MINDING THE (INCOME) GAP

DOES EXTREME INCOME INEQUALITY REALLY MATTER? IF SO, WHAT CAN BUSINESSES DO TO CLOSE THE GAP?

My son loves Hot Wheels. When I was a kid, I loved them, too. I would peruse the toy aisle in a local supermarket for hours, pining over the cars, the tracks and the accessories. But the next time my son asks for one, I will think of this ratio: 4,987:1.

You see, 4,987:1 is the pay ratio that Mattel, Hot Wheels' parent company, disclosed earlier this year. It means that Mattel's CEO, Margo Georgiadis, last year made 4,987 times more than a rank-and-file employee at the same company.

This data point exists thanks to a small provision in the Dodd-Frank Act that requires public companies in the U.S. to provide a ratio comparing the pay of their highest-ranking employee to the median. Although Dodd-Frank became law in 2010, this provision faced many delays and did not take effect until this year.

Mattel's ratio is just one of many staggeringly large pay gaps in the new data. Walmart, for example, reported a ratio of 1,188:1. McDonald's reported a ratio of 3,101:1. The Gap Inc.'s ratio was 2,900:1.

Some have been critical of this new requirement. They argue that the data is unfairly biased against companies that rely heavily on seasonal and part-time workers or those that employ much of their workforce outside the U.S. where incomes tend to be lower. Companies that provide one-time bonuses to a CEO also can appear to have an excessively large ratio.

Still, I'm not alone in my uneasiness with a ratio like 4,987:1. Management guru Peter Drucker once suggested that the ratio of CEO to average worker pay should be no higher than 25:1. A 2013 resolution in Switzerland tried (but failed) to cap the pay ratio at 12 times the average worker's paycheck.

After Dodd-Frank was passed, researchers at Chulalongkorn University and Harvard Business School wanted to find what Americans thought about actual and ideal CEO pay. Respondents said they thought CEOs should make about seven times more than unskilled workers, although they estimated that CEOs actually made about 30 times more. This means that most people already believe income inequality is a major problem. But few realize just how large the problem really is. (At the time of the survey, CEOs actually made 354 times more than unskilled workers.)

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Examining the gap

Why do so many of us have a gut feeling that companies — even if they are not breaking the law — should work to lessen inequality, both inside their organizations and in society more generally?

I posed this question to Mendoza professors Georges Enderle and Anne Tsui. Enderle is the John T. Ryan Jr. Professor of International Business Ethics, and Tsui is a distinguished adjunct professor of management who also holds appointments at Peking University and Fudan University in China. Along with former Mendoza colleague Kaifeng Jiang, they have been studying pay gaps within organizations for several years. Enderle and Tsui suggest that Catholic Social Teaching can offer answers about why we should care when there is a drastic income gap.

Catholic Social Teaching actually began with concerns about inequality in mind: How should we respond to an economic system that produces such a wide gap between rich and poor? In the founding document of Catholic Social Teaching, Rerum Novarum (1891), Pope Leo XIII affirmed our right to have private property and to receive a just wage. He rejected radical attempts (such as those by Communists) to force "equality" by seizing property and redistributing it. At the same time, he emphasized that the rich and the poor are equal in the eyes of God and should show mutual concern for one another.

Subsequent documents in Catholic Social Teaching went further, emphasizing the need to narrow the gap and work toward greater economic equality. In Quadragesimo Anno (1931), Pope Pius XI wrote that "so vast and unfair a distinction in the distribution of goods" is not "in harmony with the designs of an all-wise Creator." And, in a 1952 Christmas address, Pope Pius XII declared, "Solidarity demands that outrageous and provoking inequalities in living standards among different groups in a nation be eliminated."

The key conviction that drives these ideas is that we are interdependent, social beings. As such, we can be in harmony with one another, or we can be out of harmony. Catholic Social Teaching names the harmony between and among people "the common good," which the Second Vatican Council defined in 1965 as "the sum of those conditions of social life which allow social groups and their individual members relatively thorough and ready access to their own fulfillment." For this reason, the Council lamented the fact that "Luxury and misery rub shoulders."

St. John Paul II also powerfully decried the widening gap between rich and poor. "This fact is universally known," he wrote in Dives in Misericordia (1980), "The state of inequality between individuals and between nations not only still exists; it is increasing. It still happens that side by side with those who are wealthy and living in plenty there exist those living in want, suffering misery.... This is why moral uneasiness is destined to become even more acute." In Sollicitudo rei Socialis (1987), he expressed concerns about inequality repeatedly, saying, "The word ‘gap' returns spontaneously to mind."

While the largest inequalities often exist on a national or global level, the gaps within organizations matter as well. Businesses have their own part to play in promoting the common good, starting from within and then influencing the rest of society. John Paul II writes, "The purpose of a business firm is not simply to make a profit, but is to be found in its very existence as a community of persons who in various ways are endeavoring to satisfy their basic needs, and who form a particular group at the service of the whole of society." (Centesimus Annus, 1991)

For Tsui, in an article authored with Enderle and Jiang and published in the Academy of Management Review, this means that, "Income inequality concerns the entire business organization and cannot be compartmentalized into separate, unrelated parts because it is about the way income is distributed in an organization affecting all of its members." Thus, in order to address income inequality, we must start to think differently about what a business is. A corporation is an integrated community, not just "a piece of property that can be cut into pieces."

