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- [00:01]
Kurt Nickish
You're listening to Is Business Broken, A podcast from the Merotra Institute for Business, Markets and Society at Boston University Questrom School of Business. I'm Kurt Nickish. You may have heard me mention that we were doing three episodes on executive pay, but we actually have one more. As we've discussed over these past few episodes, there's a lot that goes into how executives get paid. But what about the people working for those executives, working beneath those executives? How do employees feel about executive compensation? And how can companies balance rewarding top leaders while keeping employees engaged and valued? Today, we explore how pay structures shape workplace culture, trust, and motivation, and what can be done to make them feel fairer. Our guests today are Charlie Tharp, professor of the practice at Bu Questrom School of Business, and Peter Fasolo, former chief Human Resources Officer at Johnson Johnson. Peter, it's great to talk to you today.
- [01:11]
Peter Fasolo
Great to be here.
- [01:12]
Kurt Nickish
And Charlie, glad to have you back.
- [01:14]
Charlie Tharp
My pleasure. Thanks.
- [01:16]
Kurt Nickish
So we've explored in previous episodes how executive pay is determined, how boards set it, how investors perceive it. But what about employees within those companies? Peter, you were the chief human resources officer at a company with 135,000 employees. How aware are employees of just how much executives at their company are paid?
- [01:40]
Peter Fasolo
Well, I think the average employee is paying more attention to the worth of their job relative to their peer group. Primarily, I would say the average employee may curiously look at executive pay as expressed through the proxy, but their primary focus, I would say, is within their job family and maybe a level or two up based on their career trajectory and their aspirations with regard to movement.
- [02:15]
Kurt Nickish
Charlie, let's back out for a second and talk about tournament theory, which is one way that researchers approach pay gaps. Right. The tournament theory suggests that if you have large pay gaps, that can push employees to work harder, believing that they have a chance to move up, and then, you know, they're really rewarded for it. Is that the way you like to think about it? And did you see that work in practice that way?
- [02:39]
Charlie Tharp
Yeah, that's a great question, because you want to have a compensation arrangement which reflects your current performance, the worth of the job, but at the same time, you want people to invest in their own capabilities, you want them to think of a career, and hopefully you're investing in them so they can grow. And so the extent to which higher paid jobs actually have a attractive and significant difference in pay, that does provide sort of a motivation to say it's worth it to put in that extra effort. Now, that tends to be one or two levels up in the organization, as Peter mentioned, it's usually not because the CEO pays more, I'm going to work harder. It's usually what's a realistic job I can aspire to. But we're. Tournament theory may not work very well, is if the company isn't providing those opportunities and helping people develop and investing in them through mentorship, through training, so that in fact they can realize that if not, I think it would be a little frustrating that I want to get promoted, but I don't see a path to do it. So tournament theory could cut both ways. And I think for most employees, the number one is that equity theory, am I paid fairly versus my peers? Secondly, is it worth working harder and investing? Because I think I can progress and make even more thinking of sort of a career earning profile within the company and not just what I'm making today.
- [04:12]
Kurt Nickish
Gotcha. Yeah, so you mentioned equity theory, which suggests that large pay gaps can actually reduce motivation.
- [04:19]
Peter Fasolo
Right.
- [04:19]
Kurt Nickish
When employees see them as unfair like that, my manager is not doing that much more. They barely know how to do my job. How come they're making that much more than me? Why even bother?
- [04:31]
Charlie Tharp
Yeah, great point. Yeah, great point. That, you know, sort of kings and cabbages. If you're paying the managers at the median or 75th percentile, but the average worker at the 25th percentile, tournament theory kind of collapses because the procedural justice or the process by which pay is determined, it really doesn't speak to be fair to employees. So I would say the number one thing is being able to tell people exactly how their pay is determined and they can make their own judgment, then if that's a fair process. But having tournament theory built on top of something where there isn't good information, where people don't trust the system because it's not transparent, I think that really erodes the opportunity for someone to not only feel they're being paid fairly today, but want to aspire to a higher level job.
- [05:28]
Kurt Nickish
Now, you've both said that the CEO pay isn't a big driver here. What effect does it have? Because a lot of people can just know how much CEOs make and know how much the CEO of their firm made somebody who maybe worked their way up through the ranks. So isn't that also a motivating factor?
- [05:48]
Charlie Tharp
Where I see it most often being referenced as an issue is where there's something that workers think isn't right. So as an example, we have a really big payout for executives. And in the proxy, the, the total pay is really, it went up a lot in a year.
- [06:06]
Kurt Nickish
I got a 2% raise and three of my team members got laid off.
- [06:10]
Charlie Tharp
Exactly. Or my medical premium just went up by 15%. Or I used to work remotely and now they're telling me I have to go back in the office. And so it's often a point that you say, well, I don't feel I'm being treated fairly. Let me show you something that I think even makes it feel worse.
