You're Paid What You're Worth

last updated 2020-01-09

by Jake Rosenfeld

Highlights and notes

How pay is determined, actual and perceived

[Our negotiations] over the appropriate distribution of organizational revenue ... are dynamically shaped by four key elements: power, inertia, mimicry, and equity.

All wage and salary determination involves the exercise of power and represents the outcome of past and sometimes ongoing power struggles.

Forms of power:

POWER, INERTIA, MIMICRY, AND EQUITY are the four basic elements shaping our pay. Of the four, power drives decisions most, since a change in power relations can upend existing inertial practices, reshaping what gets mimicked and what’s considered equitable.

Inertia at one organization often leads to mimicry by others. Mimicry, the third basic element influencing many of our paychecks, describes a common process through which your employer pays the going rate for your position in your industry.

Nearly fifty percent of US workers report that their current employer used their past salary as a factor when negotiating a starting offer.

On individuals' salary being public/transparent:

information asymmetry is but one common approach to obfuscate workers’ worth, impede their mobility, and otherwise stifle competition in labor markets.

...discussion about wages is considered concerted activity, and protected under the National Labor Relations Act (NLRA),

in companies that shared information on salaries offered to competitors’ employees, workers earned 9 percent more than their equivalents not privy to such data.

workers who said their managers were very good at sharing organizational financial information earned 8–12 percent more than those who said their managers were very poor at disclosing such information.

On pay cuts:

As one employer told Truman Bewley, a Yale University economist, in Bewley’s investigation into wage rigidity: “I know something real. Never cut wages. If you do, you make enemies.”[1] Better instead to make friends of the remaining employees thankful they’re still working, and working without any reduction in pay.

what we get paid is bound up in our sense of self. Cutting our pay is a form of moral injury...

workers are more likely to react negatively to pay cuts than positively to increases, most employers are reluctant to cut worker pay even in the most adverse business environment.

On equity:

Maintaining relative differentials is important to satisfying many workers’ equity concerns and, conversely, when these differentials are upset, some workers get upset.

...satisfaction with what we make is bound up with what we think our coworkers earn. This is true even after controlling statistically for our own pay.[2]

Research has consistently found that a worker’s satisfaction with a given level of pay is not automatically driven by their individual human capital—their training, acquired skills, and job experience. ...satisfaction with what we make is bound up with what we think our coworkers earn.

workers do reduce their effort and engage in more “social loafing” as dissatisfaction with pay increases.[3]

“the advantage of layoffs over pay reduction is that they ‘get the misery out the door,' " rather than leaving a company with a workforce aggrieved by wage cuts.[4]

From the employer’s perspective, disclosures about pay or company finances can raise serious equity concerns among workers who discover that some peers are making more than they are, or that they are taking home a very thin slice of the available pie.

Workers carry an idea about what constitutes a fair wage, and when their actual pay falls below that level, they withdraw effort. Overall organizational productivity declines as a result.

Workers who discovered they were overpaid, however, experienced no symmetrical emotional response. They weren’t suddenly more loyal to their bosses or more satisfied in their workplaces.

... most of us think we’re pretty good at our jobs. And most of us think we’re better than the majority of our colleagues ... The average self-rating was the seventy-seventh percentile

Misguided human capital perspective:

From the human capital perspective, our contribution is the additional revenue we add to the firm, otherwise known as the marginal product of our labor. Our wage reflects the amount of money an organization would forego by not hiring us—nothing more and nothing less... common human capital indicators such as education and relevant experience [are] proxies.

Research has consistently found that a worker’s satisfaction with a given level of pay is not automatically driven by their individual human capital—their training, acquired skills, and job experience.

any compensation beyond what it would take for an employee to keep showing up to work constitutes economic rent to that worker.

What do people think should influence compensation:

The majority of respondents indicated that these two components-their base pay, and their relative pay- were important to their overall satisfaction with their job. The ability to be paid in stock options, meanwhile, was less salient, with fewer than one in five reporting that this type of pay affected their job satisfaction.[5]

...workers with a college degree or more were slightly less likely than workers with a high school degree or less to say individual performance was very important

Compared to government employees, workers in private sector, for-profit firms were also more likely to think individual performance was very important to their pay.

Nine in ten women believe individual performance should be very important in deciding pay, along with two-thirds of men. No other factor aside from experience was deemed very important by more than 50 percent of the respondents.

Americans’ belief in the importance of their individual performance to their pay reflects both the deep-seated cultural sentiment of individualism and the longstanding, dominant tradition within the academy that likewise views a worker’s individual performance as the core determinant of pay.

Rewarding performance

Disentangling our individual value-added is impossible, not because we haven’t created the right measure yet but because the right measure can never exist... measures of individual productivity are rarely objective and widely agreed upon.

ranking and stacking employees and paying them based on proxy measures for productivity can lead to infighting, decreased cooperation, and general breakdowns of workplace cohesion.

The quest to motivate high achievement by pegging pay to individual performance can cause overall performance to suffer.

attaching pay to job title is one way to combat rising inequality, provided that those jobs currently underpaid get a boost while those at the top of the income distribution see their salaries reduced.

