Performance Management Evaluation and Incentives and Harvard

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Corporate Restructuring and Wage Inequality

John C. [email protected]

217-333-2383

Chichun [email protected]

Institute of Labor and Industrial Relations

University of Illinois at Urbana-Champaign504 East Armory AvenueChampaign, IL 61820


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ABSTRACT

We argue that corporate restructuring increased wage inequality in recent decades by eroding

organizational and labor market structures in two key ways: through reductions in forcewhich

increased the degree to which market forces influenced wagesand through the transformation

of payment systems, practices, and policieswhich reduced the degree to which pay depended

on seniority. We assess this claim by analyzing twenty-five years of personnel files from a

Fortune 500 energy sector firm that restructured multiple times in the 1980s and 1990s. Our

findings indicate that much of the increase in wage inequality in the firm traced to a large decline

in starting salaries for hourly employees beginning in the 1980s, coupled with an increase in

wages for managers and professionals. Our results also reveal that wage inequality increased as

a result of a decline in returns to job tenure, particularly in years following the change in the

firms performance management system. These findings suggest that employee power over wage

setting systems, practices, and policies plays an important role in wage inequality in recent

decades, as do generational factors. Overall, the findings suggest that a critical mechanism

leading to increased wage inequality in recent decades were the decisions by firms, and how they


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ORGANIZATIONAL DETERMINANTS OF WAGE INEQUALITY

Prior to the onset of corporate restructuring in the early 1980s, careers were influenced strongly

by internal labor markets (ILMs)sets of rules and processes whereby employment and wage

decisions were made within firms rather than through a reliance on the external market

(Doeringer and Piore, 1971). In ILMs, employees were buffered from market competition with

employment separation decisions the right of the employee rather than a firm (Srensen and

Kalleberg, 1981). In ILMs, jobs existed independently of the persons that occupied them (White

1970), and were linked hierarchically, with employees typically beginning their careers at entry

level portals, and progressing upwards through promotions over time (cf. Rosenfeld 1992).

Wage growth in organizations prior to restructuring was dependent on an employees

upward mobility rates, as well as on salary increases within jobs. In particular, human resource

managers assessed jobs according to their worth and placed jobs of equal value into hierarchical

grade levels, with each level having a salary range attached to it (cf. Gerhart and Rynes 2003).

Pay decisions were structured as well, with pay increases dependent on seniority in a job. As a

result, pay rose more rapidly with time in a grade level than performance did (cf. Medoff and


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represented a significant change to the nature of ILMs, although many structural features of these

systems remained in large firms following restructuring. In particular, restructuring eroded key

structural features of organizations in two main related ways: through corporate RIF, and through

the transformation of performance and reward systems, practices, and policies.

Firms engaging in RIF eliminated guarantees of protection against layoff, making

continued employment a function of market rather than non-market factors (cf. Cappelli, 1992).

Due to RIF, labor market competition was brought to bear on the employment relationship, as

firms had greater flexibility in replacing a manager if they could find a more productive one at a

given wage rate in the external market. By the same token, some surviving employees likely

benefited from the increased incidence of market forces on wages. For instance, employees in

high demand in the external market could command higher wages from their employers. In other

words, the increase in market forces would reduce the effect of job structures on wages, and

increase the influence of individual characteristics and demand for certain types of employees on

wage inequality. Firms transforming their reward and appraisal systems also reduced the degree

of structure inherent in ILMs. In particular, changes to reward systems increased the degree to


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wage rate, there will be downward pressures brought to bear on wages of these employees.

Second, employees who are in high demand in the external market may find substantial upward

pressures on wages, with this effect magnified by changes in performance evaluation systems, as

firms seek to retain highly demanded and highly productive employees. Third, one might expect

to see a declining effect of starting salary on current salary over time. That is, the staying power

of starting wages on current salary for a given cohortholding for many years in firms

characterized by ILMs (cf. Baker, Gibbs, and Holmstrom 1994)likely dissipated as a result of

restructuring. Finally, the effect of restructuring on wage inequality should show up in

increasing wage dispersion within cohort groups, as pressures on wages for employees perceived

to be more productive either in the external market and/or within firms experience significant

wage increases, and as the elimination of seniority based wage increases results in a declining

real wage for the least productive employees.

