Aaron D. HillFederico AimeJason W. Ridge
May 09, 2017
You ve probably taken a guess as to how much money your coworkers and others
make, compared with you. Evidence suggests you probably aren t very accurate.
In one PayScale survey of 71,000 people, for example, 64% of those paid the
average market rate thought they were paid less than average. At the same time,
35% who were paid above market rates also thought they were paid less than
average.
Because our perceptions about pay are often wrong, pay transparency has started
to gain popularity. Why not simply inform workers of what everyone in the
organization makes, in order to stave off speculation?
There are pros and cons to this line of thinking. On one hand, such a policy
can guard against discriminating along racial, ethnic, or gender lines while
giving people a firm grasp of where they stand in an organization. On the
other, firms naturally have differences in pay in some form. When people are
made aware of pay inequality (or dispersion ), it can lead to feelings of
inequity that affect satisfaction and motivation, increasing the likelihood
that people will quit. Because of this, some question the wisdom of openly
informing people that pay differences do exist.
We agree with both arguments. Pay transparency can be a good thing, but it can
also be a bad thing if executed poorly. So how does a firm correctly execute a
pay transparency plan? By making sure the inherent differences in pay are
justified by differences in workers performance on the job. Our research,
appearing in Strategic Management Journal, shows that if people know how much
they make relative to others, and if differences in pay can be clearly tied to
how their performance stacks up against coworkers , harmful effects of
differences in compensation can be negated. Pay transparency must go
hand-in-hand with performance transparency something that may seem obvious
but, at least in our experience, is lacking in most organizations.
To analyze this, we used data from an industry where individuals pay and
performance are quite transparent across firms and also, at least for some, are
quite unequal: Major League Baseball. We tested how differences in pay and in
players performance affected the winning percentages of MLB teams from 1990 to
2000, controlling for a host of factors including how much teams spend on
players salaries, relative to other teams; the ability of the manager; and the
overall team talent, which we measured using a comprehensive and comparative
player performance metric created by noted baseball statistician Bill James.
(While sports are different from other industries in many respects, baseball
makes a good test case for this kind of study for several reasons. First, there
s lots of transparency about individual performance and compensation. Second,
the format of the game makes it possible to separate, to a higher degree than
in other contexts, individual performance from team performance. And third, MLB
players compensation is less regulated than in other sports, so we can more
readily observe the impact of pay dispersion.)
We first show that, as in prior studies, pay dispersion is negatively related
to winning performance above and beyond the effects of the other factors. In
other words, the greater the inequality in pay, the worse the performance.
But when we looked more closely at performance, we found that teams actually
perform better (that is, they have a higher winning percentage) when there is a
match between pay and performance. In essence, a team could have a high
dispersion in pay between players, but if the pay corresponds with their
performance, the negative aspects of inequality go away, at least in the form
of a team s winning percentage.
Consider the Oakland A s as an example. In the late 1980s and early 1990s, they
were one of the top-spending and most successful teams, playing in three
straight World Series, from 1988 to 1990, and winning nearly 60% of their games
in 1992. New owners took over in 1995 and changed strategies, slashing payroll
and shifting their emphasis to using younger, cheaper players (as opposed to a
roster of expensive veterans), while also focusing their smaller payroll on
rewarding a handful of key performers. This approach, famously described in
Michael Lewis s book Moneyball, took time, as the team cycled out existing
contracts, so that by 1997 the A s had a very low match between pay and
individual performance.
But then things began to change: The match improved to about league average in
1998, and increased further in 1999. Most important, the winning percentage of
the A s improved along with the improved match in pay and individual
performance; the team went from winning 40% of games in 1997, to 46% in 1998,
to 54% in 1999. In 2000 they won 57% of their games and were back in the
playoffs, with a high match between their dispersion in pay and players
performance.
