Pile of sterling
Stephen Bevan argues that there is little empirical evidence that the wide pay gaps provide an incentive to high-fliers.Reuters

"For the first time in history officers of a company can become seriously rich without risking any of their own money. Their rewards are so beyond those of ordinary people that they risk being seen as aliens from another galaxy."

On the day when new research shows that the bosses of the UK's top 100 companies are earning 131 times more than their staff, you might expect that quotation to come from the Trades Union Congress (TUC) or from the High Pay Centre, the thinktank which produced the data.

But it originates from Sir Richard Lambert, former director-general of the Confederation of British Industry (CBI) – hardly a figurehead of radical shareholder activism.

It is an indication that, even among the friends of business, widening pay dispersion is proving harder to justify, especially if it does not reflect improvements in company performance.

Stephan Bevan
Stephen Bevan, Director, Centre for Workforce Effectiveness.The Work Foundation

The connections between leaders and the led really matter in modern organisations and the financial crisis has challenged the sometimes fragile bond of trust between senior executives and many of their employees because, in many organisations, there has been a transfer of risk from the business to the employee.

Yet the last decade has seen most large organisations investing heavily in measures of employee engagement, because they believe that engaged and motivated employees enhance competitive advantages.

The difference today is that we are in a period of intense, post-recessionary indignation about top pay and fairness which can, if badly handled, undermine efforts to engage the workforce.

Until social norms about rewards are fundamentally altered, and businesses work out that stratospheric pay for their chief executives harms their ability to reconnect with their workforces and the wider public, the fear is that the chief executive pay escalator will ride on ever upwards.

The FTSE 100 index is, it has to be remembered, still lower today than it was in 1999.

Of course, there has always been a disconnect – a sense of 'them and us' – in most organisations.

Yet the issue of top pay, and more specifically the spread of pay, has the potential to be the most corrosive aspect of the executive compensation debate.

So what does the evidence tell us about the impact that wide pay dispersion has on employee morale, motivation and engagement?

The Evidence

While some argue that wide pay gaps provide an incentive to highfliers, there is little empirical evidence supporting this, nor that any positive impact outweighs the negatives.

When pay differentials are too large, lower-paid employees consider their wages to be inequitable and react negatively, for example, by withholding effort.

Employees may also view their firm's pay distribution as a zero-sum game and choose not to help colleagues, according to a 1993 research paper by Jeffrey Pfeffer, Standford Business School, and Nancy Langton, University of British Columbia.

Collectively, wide pay dispersion is thought to harm a firm's performance by hurting the quality of employee relationships, and incentivising dysfunctional employee behaviours.

Charlie Trevor (University of Wisconsin-Madison), Greg Reilly (University of Connecticut) and Barry Gerhart (University of Wisconsin-Madison) argue that pay dispersion consists of 'dispersion that is explained by performance' (DEP) and 'dispersion that is unexplained by performance' (DUP).

Using the North American National Hockey League's data, the authors show that DEP is positively associated with team performance, while DUP is not.

Thus, pay dispersion positively impacts organisational performance only to the extent that it reflects individual performance.

Pay and Consent

This introduces the notion of consent into the debate.

If the senior team of a business are unambiguously and demonstrably driving forward business success which benefits all employees, their compensation packages – and wide pay dispersion – are more likely to be viewed as proportionate and merited.

But in the R&D context, large pay differentials among employees create disincentives that preclude innovation, according to Yoshio Yanadori, University of South Australia, writing in The Strategic Management Journal.

Yanadori's argument is that wide pay dispersion influences the development of company knowledge resources, both positively and negatively.

Large pay dispersion increases the sum of individual employees' knowledge retained in firms by attracting and retaining high-quality R&D workers.

However, in the face of wide pay dispersion, employees may be reluctant to share knowledge with others or contribute to company knowledge management systems, through a concern that this would reduce their knowledge advantages, eventually resulting in their pay relative to other employees decreasing.

Wide pay differentials may also increase the competitive tension between employees and discourage collaboration and cooperation, according to Pfeffer and Langton.

This erosion of collective effort can be highly detrimental to innovation, because generating new ideas often involves collaboration among employees.

With real wages for most employees stagnant or falling, and with executive rewards steaming ahead despite shareholder concerns and pleas from Vince Cable for restraint and transparency, I think there are real questions about whether the rhetoric we hear from many chief executives, about the value they attach to employee engagement, isn't beginning to ring a little hollow.

Stephen Bevan is director of the Centre for Workforce Effectiveness at the The Work Foundation, and an honorary professor at Lancaster University