- [06:31]
Kurt Nickish
Yeah. Now, Peter Johnson and Johnson probably had like pulse surveys and employee engagement surveys. I'm curious if even if he didn't ask about CEO pay, did it come up in like qualitative answers that folks wrote to open ended questions? I'm curious if CEO pay was a thorn.
- [06:50]
Peter Fasolo
CEO pay per se was not a very focused area for the average employee within our system. Now they would look in the proxy, they would look obviously and be aware of what the CEO or the top five Section 16 officers were making.
- [07:13]
Kurt Nickish
And just to add to that for a second, you mentioned proxies, but just recently the US Financial regulations require companies to not just disclose CEO pay, but show the ratio of executive compensation to a median employee, a ratio that's been going up.
- [07:33]
Peter Fasolo
The research is bearing out that the CEO pay ratio hasn't had a huge effect to changes in pay or awareness of pay to the average worker. Problem with the CEO pay ratio is it's across various industries. It's impacted by CEO tenure performance of the company relative to their peers. There are even attempts to stack CEO pay ratios within industries, but quite frankly it didn't get a lot of traction. Just like the distinctions we often make in executive comp on realized pay, realizable pay, and now more recently, the compensation actually paid. These are interest to obviously shareholders and proxy advisors. The average employee is paying attention more and Charlie said it in his comments just a moment ago on the fairness of pay. This distributed justice. How am I being paid relative to my comparators, my coworkers who may be in similar job families and as importantly as am I paid fairly? Employees really want to know is the process by which they are paid fair? This notion that Charlie just mentioned on process or procedural fairness, is my pay consistent? Can I understand it? Is it accurate? Am I given voice? Is it corruptible? If I see something that may be off, is it needs based or based on performance? This notion of process fairness or procedural fairness and the research bears it out, is fair. Procedures often reduce the dissatisfaction that an employee may feel relative to their outcomes of their pay because they feel as though you can address these things. If there are issues in their minds to correct their pay, it acts as a what I'd often refer to as a cushion of support to the organization to get my pay right. That's really what's important here, I think, for employees to understand. It's the clarity by which their pay is determined.
- [09:58]
Kurt Nickish
Gotcha. Who is pushing for more transparency and what kind of research is there that actually shows how it impacts employee trust and engagement?
- [10:08]
Charlie Tharp
Yeah. So I'll offer a couple of thoughts. One, it's very much a state by state initiative. Colorado was the first state. Today there are 11 states that require when you post a job ad you're looking for employees, you have to list the pay for that job, what you expect to pay. There are 12 more states are proposed or will be introducing now also transparency laws. And this is really an extension of something that started a few years ago where many states, in fact there are 23 today that prohibit asking what someone currently makes when you're interviewing them for a job.
- [10:52]
Kurt Nickish
And some of these have been based on research. Right. Showing that they have been.
- [10:56]
Charlie Tharp
And part of the research is that systemically women have been paid less than men. And building your job offer pay off of what they currently make just perpetuates that. So that was the origin and now it's morphed more into both externally and internally. Even when you post an internal job, you have to allow the person who would apply for that to know what the job pays. I think it's helping with more of what I would call the equality of information.
- [11:31]
Kurt Nickish
Peter, how have chros like you received those kind of efforts from state regulators? I mean, you see the benefits of transparency. There's also some risk. There is this movement kind of following where the industry's going anyway or kind of pulling the industry along.
- [11:48]
Peter Fasolo
Well, I think, as Charlie has mentioned, we follow and comply with all the state laws and regulations. What I determined when I was the chro at Johnson and Johnson is rather than go state by state, we simply instituted a national approach to the way we did this for all of our current and future employees. So, for example, we decided to simply utilize the same framework. We would post the worth of the job and the salary bands for all jobs we posted across the U.S. sure, yeah.
- [12:31]
Kurt Nickish
I mean, both of you have said that the CEO pay isn't really an issue for most workers, but if they care about fairness, it does seem like CEO pay packages should be an issue. You know, it is a political issue. Executive compensation in the US Is much higher. If you just look at peers at other Companies in other countries. If it's not an issue, why isn't it more of one?
- [12:56]
Charlie Tharp
It is often, as I mentioned, when there's an issue in the company or during this sort of heated political environment we've been in. It is a wonderful populist political point. There are a lot more 40,000 a year voters than 4 million a year voters in terms of earnings. And you'll probably see now, over the next couple weeks, most of the local business papers in major cities are going to compare the pay of the CEOs of the various companies that are headquartered in their town, Cincinnati, Detroit, wherever.
- [13:33]
Kurt Nickish
And you're saying that because we're in proxy season, we're in proxy season right.
- [13:36]
Charlie Tharp
In the heart of it. So I think there. There will probably be attention, but I think, as with many things, it kind of dies down. And if your company isn't undergoing a lot of layoffs or something that is really negatively impacting employees rather than sort of the passing interest, I don't think it has legs in terms of internal implications. Now, some companies, you know, Starbucks, when they hire their new CEOs, who's jetting up from a different location to headquarters, in the middle of when there was some union organizing at various stores, they got a lot more attention. And I think those two were connected quite a bit. But. But I think absent something like that, it's a passing interest for sure. But I don't think people use it as a rallying cry unless it's connected to some other issue that they want to bring attention to.
