How much inequality is ideal within your workplace?

Nicholas Fitz at Scientific American has a good summary of recent research about American perceptions of inequality. Answer two questions below to test yourself and see how your answers compare with the average American.

1) How much more should CEOs get paid than their lowest-paid full-time employees?

  • 3 to 1
  • 5 to 1
  • 7 to 1
  • 10 to 1
  • 20 to 1
  • 30 to 1
  • 50 to 1
  • more than 100 to 1

Don’t continue reading until you pick an answer.  

The average American thinks that a 7-to-1 ratio is ideal for balancing fairness and efficiency.

2) In reality, how much more do you think American CEOs earn than their lowest-paid employees?

Don’t continue reading until you pick an answer.  


Dubai skyscrapers Photo by Michele Solmi

The average American thinks that American CEOs earn 30-to-1 relative to their low-skilled workers.  The reality is that in 1965, American CEOs only eared 20 times more than their low-skilled workers.  Today the reality is 354-to-1.

It is amazing how ignorant Americans are about inequality within the big businesses where most Americans work.  A possible advantage of inequality is to give people at the bottom more incentive to work hard to try to rise to the top. If most people aren’t aware of the enormous incentives at the top, then they aren’t going to work hard to achieve it.

Too much inequality can also be bad for business.  The first Nobel-Prize winner in economics, Jan Tinbergen, thought that, “if the ratio between the greatest and least income in a company exceeds 5, it will not help the company and may be counterproductive.”  That idea used to be called the “Tinbergen Norm,” but this ‘norm’ was abandoned when CEO pay soared after the 1960s.   Marketplace concurrs:

Bill George, the former CEO of Medtronic and author of the “True North” series of books, says wide pay gaps can erode trust inside companies and hobble their performance.

Each company should be required to publish basic pay distribution statistics so that Americans stop being so ignorant about the wage at the top.  It could inspire people at the bottom to work harder to get more pay either by working harder to rise to the top (or to work harder to increase wages at the bottom).

James Cotton started advocating in the 1990s to require corporations to publish the ratio between the CEO pay and average pay within each corporation. His recommendation ultimately got written into Dodd-Frank.  But mean pay is misleading because pay is approximately log-normally distributed within organizations.  That means pay is heavily skewed in favor of the CEO at the top.  Cotton’s measure, mean pay, would work better for a normal distribution where there are few people getting low pay rather than most people getting low pay.  Using mean pay makes the CEO’s pay seem smaller in relation to everyone else than it really is.  For example, if the CEO quadrupled his own pay without giving anyone else a raise, it would raise the mean pay, but it would have no effect on median pay.  Using mean pay as James Cotton’s recommends does not fully measure the actual increase in inequality.  Secondly, median pay would be a better statistic for morale because the average employee is closer to the median pay than to the mean pay.  That would help employees feel better about how much their work is valued at the firm because it would more realistically reflect where they are within the hierarchy. Median pay is a much better statistic than mean pay for measuring the pay of the average employee.

Secondly, we should not ignore the different number of hours of work that different people do.  Part-time workers should be included in the measure and the best way to incorporate part-time work is to use hourly wage rather than annual pay. Companies have really good measures of how much part-time and hourly employees work, but they rarely keep track of hours for salaried workers.  If salaried people do not keep track of their time, then they could be simply assigned the company’s standard estimate of how many hours/year is expected of all salaried workers. That would be a healthy discussion to have.

CEOs typically work more than the average employee and using hourly pay would be a way to adjust for that.  Let the CEO inflate his hours to 80/week to help justify his pay.  It still wouldn’t make a huge difference in the 354-to-1 ratio of top to bottom.  And if the CEO is counting business meals as work time, then his employees will see that the company norm is to count lunch as paid time too!

We should require companies publish thee ordinal measures of pay:

  1. Top pay/hour,
  2. median pay/hour, and
  3. bottom pay/hour.

Then it would be easy to see the ratio of how much more the CEO makes relative to his average worker (the median) and relative to his poorest worker.  Investors, employees, and customers would all be interested in this information.  But CEOs hate sharing this basic information about the incentives at their companies, so it is hard to find.

If you are interested in more studies about ways that inequality in America is much greater than most Americans think, you can read more at the Scientific American article I mentioned above.

Posted in Inequality, Managerial Micro, Medianism

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