The Uncomfortable Questions You Should Be Asking about Pay Equity

Jun 09, 2015 - Knowledge@Wharton

How much money do you make? Are you paid fairly compared to the other people you work alongside? Do you have any idea if you’re paid fairly? How much does the head of your organization make? Do you care? Does he or she care about whether your pay is fair?

For most of us, those are uncomfortable questions. Like politics and religion, asking someone how much they earn is, at best, considered impolite dinner conversation and at worst, potential grounds for class warfare. But at a time when lavish executive pay and gender inequity in the workplace dominate the headlines, these questions have become increasingly relevant to the national dialog. According to a New York Times/CBS News poll released in June, 66% of Americans feel that the distribution of money and wealth in this country is unfair and should be more evenly distributed. Half of all people surveyed said they were in favor of limiting the amount of money earned by top executives at large corporations.

“We are highly attuned to things we think are unfair,” says Matthew Bidwell, professor of management at Wharton. “As workers, we look at the ratio of what we’re putting in, versus what we’re getting out, and we compare that to the ratio of what other people are putting in and getting out…. [It’s only] natural to think: Is this fair?”

Some chief executives have recently come to the conclusion that their company’s pay structures aren’t fair and have taken steps to address imbalances. In April, for instance, Marc Benioff, the CEO of Salesforce, said he was reviewing employee salaries at his cloud-based software company to ensure male and female workers are paid fairly and have equal opportunities for advancement. Also that month Ellen Pao, interim CEO of Reddit, announced the social-media site would no longer negotiate salaries with prospective hires. Citing research indicating that men tend to negotiate harder than women and that women are often penalized when they do negotiate, Pao says her new policy is a way to level the playing field for female job candidates. Meanwhile Dan Price, the head of a small credit card processing firm in Seattle, announced that he planned to raise the salary of everyone at the company to a minimum of $70,000 over the next three years.

“Companies are dealing with two key issues: One, pay inequity, and two, the big gap between what senior executives earn versus average workers,” says Wayne Guay, professor of accounting at Wharton. “The issue of economic inequity refers to biases within the system that cause employees to be paid or promoted unfairly because of their gender or their age. These are things that can cause the company to lose good employees. The second issue is more of a problem of perception and public relations.”

Pay equity is a complicated matter — as many companies have found. Taking into consideration all of the factors that differentiate one worker from another, it is not easy to determine what is fair. And while standardized formulas may make compensation somewhat more equal, even with a formula, there exist opportunities for other kinds of discrimination. Eliminating things like negotiation is unlikely to make that much of a difference, some observers say, and in fact, it could make gender equity worse.

While pay is a complex and difficult management challenge, it ought not be ignored, says Guay. “There are real costs to firms when they don’t deal with these problems both in terms of attracting and retaining talent, as well as company reputation.”

A Quasi-legal, Quasi-ethical Question

In a competitive market, an employee’s compensation should reflect the marginal contribution he or she brings to a company. The premise is that when wages reflect the productivity of the individual, “efficient outcomes occur,” according to Janice Fanning Madden, professor of regional science, sociology and real estate at the University of Pennsylvania. “Economists have no understanding of ‘fair,’” she says. “We are concerned with efficiency — that is, what practices increase total product for everyone.”

“There are real costs to firms when they don’t deal with these problems both in terms of attracting and retaining talent, as well as company reputation.”–Wayne Guay

But, of course, the employment market is not perfectly efficient and other considerations enter into the equation. Some jobs are harder than others. Some jobs are more desirable than others. Workers have varying levels of tenure, experience and education. Less tangible factors, such as an employee’s cache, connections or even his or her personal relationship with the hiring manager often play a role, too.

“The thing about compensation is that it’s a quasi-legal and quasi-ethical question,” says Laurence Stybel, the co-founder of Stybel Peabody Lincolnshire, the Boston-based executive career management and board advisory firm, and an executive in residence at Suffolk University’s Sawyer Business School. “The goals of compensation are internal equity and external competitiveness. The leadership issue is how to balance these two often competing forces.” 

