Should you know what your co-workers earn?
Wouldn't it be great if you knew what your boss earns? What the person in the next cubicle takes home? Pay transparency is an issue that’s sure to rile partisans on either side, but much of the debate is based on intuition or self-interest. Plenty of firms publicize starting salaries, pay grids and formulas. But should everyone know what their colleagues and bosses make?
Searching for a dispassionate, evidence-based view, we turned to economist and finance expert Pierre Chaigneau. Chaigneau, associate professor and Commerce ’77 Fellow of Finance, has researched executive compensation. He separates fact from fiction in this email exchange with Alan Morantz, senior editor at Smith Business Insight.
ALAN MORANTZ: Mainstream economists consider information asymmetry as a major source of market failure—we don’t all have equal access to information on which to base decisions. Does that mean that economists would argue for fullblown pay transparency? Wouldn’t that level the field in the workplace?
PIERRE CHAIGNEAU: At first glance, the answer is yes. Pay transparency is especially beneficial to workers to help them make better decisions. They will know more about other potential jobs they could have, which will affect their decisions to accept job offers, their leeway for negotiation before and after they have accepted a job offer, and their willingness to quit their current jobs. This is often beneficial because it reduces what economists refer to as search costs, and it also improves the efficiency of the matching between firms and employees. In simple words, this helps ensure that tasks are allocated to the best people for the job. Obviously, there are other effects at play, including countervailing effects.
I couldn’t help but notice you wrote, “At first glance.” Better decision-making for workers, lower search costs and a more efficient labour market sound like pretty good outcomes of pay transparency. At “second glance”, are there situations that would work against these outcomes coming to pass?
Yes indeed. A problem with pay transparency is that it allows employees to know how much their colleagues make. This will make them reassess whether they are paid fairly themselves. Unfortunately, such comparisons often bring dissatisfaction because most of us have an innate tendency to overestimate our abilities and contributions to an endeavour, for example, because of a self-attribution bias. In turn, a feeling that one’s level of pay is “unfair” has a demotivating effect, which reduces individual and organizational performance. This insight was at the heart of the efficiency wage theory, which recommended that employers pay above market wages.
If we take this reasoning one step further, employers may become reluctant to increase the wage of any employee when wages are publicly disclosed because this may trigger either discontent or demands for similar pay increases by other employees. Researchers Zoe Cullen and Bobak Pakzad-Hurson tested this effect in a recent working paper [“Equilibrium effects of pay transparency”] and found that pay transparency led to a small decline in wages. In this case, pay transparency backfires.
Pay transparency can be motivating if used appropriately and strategically. In a paper soon to be published, [“How much does your boss make? The effects of salary comparisons”] researchers Zoe Cullen and Ricardo Perez-Truglia found that disclosing managers’ salaries results in employees working harder when they find out that their managers earn more than they thought.
But one of those researchers, Perez-Truglia, also completed a study of extreme transparency [“The effects of income transparency on well-being: Evidence from a natural experiment”] in Norway where the tax records of all Norwegians are digitized and, since 2001, freely available. He found the gap between the happiness of the rich and the poor increased by 29 per cent as a result. Given these different and conflicting effects, how much should we factor in social welfare when devising a pay transparency policy?
Notwithstanding the difficulties associated with measuring happiness, this change in the “happiness gap” makes sense. The Nordic culture is egalitarian and frowns upon deviations from the norm. Pay transparency highlights these deviations. This finding is also consistent with the dissatisfaction effect I mentioned earlier when information about the pay of our peers is made available. In this context, peers can include co-workers, but also neighbours, family members, high school cohorts, etc. This is consistent with the finding from the study that “most [people] used the websites [with salary lists] to snoop on friends, relatives and social contacts.”
Above all, this and other negative findings emphasize that pay transparency is best applied selectively rather than broadly. It should be targeted to achieve some well-defined objectives. For example, it can be used to attract workers to overlooked occupations or organizations, to motivate hard work when employees underestimate the benefits of career progression, or even to help students make better-informed decisions when choosing their undergraduate programs. In many of these cases, it is possible, and often desirable, to provide aggregated rather than individual-level data. This allows organizations to get most of the benefits of pay transparency while minimizing its psychological costs.
It’s also worth distinguishing between transparency on pay outcomes (how much someone gets paid) and transparency on the pay-setting process (how pay is determined). For example, like many workers of the “gig” economy, Uber drivers have full discretion over when and where they work. Uber sets their pay via a publicly available formula, which is the same for all its drivers, in part to ensure that Uber drivers will be available in most places at any time. In the end, there will be important variations in pay among Uber drivers, including a gender pay gap a s documented in a recent paper [“The gender earnings gap in the gig economy: Evidence from over a million rideshare drivers”]. But the process that led to this outcome is fully transparent.
Pierre, you’ve argued persuasively that pay transparency is a blunt instrument best used selectively. But you also have skin in the game. As a university professor in Ontario, your salary is made public under the province’s so-called Sunshine List. I have to ask, How does it feel to have this information public? Has it helped or hindered you in any way?
I find this list useful. It is quite easy for me and others, including executive recruiters, to look up the salaries of finance professors at the University of Toronto, Western, but also Georgia State and Georgia Tech, since the state of Georgia (and others) have similar disclosure requirements. Now, these numbers must be put in context. Salaries will vary a lot depending on the type of employment (tenured, adjunct, etc.), the field (finance, marketing, etc.) and past achievements—especially publications in the best academic journals, which are used as a proxy for expertise. Still, it is quite easy for professors to look at these compensation numbers and figure out if they are underpaid or overpaid. Of course, it is rare for people to believe that they are overpaid, but at least those who are underpaid can now make a better case!
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