Does it really help to know how much our colleagues earn?

There was a column by Andrew Hill in the Financial Times last month on whether salary data should be openly available to everyone within a company. The columnist argued that in the age of transparency such information could perhaps be open.

Call me old-fashioned, but I disagree.

Nothing generates more animated discussion within organisations than trying to guess how much others earn. A substantial amount of time is wasted thus, at the expense of people going about their jobs. Proponents of pay transparency feel that information freely available across the company would put a stop to this.

In addition, companies would have to think harder about their compensation structures and make them logically defensible. It would also signal that the organisation truly believes in openness and freedom of information. Who can be against that?

But revealing an organisation’s compensation data would be acceptable only if people had a realistic assessment of their self-worth. Unfortunately, most people, to put it kindly, have positive illusions. Or, if I were to put it unkindly, most people are delusional.

Input and output

More than a decade ago, I wrote what was my favorite academic paper: "Reactions to Perceived Inequity in US and Dutch Interorganizational Relationships" by Lisa K Scheer, JB Steenkamp and N Kumar (published in Academy of Management Journal, 2003). It was on equity in relationships. Unfortunately, this paper failed as it has only garnered 157 Google citations after all this time. Yet, it was a great learning experience because it required me to immerse myself in the literature on compensation and equity theory.

One theoretical option is to pay everyone the same as that would be consistent with the equality principle. However, people would find this rather unfair, with good reason, because it would not reflect differential contributions. In addition, equality would have a deleterious impact on motivation. As a result, we aim for pay equity, where compensation is consistent with contribution.

According to the equity theory, people judge that they are being paid equitably when they perceive that the salaries they and others receive are proportional to their respective contributions to the company.

When the outcome-to-input ratio is unequal, inequity raises its head. Person perceive negative inequity (being undercompensated) if their income-to-contribution ratio is less than that of others. In contrast, people perceive positive inequity (being overcompensated) if their income-to-contribution ratio exceeds that of others.

Market value

As must be obvious to the reader, contribution to the organisation is just one benchmark in determining salaries and pay hikes. One has to also examine the market value of the person. Some people have high “value in use,” in that they make important contributions to the organisation but their outside alternatives may be of poorer quality.

Others may be in the opposite situation, where they have attractive alternatives to the firm, but their contributions within it may be judged to be less than those without such alternatives. As a result, beyond relative contributions to the organisation, one also has to consider the market value of the person in setting the compensation.

Across studies, one observes that about 55% of all people feel they are undercompensated –which means suffering negative inequity – while only 10-12% think they are being overcompensated. The remaining third of the workforce feels that they are being fairly compensated.

Reduced morale

Transparency in compensations would skew these numbers to a greater degree. One can always find another person in the organisation with whom a comparison would lead you to feel undercompensated. This means that pay transparency would make the proportion of people feeling undercompensated increase from usual 55%. Research has conclusively demonstrated that the larger the number of people feeling undercompensated in an organisation, the lower is the employee’s commitment, morale and trust in that company.

In this context, a faculty colleague once shared a story from an American public university, where it was mandatory to reveal pay data to the public. Each year, the list of salary increases awarded to the different faculty was put in every faculty member’s pigeonhole. In one particular year, a faculty member on receiving the list straightaway searched for the name of his rival. Realising that his rival’s raise was higher, the faculty member suffered an heart attack and had to be taken to the hospital in an ambulance.

Let me end with one of my favorite observations:

Money is a tool to be used, not an end in itself. I have learned that there are only two ways in which money can make you unhappy. First, you spend more than you earn. Second, you compare yourself with others. Unfortunately, people often get caught in this trap.

As Gore Vidal observed, “It’s not enough merely to win; others must lose.” And that is why pay transparency, despite the best of intentions, will fail.

Nirmalya Kumar is Member-Group Executive Council at Tata Sons and Visiting Professor of Marketing at London Business School. His Twitter handle is @ProfKumar. This article is written in his personal capacity.