The Unintended Consequences of Pay Transparency

Published 17 Aug 2022 | 5 min read

Companies around the world have been increasingly adopting pay transparency policies and practices as a means of narrowing the gender pay gap and fostering an engaged and positive working environment that builds trust. Pay transparency can help companies achieve these goals — but it can also have unintended consequences.

Pay transparency refers to a pay communications policy in which a company voluntarily provides pay-related information to employees — for example, about the process of the pay system (process transparency) and actual pay levels or ranges (outcome transparency), or even an open policy for employees to freely share information about their pay (communications transparency).

Why is pay transparency important? For one thing, it facilitates attracting and retaining talent, as new applicants to the workforce are demanding increased transparency with regard to pay. According to PayScale, if the process is not transparent, employees — particularly younger ones — may be more likely to leave a company within six months. For another, there can be legal implications for companies that fail to meet relevant transparency compliance standards. Moreover, public news of pay inequality at companies with more secretive pay communication practices can seriously damage their reputation, as was the case at BBC and Google. Finally, studies indicate that, at least in the short term, pay transparency may have some important benefits for employees and their employers. For example, pay transparency has positive impacts on employees’ perceptions of trust, fairness, and job satisfaction and has been found to boost individual task performance.

However, there may a dark side to pay transparency as well. Our recent global study of pay transparency involving employees in the U.S. and UK, as well as over 100 Chinese firms, suggests that there are some key caveats to consider. Here are the unintended consequences to be aware of — and how to avoid them.

Pay transparency compresses pay.

Although pay transparency is typically an enterprise-level decision, once pay information is actually made transparent, it’s the employee’s immediate supervisor who, as their first point of contact, is often left to deal with the potential fallout. They’re the ones responsible for providing disgruntled employees with the justification for visible pay differentials and responding to their requests for raises in order to address them.

Our research uncovered that in firms adopting pay transparency practices, supervisors, who may not have had any say in adopting the company-wide policies, assume a self-protective approach when this happens. Because it’s often time consuming and psychologically draining for them to address employee complaints and salary adjustment requests, we found that they take steps to reduce differences in compensation within the same job level. More specifically, we found that transparency drives managers to make employees’ performance-based incentives more similar to each other — in other words, compressing them — thereby reducing the pay dispersion driving employee concerns and complaints about pay inequity. Our findings are consistent with other research. For example, one study found that, when the government of California made city managers’ pay transparent in 2010, average compensation dropped by about 7% in 2012. The drop occurred mainly at senior levels, which is indicative of pay compression. Another study using compensation data of about 100,000 U.S. academics from 1997 to 2017 showed that pay transparency led to academics being paid more similarly to their peers.

Pay transparency prompts employees to negotiate personalized rewards.

Our study also finds that employees respond to transparency-induced pay compression by seeking alternative ways to receive the reward they feel is due to them. If a reduced pay range reduces the likelihood of securing these rewards in the form of a pay increase, employees may solicit other forms of less-visible remuneration from their bosses. Our Chinese firm-level data indicated that as pay ranges became compressed after being made visible, employees were more likely to seek individual arrangements, such as additional training for career development purposes or supplementary health benefits, collectively termed idiosyncratic deals or i-deals. Because they’re personalized, unique, and negotiated one-on-one with supervisors, i-deals represent a feasible way to redress any perceived inequities through non-monetary means.

Supervisors are likely to fulfill personalized requests.

Interestingly enough, not only was transparency-induced pay compression likely to drive employee requests for i-deals, but these requests were also more likely to be granted by supervisors. This is actually not surprising, as by doing so, supervisors are able to: a) maintain or maximize team performance and reduce the risk of losing key talent due to pay dissatisfaction while b) ensuring that — despite the transparency of pay — these reward “deals” remain out of the limelight. Supervisors are, after all, responsible for managing teams of employees, which includes motivating them and ensuring their performance and satisfaction.

Because there are limited alternatives for doling out financial rewards that are now made visible to members of the company, pay transparency, in effect, becomes a moving target, shifting reward systems from what is observable (pay) to what is unobservable (i-deals). This is particularly concerning because recent evidence suggests that this shift toward differential remuneration in the form of less-visible benefits may come at the cost of gender pay equity.

Our research also considered how company culture, particularly collectivist work culture, where people prioritize working together over working independently, may influence this effect of pay transparency. Research shows that employees of companies with collectivist climates are more likely to monitor their peers more intensively as a way of ensuring the collective is being emphasized over the individual. Sure enough, we found that pay compression as a result of pay transparency is more likely to generate employee i-deal requests and subsequent supervisor granting of such i-deals in companies that carry stronger collectivist values.

How to enhance the success of pay transparency.

To help prevent these unintended consequences of your company’s pay transparency program, follow these three steps:

Make the performance-reward link clear and objective.

Your company won’t reap the benefits of a transparent pay process if it lacks an objective performance measurement or reward system. Combining performance metrics that clearly link performance with rewards — for example, objectives and key results (OKRs) — with continuous monitoring allows employees to better understand how their work relates to specific outcomes. This takes some of the pressure off managers to judge, often subjectively, individual employees’ performance during appraisal periods, which is particularly relevant in jobs where performance is not easily quantified.

Provide training to facilitate pay-related communication.

One challenge in adopting pay transparency is managers’ limited understanding of their company’s compensation policy, even though they’re the ones managing employee inquiries. As a result, they fall short of adequately communicating the underlying processes of the  compensation system. Connected to this is a lack of appropriate channels for employees to voice their feelings about transparency policy initiatives and a lack of resources for them to understand the pay system in the first place. Without proper manager training and learning resources for employees, a transparent compensation system will only lead to further confusion.

Restructure reward systems.

Because our research reveals that pay transparency fuels more non-monetary i-deal requests, companies should consider formalizing i-deals into their reward structures, such as offering developmental i-deals to upskill employees and task or location i-deals to reward and retain loyal employees. When requests aren’t limited to an individual privilege or a hidden arrangement, the risk of unfairness can be mitigated.

In order to prevent pay transparency from becoming a moving target, companies need to move beyond simply providing access to pay information and take a more holistic approach to reward-related human resource practices, ensuring that managers and employees understand the logic underlying pay and performance management processes, and that these processes operate in sync to achieve the organization’s strategic objectives.

Click here read the article by Harvard Business Review.