DATA, MEASURES, AND METHODS

In order to assess whether corporate restructuring increased wage inequality, we analyze


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individuals having bachelors degrees typically placed into level 7, and individuals with masters

degrees placed into level 8. In addition, roughly 25 percent of the employees in the firm were

paid on an hourly basis, with roughly one-third of these employees belonging to a union.

Once hired, employees in the SGL system moved from lower to higher graded jobs

through promotions that were based on relative performance, with a move to a job in a higher

SGL representing a promotion, and a move to a job in the same level representing a transfer.

Wages were structured as well, although there was some variation over time in the degree to

which they were recurring. In particular, two years prior to the first RIF, the firm instituted an

incentive pay program that allowed managers to award subordinates with non-recurring bonuses

that depended on performance.

The personnel files cover a long time period to provide a useful test for assessing how a

large firm rewarded its employees in changing economic contexts. For instance, the records

cover the period of the oil shocks in the early 1970s, high levels of employment growth in the

late 1970s, recession in the early 1980s, and the restructuring period from the mid 1980s onward.

During the restructuring period, the firm undertook two RIF. The first RIF occurred in the mid


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consultants to help design and implement the new performance management system. The firm

transitioned from a seniority-based system to one in which pay was contingent on a managers

performance, a broad action similar to that undertaken by other large firms in the time period. In

doing so, the firm sought to make performance objectives measurable, attainable, and relevant.

As part of the performance management change, performance records were eliminated soon after

pay decisions were made. According to the firm, this decision was enacted in order to minimize

potential bias in future performance rankings, in that prior performance in theory would be less

likely to be taken into account in measuring current performance. For instance, by eliminating

performance records, the firm sought to remove the problems that arise from labeling employees,

which in turn would also ensure that wage increases were re-earned in each year.

Data Set. The firm provided a 25% random sample of full career records of the firms

U.S. employees tracing from 1967.1 For some employees, information on salary was missing in

the earliest years of the sample. Because including these employees in the sample to be analyzed

can lead to a survivorship bias (Petersen, 1995), we follow convention (cf. Petersen and Saporta,

2004) and study wage inequality only for managers whose careers could be traced from their


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The 1984-1988 time period contains the first RIF, whereas the 1989-1993 period contains both

the second RIF and the transformation in the firms performance management system. We also

provide graphs of real wages for each year from 1969 to 1993.

We assess variation in wages for a number of different independent variables over time.

We assess job type using a categorization of the firms SGL system, and with measures for

hourly employees. Due in part to a lack of managers in a number of SGL in a given year, we

grouped SGL that were similar on many dimensions. For exempt employees, we use the

following scheme: levels 7 to 9 (entry managers); levels 10 to 12 (middle managers); levels 13 to

16 (upper middle managers); and levels 17 to 24 (upper level managers). Discussions with

managers and an inspection of the data set helped me to create the salary grade level groupings.

Main results were robust to models that included all salary grade levels. We grouped non-

exempt grade levels as follows: levels 1 to 3 (entry level), levels 4 to 6, and levels 7 to 9.

We also assess wage increasing with increasing time spent in a job level, with this

measure updated monthly. We examine effects of starting salary on current salary with a

measure of the log of real wages at time of hire. Lastly, because rates of departure can have an


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hires declined by more than $12,000 from 1984-1988 relative to the previous 5 year time frame,

whereas real wages for non-union new hires declined by more than $16,000 in this period.

For exempt entry level employees, starting real wages were roughly constant over time.

However, for the few employees hired into middle management positions, real wages tended to

increase over time. These patterns are shown graphically in Figure 1, which provides the mean

starting salary (in 2007 US$) for hourly, exempt (SGL 7-24), and non-exempt (SGL 1-9) in each

year from 1969 to 1993. In particular, Figure 1 shows that hourly employees starting real

salaries increased slightly from 1969 to 1980, after which time it declined steadily for most of

the 1980s. Non-exempt employees by contrast, experienced a slight increase in starting real

wages over time, whereas exempt employees experienced a slight decrease in starting real wages

throughout the 1970s, followed by an uptick in the early 1980s.

