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Stephen  Bevan

Mind the Gap

Authors: Stephen Bevan

18 August 2014

For the first time in history officers of a company can become seriously rich without risking any of their own money. Their rewards are so beyond those of ordinary people that they risk being seen as aliens from another galaxy.”On the day when new research shows that the bosses of the UK’s top 100 companies are earning 143 times more than their staff, you might expect a quotation like this from the TUC or from the High Pay Centre which produced the data. But no, it originates from Sir Richard Lambert, former Director-General of the CBI, hardly a hotbed of radical shareholder activism. It is an indication that even among the friends of business, widening pay dispersion (especially if it does not reflect improvements in company performance) is proving harder to justify.

 

The connections between leaders and the led really matter in modern organisations and the financial crisis has challenged the sometimes fragile bond of trust between senior executives and many of their employees because – in many organisations – there has been a transfer of risk from the business to the employee. Yet the last decade has seen most large organisations investing heavily in measures of employee engagement because they believe that engaged and motivated employees enhance competitive advantage. The difference today is that we are in a period of intense, post-recessionary indignation about top pay and fairness which can, if badly handled, undermine efforts to ‘engage’ the workforce. Until ‘social norms’ about rewards are fundamentally altered, and businesses work out that stratospheric pay for their CEOs harms their ability to reconnect with their workforces and with the wider public, the fear is that the CEO pay escalator will ride on ever upwards. The FTSE 100 index is, it has to be remembered, still lower today than it was in 1999.

 

Of course there has always been a disconnection – a sense of ‘them and us’ - in most organisations. Yet the issue of top pay – and more specifically the spread of pay – has the potential to be the most corrosive aspect of the executive compensation debate. So what does the evidence tell us about the impact that wide pay dispersion has on employee morale, motivation and engagement?

 

While some argue that wide pay gaps provide an incentive to high-fliers, there is little empirical evidence of this, nor that any positive impact outweighs the negatives. When pay differentials are too large, lower paid employees consider their pay to be inequitable and react negatively, for example, by withholding effort. Employees may also view their firm's pay distribution as a zero-sum game and choose not to help colleagues (Pfeffer and Langton, 1993). Collectively, wide pay dispersion is thought to harm firm performance by hurting the quality of employee relationships and incentivising dysfunctional employee behaviours. Trevor, Reilly, and Gerhart, 2012 argue that pay dispersion consists of “dispersion that is explained by performance (DEP) and dispersion that is unexplained by performance (DUP)”. Using the North American National Hockey League's data, the authors show that DEP is positively associated with team performance, while DUP is not. Thus, pay dispersion positively impacts organisational performance only to the extent that it reflects individual performance. This introduces the notion of ‘consent’ into the debate. If the senior team of a business are unambiguously and demonstrably driving forward business success which benefits all employees, their compensation packages – and wide pay dispersion - are more likely to be viewed as proportionate and merited.

 

In the R&D context, large pay differentials among employees create disincentives that preclude innovation (Yanadori et al, 2013). The argument is that wide pay dispersion influences the development of company knowledge resources both positively and negatively. Large pay dispersion increases the sum of individual employees' knowledge retained in firms by attracting and retaining high quality R&D workers. However, in the face of wide pay dispersion, employees may be reluctant to share knowledge with others or contribute to company knowledge management systems through a concern that doing so might reduce their knowledge advantages and eventually result in decreases in their pay relative to that of their colleagues. Wide pay differentials may also increase the competitive tension between employees and discourage employee collaboration and cooperation (Pfeffer and Langton, 1993). This erosion of collective effort can be highly detrimental to innovation because the generation of new ideas often involves collaboration among employees.

 

With real wages for most employees stagnant or falling, and with executive rewards steaming ahead despite shareholder concern and pleas from Vince Cable for restraint and transparency, I think there are real questions about whether the rhetoric we hear from many CEOs about the value they attach to employee engagement isn’t beginning to ring a little hollow.

 

This blog was also featured on the International Business Times website.

 

 

Pfeffer, J, and Langton, N, The effect of wage dispersion on satisfaction, productivity and working collaboratively: Evidence from college and university faculty. Administrative Science Quarterly, 38(3), 382-407, 1993.

Trevor C O, Reilly G and Gerhart B, Reconsidering Pay Dispersion's Effect on the Performance of Interdependent Work: Reconciling Sorting and Pay Inequality, Academy of Management Journal, 55:3 585-610, June 2012.

Yanadori Y and Cui V, Creating incentives for innovation? The relationship between pay dispersion in R&D groups and firm innovation performance, Strategic Management Journal, 34: 1502–1511, 2013.