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How salary benchmarking by employers affects workers’ pay

Young Asian business woman in blue suit receiving an envelope with a salary offer
Credit: iStock

A wave of pay transparency laws aimed at reducing inequities is giving millions of workers access for the first time to information on what co-workers make and what potential employers will offer.

Yet comparing salary information is nothing new for employers. While U.S. antitrust law prohibits employers from directly sharing salary information with each other, most mid-sized and large companies routinely use aggregated data from third parties to get a read on the going rates. 

The effects of this widespread practice, known as salary benchmarking, have never been systematically studied—until now. Following White House concerns that benchmarking may be used to suppress wages and benefits, a new study offers the first evidence on its impact on workers.

The conclusion: Benchmarking does not have a negative effect on pay for the average employee. While some salaries decrease and others increase after a company uses a benchmarking tool, salaries overall simply move closer to the benchmark. 

If there was a negative effect on salaries, it would be suggestive of anti-competitive effects,” said Associate Professor Ricardo Perez-Truglia, who authored the new National Bureau of Economic Research working paper with Zoe B. Cullen and Shengwu Li of Harvard University. “That’s not what we found. If anything, we see some small salary gains for low-skill occupations.”

The researchers used aggregated data from the nation’s largest payroll processing firm to see how much employers paid new hires in hundreds of job categories before and after they used the payroll firm’s salary benchmarking tool. They found that employers paid new hires much closer to the median wage after searching the market rates for those job titles.

As a result, some new employees earned more and some earned less than they would have otherwise. “For the most part, they sort of cancel each other out,” said Perez-Truglia.

Direct sharing prohibited by law

Although U.S. law prohibits employers from directly sharing information about their employees’ compensation with each other, they can access aggregated salary data from third parties such as management consultants and payroll processors. As part of the study, the authors surveyed human resource professionals who set pay at medium and large companies and found that 87.6% use salary benchmarks, usually from multiple sources.

In July 2021, Biden issued an executive order encouraging the attorney general and Federal Trade Commission to consider revising federal guidance that lets neutral third parties share compensation information with employers—but not employees—without triggering antitrust scrutiny. “This may be used to collaborate to suppress wages and benefits,” the White House said in a fact sheet.

At that time, there was no research on the impact of benchmarking. Perez-Truglia said regulators may be responding to studies and news reports suggesting that industry consolidation is giving employers too much market power when it comes to setting salaries. 

The new study, which began in 2019, looked at starting pay offered to new hires at 586 firms that gained access to the benchmarking tool between January 2017 and March 2020. The online tool is easily searchable by job title and is based on real, aggregated and anonymized payroll records of many millions of employees.

The researchers divided the new hires into two groups: nearly 5,300 new hires where the company had searched the benchmarking tool before hiring, and a “control group” of 40,000 hires in the same companies that had not been searched. They compared pay for the two groups in the five quarters before and five quarters after the company first gained access to the salary data.

As a second control group, they looked at salaries offered to about 157,000 people hired during the same time periods in comparable roles at similar companies that never gained access to the more precise salary tool.

‘Compression toward the benchmark’

They found that on average, both high and low salaries moved closer to the benchmark. Among “searched” positions, the absolute difference between the new hire’s starting salary and the median salary for that position dropped from about 20 percentage points before the firm gained access to the tool to about 15 percentage points after. This drop is “large in magnitude, corresponding to a 25% decline,” the authors wrote. 

To illustrate this “compression toward the benchmark,” suppose the median pay for a bank teller is $40,000. Without that information, one bank might pay $30,000 and another $50,000. “Once they see the benchmark information, they are much more likely to pay new hires around the $40,000 benchmark,” Perez-Truglia said.

The researchers added that “the effects on salary compression coincide precisely with the timing of access to the benchmark: The compression was stable in the quarters before the firm gained access to the tool, dropped sharply in the quarter after the firm gained access, and remained stable at the lower level afterwards.”

For searched positions, compression around the median wage was much stronger among low-skill positions, which generally don’t require more than a high school degree, than high-skill ones. Dispersion around the benchmark dropped by 40% for low-skill jobs versus 14.6% for high-skill ones. 

“This finding is largely consistent with the anecdotal accounts in interviews with compensation managers, according to which low-skill positions are treated as commodities and thus should be paid the market rate,” the authors wrote.

They did a similar analysis looking at average salary levels and found that benchmarking “does not have a negative effect on the average salary. If anything, the effect on the average salary is positive, but small in magnitude and statistically insignificant.”

Specifically, they found the average starting salary for all searched positions was either 0.2% lower or 1.7% higher than the two control groups, respectively.

