The impact of credit rating deviation on employee compensation levels: Evidence from South Korea

We examine whether firms adjust employee compensation in response to credit rating deviation (CRD), defined as the gap between model-implied ratings based on financials and agency-assigned ratings that incorporate qualitative judgment. Using 2447 firm-year observations of Korean listed firms from 2006 to 2024, we find a positive association between CRD and employee pay, driven primarily by unfavorable deviations where assigned ratings fall below model expectations. This effect is concentrated in firms with weak board monitoring. These wage cuts do not improve subsequent performance, suggesting that managers exploit adverse external assessments to justify wage restraint. Our findings show that CRD influences internal pay-setting and highlight the role of governance in mediating firms’ responses to external evaluations.