Status Over Money, Money Over Status

Why less productive workers are paid more than they should be

A while back I read a fascinating book called Choosing the Right Pond: Human Behavior and the Quest for Status by the Cornell economist Robert Frank.

The book contains many interesting and thought-provoking ideas.

One question it tackles: Why are the least productive workers in an organization typically paid more than what they produce, while the most productive workers are paid less?

This is especially true in government and nonprofit jobs, where raises and promotions are based more on time served than on productivity. In the military, I was occasionally perturbed upon realizing I was working harder and doing more than some people who outranked me. Yet I earned less and would have no chance of obtaining a higher rank until I’d reached a certain number of years in service.

According to the theory of competitive labor markets, workers are supposedly paid based on the value of what they produce for employers.

But this isn’t reflected in reality.

In most organizations, productivity varies far more than wages for employees in the same position or doing similar jobs.

In other words, if you take a selection of workers in an office who are all earning $80k/year, what is the likelihood they are all producing the same amount of value for the firm?

Basically zero.

Moreover, the highest-ranked employees are typically paid less than what they contribute. And the bottom-ranked workers are paid more.

Some readers may be familiar with Price’s Law. One variant of this law states that half of the total value generated by a given organization is produced by the square root of the number of employees.

If you have a startup with 10 employees, about 3 contribute to half the value produced.

If you have a large organization with 10,000 workers, 100 are responsible for half the value.

One implication is that the top-ranked workers appear to be paid less than what they contribute.

And bottom-ranked workers are paid much more.

Which is a good deal for the bottom-ranked workers.

But if the top-ranked workers are underpaid, why aren’t they going to some other employer who will pay them what they’re worth? They seem to be leaving cash on the table.

If a top-ranked worker in a firm is worth $500,000 and is only making $350,000, then a rival firm could make $100,000 in extra profits by luring him away at a salary of $400,000.

But this would still leave cash on the table for other rival firms. So the worker’s salary should be quickly bid up to $500,000 because that’s the value of what he contributes.

Robert Frank suggests the reason for this is that workers would generally prefer to occupy higher-ranked positions in their work groups than lower-ranked ones. They’re forgoing more earnings to hold a higher-status position in their organization.

But this preference for a higher-status position can be satisfied within any given organization.

After all, 50 percent of the positions in any firm must always be in the bottom half.

So the only way some workers can enjoy the pleasure inherent in positions of high status is if others are willing to bear the dissatisfactions associated with low status.

The solution, then, is to pay the low-status workers a bit more than they are worth to get them to stay. The high-status workers, in contrast, accept lower pay for the benefit of their lofty positions.

The low-ranked workers are giving up status for money. The high-ranked workers are giving up money for status.

In other words, there is an implicit tax on the earnings of higher-ranked workers.

If the tax isn’t too high, the higher-ranked workers are happy to remain with the firm. Even though they could earn more elsewhere. And the lower-ranked workers find the extra pay sufficient to compensate for the burdens of low rank.

The resulting pattern is basically a progressive income tax. An interesting implication of this is that economic inequality should actually be much worse than it is, if people were paid by how much value they provided.

Status anxiety keeps earnings flatter across employees than they would otherwise be.

Another way of retaining productive employees is with what Robert Frank calls “Nonpecuniary elements of compensation.” For example, job titles.

From the book:

“Being vice president once meant being next in line to the person in charge of the organization. But no longer…In one large New York City bank, most management employees who avoid offending anyone become vice presidents after five years of service with the firm.”

If everyone after five years gets that title, then how do firms confer status on those whom they view as even more valuable? By adding additional terms to their job titles.  

More from the book:

“Of the 1100 employees of a large ad agency in New York City, 150 have the title of vice president. The same agency has 11 senior vice presidents and 11 executive vice presidents.”

Relatedly, in a paper led by UC Berkeley psychologist Cameron Anderson, the authors write:

“The motivation for status also appears to lead people to prefer roles that will afford them higher status. In a survey of 1,500 office workers, seven out of 10 said they would forego a raise for a higher status job title. For example, file clerks preferred receiving the title ‘data storage specialists’ over receiving a raise. Why was the title preferred over money? The majority of those surveyed believed that other people judged them based on their job title.”

Seventy percent of people would take a title over money.

Frank also discusses why academics promoted to chaired professorships are often compensated with research funding rather than a pay bump.

For example, a college might give a newly chaired professor who earns $100,000 an additional $100,000 for research funding. But often, a professor who is distinguished enough for such a promotion has no difficulty securing research funding from other sources. So why doesn’t the college instead increase the salary to, say, $150,000 and save $50,000?

Frank suggests the reason is that tensions will arise when some members of the group can afford to take frequent and expensive vacations and send their children to fancy private schools while others cannot. Better to keep the salary relatively low and instead pay with titles and research funding.

Relatedly, I have met academics in low-paying lecturer positions at top universities who have declined higher-paying tenure-track jobs at mid-tier schools. Even though the cost of living around top schools is often higher than in many other places.

For many people, prestige is more valuable than income. Or even job security.

It is puzzling how we spend so much time preoccupied with discussions of economic incentives but relatively little on discussions of status incentives. Perhaps because the latter are more embarrassing to acknowledge.