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A tale of two retail stores

Tsui and Enderle wanted to prove this idea by showing that inequality negatively impacts employees' experiences. They looked for a link between the level of inequality in an organization and workers' opinion of their organization, and they discovered it by comparing CEO to worker pay ratios with Forbes' list of "America's Best Employers," which is based on tens of thousands of workers' opinions about their organization and especially how likely they were to recommend their employer to someone else. They found that companies with smaller pay gaps tend to rank higher on Forbes' list.

As an example, they compare Walmart and Costco. The two companies operate in the same industry, and their employees perform similar work. But Walmart relies heavily on seasonal and part-time workers whereas Costco employs mostly full-time workers who receive benefits. In 2014, the median employee salary at Walmart was around $23,000 while at Costco it was around $31,000. Walmart's CEO made $25.6 million, putting its pay gap at over 1,000:1. Costco's CEO made $5.6 million, for a pay ratio of less than 200:1. The same year, Costco was ranked near the very top of Forbes' list. Walmart, on the other hand, did not make it into the top 500.

You might ask, "Do employees really care that much about CEO pay? How can a number like the CEO pay ratio actually affect their experiences?" Tsui and Enderle suggest that employees may not actually know the precise income gap between themselves and their company's chief executive, but they do experience what researchers call social distance. "Large social distance," they write, "causes those at lower levels to have heightened negative social comparison, extreme social anxiety, and a host of social, health, and psychological problems."

All of these problems affect not just the employees but their organization as well. Their work may suffer as they experience less engagement, lower self-esteem and less trust in the company's management. They may react with absences or anger. They may even commit sabotage, theft or violence. In short: Income inequality harms worker creativity, productivity and overall wellbeing, and it negatively affects a company's bottom line.

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Coming apart

This effect should not surprise us, say Tsui and Enderle. It is what we are seeing in society more broadly as inequality has grown over the past decades. "In 1965," they write, "the CEO made about 35 times more than the average employee in his or her company. In 2006, it was about 350 times." This relatively high level of inequality correlates with higher rates of infant mortality, mental illness, obesity, teenage pregnancies, homicides and imprisonment coupled with lower educational performance by children, lower levels of trust in society, less social mobility and even lower life expectancy.

Tsui and Enderle point out that countries such as Norway, Sweden, Finland and Denmark have the lowest income inequality and the highest wellbeing levels. They explain that "Narrowed social distances, feelings of oneness, and assurances of common bonds will foster trust, solidarity, self-esteem, motivation, performance, creativity and wellbeing."

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Searching for solidarity

What would the pay gap look like if we really recognized our interconnectedness and the way that radical income inequality harms us all?

At Mondragon, a Spanish workers' cooperative founded on the principles of Catholic Social Teaching, workers must approve ratios between the pay of top managers and unskilled workers. The ratios range from 3:1 to 9:1. But the specific number is not as important as the principle behind it: Solidarity.

Solidarity is about choosing to live as one human family. It means we all together have a stake in our common life. The point of solidarity is not to flatten society and force equality, but to live more and more into the reality of our interdependence. With solidarity in mind, the best answer to the question, "What is the ideal level of income inequality?" is simple: "Less."

This is precisely the strategy Enderle advises. In a research article in the Review of Social Economy, Enderle describes a strategy for working for less income inequality. He suggests that companies should work at both ends of their pay scale. They should raise the "floor," so to speak, and lower the "ceiling." It is crucial that companies raise the floor, or lowest wages, to the level not of the minimum wage, but rather a living wage, a wage that allows workers to support themselves and their family. Enderle writes that workers' right to a living wage "is based on [their] personal dignity and their right to a decent livelihood as citizens and not merely productive forces."

At the same time, companies should find ways to lower pay for top executives to more reasonable levels. Enderle argues that because each organization is a community of human persons and not "a piece of property, a production function or a nexus of contracts," lowering CEO pay can benefit the organization in many different ways. "Expectations for solidarity and mutual respect arise and — if met — are a strong motivational force for collaboration and the feeling of ‘being in the same boat,'" he writes.

Enderle admits there is still no clear answer as to the ideal ratio of CEO to median worker pay. But increased transparency is helping. It is sparking a national conversation that may result in important changes. Shareholders may eventually get more of a say with regard to executive pay. Companies may establish their own pay codes. And if companies do not take action, the government might; there may be no good way to solve drastic income inequality without legislation.

But companies still have the opportunity to be proactive. In a time of great division and mistrust within society, we all need an education in solidarity, and businesses have the opportunity to give us that. Perhaps a time will come when we look at a pay ratio, and the colon that separates the two numbers will no longer seem like a wall dividing haves from have-nots. Instead, it will be a link, a connection, a little typographical symbol of solidarity.