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Todd Zenger
September 30, 2016
Calls for pay transparency as a cure for pay discrimination are abundant. As
the argument goes, if everyone knows everyone else s pay level, patterns of
discrimination will be broadcast, so pressure to remedy them will mount. But
the claims of pay transparency s beneficial powers go far beyond remedying pay
discrimination, extending to boosting an organization s overall morale and
performance.
Far from a panacea, pay transparency is a double-edged sword, capable of doing
as much or more damage as good. Broadcasting pay is as likely to demoralize
as it is to motivate. While pay transparency may accelerate attention being
paid to remedying pay discrimination, managers should consider moves toward
transparency with their eyes wide open.
Pay transparency does provide more information with which to assess the
fairness of pay allocation. But herein lies the challenge. In most work
settings individual performance is not easily observed, in part because our
performance is a joint product that reflects both our own effort and that of
many others. This seems to give us wide latitude to exaggerate our performance
and our contributions to the organization and to do it a lot. Some years ago
I asked a group of 700 engineers from two large Silicon Valley companies to
assess their performance relative to their peers. The results were startling.
Nearly 40% felt they were in the top 5%. About 92% felt they were in the top
quarter. Only one lone individual felt his or her performance was below
average. This inflated sense of self-worth makes the organization s task of
linking performance to pay tremendously difficult.
Widely publicizing pay simply reminds the vast majority of employees, nearly
all of whom possess exaggerated self-perceptions of their performance, that
their current pay is well below where they think it should be. Transparency
creates an expanded playground for our comparisons, potentially heightening our
attention and obsession with it and elevating the negative emotions and
behaviors that result. Admittedly, there is much that remains to be explored
about the effects of pay transparency, but the evidence points to transparency
elevating three costly responses:
Employees who suddenly discover they are underpaid become more dissatisfied
with their employer and more likely to depart. Shortly after the University of
California began making its employee salaries public, a team of scholars
conducted a fascinating experiment. They sent letters to a random set of
faculty in the UC system, informing them of a newspaper website they could use
to find out the salaries of their peers. A few days later the researchers
surveyed all campus employees, asking about their use of the website, their job
satisfaction, and their job search intentions. The researchers then compared
the responses of those who were informed about the website and those who were
not. Most who were informed about it accessed the site and examined the pay of
colleagues in their department. The result was that those who were invited to
visit the website and discovered they were paid below the median were much less
satisfied with their jobs and more likely to express an intent to depart than
those who were paid below the median but didn t receive the prompt to compare
their pay. Transparency encouraged dissatisfaction and turnover.
Employees reduce their productivity when consistently reminded of what they
perceive as unfair rewards. My colleague Tomasz Obloj, of HEC Paris, and I
recently examined the effects of an awards program implemented at a European
bank selling small consumer loans. The awards program invited each of the bank
s 164 outlets to compete for an all-expenses-paid, weeklong vacation to an
exotic resort. However, the 164 outlets were divided into four tournament
groups, and each tournament group competed for a different number of prizes.
Those assigned to tournament groups competing for fewer awards felt predictably
slighted; the awards program was significantly less effective for these groups.
The more interesting finding was that outlets geographically surrounded by or
socially connected to other outlets in better tournament groups actually
decreased their performance and the magnitude of the reduction corresponded
with how physically or socially close these advantaged outlets were. What might
this say about pay transparency? The more in your face those receiving
preferred rewards are, the greater the negative emotions that dampen
productivity. It is hard to imagine a policy change that does more to place pay
comparison in everyone s face than pay transparency.
Employees suddenly made aware of their peers high pay take up politicking for
change. For many years, Harvard managed the bulk of its endowment portfolio
with internal Harvard employees but paid them much like fund managers employed
by external investment management firms. The performance of these Harvard
employees was quite remarkable during the early 2000s. As a result, some of
these Harvard employees earned in excess of $30 million in yearly pay, due to
performance that was truly exceptional against industry benchmarks. Their
superior performance earned billions for Harvard, and all was fine until these
pay outcomes became transparent to the Harvard community. This transparency set
off a wave of opposition from students, faculty, and alumni alike. All efforts
to justify these rewards, based on claims that payments to outside fund
managers for such exceptional results would have been greater, fell on deaf
ears. Harvard s president at the time, Larry Summers, relented and flattened
pay, pushing several fund managers to leave. Harvard also moved the management
of a much larger share of the endowment to external fund managers, including
many who had just departed Harvard. Transparency prompted lobbying for change.