...three wrong assumptions: that there is such a thing as a worker’s marginal product; that such a thing can be calculated, and that paying workers based on it is a good idea.

... there is no way to disentangle the productivity of one worker from that of others in the organization ... productivity should be understood as a collective endeavor, a social achievement, not the sum of atomized employees working individually to accomplish the organization’s goals.

When an organization allocates pay simply based on individual productivity, what should be a cooperative workplaces can turn competitive, which can lower overall productivity.

... nearly every worker wants to be paid for her performance. Nearly all pay-setters want to allocate pay according to individual performance, as well. In theory, it’s an intuitive, no-brainer idea. In practice, it’s incredibly complicated, in many cases downright impossible...

“Whenever reward is tied to measured performance, metric fixation invites gaming.”[6]

The general thrust of the academic literature, however, has been toward caution when implementing an individual pay-for-performance plan.[7] A recent study found elevated rates of work-related injuries in firms with individual incentive pay, which led to lower financial performance and product quality.[8] Another linked performance pay with working excessive hours, with those workers taking on punishing shifts ending up with higher rates of absenteeism.[9] A third linked performance pay to more drug and alcohol abuse among workers.[10] It turns out that attempts to disentangle each worker’s distinct contribution, and to peg pay to it, often end up backfiring. As a result, despite what we tend to think, and many experts like to imply, most of us aren’t actually paid for our individual performance.

“The Folly of Rewarding A, While Hoping for B”

... inequality among workers is higher in performance pay jobs, and the growth in inequality in these jobs increased faster than in positions that did not allocate pay this way.[11] The effect of performance pay on inequality was especially large among high-earners in managerial and professional positions.[12] Among those in the 90th–99th percentile of the earnings distribution, the spread of performance pay practices accounts for nearly all the rise in inequality.[13]

Inequity at the top

Depending on how one accounts for the value of stock options, today a CEO of a large firm earns anywhere between 224 and 271 times that of the average worker.[14]

When Romney first realized he was a millionaire, he told his biographer that he lost his equilibrium for a moment, saying that the achievement of such worldly success is often when “most people lose out.”[15] He didn’t like the feeling and the temptations it engendered, so he remained a rich man, but not an extravagantly rich one, very much of his time.

A 2014 study found that Americans believed the ideal pay ratio between a CEO and an unskilled worker should top off at about seven to one.

Shareholder capitalism is a system, at heart, of income redistribution away from today’s workers and toward executives and investors.[16]

The squeeze of private equity

Analyzing thousands of manufacturing companies acquired by equity firms between 1980 and 2005, a group of economists found that two years following the buyout, earnings per worker averaged 2.4 percent lower than at otherwise similar companies. ... Job losses in those first two years post-buyout tended to be higher, too, although most of these were counteracted by the simultaneous addition of new jobs.

"Creative destruction" as objective of purchase, aggressive operation:

...creative destruction is the force at the heart of capitalism, and private equity’s defenders argue that increased creation along with a dash of destruction was exactly the recipe needed to invigorate US businesses in the late twentieth century.

...that average workers bear the brunt of this economic churn, in the form of greater job reallocation and lower wages.

seeking scale economies through mergers and acquisitions, actually diminished profits on average ... Fligstein and Shin conclude that, similar to how pay practices often spread, “mergers and layoffs may be ritualistic and imitative.”[17]

Good jobs, bad jobs

A few organizational factors stand out in the empirical literature. First, large firms remain more likely to have internal labor markets in place (despite their recent declines).[18] The development of firm-specific skills takes time, and, as a result, high turnover at companies with these structures is especially costly. To employers who don’t want to lose someone in whom they’ve invested so much training over a long period, a tried-and-true tactic to win workers’ loyalty is to pay them comparatively well. That’s one reason why large firms with internal labor markets pay more than smaller firms lacking this organizational feature. Second, there are equity concerns. Large firms, on average, have more complex division of labor, with employees filling a range of jobs from the bottom to the top of the organizational hierarchy.

At smaller firms, a flat organizational hierarchy combines with low profits to constrain workers’ claims-making ability. And if the available pie, after all fixed costs are accounted for, is down to mere crumbs, there simply isn’t money to redistribute to even the most treasured workers.

...power is tilted decisively toward employers who take advantage of a claims-making environment in which workers possess few resources. These are the “bad jobs” of today, but they can be better. We know, because in certain places, and at certain periods in our history, they have been.

Fissuring has several roots, but a clear one is the rising power of shareholder capitalism over corporate decision-making. When the only stakeholder deemed worthy of attention—and one with the power to punish—demands your firm focus only on “core competencies” and keep your labor costs low, you’re likely to comply.

Toward a fairer wage

the notion that paying workers too little to live on is morally wrong, and if that means some profit margin has to be sacrificed to raise workers’ living standards, so be it.

Maintaining workers’ sense that their company pays fairly, in practice, often requires pay compression between similarly situated workers and compression up and down the corporate chain.

...the unions’ decline can be seen as a form of rent destruction among the working and middle class, contributing to wage stagnation.

