The Effect of the Pay Gap between the CEO and the Top Management Team on Related Party Transactions

We examine whether the pay gap between the CEO and Top Management Team (TMT) is associated with managerial decisions concerning the related party transactions in Korean firms. While the pay gap encourages managers to work harder to improve their performance, related party transactions can negatively affect firm performance and executives’ performance. Hence, we test whether executives hesitate to engage in related party transactions. Using firms listed on the Korean stock market from 2013 to 2020, we find that the pay gap between CEO and TMT is linked negatively to the firm’s level of related party transactions. The effect of the pay gap on related party transactions is still pronounced when the controlling shareholders have a significant influence on the firm’s decision-making process. We make several robustness tests to control for the endogeneity issue which may exist in the pay gap and the Korean government’s regulation effect. We consistently find a negative relationship between the pay gap between the CEO and TMT and related party transactions. Overall, we conclude that the pay gap makes TMT avoid related party transactions to maximize firm-level performance. Thus, a large pay gap could have an additional effect which decreases the related party transactions by playing a monitoring role.