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Harnessing pay inequality to increase employee trust

Of all the issues they face, those related to workplace pay inequality can be the hardest for managers to deal with. Pay is an important way to encourage career progression, and to reward those with greater skills, responsibility or who undertake more complex tasks.

If an organisation’s pay systems are seen to be truly meritocratic, employees accept it as fair. But when the pay differentials between those on the shop floor and those in the boardroom pass a certain threshold, employees’ trust in their managers is undermined. Workplace relationships can be damaged, and managers have to deal with the fall-out.

But does it have to be this way? Is it possible for managers to harness the potential of unequal pay to actually motivate employees and forge better relationships at work? Or do firms with higher levels of pay inequality inevitably suffer from a lack of trust between employees and managers?

The ups and downs of pay inequality:

Wage inequality has been exacerbated by the pandemic

Unemployment falls but wage inequality rises

Exec pay falls by 13% but gulf between top and bottom of firms remains "unacceptably wide"

We looked at the relationship between pay inequality and employee trust in managers in more than 1,600 British workplaces and found that – up to a point – the greater pay gap between employees actually has a positive effect on how much they trust their managers. 

But past a certain level, any further increase in pay inequality is likely to decrease the level of trust that employees have in their managers.

The notion of fairness lies behind these findings – this is because employees want pay differences to reflect the differences such as education, responsibility, experience and effort.

This applies not only for themselves but also in comparison with other employees. But past a certain point, employees simply start seeing pay gaps as unfair and demotivating, and out of line with the differences in contribution.

Our research identifies the level of pay inequality that is likely to be perceived as unfair: a Gini coefficient (a statistical measure of income or wealth inequality) of 0.3 and above.

This is comparable to the level of income inequality in Switzerland or France, but well below the current levels of inequality in the UK (0.36). These findings have important implications for managers designing pay systems. 

First, managers who want to harness the positive potential of pay inequality should look closely at industry pay benchmarking surveys. 

This will allow them to monitor how pay inequality levels in their company compare with their competitors, and to industry norms.

As employees engage in pay comparisons inside their workplace and with employees in similar occupations in other firms, straying from industry norms is likely to be perceived as unfair, damaging employee trust.

Second, managers should use staff attitude surveys – both at a company and business unit level – which include questions on the extent to which employees think their pay is fair: in general, when compared with others and whether there is a fair balance between employees' inputs and outcomes. Employees’ answers will allow managers to adjust pay in the right way.

Providing a means for employees to voice their opinions through employee representatives such as works councils and trade union can benefit organisations.

This can help to monitor employees’ perceptions of fairness and share the information with management. Our findings also suggest that giving employees a voice in pay decision-making and in the formal procedures leading to pay decisions can help to reduce the negative effects of high degrees of pay inequality. Put simply, employees in organisations which use collective bargaining react more positively to higher levels of inequality and show higher levels of trust than those in workplaces which don’t when pay inequality is high.

Designing pay systems is difficult, but managers should be open to working with trade unions to formalise pay procedures, establishing some degree of pay transparency (for instance through pay bands) and giving the opportunity for corrective measures. Improving employees’ perceptions of fairness should increase levels of employee trust in management and could even make managers lives a little bit easier.

Felix Schulz, Danat Valizade and Andy Charlwood are from the University of Leeds