- [14:33]
Kurt Nickish
Mm. Peter, you mentioned how you led implementation of a transparent pay model across the company that went further than what regulators were asking for. Are there any innovative models out there, pay systems that, you know, feel fair and show fairness to employees, while also fostering a sense of healthy competition and shared success?
- [14:56]
Peter Fasolo
I was very proud at Johnson and Johnson. We had variable pay in the system. Everyone was obviously paid a base salary based on their worth in the marketplace and their performance. We also had variable pay that was more at the what I would call local level or department or business unit level on metrics that matter to that business in the pharmaceutical or medtech parts. But then we also had an overlay to that on how the company would do at the. In the course of the year. And this bonus multiplier, if I can call it that, would be applied to all of the bonuses in the US Bonus eligible employees, but we would not include the CEO or the top executive team. In many cases, that bonus multiplier, quite frankly, was positive. So it'd be 105, 110%. So you would get a bonus or a positive kicker to your actual bonus. And the reason we excluded the CEO and his direct reports on that is because it was a way for us to communicate to our employees that their efforts and their contributions were a direct result of the overall company doing extremely well in most of these cases. In that the CEO and the top executive team were focusing, yes, on performance, but at the same time more long term strategic efforts to position Johnson and Johnson for the long term. And I think that went a long way to demonstrate that the employees in the organization would get the benefit of that bonus multiplier, but we would exclude the top team from that benefit.
- [16:52]
Kurt Nickish
Yeah, that's a really interesting way to build employee trust in the pay system while still offering competitive executive compensation. So if you had to redesign corporate pay structures, it's really interesting to hear how you think thought about it there. But if you had a chance to sort of start anew, what would you change? Is there a principle that you would prioritize above everything else as you set it up?
- [17:17]
Peter Fasolo
The clarity of the metrics you are going for that is consistent with the strategic direction of the firm and the operational priorities of the firm is really, really important. This alignment of value creation, long term and short term, and the understanding of that and how I as an employee within the firm contributes to that is extraordinarily important. And I think companies should always be striving to do better at communicating not just the what, but the why behind pay and how my individual efforts and performance is aligned with that contribution. That requires clarity, communications, frequency of interactions. That would be the first point I'd make. Secondly, I tend to be a big fan of variable pay in addition to base pay. I think everyone should be paid a base salary that is consistent with the worth of the in the market. But every employee should be given the opportunity that when he or she outperforms at a certain level of an objective, they should in part be rewarded for that effort and that should be determined. It's the classic effort and reward or path hole theory of the framework of I can see the goal, I understand the path towards that, I have the resources to go after that goal and I should be rewarded for my effort. I think that is a very healthy culture and dimension to have at a high performance and a pay for performance culture in any club.
- [19:05]
Kurt Nickish
Peter, you've talked a lot about how companies try to strike the right balance between, you know, rewarding top executives and ensuring mid level managers and high Performers feel valued. What would you see in a company that would make you feel worried that this, that the disparity between CEOs and the median worker is just too far apart and is becoming a problem? Like what would keep you up at night and what would really worry you if you saw it?
- [19:30]
Peter Fasolo
Charlie, did you want to take that? Yeah.
- [19:32]
Charlie Tharp
I think if you see long term success of a company and very attractive awards for executives and others aren't being brought along on that journey, that to me is a real concern because I think we should live in an economy where you can make as much money as you want and work as hard as you want, but at the same time, there should be a path for others to also benefit. And if I were going to change the overall structure of compensation in American companies, I would look for a way to get more ownership in the hands of all employees. And right now, a lot of investors don't like the dilution of giving too many shares to employees. And some of the accounting rules make that a little difficult from the profit and loss statements. But finding a way to make everyone in the company an owner, well, in addition to paying them fairly, but use sort of the Lincoln Electric model where they have a very strong profit sharing. People can make $100,000 a year on profit sharing, but you can do that also through equity. You've seen what's happened to the stock market over the last decade. Executives benefit, employees don't.
- [20:48]
Kurt Nickish
Peter, your one word reaction to that and thanks for coming on the show.
- [20:53]
Peter Fasolo
I think Charlie's exactly like this ownership model where everyone is aligned with value creation with all stakeholders, shareholders, investors, executives and employees. This ownership mindset is exactly the right direction to go in.
- [21:12]
Kurt Nickish
Peter, thanks so much for joining us.
- [21:15]
Peter Fasolo
Thank you for having me.
- [21:16]
Kurt Nickish
Yeah. And Charlie, thank you. That's Charlie Tharp and Peter Fasolo. Next week we look at innovation in healthcare. Why is it so hard? Are the financial incentives misaligned? And if so, how badly and what can be done to fix them? That's next week. To get that episode and more, please follow the show on Apple Podcasts, Spotify or wherever you listen. Thanks for listening to Is Business Broken? I'm Kurt Nickish.