It is widely known that many leaders fail at creating internal equity — especially when it comes to gender. Indeed, gender equity in the workplace has long been a hot-button topic, and in the era of Lean In, the issue has become even more urgent. According to the Institute for Women’s Policy Research, female full-time workers made only 78 cents for every dollar earned by men, a gender wage gap of 22%. In fact, women, on average, earn less than men in almost every single profession for which there is sufficient earnings data for both men and women to calculate an earnings ratio.

The discrepancy is not lost on average workers: According to a Pew Research Center Survey conducted last fall, more than three-quarters of U.S. women and 63% of men said that “this country needs to continue making changes to give men and women equality in the workplace.”

Some in corporate America — including Salesforce’s Benioff — are attempting to do that. He announced he was examining the pay of all 16,000 employees at his company to ensure pay equity and vowed to right any salary differences. “My job is to make sure that women are treated 100 percent equally at Salesforce in pay, opportunity and advancement,” he told The Huffington Post. “When I’m done, there will be no [pay] gap [between male and female employees].”

Benioff’s move is being closely watched by other large organizations — and for good reason, according to Steve Gross, a senior partner at Mercer, the consulting group. “Every major company has an obligation to ensure to its shareholders and employees that it is not engaging in inadvertent discrimination,” he says. “I’ve never met a company that wanted to discriminate. But the trouble is that on a local basis, managers make hiring and compensation decisions, and sometimes [discriminatory] patterns occur.”

The way to address this problem is relatively straightforward, he says. Companies need to “take out the subjectivity” of the compensation process by running statistical analyses that predict employees’ salaries. These predictions should be based on a worker’s capabilities, experience, education, performance ratings and tenure. Then, the company needs to “look for outliers” — those earning way above or way below the expected salary band, he says.

If, say, the company finds that Bob is earning $64,000 and Mary earns $50,000 for the same job, which has a predicted salary of $58,000, he says that “the question becomes: Can they defend that decision based upon objective factors?”

“The goals of compensation are internal equity and external competitiveness. The leadership issue is how to balance these two often competing forces.”–Laurence Stybel

The right answer is not always obvious — perhaps Bob has more relevant experience or maybe Mary is on a performance improvement plan — but the process, says Gross, is critical to ridding and preventing gender or other biases within organizations. And it’s “not only pay in the current job” that’s at stake, he says. “It’s also the trajectory of the employee’s career and making sure that everyone at the organization has an equal opportunity to move up and get ahead.”

Playing Hardball

A lack of equal opportunity was at the heart of Ellen Pao’s gender discrimination suit against her former employer, Kleiner Perkins. Her suit claimed that Kleiner — one of the most powerful venture capital firms in Silicon Valley — failed to prevent gender discrimination. Her lawyers argued that the firm did not promote her because she was a woman and retaliated against her for complaining about it, which culminated in her dismissal in 2012. Pao lost her case, but she succeeded in highlighting two important issues: the lack of diversity in technology and venture capital, and the biases women face in those industries.

Shortly after she lost, Pao announced that Reddit, where she is now CEO, has removed the ability of job candidates to negotiate their salary in order to make the hiring process fairer. “We come up with an offer that we think is fair,” she said in an interview with The Wall Street Journal. “If you want more equity, we’ll let you swap a little bit of your cash salary for equity, but we aren’t going to reward people who are better negotiators with more compensation.”

Pao’s new mandate is borne out of research that shows that women don’t get what they want (and deserve) because they tend not to ask for it. A series of studies conducted by Linda Babcock, a professor at Carnegie Mellon, found that men are more likely than women to negotiate for their salaries and that many organizations punish women when they do ask. Women who forcefully pursue their ambitions and promote their interests may be branded as pushy, brash or worse, according to Babcock’s research.

