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The Pay Gap That Matters Most

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The Robert H. Smith School of Business is an internationally recognized leader in management education and research. One of 12 colleges and schools at the University of Maryland, College Park, the Smith School offers undergraduate, full-time and part-time MBA, executive MBA, online MBA, specialty master's, PhD and executive education programs, as well as outreach services to the corporate community. The school offers its degree, custom and certification programs in learning locations in North America and Asia.

Apr 02, 2015
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Frontline workers making minimum wage sometimes get angry when they discover how much more their CEO earns. Yet if the goal is to motivate performance, new research from shows that rank-and-file employees care more about the pay divide between them and middle managers.

The study by Smith professor Hui Liao, with co-authors Wei Chi, Lei Wang and Qing Ye from Tsinghua University in China and Rui Zhao from the University at Albany-State University of New York, sets emotion aside and explores compensation design as a strategic tool.

Liao says organizations focused on attracting and motivating high achievers should consider at least three elements of tournament theory when allocating pay. “Sports tournaments such as Wimbledon provide helpful analogies,” she says.

Think vertical

First, organizations must distinguish between vertical and lateral pay gaps in their hierarchies. Lateral gaps exist when workers at the same level of an organization earn different wages. “Consider the backlash Wimbledon would face if it tried paying different amounts to players at the same level of the tournament,” Liao says.

She says vertical pay gaps have a different effect because people expect to earn more when they move up in an organization, just like tennis professionals expect to earn more when they work hard to advance in a tournament.

Add transparency

Many organizations shroud their pay schemes in secrecy, yet Wimbledon announces precise prize amounts at each level of the tournament before it starts.

“The same degree of transparency might not work in a corporate setting, but awareness of pay ranges associated with each step in the hierarchy can motivate effort and attract high achievers,” Liao says. “Low performers might welcome equal pay just for showing up, but high achievers prefer vertical steps.”

Spread the wealth

Although executive salaries make sensational headlines, Liao says companies must consider vertical pay gaps throughout their hierarchies.

Five-time champion Serena Williams might care about the grand prize at Wimbledon, but tournament newcomers might be happy to advance one or two rounds. Likewise, frontline workers might not see themselves in the C suite, but they will push themselves when they see rewards within reach.

“This means employers must think strategically about how they allocate money across all levels of an organization,” Liao says. “Compensation design matters, and not just at the top.” 

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