I'm a long-time proponent of pay process transparency, but have been skeptical of publishing employee-level data. Some new research has me wondering whether I should reconsider my thoughts on the issue (I'm not yet convinced, as I discuss below).
The fact that our behavior is shaped by the constant comparisons we make between ourselves and those in our reference group has been well established in sociology, psychology and economics. With respect to differences in compensation, much of the research has focused on how these differences lead to feelings of discontent and envy.
In his paper "Relative Concerns at the Workplace: On the Design of the Firm as a Social Space," Walter Hyll argues that these 'relative concerns' can be transformed into a positive force for productivity and profitability. While his analysis presents a mathematical solution to optimizing the mix of low-skill and high-skill workers, he does reference some implications of pay differentials associated with skill differentials.
The central idea underlying Hyll's hypothesis is that workers derive satisfaction (deprivation) if they do better (worse) than members of their reference group. He makes the following two arguments:
- If a worker experiences a sense of relative deprivation, he will respond by increasing his optimal level of effort to reduce the gap between his own earnings and the earnings of those within his reference group;
- If a worker experiences a sense of relative satisfaction, he will respond by increasing his optimal level of effort to increase the gap between his own earnings and the earnings of those within his reference group.
In other words, if you're unhappy with being paid less than your reference group, you will work harder to catch up. If you're already earning more than others in your reference group, you will work harder to stay ahead. So, feelings of relative deprivation and relative satisfaction both lead to working harder. Working harder increases productivity, which ultimately leads to higher profits.
In terms of the mathematics, Hyll's argument is correct. It is also correct from a theoretical perspective when we assume that individuals are rational utility maximizing agents, firms are profit maximizing agents, both workers and firms have perfect information, individuals have appropriately defined their reference group, etc. The biggest assumption, however, is that any differences in pay are attributable solely to differences in productivity.
I wish this assumption was consistent with reality, I really do. It would solve so many of the problems that practitioners face. Unfortunately, in most cases this assumption is unfounded. In all but the strictest performance pay schemes with easily quantifiable objective outputs, pay determinations are influenced by things other than pure productivity. Seniority pay, previous relevant experience (that may or may not relate to productivity), salary history, implicit bias, and intentional discrimination all influence decisions when setting a worker's pay. If the reason for differences in workers' pay includes any of these elements, I question whether the worker will respond with an increased level of effort.
From an academic perspective, I am happy to see that questions such as this are being examined. From a practical perspective, I think that a lot more work needs to be done. Starting from a purely theoretical framework is appropriate - that's how we understand the mechanisms at work. But the findings generated from this theoretical framework are, in my opinion, not yet ready for a real-life workplace. Many of these assumptions need to be relaxed, and the reality-based imperfections discussed above need to be incorporated.
Stephanie Thomas, Ph.D., is a Lecturer in the Department of Economics at Cornell University. She teaches undergraduate and graduate courses on economic theory and labor economics in the College of Arts and Sciences and in Cornell’s School of Industrial and Labor Relations. Throughout her career, Stephanie has completed research on a variety of topics including wage determination, pay gaps and inequality, and performance-based compensation systems. She frequently provides expert commentary in media outlets such as The New York Times, CBC, and NPR, and has published papers in a variety of journals.