“In other words, women can’t play hardball because there’s often a backlash,” says Nancy Rothbard, a professor at Wharton. “This is where Ellen Pao is coming from. She is offering a solution to a real problem as a way to level the playing field.”

The challenge, however, is that people like to negotiate. Research by Adam Galinsky, a professor at Columbia Business School, shows that when people accept an objectively good offer the first time, they are less satisfied with their deal compared with people who get an objectively worse offer that improves after several concessions, but is still worse than the deal the non-negotiators obtain. Both parties are more satisfied with the outcome if there was some back and forth, according to the research. Intuitively this makes sense: Sellers want to feel that they drove a hard bargain, and buyers want to feel as though they got a good deal.

While Pao’s ban on negotiation may rally women, and even some men, to want to work at Reddit, it will also “make a lot of people unhappy,” according to Rothbard. “There’s going to be a feeling of: ‘I didn’t get what I deserve,’” she says. “The trouble with a ‘take it or leave it policy’ is that you need transparency in terms of who is making what salary. If you take away agency, you’ve got to do something to balance that out.”

Another concern about prohibiting salary negotiation is that it has the potential to worsen gender discrimination in the workplace. Financial compensation is only part of what companies provide in terms of recognition and reward. Anything that is “scarce and desirable in the workplace” — including perks like flexibility, paid holidays, as well as things like plush offices and plum assignments — is part of the overall package, notes Iwan Barankay, a management professor at Wharton.

“The trouble with a ‘take it or leave it policy’ is that you need transparency in terms of who is making what salary. If you take away agency, you’ve got to do something to balance that out.”–Nancy Rothbard

“When employees are no longer allowed to negotiate their salary, they will look for other ways to be rewarded, particularly in terms of those softer perks,” he says. “But it is not clear how management is dealing with this, and the risk is that the allocation of those non-monetary rewards will be even more discriminatory than what we see with salaries.”

A final problem with taking away the ability to negotiate is that not all candidates have the same talent or skill level. This gives rise to what’s known in economics as an adverse selection problem, whereby the people who are above average will not be attracted to the contract, and the below average people will be. “This is analogous to an insurance company offering the same flood insurance policy to everyone — home owners in high flood risk areas will find the policy attractive, but home owners in low risk areas will find the policy too expensive,” says Guay. “The danger with respect to the employment contract is that the employees who find it most attractive are the people you want least.”

No One-size-fits-all Approach

Other corporate leaders are taking a more novel approach to employee pay. Earlier this year, Dan Price, the founder of Seattle-based Gravity Payments, stunned his 120-person staff by announcing that he planned to increase the salary of even the lowliest clerk and salesman to a minimum of $70,000 over the next three years. He told The New York Times that he intended to keep his own salary low until the company earned back the profit it had prior to the new wage scale taking effect.

Wharton’s Bidwell predicts Price will reap “collateral benefits” from the move. “He’s going to be able to hire some great people. And he’ll get a lot of loyalty from them,” he says.

Price, for his part, said his move was motivated by concerns about rising income inequality and exorbitant executive pay, especially in comparison to the typical worker. According to a 2014 study by the Economic Policy Institute, the advocacy group, CEO compensation as a multiple of the average worker’s pay soared from an average of 20 times in 1965 to 295.9 times in 2013. The Securities and Exchange Commission was supposed to require all publicly held companies to disclose the ratio of CEO pay to the median pay of all other employees under a financial overhaul passed by Congress in 2010. So far, however, it has failed to put it in effect.

Guay regards Price’s new policy as little more than a publicity stunt. “An employee doesn’t benchmark his salary against the CEO of the organization. He benchmarks it against the person working in the office next door,” he says.

And while Price’s approach may improve pay equity and fairness at his company, it is not a scalable solution. “Solving all these problems is tricky, and there is no one-size-fits-all approach Twitter ,” Guay says. “In small companies, there may be more you can do because senior managers know the employees and their individual talents. For big firms, processes must be put in place to hold managers accountable for hiring talented applicants and setting their compensation competitively.”