Equilibrium effects of pay transparency

Summary

Cullen and Pakzad-Hurson's (2023) research paper, "Equilibrium effects of pay transparency," investigates the often-overlooked equilibrium responses of employers to pay transparency. While public discourse typically focuses on the partial equilibrium effects, where workers leverage disclosed salary information to rectify pay inequities, this study delves into how firms and the broader labor market adapt when pay transparency is an anticipated reality for both employers and employees. The authors develop a theoretical model of bargaining under two-sided incomplete information, where workers and firms possess private information about their respective values and reservation wages. This model posits that increased pay transparency alters the dynamics of wage negotiation by introducing two key equilibrium effects: a "demand effect" and a "supply effect". The demand effect causes a firm's maximum willingness to pay for labor to decrease because information about one worker's pay raise would quickly spread, leading to costly renegotiations with other employees. Simultaneously, a supply effect means workers, expecting to learn peer wages and renegotiate later, may make lower initial wage offers to increase their chances of being hired. To empirically test their theoretical predictions, the researchers conducted an event-study analysis of U.S. state-level laws that protect private-sector workers' rights to discuss salary information with colleagues. This methodological approach allowed them to observe the causal impact of pay transparency mandates on wages. Their findings consistently supported the model's predictions: pay transparency laws empirically led to a decline in average wages by approximately 2%. A crucial insight from their study is that the impact of transparency is not uniform across all labor markets. They found that wage declines were most pronounced in markets characterized by high individual bargaining power, often indicated by low unionization rates. Conversely, in markets where workers possess low individual bargaining power, such as those with high unionization rates or posted wages, the effect of pay transparency on average wages was significantly muted or negligible. The implications of this research are substantial for understanding the broader economic consequences of pay transparency policies. The study reveals that pay transparency, rather than uniformly benefiting workers, can shift bargaining power from workers to firms, resulting in lower average wages and a reduced per capita wage bill for employees, while potentially increasing firm profits. This challenges the conventional wisdom that increased transparency directly leads to higher wages for low-paid workers. The framework presented by Cullen and Pakzad-Hurson offers a unified approach to analyze diverse pay transparency policies and helps reconcile varying effects observed in different countries and contexts. The findings prompt questions about why firms do not more frequently adopt high levels of pay transparency voluntarily, given the potential for increased profits.