Wage Inequality Offers Short-Term Boost and Long-Term Problem

The pandemic put a spotlight on the growth of wage inequality between top managers and employees. As The New York Times wrote: “While millions of people struggled to make ends meet, many of the companies hit hardest in 2020 showered their executives with riches.”

Results show that unequal wages between top managers and employees can boost the short-term profitability of a firm. In the long run, however, this benefit fades. What persists is that wage inequality motivates employees to opportunistically exploit customers and weakens a firm’s customer-oriented culture, thereby harming customer satisfaction.

How does this happen? In firms with high wage inequality, there is a strong incentive for employees to work hard to reach higher paying positions in management. But in the process, our findings show that they are more likely to engage in opportunistic behaviors and also collaborate less with coworkers. For example, to enhance her chances for promotion, an employee might show more effort by interacting with customers more frequently to better understand and fulfill their needs to boost sales. By contrast, she could also distort facts about products to close deals more quickly.

Non-customer-facing employees could also be affected. Take, for instance, an R&D employee. He could interact with customers more often to learn and adapt innovations to their needs to increase sales. Conversely, he could also design products to fail to force customers to buy a product over and over again.

At the same time, wage inequality might also weaken collaboration among coworkers. An employee who worries about advancing to the next higher level is less concerned about her coworkers. But less collaboration impairs the flows of information and knowledge about customers throughout the firm. This, in turn, can lead to worse coordination between departments. Ultimately, the firm becomes less responsive to the changing needs of customers. We find that wage inequality weakens the customer-oriented culture of a firm.

Our findings show that wage inequality does raise the firm’s short-run profits directly. However, the adverse impact wage inequality has on opportunism and customer-oriented culture ultimately extends to customer satisfaction and reduces these short-term profits although the effect remains weakly positive.

We find this weak positive effect on short-term profitability holds in a different sample with more than 500 observations of U.S. firms selling to consumers. But when we analyzed how wage inequality plays out in the long run, the situation reverses. The harm that wage inequality costs to customer satisfaction siphons away positive benefit of wage inequality. In sum, a firm sees no profitability lift from wage inequality in the long run.

Do firms have an incentive to raise wage inequality? In terms of bottom-line impact, the answer is: “Yes” in the short run and “No” in the long run. However, when looking at the customer impact, the answer is “No” because of the negative impact of wage inequality on customer satisfaction, which weakens firm profits.

What can managers learn? If you aim for short-term profitability, go with higher wage inequality but keep an eye on the types of negative employee behaviors that can hurt customers and your firm’s customer-oriented culture—and ultimately weaken customer satisfaction. If you are interested in the long-term success of your firm, consider reducing wage inequality to help your team orient toward customers instead of competing for more wages.

What can shareholders learn? Suppose that you care about the long-term profitability of your investment. In that case, make sure to reward top managers for achieving sustainable profitability and good customer relationships.

What can policymakers learn? Wage inequality is not in a firm’s long-term interest. This argument can help to create a consensus with managers to restrain wage inequality. However, short-term-oriented managers might care little about the damage wage inequality does to society. It thus might be necessary to disincentivize them from raising wage inequality.