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Salary Crunch :What is the Price of Wage Transparency?

July 27, 2010

​​​​It's not surprising that wage transparency – being open about how much employees are paid – tends to generate negative feelings and reactions. Jealousy, resentment and rivalry may result when employees learn how much their colleagues are earning. But market forces and other circumstances make wage discrepancies a fact of corporate life.

"Salaries are not set in a vacuum," points out Jairus Ashworth, head of reward at human resources consulting firm, Hewitt Associates. "They're set in the constantly changing real world where wage transparency often highlights situations that are not always ideal. For example, there may be instances where you wouldn't have paid a particular person so much if circumstances hadn't meant you were desperate to get them on board. An above-average salary may have been offered to an employee from a high-paying competitor. And, even though he or she was a high performer in their last company, that employee may be just average in yours."

Regardless, wage discrepancies can be de-motivating for those who are paid less. That's why, within the corporate world, there's a preference for confidentiality about salaries. But there is no stopping water-cooler talk and the reactions of employees, particularly when it's discovered that a colleague with a similar skill set and workload is more generously remunerated.

Work or Shirk?

​In the field of economics, there has long been an observation that wages are less dispersed than they should be, notes Ben Greiner, an economics lecturer at the Australian School of Business. It's commonly believed that high performance is underpaid and low performance is overpaid. However, new research shows workers' awareness of wage dispersion may cause of a number of performance problems.

Greiner and colleagues recently investigated the effect of wage transparency on performance in a laboratory-based study. In the first part of their experiment, identical wages were paid to a group of workers, while in the second they introduced wage differentials that were either transparent (known to workers) or not. The study also explored the role of transparency under both fixed and piece-rate wage schemes.

It revealed when people knew what their peers were earning, higher paid workers tended to work more accurately and actually increased their efforts, while low earners under piece rates increased work quantity at the expense of quality and were more inclined to shirk. When wages were kept confidential there was no difference in performances – so wage differentials cause performance to change only when transparent.

"When we lowered the piece-rate wages, the lowly-paid workers increased their quantity but reduced their quality of production," says Greiner. "They were shirking on the quality to get a higher income. The people who were paid higher piece rates actually provided higher quality work while their quantity stayed the same. [But] the changes went away when we didn't tell people the income of others around them. So the changes only exist when people can compare themselves to others."

Beyond the lab, managers may be seeing similar effects in the workplace – although transparency about wages is not always a negative in organisations, notes Martin Turner, a principal in Mercer's human capital business. "When it comes to salary packaging, I'm not a big fan of transparency. It's a matter of confidence between the employer and the employee. It's inappropriate for an employer to disclose the remuneration of specific staff." Remuneration is a "hygiene" factor, Turner says. If paid at – or above – what is perceived to be a fair and reasonable level, then individuals are not de-motivated. It's when rates drop below that level that the problems begin.

How can the damage caused by discrepancies in pay levels be avoided? Ashworth believes all-round pain can be minimised by ensuring there is clarity of process around income. "This means being clear, in an individual negotiation or discussion, about how a person's level of pay is determined: What factors are involved? Which criteria are being considered? The staff member should have a clear vision of how their pay rate has been determined." Such considerations, Ashworth says, include the capacity of the company to pay, individual performance and demonstrated achievement, as well as market rates and movements for the role, the industry and the economy as a whole.

"If someone is genuinely satisfied that the process that determined their income is fair, then that takes away some of the interest in hearing about what others are earning," Ashworth says. "Being transparent doesn't mean revealing the details of other staff members' pay levels, it means letting that individual know exactly how their income was calculated. This clarity should carry into the regular performance and pay reviews, so the person's understanding of their level of income is constantly updated."

No Arbitrary Factors

​This is a sound point, Greiner says. "In our experiment, we paid a higher piece-rate to some participants independent of their performance. This is the same as paying one employee a higher performance bonus than another, even though both deliver the same performance. It's deemed unfair and crowds out motivation. Many people might observe wage differentials and think that they are unjustified, so they lead to the negative effects. Explaining to them that differences in pay are based on performance – and not arbitrary – might help to mitigate these comparison effects."

If they have a good understanding of the process, Ashworth says, then staff should understand that there have to be some discrepancies. "But when they understand the reasoning behind their income level, then they can trust there was solid reasoning behind the other person's levels, as well."

Businesses that offer bonuses can use these to help even out remuneration discrepancies between workers. A recent empirical study by Greiner's co-authors, Axel Ockenfels and Peter Werner, showed that happiness within a workplace has more to do with relative income than salary. For example, people who receive a regular bonus that brings their annual income to A$50,000 are happier than those who receive a flat income of A$50,000 and no bonus.

Variable compensation in all of its forms can mitigate unease over salary discrepancy, Ashworth agrees. And if bonuses are truly results-based, which is common with sales forces, then they can be a positive inspiration for the quality and quantity of work. The issue of transparency is taken out of employers' hands as the results of greater wealth become visible. "It's about who turns up with a nice new car and who went out on their boat last weekend," he suggests. "That competitive pressure is a good driver to perform. Staff can simply look at the sales board and see that they're being paid less because others are selling twice as much as they are."

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