2017-05-11 07:23:50
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.