There are also examples of pay and performance mismatches, either by having
highly dispersed pay or highly similar pay (low dispersion) that is not
justified by performance. In 1998, just a year after winning the World Series,
ownership of the Florida Marlins (now named the Miami Marlins) engaged in a
fire sale, cutting the payroll to one-quarter of its previous total. As with
the A s, certain players and contracts were hard to trade, and the result was
that the Marlins had a highly dispersed payroll the highest in the league, in
fact. That same year, the Montreal Expos (now the Washington Nationals), which
had been cutting payroll for the previous few years, had a roster full of
inexpensive players all paid relatively the same, resulting in the lowest pay
dispersion in the league. Yet for both teams, dispersion in individual
performance was about average, creating high mismatches for the two teams but
in different ways: high dispersion in pay with average dispersion in individual
performance for the Marlins, versus low dispersion in pay with average
dispersion in individual performance for the Expos. Unsurprisingly, the Marlins
won only one-third of their games, while the Expos won 40%.
That same season, however, the New York Yankees set a then-record for wins in a
season, and the next winningest team, the Atlanta Braves, won nearly two-thirds
of their games. While the former was in the bottom quarter of the league for
payroll dispersion and the latter was in the top five, both rated highly in
terms of the match between the dispersions of pay and the dispersions of
individual performance.
In the end, our analysis points to two general conclusions. First, the negative
impact of high pay dispersion is not about equality but about equity. Or, more
specifically, group performance suffers when pay differences or similarities
are not justified by individuals performance. Relatively high or low
dispersion is not in and of itself bad; rather, it is the match (Yankees/
Braves) and mismatch (Marlins/Expos) between pay and individual performance
that creates problems.
While there are some limitations to the generalizability of our research,
including the head-to-head nature of competition in baseball and the openness
of pay and performance data, we suspect similar dynamics may be at play in the
workplace. Sports data is useful for studying pay and performance since it is
widely available, but studies identifying problems associated with pay
dispersion appear in diverse contexts, ranging from hospitals to trucking firms
and concrete pipe manufacturers, and from administrative professionals to
executives in S&P 500 firms.
As such, it is imperative that pay be allocated based on equity, where pay
matches performance. If not, firms that pay more or have better overall talent
may not perform as well as expected, if high performers are paid the same or
less than their lower-performing peers. Similarly, firms with employees who
perform similar tasks, and to a similar degree of quality, should all be paid
similarly to eliminate any harmful effects of pay dispersion. If not, high
performers may lack motivation to continue to outperform their peers who do
less but make the same, and low performers may lack motivation to perform
better when they can make the same as high performers by doing less work.
Our second conclusion is that it s important to understand pay transparency as
a complex issue. As calls for pay transparency increase, it s important for
companies to understand when it may and may not pay off. Sure, it can be a tool
for broader pay equity and for employee motivation. But if pay is transparent
and performance does not justify any discrepancies or similarities, pay
transparency can have disastrous effects.
Consider the infamous case of Seattle credit card processer Gravity Payments,
which, in 2015, set a minimum salary of $70,000 for all employees. Two
employees interviewed by the New York Times ultimately quit. One was frustrated
with people who were just clocking in and clocking out earning the same as he
was. Another was upset by the lack of fairness, noting the company gave raises
to people who have the least skills and are the least equipped to do the job,
and the ones who were taking on the most didn t get much of a bump.
The bottom line for companies is that people are going to make comparisons
about pay and, more often than not, will make them inaccurately. Rather than
hiding pay information or making it accessible without context, organizations
would be better off forming transparent performance metrics, matching pay to
those metrics, and having open conversations with employees about where they
stack up. That, more than anything, is what a truly transparent compensation
program would look like.
Aaron D. Hill is an Associate Professor and William S. Spears Chair in Business
Administration at Oklahoma State University. His research focuses primarily on
how key employees, and particularly executives and individuals in the political
arena like congresspersons and lobbyists, affect firms.
Federico Aime is the Spears Chair of Business Administration at Oklahoma State
University. He received his Ph.D. from Michigan State University and an
honorary doctorate from Moi University (Kenya). Before becoming an academic,
Dr. Aime occupied several senior management positions in foreign and
international organizations such as Citibank and Zurich.
Jason W. Ridge is an Assistant Professor of strategic management at the
University of Arkansas. He received his Ph.D. from Oklahoma State University.
His research focuses on the intersection of executive leadership, compensation,
and political strategy.