New Research Debunks a Common Criticism of Pay Transparency

For years, managers have been advised to avoid pay transparency among rank-and-file employees, but our research using employee ratings of compensation satisfaction from more than 1,300 publicly traded firms shows that this may not always be the right choice. The old thinking assumed that employees who discover they are paid less than others will be unhappy, while those who learn that they earn more than others will feel their pay is justified, leading to no change in their satisfaction. If these reactions to pay transparency hold true, firms only face downsides from being more transparent about pay. However, our research shows this conventional thinking may be unfounded. We conducted a study using Glassdoor compensation satisfaction ratings from before and after the SEC’s 2018 mandate that companies disclose the CEO pay ratio, which compares CEO pay to that of the median employee. We found that the transparency brought on by the new disclosure made employees more satisfied, on average, with their own pay. Employees develop beliefs about what their colleagues are paid whether or not a company discloses salary information. They can develop intuitions from whatever information they have access to. They hear gossip from their coworkers and form judgments based on visible signals of wealth, such as expensive cars in the company parking lot or their peers’ vacation photos on social media. Additionally, they can use anonymous online sources like Glassdoor, Monster, and Indeed, which provide a view of rank-and-file worker pay levels, although the data may be incomplete or inaccurate. By not giving employees accurate and trustworthy information, managers leave employees to guesstimate what a fair wage is for them—and that self-determined wage is likely inflated. Indeed, other research shows that employees overestimate what their peers make. The CEO pay ratio rule provides a great example of how employees can use accurate salary disclosures to update their perceptions of their own pay. In 2018, when the SEC mandated the disclosure, firms had to disclose the pay of the median employee alongside the pay of the CEO. In the years since, researchers have studied the negative impacts of the disclosure on share prices and the fact that it did not lead to reductions in CEO pay. But our research, which looked at approximately 300,000 individual compensation ratings across firms in 62 different industries, shows that employees focused on a different part of the disclosure: the surprisingly low values of median employee pay. Employees already knew their own personal CEO pay ratio (i.e., the ratio of the CEO’s pay to their own pay). What they didn’t know, before the pay ratio disclosure, was that their peers were also earning a lot less than the CEO. Seeing the median employee pay value gave them a more realistic and lower reference point for their own pay. We find that this effect holds even when controlling for CEO pay, the ratio itself, firm characteristics, and market-wide factors. Moreover, we find that the effect strengthens when employees had less pay information available to them before the disclosure, confirming our intuition that they were responding to the new median employee pay information. The disclosure of median employee pay was one small step toward more pay transparency. Looking to the future, managers can use the lessons learned from the CEO pay ratio to develop pay transparency policies for their firms. What the research shows us is that sharing more meaningful pay reference points can help employees understand how fair (or unfair) their pay actually is. Managers who seek to develop their own pay transparency policies should consider the following critical questions: What salary information is available already? Employees can and do check salary information posted on job search websites. Managers should assume their employees see this information. Are these numbers accurate? If the information online is wrong and inflated, managers may benefit from providing accurate salary information to employees. Take control of the information about your firm, as doing so can improve employee morale. What are the current sentiments of employees? Many firms conduct anonymous surveys annually. They often find that employees believe they are underpaid and that some demographic groups believe that more strongly than others. If employees think this, even though the pay practices may be fair, a firm may stand to benefit from increased pay transparency. Correct the incorrect assumptions, and employee satisfaction may increase. How competitive is the labor market? If employees are in a tight labor market, where they can easily get offers from other firms, they likely know what they can earn elsewhere (i.e., they know the market wage). They are not dreaming of salaries and roles that do not actually exist. However, if the employees are not likely to receive outside offers because of labor market conditions or geographic location, they will have more limited information. Our research shows that these employees’ pay satisfaction levels will likely benefit the most from the accurate disclosure of rank-and-file employee pay information. . . . Instead of maintaining an old-fashioned approach to pay, where secrecy reigns, managers should develop pay transparency policies that fit the information environment of their workforce. In doing so, employees can base their ideas about fair pay on accurate information from their managers, instead of relying on gossip and online rumors. Our research indicates that knowing the truth might make employees happier.

New Research Debunks a Common Criticism of Pay Transparency

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