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Essays on income distribution: Special reference to pay inequality, labour share and income inequality

This thesis comprises three essays on important areas of income distribution: pay inequality, labour share, and income inequality. The primary objective of this research is to enhance our understanding of the factors influencing or the consequences associated with these three domains. The first two essays in this thesis focus on firm-level income distribution by investigating the determinants and impacts of pay inequality and labour share within firms. The third essay gives attention to the determinants of income inequality at the macro-level. The first essay investigates the relationship between CEO-employee pay inequality and employee performance. Existing empirical studies are inconsistent about the directionality of the effect. However, this study argues that seemingly contradictory predictions about the linkage between pay inequality and employee performance are more complementary than contradictory. Using a sample of Australian firms, this study estimates expected pay inequality according to CEOs’ and employee skills, company characteristics, and the labour market. Consistent with our expectation, our result shows that pay inequality is positively associated with CEOs’ skills while negatively related to employee skills, employee outside opportunities and corporate governance effectiveness. We then assess the impact of pay inequality on employee performance. Our results show that pay inequality explained by individuals’ skills, company characteristics, and the labour market is positively associated with employee performance. This positive impact on employee performance declines at high levels of such explained pay inequality. However, pay inequality unexplained by those factors has a negative impact on employee performance. In general, this study has managerial implications for designing compensation structures across hierarchical levels within a firm to motivate employees and enhance their performance. The second essay examines the drivers of labour share and its relationship with personal income distribution. Recent decades in Australia have seen a fall in labour share and a rise in income inequality, resulting in a growing number of empirical studies attempting to explain these trends and their relationship. However, most studies rely heavily on country or industry aggregate macro data and downplay the importance of firm-level data. Using panel data for Australian listed firms between 2004 and 2019, we first examine the impact of technological progress, product market power and labour market power on firm labour share. The results show that the decline in Australian labour share is mainly driven by technological progress and increasing product market power. However, labour market power does not have a significant impact on labour share. Further analysis shows that technological progress is not a significant driver of labour share in firms with highly skilled employees or those firms that are less capital-intensive. Technological progress and product market power have a more considerable negative impact on labour share in firms with a higher level of external funds. This study also examines the impact of within-firm labour share on pay inequality between CEOs and employees. It finds that declining labour share is a significant factor in the evolution of pay inequality. Moreover, a 10% decline in labour share increases pay inequality by 4.19%. Additional tests show that the significant determinants of labour share, technological progress, and product market power can moderate the negative impact of labour share on pay inequality. We find that labour share has a larger negative impact on pay inequality in firms with lower technological productivity and higher product market power. Overall, this study extends the current literature by documenting firm-level drivers of labour share in Australia, covering all sectors, and providing novel firm-level evidence on the relationship between labour share and pay inequality. Turning to our analysis of income distribution at the macro-level, the third essay explores the impact of financial development on income inequality. Despite the development of the financial system, income inequality has risen in many countries since the 1980s. This has led to a debate about whether financial development comes at the cost of income inequality. Despite the increasing academic focus on this subject, the income distributional impact of financial development remains unsolved. This study argues that a country’s openness to international trade and capital flows may affect the nexus between financial development and income inequality. Using a panel of 71 developing and developed countries for 1994–2017, our empirical results suggest that in an economy relatively closed to the world financial or goods markets, growing financial development does not significantly influence income inequality. However, if an economy is relatively open to the world financial and goods markets, inequality within the domestic economy increases as its financial markets develop. This finding is consistent across different econometric methods, subsamples and interaction analyses, and distinct financial development indicators. Overall, the evidence of the pro-inequality impact of financial development in open countries informs policymakers about the importance of redistribution policies in countries with a higher degree of openness.
Type of thesis
The University of Waikato
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