What determines pay?

[Mokele]

I've been thinking about this recently, especially with all the Wall Street stuff on the news, and I was wondering if there's any studies on what determines pay.

 

I know, I know, "Supply and Demand", but that doesn't seem to be the only factor. For instance, look at any engineering company - the managers get paid more than the engineers, even though you need fewer of them and there's far, far more to hire. It seems ubiquitous - those who are 'in charge' are paid more, regardless of their relative position on the supply vs. demand curve, probably as a result of basic instinctual programming from our days as troop primates.

 

For another issue, consider pro athletes and academic scientists. In both cases, there are many, many more people than there are job openings (high supply, low demand), so even though the employer stands to make great money from either (stadium seat sales or grant overheads), they should both be paid poorly, right? Yet the one regarded as 'prestigious' is paid exceptionally highly. Yes, the athletes make more absolute money for the employer, but what incentive is the employer under to share that when he could just hire a replacement so close in skill as to be effectively identical? Shouldn't that keep wages low? Ditto for Hollywood actors.

 

So, has much actual research been done on this? How much do we know about factors, primarily psychological, altering or even over-riding the traditional 'supply and demand' model? And have any companies actually tried circumventing these issues?

[swansont]

Ability counts, too. There may be a lot of athletes who would like to turn pro, but bad athletes make for a bad product. The problem is that you aren't hiring someone close in skill level; if you look at the whole adult population from which you are drawing your employees, you're talking about the top ten thousandths of a percent or thereabouts.

 

Supply and demand has to include "what the market will bear" as its baseline. Better athletes will be paid more than marginal (at the professional level), but that doesn't explain multi-million-dollar salaries.

[john5746]

It seems ubiquitous - those who are 'in charge' are paid more, regardless of their relative position on the supply vs. demand curve, probably as a result of basic instinctual programming from our days as troop primates.

 

I agree, we seem to be programmed to think that the boss should be smarter and more knowledgeable than ourselves, thus demanding more money. We want more money than those we lead.

 

Yes, the athletes make more absolute money for the employer, but what incentive is the employer under to share that when he could just hire a replacement so close in skill as to be effectively identical?

 

They know the competition will pay that person $X dollars, so they will pay that to get them on their team. I do think we overvalue people at the top, thinking they can do something that no one else can do. Assuming they will save the company/team.

[D H]

Just because there are fewer management slots does not mean the supply exceeds the demand. The supply is limited by the number of people qualified to do the job. That concept certainly pertains to professional sports. How many people can hit a 100 mph fastball? How many can throw one?

 

That said, many professions, such as medical doctors, actively work to reduce supply. Would doctors in the US be paid so much if medical schools didn't have artificially low size constraints or if restrictions on doctors educated in non-US medical schools were lifted? (The regulations on who is qualified to be a doctor in the US almost certainly violates many international treaties, and yet the medical community gets away with it.)

 

Medical doctors are just a bit more protective of their turf than other intellectual professions. It is a difference of degree, not kind. Most intellectual professions have artificial barriers. My employer, for example, most certainly would not entertain the idea of hiring someone without an appropriate degree.

[Mokele]

Ability counts, too. There may be a lot of athletes who would like to turn pro, but bad athletes make for a bad product. The problem is that you aren't hiring someone close in skill level; if you look at the whole adult population from which you are drawing your employees, you're talking about the top ten thousandths of a percent or thereabouts.

 

But at that level, the differences are minor, because you bump up against physiological limits. The distribution of sports performance (or any other biological performance) doesn't have an infinitely long tail, and once you're in the top fraction of a percent, you're at the limits of what physiology and skill can accomplish.

 

Just because there are fewer management slots does not mean the supply exceeds the demand. The supply is limited by the number of people qualified to do the job.

 

No, the sheer number of graduates churned out by business schools means supply exceeds demand. Even if you take the top 10% of these, they still exceed demand to a much greater degree that the skilled workers under them, such as engineers.

 

How many people can hit a 100 mph fastball? How many can throw one?

 

More than you'd probably think, if you actually tested. As I pointed out about, physiology limits our capacity, regardless of skill, so the 'long tail' doesn't go on infinitely.

 

That said, many professions, such as medical doctors, actively work to reduce supply.

 

True, but then why the low salaries compared to jobs without such restrictions (such as business) where skill is important?

[CharonY]

I think that some jobs have certain expected salary that are at least somewhat disconnected from the simple supply/demand equations.

I am pretty sure for instance that payment in academia does not change noticeably in accordance with the supply. Supply has increased over years- worldwide, with hardly an increase in tenured positions. Yet the salary is largely unchanged. In fact it has risen a little bit, mostly due to lobbying inside or connected to the NIH.

Also it is obvious that not only the most capable ever get tenure. It is clear that there is an almost random weeding out from postdoc to nontenured, and again from nontenured to tenured PI. Yet it is expected that at every step there is a significant salary increase. Yet dropping the salary would not reduce the salary by too much as once you are in the system many are desperate for tenure, even they would reduce the final salary.