---Insert Table 1 and Figure 1 about here---

Figure 2 provides information on average real wages for employees in different job

groups over time (for new entrants to the firm from 1969 to 1993). Similar to the patterns in

Figure 1, it shows that hourly employees experienced a decline in real wages, with the largest


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Finally, (unreported) exploratory analyses of measures of wage inequality such as the

variance in log wages (cf. Mouw and Kalleberg 2007), and quantile regression (cf. Morris,

Bernhardt, and Handcock 1994) suggest that restructuring increased within-cohort inequality,

due not only to the reduction in starting salaries for hourly employees, but also to the decline in

effects of seniority in a job on wage growth along with increasing returns for employees who are

promoted at a relatively more rapid rate.

DISCUSSION

In this article, we developed a framework to explain the effects of corporate restructuring on

wage inequality. Our findings indicate that corporate restructuring reduced effects of labor

market structures on wages, such as those related to starting wages of hourly employees. These

patterns help to explain why wage inequality began to increase in the early 1980s. In particular,

our findings show a considerable decline in starting wages of hourly employees throughout the

1980s, a general increase in starting salaries for exempt employees for part of this time frame

and stagnant wages for non-exempt employees.


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Unfortunately, as noted, we do not have records of employee performance, which would

provide additional insight into the determinants of wage inequality within firms over time. Thus,

for instance, we can not say for certain that effects of performance on earnings would vary across

racial and ethnic groups, as recent research suggests (Castilla, forthcoming), or of whether firms

employing forced performance curves create a disjoint between wages and productivity. In

addition, the lack of performance records somewhat preclude our ability to assess claims that

unobserved ability is a key driver of wage inequality as economic accounts indicate (Juhn,

Murphy and Pierce 1993), although they do lend support to the notion that sociologists must take

such possibilities into account in their explanations for inequality (Nielsen 2007).

DISCUSSION

In this article we responded to calls for a sociological approach to explain the well-known but

little understood increase in wage inequality from the 1980s to present. Our firm-level

framework highlights the importance of corporate restructuring in reducing effects of labor

market structures and institutions on wages, which in turn leads to increased inequality among


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Baker, George F, Michael Gibbs, and Bengt Holmstrom. 1994. The Wage Policy of a Firm."Quarterly Journal of Economics, 109, 921-55.

Baron, James N. 1984. Organizational Perspectives on Stratification. Annual Review ofSociology, 10-37-69.

Batt, Rosemary. 2001. Explaining Wage Inequality in Telecommunications Services: CustomerSegmentation, Human Resource Practices, and Union Decline.Industrial and Labor

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Consequences. New York: Russell Sage Foundation.Cappelli, Peter. 1992. Examining Managerial Displacement.Academy of Management

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Eds. 1997. Change at Work. New York: Oxford University Press.Cascio, Wayne. F., Clifford Young, and James R. Morris. 1997. Financial Consequences of

Employment Change Decisions in Major US Corporations.Academy of ManagementJournal 40: 1175-89.

Castilla, Emilio J. Forthcoming. Gender, Race, and Meritocracy in Organizational Careers.American Journal of Sociology

DiPrete, Thomas A. 2005. Labor Markets, Inequality, and Change?: A European Perspective.Work and Occupations 32: 119-139.

Doeringer, Peter, and Michael Piore. 1971. Internal Labor Markets and Manpower Analysis.Lexington, MA: Heath.

Farber, Henry. 2003. Has the Rate of Job Loss Increased in the Nineties. Working Paper No.


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McCall, Leslie. 2004. The Impact of Organizational Changes on Aggregate Inequality: TheCase of Downsizing. Working Paper.

Medoff, J. and K. Abraham. 1980. Experience, Performance and Earnings. Quarterly Journalof Economics 95: 703-736.

