22 Sep. 2017 | Comments (0)

In 1980, Jim Baron, now a professor at the Yale School of Management, and William Bielby, now a professor at the University of Illinois, published a seminal article on firms and inequality. In it, the authors, both sociologists, made a compelling argument that, to understand labor market outcomes like inequality, it wasn’t enough to look at the supply and demand for individuals’ skills. We should also look, they argued, at the decisions made by firms.

In his recent Harvard Business Review article, Stanford’s Nicholas Bloom presents research on the role that firms play in explaining rising wage inequality in the U.S. Both the article and the research are revelatory in a number of respects, and I applaud Bloom’s efforts to return firms to the inequality conversation. I also agree with many of the arguments he advances. However, any discussion of firms and wage inequality must not be limited to discussion of market forces. Consideration must also be given to the decisions made by executives in those firms.

Borrowing from the foundational insights from Baron and Bielby, as well as other scholars such as Jerry DavisArne Kalleberg, and Jeff Pfeffermy research contends that although market forces play an important role in rising wage inequality, firms are not passive recipients of these forces. Rather, executives make decisions about how to organize work, how to reward individuals for their labor, and where the boundaries of their firm should be. In aggregate, these decisions play an important role in determining how much each of us gets paid.

Companies can be divided into two types, in terms of how they approach hiring and compensation: organizational oriented and market oriented. The main distinction between the two types is the extent to which they rely on internal (organizational) or external (market) criteria in the structuring of employment relationships. An organizational focus is associated with stable employment with low turnover, extensive use of training, and the dominance of internal considerations, such as a desire for equity in pay. In such a system, employers protect workers from many of the vagaries of market forces; they take a longer-term perspective on firm performance, and favor corporate strategies that necessitate a stable, well-trained, and loyal workforce.

A market focus, on the other hand, is characterized by flexible employment relationships with higher turnover, fewer opportunities for training, and pay and allocation decisions based on market forces. The shorter-term orientation discourages employers from bearing risks on behalf of their workers and encourages them to use employment practices that lower direct costs and increase flexibility.

In practice, firms fall along a continuum between these two ideal types.

When a society is composed of a greater number of firms holding an organizational orientation, wage inequality in that country will be lower. Such an orientation tends to lift wages for low- and middle-skill workers relative to high-skilled ones, which compresses the wage distribution inside the firm relative to what we would expect from market forces alone. In aggregate, such dynamics would operate in a similar manner as unions, systematically raising the wages for low and middle earners relative to high-earners, such that the wage gaps between them are narrowed, thereby lowering wage inequality. In the post–World War II era up to the late 1970s, employment systems in the U.S. were frequently characterized as being more organizationally oriented. Since that time, however, the U.S. has transitioned to a market-oriented system of employment.

Scholars from a number of fields have offered explanations for this transition, including globalization, technological change, declining unionization, heightened product market competition, and the rise of finance. Each of these factors likely has played a significant role in the shift from a predominately organizationally oriented system of employment to a market-based one. Yet despite these changing market and institutional forces, we still observe important and significant variation among firms in their employment practices and strategies.

For example, Costco has long been recognized as a “high road” employer that pays above market wages, offers good benefits, and provides workers opportunities for advancement. Despite these significant labor investments, from 2007 to the end of 2016, Costco’s stock price increased over 200%, far outpacing the overall growth of the S&P 500 (58%) and that of competitors like Walmart (45%) and Target (26%), which is known to pay workers low wages and offer relatively meager employee benefits. Of course, this is just one example, and there are a number of reasons why these firms’ performance varied during this period. But research shows that firms that pay workers higher wages, provide better benefits, and offer predictable working hours attract workers who are more productive and more committed to their employers. And improved worker productivity and lower turnover frequently more than offsets these firms’ higher labor rates.

Furthermore, research has found that whether or not technology is “skill biasing” — whether it mostly benefits high-skilled workers — depends in large part on how it is implemented and used by firms. Take, for example, computer-aided design software, which has greatly transformed the organization of work in many industries. Firms varied in the extent to which frontline operators were responsible for programming these machines, versus engineers maintaining control. There was also variation in whether these capital investments led to workforce reductions. Thus, when confronted with the same market constraints and opportunities, individual firms frequently make different choices about how best to organize work and reward their employees.

It is clear that most corporate executives face a daunting set of challenges in dealing with the pressures of globalization, technological change, heightened competition, and financial performance targets. However, the examples above highlight the fact that, when facing a similar set of conditions, corporate executives often come to different conclusions about the best way to organize work at their firms. In particular, they make very different decisions about whether to utilize a more organizational or a more market-oriented system of employment. In other words, even given the pressure CEOs are under, there is room for them to do more or less for their workers.

And although I support the idea that executives maintain some discretion, it stands to reason that as a society we may be able to provide a helpful nudge to these executives so that they are incentivized to organize work differently and in ways that may reduce wage inequality.

Presently, many U.S. public policies do little to incentivize firms to take a longer-term view of their workforce. What if we changed some of those incentives? As my colleague Peter Cappelli recently argued, automation technologies are profitable, in part, because they are considered an asset on a firm’s balance sheet that can be depreciated. Could we treat workforce training and other investments in employee skill and well-being similarly? Might executives be more willing to make such investments if they received more-favorable treatment in our accounting and taxation policy?

Additionally, there have been a number of proposals to curb the detrimental impact of short-term decision making on corporate strategy. For example, lowering capital gains taxes for longer-term shareholders or providing longer-term shareholders with greater voting rights, an initiative that has generated interest in Europe, might encourage equity holders to take a longer-view of corporate strategy. In fact, my colleague Brian Bushee has shown that firms engage in longer-term strategies when their equity is owned by institutional investors with a longer-term orientation. Corporate boards could also change the compensation structure of CEOs and other executives to reward longer-term performance (e.g., three to five years). Requiring CEOs to hold onto a significant proportion of their exercised stock options for longer durations might motivate these individuals to take a longer-term view of firm performance.

With incentives to invest in their firm’s labor force and absent pressures to cut costs to make quarterly earnings targets, corporate executives might be motivated to engage in longer-term strategies. These changes may provide a powerful incentive for corporate organizations to forge longer-term commitments with their workers. These practices may be particularly beneficial to low- and middle-wage workers, who have been hurt the most by the shift from an organizationally oriented employment system to a market-oriented one.

We know that much of the rise in wage inequality is due to growth of the highest earners, and these proposals are not going to directly tackle that concern. But as Bloom mentioned in his article, boosting incomes for low- and middle-wage workers and creating more equality between the 10th and 80th percentiles of wage earners would clearly be a benefit to society, while also making inroads toward lowering wage inequality.

What I have suggested here is just a sample of the types of proposals that could potentially motivate firms to take a longer-term, organizational approach to their employment relations. But if we believe that market forces alone do not determine firm strategy, and if we believe that executive decision makers have some discretion to make choices about things like whom to hire (versus contract), and how much to pay, then we can design policies and incentives that encourage executives to use practices that will provide greater benefits to workers and thereby reduce wage inequality. This is undoubtedly easier said than done, but the consequences of inaction seemingly warrant the effort.

 

This blog first appeared on Harvard Business Review on 03/30/2017.

View our complete listing of Talent Management, Labor Markets, Compensation & Benefits and Strategic Human Resources blogs.

     

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