When New Hires Get Paid More…

By Andrea Derler, Peter Bamberger, Manda Winlaw, and Cuthbert Chow, Harvard Business Review, March 5, 2024

To attract top talent, employers often pay new hires more than they pay existing employees in equivalent roles. This isn’t new. But today, regulatory changes and technological advances have dramatically increased pay transparency in many sectors, making employees more aware of these pay disparities. Moreover, data from the U.S. Chamber of Commerce indicates that the workforce is expected to shrink in 2024, while a global survey of more than 30,000 employees found that salaries are expected to increase by an average of 4% in 2024, suggesting that these pay gaps will likely continue to expand.

But how does this influx of higher-paid workers impact existing employees, especially top-performing ones? And what can organizations do to balance the need to recruit new talent with mitigating the risks of creating increasingly visible pay disparities on their teams?

To explore these questions, we used a sample from our customer database, the Visier Community Data, of more than 4 million live employee records from nearly 100 companies across the U.S., Canada, and Europe during the period of 2018 to 2023. We looked at the tenures and salaries of higher- and lower-performing employees, leveraging statistical methods to identify patterns and trends in the data. We were particularly interested in how likely employees were to resign after the addition of a higher-paid coworker, as well as the extent to which getting a pay raise might reduce their chances of resigning.

Our Findings

Through our first round of analyses, we determined that employees whose pay was increased soon after the addition of a higher-paid coworker tended to stay in their jobs a lot longer, whereas those who had to wait for a raise were more likely to quit.

When pay was adjusted within a month of the new addition, existing employees remained with their companies for an average of another two and a half years. In contrast, when pay adjustments took six months, employees stayed on board for an average of just one and a half years, and when pay increases took an entire year, employees quit an average of just 13 months after the new hire joined. In other words, employees resigned more than two times sooner if their employers took a year to adjust their pay.

In a second round of analyses on the Visier Community Data, we found that high performers were disproportionately represented among resigning employees. While normally, about one in four resigning employees are high performers, in the aftermath of the addition of a higher-paid new hire, that number increases to more than one in three. In other words, hiring new employees at higher salaries than existing employees doesn’t just lead to generally higher turnover rates for current employees — it increases attrition specifically among the employees who add the most value to their organizations.

There are a few reasons for this effect. On the one hand, when high performers feel that their efforts are under-rewarded, it reduces their motivation, making them less excited about their jobs and more likely to start looking elsewhere. This is often compounded by downstream effects, as other employees’ motivation also suffers when they see their team members become demotivated.

There’s also a phenomenon psychologists call the “sucker effect.” Similar to FOMO, or fear of missing out, the sucker effect refers to employees’ fear of being a “sucker,” or of doing more than their fair share and missing out on better opportunities. Interestingly, even employees who aren’t actively looking for a new job may become more aware of shifting market prices when a new hire joins at a higher salary, sparking concerns that they may be being taken advantage of.

Our findings suggest that even in organizations with limited pay transparency (i.e., in which existing employees may not know how much a new hire is making), just the knowledge that new team members are being hired at all can foster fears among existing workers that they may not be being paid fairly. A new employee joining the team serves as a reminder that switching jobs is always an option, pushing people to do a reality check around their own job satisfaction.

And finally, existing employees are likely to resign in response to sustained pay disparities because these situations significantly erode their trust in their teams and broader organizations. When people perceive their organizations as treating them unfairly and paying them inequitably, their morale and commitment falter, making them that much more likely to start looking for the door.

How to Make Compensation More Equitable

The good news is, our research highlights several strategies that can help managers and leaders address these issues, ensuring that both new hires and existing employees — especially top performers — are treated fairly and set up for success.

Raise awareness

First and foremost, it’s critical for employers to raise awareness about the impact of pay inequity across their organizations. That means dedicating time and resources to training not just for HR teams, but also for managers, executives, and any other relevant stakeholders.

