Beware the unintended consequences of pay transparency!
That’s the warning issued by British journalist Soumaya Keynes in an article in the Financial Times. Of course, she says, pay transparency seems like a good remedy for the gender inequalities that continue to plague our society.
In a more transparent world, companies that underpay women based on gender will be exposed and held accountable. But (and here’s the catch) this will be at the expense of male employees, who will see their overall pay decrease. When pay transparency legislation is introduced, employers often end up limiting pay increases for men rather than raising women’s salaries to bring them in line with their male colleagues.
This is the famous ‘race to the bottom’ argument that we hear regularly in discussions about pay transparency.
(I touched on it briefly in a previous edition of this newsletter.)
The FT article is supported by solid research, including an academic article published by the researcher Zoë Cullens in the Journal of Economic Perspective.
So, why do I continue to firmly support pay transparency, even after reading this article and the studies it cites?
The hidden cost of transparency
Let’s get one thing straight: I don’t deny all of the conclusions of the Financial Times article. This paradox is backed up by numerous studies: while transparency does close pay gaps between men and women, it’s often at the expense of men. Even worse, a study conducted in Denmark showed that legislation introduced in 2006 ended up decreasing productivity among employees who were frustrated by seeing their pay increases slow down.
The irony is, this decrease in productivity will have cost businesses more than the increase budget they saved by freezing salaries for male employees.
But it’s important to remember that none of these studies were carried out in the context of pay transparency at the same magnitude as that required by the EU directive. That means they’re not necessarily representative of what’s to come.
It’s true that in the era of pay transparency, employers will need to be able to justify any difference in treatment between two employees according to objective criteria. That means that, to give a raise to a top performer, you first need to demonstrate that they are a top performer.
For certain functions in particular, this will be a long and difficult process. To avoid it, many employers will simply standardise increases by sprinkling them across the board.
This will lead to frustration for the best employees, who may end up seeking better offers elsewhere. I’m certain that as pay transparency increases, we’re going to see high turnover rates.
And what about those who think they’re top performers even if they're not? Soumaya Keynes reminds us that employees are usually not very good judges of their own performance. This will lead to uncomfortable discussions and even conflicts as employers are forced to tell employees that they’re not as good as they think they are.
(And once again, managers will find themselves in the firing line).
Pay transparency is a revolution — and every revolution has its price. It would be naive to imagine the transition will be completely smooth and seamless.
What type of transparency are we talking about?
It’s important to be specific here: the negative side-effects I’ve been talking about are only a risk of one type of pay transparency. The type that gives each employee access to the salaries of their colleagues on the same level within a given business.
In her article for the Journal of Economic Perspective, Zoë Cullens calls this ‘horizontal transparency’.
She also identifies two other types of transparency, whose effects are generally positive:
- Vertical transparency, where transparency extends to different layers of seniority within an organisation (= knowing compensation levels for people above or below you in the org chart). This can lead to increased motivation and performance by showing employees opportunities to increase their pay.
- Cross-firm transparency, where employees have access to pay information from competing organisations. This will lead to more competition for top employees, which could counter the impact of the ‘race to the bottom’ idea induced by horizontal transparency. Businesses will have to ensure their salaries are aligned with the market to retain their best people.
The studies cited in the Financial Times were not conducted in an environment of widespread pay transparency including all three types mentioned above — which is what we’ll see under the EU directive.
In this new era, the most seasoned businesses will be able to take advantage of these three types of transparency to gain a competitive advantage and influence the market… and to build a fairer, more equitable society overall.
This will have a positive impact not just for women, but for all minorities facing discrimination as well as employees from modest backgrounds. In the new era, these employees will have the same access to information as their more affluent colleagues, who generally have a better understanding of salary trends.
For example, Zoë Cullens’ paper shows that understanding the impact of higher education on salaries can encourage those from underprivileged backgrounds to pursue university studies. The fact is, we’re progressing towards more transparency, which will have beneficial effects on society as a whole.
If we zoom in on each individual business struggling with this transition, the weight of the change seems enormous… But it’s also an opportunity for the best employers to stand out.
A significant comparative advantage
That’s why I still believe in pay transparency despite the ‘race to the bottom’ argument. In truth, the unintended consequences of pay transparency can be mitigated by companies that know how to handle it, and that take action early.
For this reason, my advice to CEOs and CHROs is to review their compensation philosophies as soon as possible. This also means reassessing their pay-for-performance systems to ensure they’re set up to fairly reward top talent.
Early adopters of this approach will be rewarded in several ways:
- They’ll be able to make pay transparency a real competitive advantage during recruitment. Jeremy Cledat, CEO of Welcome to the Jungle, recently confirmed this during a talk we gave together: transparent job offers receive up to twice as many applications.
- If they can avoid falling into the trap of standardising salary increases across the board, they’ll be able to maintain a performance culture and avoid disengagement and attrition of top performers.
- If they can measure and improve internal equity, they’ll be able to avoid the disengagement that arises when employees discover they are being treated unfairly.
- They will become a ‘refuge’ for top performers leaving rigid companies that fail to recognise their true value.
These best-in-class companies will also have a positive impact on society as a whole. Others will have to align with them and their policies will become the new norm — what’s expected by employees and candidates.
There’s no denying that the transition to the pay transparency era will come at a price. But not only is it a price worth paying for a more equitable future, I think it will also be an opportunity for companies that act quickly to come out ahead and turn it to their advantage.
Let’s keep the conversation going
Here’s a selection of content to give you food for thought. Feel free to send me articles that you’ve found interesting on this subject!
Letter: Groups embracing EU pay transparency rules will thrive — Financial Times
My response to Soumaya Keynes’ article, published in the Financial Times.
Elon Musk, Rupert Murdoch didn’t act in ‘good faith’ with Tesla, News Corp salary transparency, says New York City — Chris Marr, Bloomberg
In the United States, the first penalties related to transparency laws have been imposed. Here, Tesla and News Corp are being sanctioned for publishing overly broad ranges, which go against the spirit of the law. It remains to be seen how these court decisions will influence companies' behaviour.
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