[Sisyphus]

With regards to sports stars, I think you're underestimating the differences even at the level. Professional leagues are on the whole presumably made up of the best of the best of the general population (or at least of those who have attempted the particular sport), yet even there, there are clearly stars among even this highly rarified group, and those stars make a real difference in winning games. There are only a few Michael Jordan equivalents out there, and the teams that win their contracts win more games. And there are dozens of swimmers almost as fast as Michael Phelps (in the entire world, but still), but the he's the only one bringing home eight gold medals. So yeah, despite the very large supply of aspirants, there's an extremely limited supply of stars. So too with the huge number of business school graduates vs. the number of people who could individually give a billion dollar company a tiny (but compounded) edge over the other billion dollar companies.

[Mokele]

So yeah, despite the very large supply of aspirants, there's an extremely limited supply of stars.

 

But couldn't that also be said for any field? Engineering, delivery driving, welding, janitorial services, there are always individuals who are hyper-skilled. Why aren't the hyper-skilled rewarded in the same manner in all fields, if they offer such an advantage?

 

With regards to sports stars, I think you're underestimating the differences even at the level.

 

I disagree - our highly-selective, multi-stage winner-take-all nature of athletic competition creates that illusion. We purposefully make events as demanding as possible to ensure maximal variation within humans, and then select only a tiny fraction.

 

I've been thinking about exactly this for frog jumping recently, so I'll use that as an example. Every year in CA, there's a large frog-jumping competition, with prizes for the longest jump. Competitors collect thousands of (invasive) bullfrogs, test them, and then put the best of those through a system of tryouts, semi-finals and finals, eventually finding the longest jumper. But while we as humans like to see which number is higher, how much does it actually matter in nature? Does a frog that can jump 7 feet stand a significantly better chance of evading predation than one which can jump only 6 feet? And what's the distribution within a population? Normal? Skewed high or low?

 

Does that tiny difference in ability actually translate to substantial benefits? If I have two CEO job candidates, one of whom wants 10x the salary of the other, will he actually be 10x as good for the company? Especially since I can use what I save to do productive things like expand, research, advertise, etc.?

 

I know I'm on a bit of a frog-kick, but the real question is whether this is like frog calling or frog jumping. A jumping frog just has to be faster than the reflexes of the best predator, and improvements beyond that don't matter much. For calling frogs, however, the very loudest and best get all the rewards. We assume it's like the latter, and pay like it is, but is it? What if it's more like the former? Has anyone actually checked?

 

 

That's the big problem - Where's the empirical data? The manipulative studies? If ecologists can do similar studies (which are fare more difficult, since animals can't talk), why can't economists? Or have they, and I just don't know of them?

 

Without empirical (and preferably manipulative) studies, we'll just talk around in circles endlessly about possibilities and theory. Where's the data?

[Saryctos]

It's important to take note of risks associated with the position. If an hourly employee screws up, their mistake usually cost only hundreds to thousands of dollars in merchandise. If management screws up it costs tens to hundreds of thousands of dollars, with possible down sizing to recover the costs, or loss of customers to a really screwed up order. So as a company you'd be willing to shell out a bit more money to attract the higher quality staff.

 

I'm sure there isn't a whole lot of analysis in the general business world on what you're going to pay a position. I'm guessing that it works along the lines of finding what the average pay for a position you want to fill is, then increasing or decreasing the amount based on how important it would be to your business.

 

Without empirical (and preferably manipulative) studies, we'll just talk around in circles endlessly about possibilities and theory. Where's the data?

I'm sure that this data costs large sums of money to obtain from some auditing or consulting business who makes their money on selling this to big corporations.

[Sisyphus]

But couldn't that also be said for any field? Engineering, delivery driving, welding, janitorial services, there are always individuals who are hyper-skilled. Why aren't the hyper-skilled rewarded in the same manner in all fields, if they offer such an advantage?

 

Because those professions are like frog jumping, and professional sports is like frog calling? The best delivery driver in the world is, as with the best basketball player in the world, probably only a tiny bit better than a large number of runners up. However, if you graphed the value to employers vs. skill level in the two professions, delivery driving would probably increase slower than skill at the high end and approach a horizontal limit relatively early on, while the professional athlete graph would be basically flat for most of its length, then get crazily, exponentially steep at the end, where tiny differences in skill make huge differences because of the directly competitive and winner-takes-all nature of the business.

 

I disagree - our highly-selective, multi-stage winner-take-all nature of athletic competition creates that illusion. We purposefully make events as demanding as possible to ensure maximal variation within humans, and then select only a tiny fraction.

 

Well, right, except that it's not an illusion. The differences are small, but the nature of the contest magnifies those small differences to great importance. The slightly louder frog gets rewarded all out of proportion to its increased volume over the other frogs, right?

[Mokele]

Because those professions are like frog jumping, and professional sports is like frog calling?

 

So which describes business? Is being a CEO really like frog calling, where only the best give any benefit at all? Or is it like frog jumping, where you only actually have to be 'good enough', and our troop-primate brains have decoupled this from actual compensation? Basically, what if the difference to the company between a good and great CEO isn't that big, but our primate minds have turned it into a "who's the alpha male of the troop" situation and showered rewards according to psychology, not economics?