It’s also important to note that this isn’t just about reminding people of the existence of disparities in general. It’s also about identifying and talking about the particular sensitivities of different employees within a specific organization or department. For example, analyzing your company’s retention rates and pay histories for different employee groups can help you identify (and compellingly communicate) where inequities are causing the most harm. Health care company Providence conducted such an analysis and determined that with targeted pay increases, they could actually save $6 million in turnover costs, illustrating the importance of raising awareness about the impact of pay disparities on both individual workers and on an entire organization’s bottom line.

Audit pay equity regularly

Of course, identifying pay disparities is not a one-and-done activity. To the contrary, employers should take accountability on an ongoing basis by conducting regular pay-equity analyses. These audits should focus on identifying which disparities are fully explainable and which represent inequities.

Importantly, the goal isn’t for every employee to make exactly the same salary, or even for every title to be compensated the same way. The art of ensuring an equitable pay structure is nuanced and complex, and it requires leaders to take a range of factors into account, from the different benefits and perks that employees may have negotiated for to cost of living adjustments to variance in the contributions that different people in similar roles may offer.

This is hard work, and there are no easy answers. However, a critical first step is to ensure that whenever there are any disparities, that there is at least some way to explain them. After all, the real problems emerge when pay inequities seem arbitrary, or worse still, turn out to be the result of bias rather than relevant factors.

Address pay inequities ASAP

Next, once an inequity has been identified, it’s critical to address it as soon as possible. While some organizations may be tempted to leave pay adjustments to annual reviews or lengthy performance management processes, our research demonstrates that that simply isn’t good enough. As we mentioned previously, in our study, a delay of just six months in addressing pay disparities between new and existing employees led workers to resign 1.8 times sooner than they otherwise would — and they resigned more than twice as quickly if pay adjustments took an entire year.

To get ahead of this, rather than waiting for an unhappy top performer to complain to their manager (or even worse, to just turn in their two weeks’ notice), organizations should proactively offer compensation adjustments as soon as they notice a disparity. This doesn’t mean that new hires can’t be offered competitive rates. But it does mean that if you want to keep your existing employees, you need to adjust their remuneration accordingly.

Invest in agility

Finally, for many organizations, this kind of rapid response to pay inequities necessitates some investment into new tools and processes. Plenty of well-meaning managers and leaders may fully intend to correct disparities within their teams, but without the tools to move quickly and effectively, those good intentions are unlikely to make much of a difference.

That means taking a fresh look at everything from your formal performance management systems to your informal norms and company culture surrounding pay conversations. Does your HR department depend on outdated, clunky software or slow-moving, bureaucratic processes? If so, it’s going to struggle to keep up with the rapidly evolving needs of its workforce. Similarly, are managers accustomed to engaging in open and transparent conversations with their reports about compensation and related concerns, or are these topics so taboo that employees would rather just resign than attempt to get the raise they feel they deserve?

Adopting more agile processes and mindsets can come with some growing pains, but these transitions are critical for any employer to stay competitive. After all, our research shows that to avoid attrition, and in particular to avoid losing top performers, pay adjustments have to happen fast.

The world of pay and compensation is incredibly complex. There are countless factors to balance, and no guarantees of success — even with the best of intentions. Moreover, while our research focused on a general analysis of workforce behavior, prior work suggests that inequities are likely further exacerbated by gender and racial biases. For example, data from the Pew Research Center has shown that American women still make just 82 cents for every dollar earned by men, and that gap is even greater for Black and Hispanic women.

In addition, every organization faces its own unique challenges. While our analyses highlight big-picture trends, they represent correlations, not necessarily causal effects, and they may not hold for all employers. It’s up to individual organizations to analyze their own data to test whether they see similar patterns and to identify any effects that may be specific to their environment and workforce.

That being said, our data suggests that unless employers adjust existing employees’ wages soon after making a higher-paid new hire, employees tend to resign — and that top performers tend to resign even faster than others. As such, employers should be aware of the psychological effects that hiring higher-paid external talent can have on their teams, they should conduct regular pay equity analyses to ensure that any disparities are fully explainable, and they should develop the agility necessary to adjust wages as soon as inequities are identified.

-HBR, March 5, 2024

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