by Larry Reissman 

Crisis in the Chinese language is made up of two characters: one for danger and the other for opportunity. We understand all too well the danger part of a crisis. Let’s look at the current Covid-19 crisis from an opportunity perspective. Specifically, will the crisis trigger action that reduces income inequality in the United States.

According to Stanford University economist Walter Scheidel, never has extreme economic inequality shrunk in a meaningful way without a major crisis. The Black Death helped end feudalism. The Great Depression gave us the New Deal. Crises bring attention to what is already broken or breaking in our society. Covid-19’s disproportionate impact on low-income communities is highlighting the issue of income inequality.

Corporate America’s Unfair Reliance on Market Pay

Most demands for action call for changes in our tax structure, or universal income or increases in minimum wage. These are government led solutions. The pandemic has also put the spotlight on large companies and how they compensate lower-paid workers. For this crisis to lead to meaningful improvements in low income households, Corporate America should be part of the solution. More on this later. But for large employers to play a role in addressing income inequality, they will need to stop using competitiveness with market pay as a proxy for fairness when judging how they pay lower skilled employees.

I say this based on my four decades of advising business leaders across nearly all industries on how to pay employees. Market pay, what other employers pay for comparable talent, is the foundation upon which virtually all compensation systems are built. Even pay programs that incorporate internal values are ultimately calibrated to market pay norms. The economic logic for using market pay seems irrefutable because it is an efficient way to determine the price for labor. It is based on supply and demand; when these two market forces meet, an equilibrium or market wage rate is established.

It may be efficient but is it fair? It is a reasonable question to ask now when we see workers during the pandemic risking their health and earning minimum or near minimum wages. That is the fallacy of market pay. It is not fair. It is thought to be fair because there is someone selling their talents, the employee, and a buyer of those talents, the employer, and they agree on a price. But this view ignores the power differential between the two parties. A requirement for setting a fair market value is there is no undue pressure to trade. But when someone needs a paycheck to keep a roof over their head and food on the table saying no to a job paying a market rate is not an option. Paying these employees based on market may be an efficient system, just don’t call it fair.

Trends in Corporate Social Responsibility Support Changes in Market Pay’s Role

However, seeing and acknowledging the unfairness of the situation is probably not enough to change it. Raising wages for these lower paid workers above market norms during an economic crisis seems to make little sense. At least not from an economic standpoint. Labor historian Nelson Lichtenstein from University of California, Santa Barbara says that “a crisis on its own has not been enough to start a labor movement, but if a movement has been simmering, a crisis can make it boil over.”

So, the question is, are there pre-pandemic trends in Corporate America that suggest that the time has come to replace the reliance on market pay, at least as it applies to lower skilled workers?

I believe part of the answer is the emergence of Corporate Social Responsibility (CSR). CSR recognizes that a company’s responsibility extends beyond shareholders to all stakeholders, including employees, consumers, the environment, and the broader community. The Business Roundtable endorsed a new Statement of Purpose of the Corporation that embraces CSR principles. These principles were signed by 181 CEOs from America’s largest companies. Part of the Corporation’s Purpose commits to: “Investing in our employees. This starts with compensating them fairly and providing important benefits”.

Even before the pandemic there was skepticism about CSR. But if you follow the money, there appears to be support. Blackstone, the world’s largest private equity firm, is a leader in incorporating CSR and Environmental, Social and Governance (ESG) principles into their investment decisions. Global socially responsible investments grew by 34% from 2016 to 2018 to over $30 trillion. Even during the pandemic (January through April 2020) Morningstar Direct reported that ESG related investments doubled compared to the same period last year, which was during a bull market.

Business Case for Change

There are good and altruistic reasons for supporting CSR and ESG principles. But is it good business? The business case to support ESG initiatives requires metrics to understand impact. Investing in these initiatives often means trading off short-term gains for longer-term results. The long-term benefits for trading off market-based pay with paying more than what the market requires include:

Generates customer loyalty: Attitudes of young people will be shaped by growing up during the pandemic. This “pandemic generation” will increasingly question old norms that resulted in the pandemic having a disproportionate impact on poorer communities. This generation is important because they represent tomorrow’s employees and buyers. Who they work for, who they want their company to partner with and who they buy from will be influenced by a company’s CSR brand. Their voices will be heard in the coming decade.

Enables company resiliency: Raising pay above market to a sustainable wage also improves a company’s workforce resiliency. Employers can select the best from the available candidate pool. For jobs requiring lower skills, the best often means individuals with competencies that predict job performance and future success, such as adaptability, communication, results orientation, and decision- making. These softer skills give managers more flexibility on how to deploy workers resulting in improvements in productivity, quality, and customer satisfaction.

Improves employee productivity: Investing in a sustainable wage also improves the organizational environment. Individuals earning a sustainable wage become loyal and committed employees. This goodwill will likely permeate the entire organization. It is not unreasonable to expect reductions in absenteeism and turnover, resulting in cost savings to help offset higher wages.

Decreases turnover: The cost of turnover is well understood. Employee Benefits News and Work Institute conservatively estimates the cost of turnover is about one-third of salary, when you include the cost to hire a new employee, lost productivity, and investment in training. For jobs paying $25,000 to $30,000 a year, each termination costs employers $8,000 to $10,000. With hourly turnover rates between 25% to 50% depending on industry, turnover among lower paid employees represents a significant cost to business.

In Closing

My intent with this post was to examine whether Covid-19 is a tipping point moment. Large private enterprises are evolving from a purely economic purpose, where shareholder is the sole stakeholder, to a more holistic perspective that balances short-term economic considerations with longer-term social responsibility. Compensation systems need to evolve to support this new corporate purpose. Socially responsible companies do not rely solely on an economic labor model of supply and demand to set wages. Socially responsible companies pay enough so that their employee stakeholders can sustain at least a minimum standard of living. That seems fair as companies and our society transition to a new normal.

There are many unanswered questions. If we agree that market pay is not fair, then what is the alternative? Is a living wage a viable option? How do we go from where we are today to a new normal in compensating the least fortunate among us? I look forward to discussing these and many other questions.