_____. 1981. Are Those Paid Really More Productive? The Journal of Human Resources16:186-216.

Morris, Martina, Annette Bernhardt, and Mark Handcock. 1994. Economic Inequality: NewMethods for New Trends.American Sociological Review 59: 205-219.

Morris, Martina, and Bruce Western. 1999. Inequality in Earnings at the Close of the TwentiethCentury.Annual Review of Sociology 25: 623-657.

Mouw, Ted, and Arne Kalleberg. 2007. Occupations and the Structure of Wage Inequality inthe United States, 1980s-2000s. Working Paper.

Myles, John. 2003. Where Have All the Sociologists Gone?: Explaining Economic Inequality.Canadian Journal of Sociology 28: 553-561.

Nielsen, Franois. 2007. Economic Inequality, Pareto, and Sociology: The Route Not Taken.American Behavioral Scientist50: 619-638.

Petersen, Trond. 1995. Analysis of event histories. Pp. 453-517 inHandbook of StatisticalModeling for the Social and Behavioral Sciences, edited by G. Arminger, C. C. Clogg,and M. E. Sobel. New York: Plenum Press.

Petersen, Trond, and Ishak Saporta. 2004. The Opportunity Structure for Discrimination.American Journal of Sociology 109: 852-901.

Petersen, Trond, Seymour Spilerman and Sven-Age Dahl. 1989. The Structure of Employmentand Terminations among Clerical Employees in a Large Bureaucracy. Acta Sociologica32:319-38.

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Srensen, Aage B. 1994. Firms, Wages, and Incentives. Pp. 504-28 in The Handbook of


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FIGURE 1

FIGURE 2

80000

100000

Real Wage

Mean Real Wage for New Entrants from 1969-1993

20000

40000

60000

80000

Real Income

1970 1975 1980 1985 1990 1995Year

Hourly Non-Exempt

Exempt

Mean Starting Wage by Year in 2007 Dollars


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FIGURE 3

35

000

40000

45000

50000

55000

Rea

lWage

1970 1975 1980 1985 1990 1995

Year

Union Hourly Non-Union Hourly

Mean Real Wage for Union and Non Union Members


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TABLE 1.

Characteristics of Employees at Initial Hire in a Large U.S. Manufacturing Firm

Variable 1969-1973 1974-1978 1979-1983 1984-1988 1989-1993 All Years

Total Number of New Hires 3,352 4,242 5,658 3,666 3,562 20,480

% SGL 1-3 Non-ExemptAverage Real Wage ($2007)

26.49%$26,598

18.69%$24,761

16.31%$24,731

13.07%$23,035

8.87%$24,397

16.60%$24,956


33.05%$35,801

21.64%$35,557

21.14%$33,619

17.27%$35,429

16.56%$35,698

21.70%$35,098


0.92%$49,074

1.74%$52,941

3.98%$49,704

3.27%$47,925

5.87%$43,309

3.22%$47,686

% SGL 7-9 ExemptAverage Real Wage ($2007)

13.93%$59,563

20.89%$61,170

27.24%$59,108

20.84%$58,108

24.65%$56,565

22.15%$58,897


3.85%$87,679

5.23%$91,877

5.83%$93,929

6.93%$95,086

5.95%$96,494

5.60%$93,560


0.69%$138,746

0.64%$133,368

0.51%$147,005

0.87%$145,343

1.12%$154,532

0.74%$144,950


0.06%$278,435

0.05%$269,529

0.04%$225,840

0.08%$263,606

0.14%$215,040

0.07%$243,830

% HourlyAverage Real Wage All Hourly ($2007)

21.00%$45,619

31.12%$48,480

24.96%$44,232

37.67%$27,736

36.83%$25,353

29.93%$37,548

Average Real Wage Union Hourly ($2007) $46,989 $51,401 $49,721 $37,393 $36,708 $46,077% Main Corporate Office 10.05% 16.50% 15.59% 21.14% 24.20% 17.36%% Human Resource Function 0.57% 0.64% 0.67% 0.92% 1.54% 0.84%Age 27.44 27.51 28.30 29.42 28.90 28.30% with bachelors Degree 9.76% 17.47% 24.44% 20.29% 24.99% 19.95%% with masters or Ph.D. Degree 4.39% 8.13% 9.12% 7.09% 6.43% 7.31%% Female 34.13% 32.15% 37.31% 47.71% 49.32% 39.67%% Minority 22.34% 18.39% 14.92% 17.73% 27.09% 19.47%


