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Unfair – And Unfixable? The Simple Truth About Salaries

By Knowledge Wharton. Originally published at ValueWalk.

Look across the ranks of almost any office, retail floor or faculty lounge, and you’ll see many workers doing essentially the same job. Peek at their pay-stubs, though, and you’ll likely find disparity. Pay differences among workers can hinge on objective matters like experience. But salary disparity is often a function of more arbitrary factors — raising the question of why establishing compensation hasn’t evolved into a more fair, equitable and objective system. How do qualities as intangible and unpredictable as work ethic, creativity and esprit de corps get translated into compensation?

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“It may seem crazy and arbitrary, but there is no effective way to do this, because you are trying to trade off against goals that aren’t necessarily comparable,” says Wharton management professor Matthew Bidwell. “And so, if you want a system that is fair and equitable, preferably with a fair amount of transparency so people know the system is fair and equitable, you [also] want a system to attract and retain top performers and that rewards the right behaviors, particularly behaviors that are good for the organization.” The big challenge is that all of those things are hard to measure, Bidwell adds.

One of the big hurdles to a better model is the distorting effect that extremely high executive compensation has had on the entire compensation conversation, says Wharton emeritus management professor Marshall W. Meyer. “We created this culture of the CEO as someone who has exceptional talent and deserves to be rewarded exceptionally,” he says. “The ratio of CEO to worker pay used to be something like 20 to one, and now is more like 2,000 to one, and that makes compensation problematic. When people look at the numbers being pulled down by CEOs — with CEO salaries not just in the six-digit range, but the seven-digit range — while meat packers are getting paid the same as they were in the 1960s, that immediately raises difficulties. So, what is equity in compensation?”

The system often in place today, he says, lines up like this: “Salaries that don’t support a middle-class lifestyle, management gets rewarded for serving shareholders, and everyone is miserable.”

The Persistence of Pay Gaps

Part of the reason firms haven’t been able to develop a better way of setting salary is that it’s really difficult, says Wharton management professor Adam Cobb. “You could make the case that this is the biggest HR challenge in most organizations: How do you pay people fairly, in a way that’s motivating and encouraging the right kinds of behaviors? Because it’s a moving target. We are human beings, and our perception of these things changes over time. What you think is fair and equitable might not be what I think is fair and equitable.”

Still, there is good reason to believe that the current system for determining compensation can be more fair and equitable than it is. Though little talked about, arbitrary factors governing compensation shadow workers for their entire careers. Daniel Hamermesh, economics professor at the University of Texas at Austin, found that good-looking workers typically earn 3% to 4% more than workers who are more homely. Over a lifetime, that adds up to an advantage totaling $230,000 for the typical more attractive person, or even, for an average-looking worker, $140,000 more, he says in Beauty Pays: Why Attractive People Are More Successful. The disparity wasn’t found only in professions where looks might obviously matter — newscaster, for instance — but, he says, across all professions.

“How do you pay people fairly, in a way that’s motivating and encouraging the right kinds of behaviors?… [I]t’s a moving target.”–Adam Cobb

Relatively recent efforts to address the gender gap in pay may have suffered a setback. In April, the 9th U.S. Circuit Court of Appeals, in overturning a lower court decision, ruled that employers can pay women less than men for the same work when the determining factor is the difference in workers’ previous salaries. The suit was filed by a California school worker who discovered while having lunch with colleagues that her male counterparts were being paid more than she was. Her lawyer has argued that the decision perpetuates the gender pay gap, and the case appears headed for the U.S. Supreme Court. Women earn 79 cents for every dollar earned by men, according to the U.S. Census Bureau. In large part as an effort to close the pay gap, Philadelphia earlier this year became the first city in the nation to pass a law prohibiting employers from asking about a job applicant’s prior earnings, which tends to extend inequity.

The wage gap between black and white Americans is the largest in 40 years, according to the Economic Policy Institute. In 2015, the difference in hourly pay between blacks and whites widened, with blacks making an average of 27% less than whites with the same experience and educational level, according to the EPI.

Some industries have been able to move into more objective systems of compensation, with some apparent benefit to both worker and the firm. After Safelite Glass Corporation, the large auto glass company, moved to a system of piece rate pay from hourly pay, Stanford University professor Edward P. Lazear examined data from 3,000 workers over a 19-month period, and concluded that the change had a salutary effect on productivity as well as paycheck. The average level of output per worker rose by 44%, and pay increased by 10%, wrote Lazear in “Performance Pay and Productivity,” published in the American Economic Review in 2000.

“About half of the increase in productivity results from the average worker producing more because of incentive effects. Some of the increase results from an ability to hire the most productive workers and possibly from a reduction in quits among the highest output workers,” concluded Lazear. “More ambitious workers have less incentive to differentiate themselves when hourly wages are paid than when piece-rate pay is used. Claims by sociologists and others that monetizing incentives may actually reduce output are unambiguously refuted by the data. Not only do the effects back up economic predictions, but the effects are extremely large and precisely in line with theory.”

“The interesting part is, they are saying, ‘here is how the process works.’ By showing that process, at least everyone knows what they are signing up for….”–Adam Cobb

The system was not without its bumps. “One defect of paying piece rates is that quality may suffer,” Lazear writes. Workers were required to fix defects on their own time, though they don’t bear the cost of wasted glass or other costs associated with redoing the job. “Because re-dos are costly to the worker, he is motivated to get it right the first time around.”

The pay-for-piece program also drew a class-action lawsuit in 2015 from a technician who claimed that the system of compensation failed to pay for work such as cleaning, attending compulsory meetings and other tasks. The U.S. District Court of California’s

The post Unfair – And Unfixable? The Simple Truth About Salaries appeared first on ValueWalk.

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