It’s time for vertical pay transparency

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On 30 March, the European Parliament passed new pay transparency legislation. As a result, all European Union (EU) companies will be required to disclose information on individual and average pay levels.

If this pay reporting shows that a company has more than a 5% gender pay gap, the employer will be required to carry out a pay assessment.

The aim is to close the EU’s gender pay gap that currently stands at 13% - this means for every euro that men earn, women earn just 87 cents.

Employers will face fines if they fail to comply with current pay secrecy rules; the burden of proof has shifted from workers to employers so employees will now rights to compensation on the grounds of discrimination.

These rules will now need formal approval by the European Council, and then they will be signed into law.

The case for vertical pay transparency

While this legislation brings the EU in line with the likes of Scandinavia, Canada and many US states, it actually goes further than many pay transparency policies.

This is because the EU’s new rules don’t just enable workers to compare their salaries with their co-workers who are on the same level as them (aka make horizontal pay comparisons).

It also allows them to ask for information about other pay bands in the business – this is known as vertical pay transparency.

According to new data published in the National Bureau of Economic Research, while horizontal pay transparency has successfully narrowed gender pay gaps, there have been some downsides.

For instance, counterproductive peer-to-peer comparisons (and often causing a decline in employee motivation and productivity).

It has also often caused more aggressive bargaining over pay from employers lowering average wages.

The problem is that horizontal pay transparency creates “spillovers between negotiations, meaning a dollar raise to one worker is now more costly due to renegotiations with other workers, causing employers to bargain aggressively”, wrote Harvard Business School’s Zoe B Cullen wrote in her paper.

Whereas, vertical salary transparency goes beyond this and has a huge benefit on how employees see their future earnings potential.

Cullen added: “In experimental and quasi-experimental settings, ‘vertical’ pay transparency has increased people’s perceptions about what they could earn if they were to be promoted, resulting in increased effort and productivity in meritocratic environments.”Cullen added: “In experimental and quasi-experimental settings, ‘vertical’ pay transparency has increased people’s perceptions about what they could earn if they were to be promoted, resulting in increased effort and productivity in meritocratic environments.”

Cullen also called for so-called ‘cross-firm’ transparency – these policies inform “prospective candidates about which employers pay more than others and led applicants to redirect their search toward higher paying firms, and led to more favorable negotiations”.

“The key design feature for all these pay transparency policies is that they shine the light outward, away from co-workers under the same employer, toward “vertical” and “cross-firm” pay differences,” continued Cullen.

The paper concluded that “’cross-firm’ and ‘vertical’ pay transparency policies have proven potential to increase motivation, allocation of talent, and sharpen competition.”The paper concluded that “’cross-firm’ and ‘vertical’ pay transparency policies have proven potential to increase motivation, allocation of talent, and sharpen competition.”

Cullen stated: “These policies are not designed to draw attention to employers who pay similar workers different wages, but instead these policies educate workers about the full range of opportunities to earn higher wages when they make decisions about training, where to apply, and how hard to work.”

So, employers, if you want to keep your workers motivated, think about your pay transparency approaches.

EU companies need to read the new rules carefully when they come into effect, but for the rest of the world, remember you don’t have to wait for legislation to take action – getting ahead of the game will pay dividends in terms of talent retention and attraction.

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