Three major changes are needed:

  1. Raising the pay floor
  2. Expanding the middle
  3. Lowering the ceiling

One component of internal labor markets that unions pushed for was seniority-based pay structures, which stripped managers of some of their power to play favorites and discriminate against certain workers. Added to that was pay tied to job classification, not to the individual, which again constrained capricious managers from allocating pay unfairly. Tying pay to seniority and job classification become two pieces central to the internal labor market system.

Experimental research reveals that when left to their personal determination, managers discriminate against women and minorities in pay, especially in organizations in which “meritocracy” is a core value.[19] Seniority-based pay can help mitigate these effects.

Encouraging organizations to link a portion of wages and salaries to organizational revenue would have at least two salutary effects on our economy. First, it would align the organization’s goals with those of the workers. ... second, it would establish a precedent that, over time, could become an ingrained expectation for workers, who have grown far too used to “we’re all in this together” rhetoric emanating from corporate headquarters without out any tangible evidence that the sentiment is true.

Year-end bonuses are fairly common, but handing workers a one-time lump sum of a size unknown in advance introduces too much uncertainly for families trying to budget expenses over the long term. Better for organizations to bank a certain fraction of their increased revenue in advance, and then distribute it over a specified period of time, as mutually agreed upon by the employer and workers. It’s true that research finds that paying for organizational performance avoids the disequalizing effects of paying for individual performance.[20]

firms with worker [board] representatives engage in more capital formation and aren’t less profitable than firms solely controlled by management.[21] The authors suggest worker presence on corporate boards facilitates cooperation and leads to more long-term decision-making than found in companies focused on quarterly returns.

1. Truman F. Bewley, Why Wages Don't Fall During A Recession (Cambridge, MA: Harvard University Press, 1999), 175.
2. For some examples on US factory workers, see Karyn A. Loscocco and Glenna Spitze, “The Organizational Context of Women’s and Men’s Pay Satisfaction,” Social Science Quarterly 72 (1991): 3–19; on German workers, Sauer and May, “Determinants of Just Earnings”; and, on a sample of US workers from various industries, Paul D. Sweeney, Dean B. McFarlin, and Edward J. Inderrieden, “Using Relative Deprivation Theory to Explain Satisfaction with Income and Pay Level: A Multistudy Examination,” Academy of Management Journal 33 (1990): 423–436.
3. Robert C. Liden, Sandy J. Wayne, Renata A. Jaworski, and Nathan Bennett, “Social Loafing: A Field Investigation,” Journal of Management 30 (2004): 285–304.
4. Bewley, Why Wages Don’t Fall During a Recession, 16.
5. Christina Lee, Alexander Alonso, Evren Esen, Joseph Coombs, and Yan Dong, “Employee Job Satisfaction and Engagement: The Road to Recovery,” Society for Human Resource Management, May 2014.
6. Muller, The Tyranny of Metrics, 19.
7. Jason D. Shaw, “Pay Dispersion,” Annual Review of Organizational Psychology and Organizational Behavior 1 (2014): 521–544, 537.
8. Jed DeVaro and John S. Heywood, “Performance Pay and Work-Related Health Problems: A Longitudinal Study of Establishments,” ILR Review 70 (2017): 670–703.
9. Jed DeVaro and John Pencavel, “Working Hours, Health and Absenteeism, and Performance Pay,” paper presented at the Allied Social Sciences Association Annual Meeting, January 2020.
10. Benjamin Artz, Colin P. Green, and John S. Heywood, “Does Performance Pay Increase Alcohol and Drug Use?” paper presented at the Allied Social Sciences Association Annual Meeting, January 2020.
11. Lemieux, MacLeod, and Parent, “Performance Pay and Wage Inequality,” Figure V.
12. Hanley, “Investigating the Organizational Sources.”
13. Lemieux, MacLeod, and Parent, “Performance Pay and Wage Inequality,” 38.
14. Lawrence Mishel and Jessica Schieder, “CEO Pay Remains High Relative to the Pay of Typical Workers and High-Wage Earners,” Economic Policy Institute Report, July 20, 2017, Figure B.
15. Harris, Romney’s Way, 186.
16. Lin and Tomaskovic-Devey, “Financialization and U.S. Income Inequality,” 1313.
17. Fligstein and Shin, “Shareholder Value and the Transformation of the U.S. Economy,” 420.
18. J. Adam Cobb and Ken-Hou Lin, “Growing Apart: The Changing Firm-Size Wage Premium and Its Inequality Consequences,” Organization Science 28 (2017), 429–446.
19. Emilio J. Castilla and Stephen Benard, “The Paradox of Meritocracy in Organizations,” Administrative Science Quarterly 55 (2010): 543–576.
20. Erling Barth, Bernt Bratsberg, Torbjørn Hægeland, and Oddbjørn Raaum, “Performance Pay, Union Bargaining and Within-Firm Wage Inequality,” Oxford Bulletin of Economics and Statistics 74 (2012): 327–362.
21. Simon Jäger, Benjamin Schoefer, and Jörg Heining, “Labor in the Boardroom,” IZA Discussion Paper No. 12799, Institute of Labor Economics (IZA), July 2019.

Compiled 2024-2-14