Pay Disclosure Leads to More Efficient Markets

I had a great conversation with a mentor/friend yesterday around (non-executive) pay disclosure. It was a good exchange of ideas, so I’m writing about it here.

My thinking on the subject is that widespread accessibility to pay information leads to more efficient markets, in the same way, increased accessibility to information improves market efficiency in any other industry.

The current relationship is as follows: An employer wants an employee for as cheaply as possible, and an employee wants to provide their service for the maximum possible rate. As such, when the two parties seek an agreement there is a give and take (i.e. negotiation).

…The thing is, in the market as currently constructed the employer has a lot more leverage than the employee because the employer has greater access to information. I don’t view this as fair or unfair – it is what it is.

With that said, this creates inefficiency in the market place. Instead of the best people working for the employers most willing to pay for (and assumingly generate the most return from) their services, they instead work for the employers who happen to offer the best extrinsic/intrinsic reward package that they know of.

Increased pay disclosure in the labor market would change this dynamic.

I think the executive pay market is a good example of pay disclosure working in the labor arena. Mostly due to government disclosure rules, CEO/CFO pay rates are widely available to anyone interested (one need only make a trip to the SEC website). As such, when a company evaluates a CEO’s compensation for fairness they benchmark against the executive’s peers.

A CEO that is paid below the median of his/her peer group has an easy argument to make for being underpaid since the data on CEO pay is accurate, available in a consistent format, and easily accessible to anyone interested in it. The question of if an employer can afford a particular CEO is a matter of supply and demand – they can pay the market rate for the talent they want or they can’t. If they can’t afford the market rate for the talent they want then1. There are certainly some real issues with the executive pay structure in the United States (specifically that all employers target p50 or higher which creates a ratchet/lake Wobegon effect), but underpay for services rendered is not one of them. If similar disclosures existed for pay philosophies/market rates, we would probably see less pay disparity, and it would largely be because pay disclosure forced employers to pay competitively for positions that they’ve historically been able to underpay for.they look for someone who will work beneath it. 1

As a huge free-market guy, I certainly respect and endorse the decision of employers (typically) not to disclose pay information (it’s in their best interest not to), but I also recognize that the lack of available wage data creates an economic environment in which the overwhelming majority of employees aren’t paid a wage in line with the value they add to their respective organizations. 2 This not only creates a market inefficiency that harms the employee, but it also damages the economy as a whole. 3

Competition is good for the market (although perhaps not for any individual company). To see this is true one must only think of how almost2. There is a great article from the Economic Policy Institute that summarizes the issue well, but in short: Employers are realizing the gains of increased productivity, but most employees’ wages have held largely flat over the past several decades. any other market outside of the labor market works:

Example: If I go into a store I can see the price of every brand of gum in that store. This doesn’t disrupt the competitive balance of the market. Companies charging higher prices compete with lower-priced gums based on quality, brand, and shelf space/positioning, etc. This same reality holds true for thousands
3. Much of this is also cultural. Employees don’t discuss salaries with one another as it is considered taboo (though this is rapidly changing). Most employers insist employees disclose their current wages before extending a competitive offer (while often refusing to disclose pay range or philosophy on their end). It’s a lopsided arrangement that heavily benefits employers.
(millions?) of other products. Consumers go to gas stations and pay premiums for the products there (as opposed to going to supermarkets) because of convenience. People buy technology devices based as much on supplementary product offerings as the price of the product itself. Even in markets where there is a range/unclear market signals (like when buying a car), both parties are on relatively equal footing since a car customer can choose not to disclose the most he is willing to pay (and has dozens of easily accessible online resources that show what competitors are offering for similar vehicles, etc.). Only the labor market (and a few others) is fundamentally different here because the value of labor is such a closely held secret.

If starting tomorrow employees knew more about the value of their labor, in the short term there would probably be a rise in market turnover. Afterward, however, I think the markets would stabilize; employers would both pay more competitively *and* draw more lines in the sand (there would be fewer counter offers) I also think you would see wages as a whole rise… and employers who couldn’t compete on wages would start to compete on fringe benefits / intrinsic rewards instead.

Of course, pay disclosure on any wide scale level is unlikely to ever happen. Employers paying below p50 (and perhaps even p75) would lose far too much talent to competitors if wage info were to become widely available in the way that executive compensation is.

I will say that I think there will be a shift to the center here going forward (with employees gaining more leverage). Gen Y is much more open to sharing salaries with one another. We typically don’t share salary info internally (there is an implicit understanding that there is blowback if the employer finds out), but we share much of this info freely amongst friends outside of our organizations. Much of my social circle is in HR/Marketing/Finance, and we all know one another’s salaries (and the salaries of friends of friends in some cases as well). If someone in my peer group is unhappy with pay it isn’t hard for him/her to learn the names of 10 companies that pay better for similar work. A decade ago those same people would have just had a sneaking suspicion they were below the market average.

Between informal social networks and sites like Glassdoor / Payscale (which are getting cleaner in their data collecting methodology), employees are becoming more educated around pay. Whether that creates any leverage or not remains to be seen.


Categories: Compensation