the CEO pay ratio?
- What underlying motivations drive female directors to affect this ratio?
- Under what conditions is their impact greatest?
To answer these questions, we analyzed the CEO pay ratio for a sample of S&P 1,500 firms from 2018 to 2021. Our primary measure is the ratio of a CEO’s total compensation to that of the median employee, as disclosed by public firms under an SEC mandate that took effect in 2018.[2]
A Natural Experiment in Board Gender Diversity
A major challenge in corporate governance research is endogeneity. For example, if we simply observe that boards with more women have lower CEO pay ratios, we can’t be sure of the cause. Do female directors reduce the pay ratio, or are women with a preference for equity simply more attracted to serving on boards of firms that already have lower pay ratios? This “matching” phenomenon, which was validated in other contexts by studies on the market for corporate directors, makes it difficult to prove causation.
To tackle this issue, we employ the implementation of California’s Senate Bill 826 (SB 826) from 2019 to 2021 as an exogenous shock to increase BGD in California-headquartered firms. Signed into law on September 30, 2018, SB 826 was the first of its kind in the U.S., mandating that all public companies headquartered in California add women to their boards. The law required firms to have at least one female director by the end of 2019, with the requirement rising to two for firms with five board members and three for those with at least six members by the end of 2021.[3]
It’s important to note that this mandate-driven increase in female directors occurred on top of a nationwide trend toward greater board diversity, fueled by pressure from investors. Our analysis confirms the law had a distinct impact, as the increase at affected California firms was significantly greater than at their peers elsewhere. Despite its significance, the law faced legal challenges and was ultimately ruled unconstitutional by a California court in May 2022.
To ensure a clean comparison, our study constructs a robust comparison group using propensity-score matching. This process identifies, for each California firm required to add female directors, a set of highly similar firms –including both compliant California firms and firms headquartered elsewhere. By ensuring the two groups were on parallel tracks before the law, this method allows us to isolate the law’s real impact.
A Substantive Impact on CEO Pay Ratio
Our primary finding is that the increase in female directors led to a statistically and economically significant reduction in the CEO pay ratio. Our estimates imply that the addition of a single female director is associated with a 27.8 percent reduction in the pay ratio. This result was surprisingly large, and we confirmed its robustness using several different matching and weighting algorithms.
The substantial impact of this change prompts the question of what factors could explain it. One plausible factor is the unique timing of the law’s post-implementation period (2020–2021), which coincided with the COVID-19 pandemic. This crisis heightened public scrutiny of inequality, and an unprecedented number of firms announced CEO salary reductions, often framed as “sharing the pain” with employees. In this environment, a stronger aversion to inequity may have motivated female directors to advocate more forcefully for reductions in CEO pay. This aligns with other research showing female directors are often more attuned to stakeholder relations than their male counterparts.
However, the pandemic’s timing also raises a critical concern: Could our results be an artifact of other pandemic-related trends? For instance, perhaps the firms required to add women were simply clustered in industries that disproportionately cut executive pay, or maybe California-based firms reduced CEO compensation more than firms elsewhere. We conducted several robustness checks to address these possibilities and found that neither industry-specific nor state-specific trends could account for the significant reduction in the pay ratio we observed.
Unpacking the “Why”
While an aversion to inequity is a plausible explanation for our findings, we also examine two other theories: “window dressing” and “diligent monitoring.”
Window dressing is based on the idea that rather than taking substantive actions to reduce pay ratio, firms simply manage perceptions. Under the SEC’s disclosure rule, firms have considerable discretion in how they calculate the ratio, using tactics like choosing a favorable date to identify the median employee, annualizing pay for part-year workers, excluding a portion of their non-U.S. workforce, or disclosing an alternative ratio that is lower than the required one. Our analysis, however, indicates that the pay ratio reduction was not driven by these disclosure tactics. Instead, it was driven almost entirely by a substantive decrease in CEO compensation. This suggests a real economic action, not just managing perceptions.
Next, we tested the diligent monitoring theory, that female directors are more effective monitors who can better curb excessive CEO pay. A key aspect of effective monitoring is independence. If this factor were the primary cause, we would expect the pay-ratio-reducing effect to be stronger when the newly added female directors are independent. However, our tests showed the effect of female directors was just as strong for those who were not classified as independent, challenging the notion that diligent monitoring is the main explanation.
With little evidence to support the first two possibilities, the most plausible explanation is the innate preference for equity among female directors. This aligns with the “sharing the pain” narrative that became so prevalent during the pandemic. In a crisis that magnified concerns about inequality, the aversion to inequity appears to have motivated female directors to push for substantive changes, ensuring that the gestures toward fairness were backed by real financial adjustments at the top.
A Seat at the Right Table
Our analysis also highlights an important condition for female directors to be effective in this domain: their presence on the compensation committee. We found that the pay-ratio-reducing effect is dependent on women serving on the compensation committee. This finding is intuitive yet powerful. The compensation committee is the primary body responsible for designing and approving executive pay packages. A seat at that specific table provides the most direct way to turn a preference for fairness into policy. It suggests that, for BGD to be most effective in shaping pay equity, power and position in the boardroom rather than just presence are required.
Conclusion
While policymakers and investors have long promoted board gender diversity, causal evidence of its impact on inequality within a firm has been scarce. Our research, leveraging California’s landmark SB 826, provides evidence that adding women to corporate boards can be an effective governance mechanism for reducing the CEO pay ratio. This effect appears to be driven not by disclosure management or simply by enhanced monitoring, but by a substantive reduction in CEO pay, consistent with female directors acting on a stronger preference for equitable outcomes. For those concerned with rising inequality, our findings suggest that board composition is a meaningful lever for change.
ENDNOTES
[1] https://www.epi.org/publication/ceo-pay-in-2022/#full-report
[2] The SEC rule applied to fiscal years starting on or after January 1, 2017. Since most firms follow a calendar-year fiscal schedule and file proxy statements several months after the end of their fiscal year, the first disclosures, which covered the 2017 fiscal year, were predominantly made in 2018.
[3] We chose 2020 as the first “post-implementation” year because the law’s more stringent 2021 requirement was its primary binding constraint, rather than the initial 2019 deadline.
This post comes to us from professors Dong Chen at the University of Baltimore and Yudan Zheng at Long Island University. It is based on their recent article, “Board Gender Diversity and CEO Pay Ratio,” available here.