[Sisyphus]

Well, I don’t know about that. Probably you’re right and there’s inflation. But how much? If you’ve got a ten billion dollar company and only one CEO, and having one of the absolute best guys instead of just a very good guy helps you increase your stock prices by 6 percent instead of 5 percent, that’s still an extra 100 million dollars, so paying your CEO tens of millions of dollars a year is actually worth it.

 

Now, I have no idea if that’s what really happens and I don’t know in what ways it’s been studied, but it does seem at least plausible, right?

[Mokele]

Now, I have no idea if that’s what really happens and I don’t know in what ways it’s been studied, but it does seem at least plausible, right?

 

Exactly, but that's also the problem - the only way to distinguish 'plausible' from 'real' is empirical data, which seems to be lacking.

[swansont]

But at that level, the differences are minor, because you bump up against physiological limits. The distribution of sports performance (or any other biological performance) doesn't have an infinitely long tail, and once you're in the top fraction of a percent, you're at the limits of what physiology and skill can accomplish.

 

But one base hit per week in baseball — just one — is the difference between a .250 hitter and a .300 hitter. (500 AB, 25 weeks) Big difference in pay for that difference in performance.

 

Last year, 31 players (with enough at-bats to qualify) hit .300 or better. Out of ~450 non-pitchers in the league on a 25-man roster. That's about one player per team. These players are not in great enough supply to be interchangeable.

Edited March 23, 2009 by swansont

[bascule]

Managers get paid more because they determine the payroll

[tomgwyther]

Personality has a bit of a bearing on pay too, some people command enormous wages simply for who they are.

Example: If Joe Bloggs and John Smith have a boxing match, it may be a very entertaining match between two professional and/or famous boxers, and they'd both be paid handsomely.

However, If you wanted George W.bush and Bin Laden to get in the ring together, you'd have to pay them a fortune, and the tickets would be like gold dust.

Sports stars and pop stars are similar.

David Beckham got paid an awful lot by LA Galaxy, not because he's the best fottballer, but simply because he's David Beckham.

[SkepticLance]

An important factor is employee power.

 

If an employee belongs to a powerful union, which can drive a company to the wall by all going out on strike, guess what? Its members get paid more. Sometimes a hell of a lot more.

 

Film stars in the early days of silent movies got paid a pittance. Even the ones that were at the very top in popularity still got paid peanuts. Then they realised their power! They started wielding pressure. The film studios needed their drawing power, and salaries started going up. The end of the process is that, today, top film stars get paid tens of millions per movie. Power permits pay.

[D H]

The compensation in most intellectual fields is fairly egalitarian. The salary of Nobel Prize-winning professor who works a top-rated school is only a few times that of a mediocre professor at Mediocre State. The salary of an engineer or scientist who manages several dozen people and has decades of experience is only a few times that of a fresh out. There are exceptions, of course. The medical profession isn't all that egalitarian (neurosurgeons are paid a lot more than GPs), and the compensation for the upper echelon of Borg Technologies, Inc ("Resistance is futile") can be quite obscene.

 

Other communities such as business and law are far from egalitarian. Most business and law majors do not get anywhere close to six figure salaries out of college. Most get less than engineers and scientists. Some get a whole lot more, and the disparity grows wider over time.

[jackson33]

Personality has a bit of a bearing on pay too, some people command enormous wages simply for who they are.

Example: If Joe Bloggs and John Smith have a boxing match, it may be a very entertaining match between two professional and/or famous boxers, and they'd both be paid handsomely.

However, If you wanted George W.bush and Bin Laden to get in the ring together, you'd have to pay them a fortune, and the tickets would be like gold dust.

Sports stars and pop stars are similar.

David Beckham got paid an awful lot by LA Galaxy, not because he's the best fottballer, but simply because he's David Beckham.

 

That's called 'Name Brand', (aka recognition) which all entertainers (including athletes) try to develop. It's really not much different with a product, where the customer will buy a name brand over a generic, of channel surfing where you'll spend time checking out some person you know. It's worth a fortune and the entertainment fields will pay a fortune for some...Didn't Jolene, sell a picture of her child for two million.

 

Mokele; Corporation, work a little different, maybe extremely different. Most of those multi million dollar pay PACKAGES, are not salary based, often times a fraction of the total. If some Board of Directors, likes a particular candidate for CEO, COO, CFO or high ranking division manager (say overseas) they will negotiate a package, including perks, wages and the big gun 'Stock Options' which are linked to performance.

 

As for studies, psychological testing or aptitude testing, there are hundreds of studies and many Firms, that do only those test. The US Military, has a battery of test dating back to at least 1955, where an enlisted persons military career is determined, including Officer Training, additional Schooling or some specialized field.

 

In the News; Would guess this means money managers in general, those that handle money for other in Hedge Funds, Mutual Funds or for the investments of some Financial Institution. I feel sure beginners, those not tested or just out of school are accepted by Education/School, grade levels, probably some aptitude testing and offered lower wages with higher performance rewards, before lengthy contracts are offered. Once tested, contract can vary a great deal...