The hidden costs of pay transparency
Some say that sunshine is the best disinfectant. But is this true in the realm of workplace compensation?
Several trends show that pay transparency is growing. Socially, 42 per cent of gen-Z workers and 40 per cent of millennials have revealed their salaries to coworkers and professional contacts. Technologically, websites such as Glassdoor and PayScale gather and disseminate pay data with ease. Legally, though shelved, the 2018 Ontario Pay Transparency Act may be a harbinger of future legislation. In summary, Canadians may need to get used to talking to coworkers about how much they get paid.
Proponents of pay transparency suggest that it can deter workplace discrimination. The idea is that employees doing equal work should receive equal pay regardless of personal characteristics such as gender and ethnicity. However, equality should not be confused with equity. Equitable pay implies that individuals who are more productive and contribute more to the organization receive more compensation. Inequitable pay often leads to employee dissatisfaction and turnover, especially among high performers.
Pay transparency can present a dilemma for management. Suppose Harry and Sue are both engineers in a company but are assigned to different projects and report to different managers. Further suppose that one is paid a higher bonus for the year. When pay is transparent, the lower paid individual may question whether the company is accurately measuring performance. It would have been easier for the company to justify pay discrepancy if Harry and Sue worked on the same project and in similar capacities. But in a world where employees perform complex and non-homogenous work, such determinations are not easy.
Without careful consideration of how pay discrepancies can be justified, employees can become dissatisfied even if there is no overt discrimination. The reason lies within awell-known bias called the “better than average effect.” A popular academic finding is that 88 per cent of people believe they are above-average drivers, which is mathematically impossible. It is not surprising that such biased beliefs can permeate the workspace, especially when one does not have first-hand knowledge of other individuals’ productivity. Knowing what others get paid may cause some employees to resent others, believing that they are not working as hard.
A case study of the University of California pay transparency initiative demonstrates this problem. When a policy change allowed its employees to learn what everyone makes, those who were paid below the median for their pay unit and occupation reported lower job satisfaction. They also showed a higher likelihood of looking for a new job, while above-median earners did not change their attitudes.
A less talked about, but equally pernicious, problem is caused by managers’ centrality bias. The complexity of work at some firms requires managers to subjectively determine the performance of employees and assign scores. However, conflict averse managers may resort to giving employees similar scores despite actual different performances. Such behaviour may cause higher performers to be under-rewarded in the short term, and high turnover in the long term.
Despite these problems, pay transparency, if executed correctly, can improve performance. The sense of equity can be improved if employees know that individuals are paid according to their contributions and that the employer is willing to stand behind meritocracy. But this is a difficult task. Before presenting pay information to all employees, firms need to commit to collect sufficient performance data to remove the biases and errors in the system. In the case of subjective evaluation, managers need to abide by clear criteria and be accountable for their decisions.
In summary, firms should tread carefully when taking the path to pay transparency. My colleagues and I have multiple research inquiries into the effect of pay dispersion and pay transparency on both employee productivity and manager compensation allocation decisions. It is our belief that the voices may be calling for transparency, but employees will not be satisfied until they obtain equity.