Of course, these responses to transparency departures, boycotts (reduced
effort), and active politicking may be precisely what the advocates of
transparency expect and want. The behaviors prompt change, including change
that corrects gender-based inequities. However, pay transparency unveils more
than real gender-based inequities; it also fuels perceived inequities prompted
by inflated self-perceptions. To avoid the departures, reduced effort, and
costly politicking that these perceived inequities provoke, organizations must
respond to those perceptions. Unfortunately, the managerial remedies are often
as harmful as the diseases they attempt to cure:
Organizations can flatten pay. Companies may respond by weakening incentives,
essentially dropping any pretense of a link between performance and pay. They
may instead reward something like seniority or position, as these are easily
observed and verified. Pay transparency thrives in organizations that abandon
pay for performance; it struggles in environments where rewards are linked to
subjective metrics. Abandoning the link between pay and performance, though,
has predictable outcomes: Motivation declines, and the best, brightest, and
most capable depart for firms that reward performance and recognize ability.
Organizations can physically and socially separate those with distinct patterns
or levels of pay. Organizations can, in essence, isolate the people likely to
provoke others to envy (or isolate those with a basis to envy). An executive of
a very large industrial manufacturer shared a fascinating illustration with me.
The firm housed two distinct employee groups with very different reward
structures at a common physical location. One group was a well-paid,
well-educated group of client-facing engineers. The other group consisted of
production employees operating in a factory setting. Efforts to retain the
first group with higher pay were plagued by unrelenting complaints and
discontent from those less highly paid. In response, management took a
succession of steps targeted at reducing transparency or eliminating the
opportunity for comparison. They first attempted to isolate the higher paid
group at the same site constructing a brick wall down the middle of the
building, creating separate entrances, and dividing the parking lot thus
limiting transparency. When all of that proved insufficient to quell the
negative behavioral responses, they physically moved the high-paid group to a
new location, several miles away. Of course, actions taken to separate
employees may contradict what is necessary for effective work flow and
communication.
Organizations can outsource those activities where competitive rewards demand
pay that diverges dramatically from the rest of the organization. For years,
large pharmaceutical firms purchased small biotech firms with promises to keep
their entrepreneurial rewards intact. But the large firms quickly discovered
that social comparison processes made this highly problematic. Attempts to
maintain these incentives wreaked havoc on the sense of fairness and equity in
the remainder of the firm. Yet abandoning these incentives caused key talent
the talent that prompted the big company s acquisition in the first place to
exit. Big Pharma quickly moved to a model of contracting out research to
smaller firms, and then paying to license any discoveries. Of course, the story
with Harvard and the management of its endowment echoes this same pattern. Pay
transparency pushed Harvard to outsource.
Composing effective reward systems is no simple task. While gender pay
inequities merit swift remedy, pay transparency is no panacea. Unless
performance is highly transparent, imposing transparency will elevate feelings
of inequity that will inevitably push employees to depart, reduce effort, and
lobby for change. Remedying gender inequities will certainly be one of those
changes, but it s unlikely to be the only one. Unless you have a clean, clear,
and broadly accepted measure of individual performance, transparency will
likely push you to flatten pay linking rewards to factors you can precisely
measure, such as seniority or hierarchical position. Of course, rewarding these
factors will demotivate and drive away the talent you would like to keep.
What do effective organizations do? They link individual performance to rewards
but recognize that they must be vigilant in efforts both to measure performance
and to convince employees that their necessarily imperfect measures are
acceptably fair. The real problem with pay transparency is that it focuses
individuals on comparing pay rather than on elevating performance.
Todd Zenger is the N. Eldon Tanner Professor of Strategy and Strategic
Leadership and Presidential Professor at University of Utah s Eccles School of
Business. His recent book, Beyond Competitive Advantage: How to Solve the
Puzzle of Sustaining Growth While Creating Value (Harvard Business Review
Press, June 2016) explores how value creating corporations compose corporate
theories that guide their ongoing growth, including acquisitions. You can
download a free chapter at ToddZenger.com.