There were some statistically significant gains for low-skilled employees: Their average pay increased by 5% or 6.7% depending on the control group. The study also found that the small boost in salary for low-skilled employees increased their retention. More precisely, there was an increase of 6.7 percentage points in the probability that those employees were still working at the company one year later. 

“This evidence suggests that firms may be using salary benchmarking to raise some salaries in an effort to improve, among other things, the retention of their employees,” the paper says.

For high-skill positions, starting pay went down by 2.9% or 1.6% depending on the control group, “but those effects must be taken with a grain of salt, because they are statistically insignificant,”  Perez-Truglia said.  

“Typically low-skilled employees are less likely to negotiate than high-skilled employees. They are often made take-it-or-leave-it offers,”  Perez-Truglia said.  Benchmarking could provide “more equality for those workers.”

There is also a growing body of literature on pay transparency, but much of it focuses on giving employees more access to information, usually as a way to reduce gender and racial pay gaps. A new law in California requires all private employers with 15 or more employees to provide pay ranges in all job postings starting Jan. 1. Colorado, Washington, and New York City have passed similar laws.Although employees can’t access the same kind of “super-sophisticated” pay data that employers can use, Perez-Truglia said, they can use online sources such as Glassdoor, LinkedIn, Teamblind.com and Levels.fyi to get a read on competitive salaries. Companies are also consulting these sites, he added, which generally rely on employees reporting their pay at current or past employers

Just in: Three new books by Berkeley Haas professional faculty members

Three new books written by Haas professional faculty members share one thing in common: deep learning from the successes of people making innovative change in business today. Here’s more on each new book:

Clusters of Innovation in the Age of Disruption

Edward Elgar Publishing, published August 2022

By Jerome Engel, founding executive director emeritus of the Lester Center for Entrepreneurship (now the Berkeley Haas Entrepreneurship Program)

Much has changed since Engel’s 2014 publication of Global Clusters of Innovation: Entrepreneurial Engines of Economic Growth around the World, a book that explored the explosion of entrepreneurship and innovation ecosystems globally, a movement that spread Silicon Valley business practices around the world. By 2022, economic disruption from the COVID-19 pandemic, global warming, and environmental degradation led Engel to ask how innovation ecosystems can support the evolution of more robust, agile, and sustainable societies. Those questions led to this book about innovation ecosystems, clusters of innovation, and the global networks of clusters of innovation that naturally form. He argues that entrepreneurs, collaborating with venture investors and major corporations, can create clusters of innovation that help build the resiliency required to quickly adapt and rebound from economic shocks. The process is helped along by supportive government, universities, and other elements of the ecosystem. 

 

Global Class: How the world’s fastest-growing companies scale globally by focusing locally

Matt Holt (BenBella Books), published August 2022

By Aaron McDaniel, BS 04, lecturer with the Berkeley Haas professional faculty, and Klaus Wehage

Aaron McDaniel, who teaches entrepreneurship to undergraduates at Berkeley Haas, and Klaus Wehage are co-founders of 10X Innovation Lab, which helps build innovation ecosystems worldwide. During the pandemic, the authors said they realized there was no book published on innovation in international business expansion that matched the success of Eric Ries’ The Lean Startup. So over 1 1/2 years, they interviewed more than 300 executives from the world’s fastest-growing companies across 50 countries to understand what made them successful in reaching global scale. The list included CEOs and founders of Apple, Zoom, Slack, and Airbnb. The authors suggest that applying agile principles will enables global-class companies to more easily pivot their business and successfully localize in overseas markets with different cultural contexts. McDaniel said he hopes that Global Class will provide a tool kit and framework for companies of all sizes and stages to help build global, distributed teams; manage a diverse footprint; and balance cultural differences.

 

Becoming a Changemaker: An actionable, inclusive guide to leading positive change at any level

Balance (Grand Central Publishing), published September 2022

By Alex Budak, Haas lecturer and creator of the Changemaker course

Stepping into a leadership role doesn’t require people to be at the top of a group or organization. Anyone—regardless of title, personality, race, gender, age, or class—can be a changemaker and effect powerful, positive change from where they sit in a workplace or community, Haas Lecturer Alex Budak argues in his new book. Based on Budak’s popular Berkeley Haas course of the same name, the book is anchored by the Berkeley Haas Defining Leadership Principles Question the Status QuoConfidence Without AttitudeStudents Always, and Beyond Yourself.  Budak introduces concepts and tools aimed at helping readers develop the confidence, courage, and commitment to lead change from wherever they are—and includes examples across industries, age levels, and abilities. The book includes a longitudinal study of how people develop key changemaker skills over time and provides access to some of the same exercises he uses in his class.