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TABLE 2

OLS Models Predicting Log Real Wages for New Entrants in a Large US Manufacturing Firm, 1969-1993Variable Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

SGL 1-3 Non-Exempt -.33*** (.00) -.34*** (.00) -.34*** (.00) -.15*** (.00) -.15*** (.00) -.14*** (.00)SGL 4-6 Non-Exempt -.09*** (.00) -.09*** (.00) -.09*** (.00) -.02*** (.00) -.02*** (.00) -.02*** (.00)

SGL 7-9 Non-Exempt .16*** (.00) .17*** (.00) .17*** (.00) .10*** (.00) .10*** (.00) .10*** (.00)SGL 7-9 Exempt .34*** (.00) .34*** (.00) .34*** (.00) .19*** (.00) .19*** (.00) .19*** (.00)SGL 10-12 Exempt .63*** (.00) .63*** (.00) .63*** (.00) .35*** (.00) .35*** (.00) .35*** (.00)SGL 13-16 Exempt .94*** (.00) .94*** (.00) .94*** (.00) .53*** (.00) .53*** (.00) .54*** (.00)SGL 17-24 Exempt 1.35*** (.00) 1.36*** (.00) 1.37*** (.00) .79*** (.00) .79*** (.00) .79*** (.00)Departure -.28*** (.00) -.24*** (.00) -.24*** (.00) -.14*** (.00) -.04*** (.00) -.13*** (.00)Job Tenure in Months*12 .005*** (.00) .005*** (.00) .005*** (.00) -.014*** (.00) -.014*** (.00) .008*** (.00)Log Starting Wage .61*** (.00) .62*** (.00) .61*** (.00)Entry Year 1974-1978 -.004*** (.00) .03*** (.00) .02*** (.00) .02*** (.00) .03*** (.00)Entry Year 1979-1983 -.046*** (.00) .02*** (.00) .03*** (.00) .03*** (.00) .03*** (.00)Entry Year 1984-1988 -.135*** (.00) -.04*** (.00) .01*** (.00) .01*** (.00) .00 (.00)

Entry Year 1989-1993 -.175*** (.00) -.05*** (.00) .01*** (.00) .01*** (.00) -.01*** (.00)Year 1974-1978 -.01*** (.00) .00 (.00) .00 (.00) -.01*** (.00)Year 1979-1983 -.07*** (.00) -.05*** (.00) -.05*** (.00) -.03*** (.00)Year 1984-1988 -.09*** (.00) -.06*** (.00) -.06*** (.00) -.03*** (.00)Year 1989-1993 -.13*** (.00) -.10*** (.00) -.10*** (.00) -.06*** (.00)Year 1974-1978*Depart -.06*** (.00)Year 1979-1983*Depart -.07*** (.00)Year 1984-1988*Depart -.15*** (.00)Year 1989-1993*Depart -.14*** (.00)Year 1974-1978*Tenure -.003*** (.00)Year 1979-1983*Tenure -.019*** (.00)

Year 1984-1988*Tenure -.021*** (.00)Year 1989-1993*Tenure -.025*** (.00)

Constant 10.48*** (.00) 10.49*** (.00) 10.47*** (.00) 4.06*** (.00) 4.06*** (.00) 4.06*** (.00)Df 27 31 35 36 40 40Adj R-squared .78 .79 .79 .90 .90 .90Note: Hourly employees are the omitted job-type reference group. Controls for age, seniority in firm, education, promotion, demotion, gender, ethnicity,division, and union status included in all models (results not reported). Sample size in all models is 20,480 employees (1,197,360 employee months). Robust(Huber/White) standard errors in parentheses. p

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Performance Management Evaluation and Incentives and Harvard