NBER WORKING PAPER SERIES DOES TRANSPARENCY LEAD TO PAY COMPRESSION? Alexandre Mas Working Paper 20558 http://www.nber.org/papers/w20558 NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 October 2014 I am grateful to Will Dobbie, Matthew Gentzkow, Ilyana Kuziemko, Emmanuel Saez, Jesse Shapiro, and Orie Shelef for helpful comments, as well as seminar participants at University of Chicago, Harvard, UC Berkeley, NBER, Princeton and Yale. Mingyu Chen, Kevin DeLuca, Kwabena Donkor, Helen Gao, Disa Hynsjo, Samsun Knight, Rebecca Sachs, Dan Van Deusen, Jessica Wagner, and Yining Zhu provided excellent research assistance. This project has been approved by Princeton's Institutional Review Board.The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peer- reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications. © 2014 by Alexandre Mas. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source. Does Transparency Lead to Pay Compression? Alexandre Mas NBER Working Paper No. 20558 October 2014, Revised February 2016 JEL No. J01,J31,J45,J63 ABSTRACT This paper asks whether pay disclosure in the public sector changes wage setting at the top of the public sector distribution. I examine a 2010 California mandate that required municipal salaries to be posted online. Among top managers, disclosure led to approximately 7 percent average compensation declines, and a 75 percent increase in their quit rate, relative to managers in cities that had already disclosed salaries. The wage cuts were largely nominal. Wage cuts were larger in cities with higher initial compensation, but not in cities where compensation was initially out of line with (measured) fundamentals. The response is more consistent with public aversion to high compensation than the effects of increased accountability. Alexandre Mas Industrial Relations Section Firestone Library Princeton University Princeton, NJ 08544 and NBER [email protected] Pay transparency policies are growing in importance. Recent examples include states and cities that have increasingly disclosed worker salaries as part of sunshine initiatives, a U.S. presidential memorandum that recommends requiring federal contractors to submit summary data on employee compensation by race and sex, and a newly imposed rule that requires publicly traded companies to compare CEO pay with the pay of the median worker.1 In an extreme example, Norway publishes all of its residents’ tax returns online (MacDougall 2009). While the literature has made progress in understanding how preferences about inequality and redistribution are shaped by available information (e.g. Bartels 2005; Card et al. 2012; Cruces, Perez-Truglia, and Tetaz 2013; Kuziemko et al. 2013; Karadja, Mollerstrom, and Seim 2014), little is known about whether transparency affects pay. Two reasons why salary transparency might change the compensation structure in organizations, particularly at the top of the distribution, are (1) greater accountability and (2) public aversion to salaries perceived as excessive. Advocates for transparency polices in the public sector have stressed that increased disclosure should lead to increased accountability.2 Better information might allow the public to hold elected officials more accountable for gaps between pay and productivity. 3 Increased accountability could result in lower manager compensation if capture and managerial power are restrained. 4 Consistent with this hypothesis, using survey data from across 175 countries, 1 See https://ballotpedia.org/State_government_salary for states with employee salary databases, www.whitehouse.gov/the-press-office/2014/04/08/ presidential-memorandum-advancing-pay-equality-through- compensation-data for the presidential memorandum, and https://www.sec.gov/news/pressrelease/2015-160.html for the SEC rule of CEO pay relative to the median worker. 2 See, for example, The Economist, “Sunshine or colonoscopy?” November 19, 2011. http://www.economist.com/node/21538774 3 Greenstone, Oyer, and Vissing-Jorgenson (2006) find evidence that mandated disclosure requirements in the 1964 Securities Act led managers to focus more on maximizing shareholder value. 4 See Di Tella and Fisman (2004), Diamond (2013) and Brueckner and Neumark (2014) for evidence of rent extraction in the public sector. 3 Djankov et al. (2010) find that public disclosure of politicians’ income is associated with lower perceived corruption and better government. Transparency may also lead to pay compression if there is public sentiment against high levels of compensation, even if compensation is in line with fundamentals. Such a response would be consistent with inequality aversion on the part of the public (Fehr and Schmidt 1999).5 There has been speculation in the executive compensation literature that this type of “populist” response to seemingly high levels of compensation has contributed to lower executive pay in publicly traded companies where top salaries are disclosed (Jensen and Murphy 1990), though there is little quantitative evidence of this phenomenon. Understanding the effects of transparency on wage setting, as well as the underlying mechanisms, is important for guiding policy. Estimating this effect is challenging, as it requires finding variation in transparency at an organizational level, as well as data on wages. This paper seeks to overcome these difficulties by examining how a 2010 California mandate that required cities to disclose municipal salaries affected the compensation of the Chief Administrative Officer (“city manager”) position—typically the highest paid city employee. The research design exploits the fact that prior to the mandate a subset of cities (“previous disclosure” cities) had already disclosed the salaries of their top managers.6 Using the Internet Wayback Machine and archives of more than three hundred local newspapers, I identify cities where the salaries of city managers were already disclosed to the press or on their websites at the time of the mandate. Prior to the mandate, 63 percent of cities already disclosed the salary of the city manager. I 5 A related mechanism is morale considerations on the part of workers since transparency can lower job satisfaction (Card et al. 2012) and being paid below expectations can lead to declines in productivity (Greenberg 1990; Krueger and Mas 2004; Mas 2006; Mas 2008; Cohn et al. 2014). Employers might internalize these fairness concerns when setting pay (Frank 1984, Akerlof and Yellen 1990, and Bartling and von Siemens 2010). Transparency might also reduce gender and race wage gaps by making it easier to compare wages of workers in similar jobs; this was, in fact, the stated motivation behind the 2014 presidential memorandum referenced above. 6 This strategy is similar to the one used by Bo, Slemrod, and Thoresen (2014) who study the effects of disclosure on tax avoidance in Norway. 4 compare these cities to other cities where the mandate represented the first recorded disclosure of city manager salary (“new disclosure” cities). I also make comparisons to wages in Arizona cities, where there were no changes in disclosure policy. One difficulty when studying the effects of disclosure policies is that pre-disclosure information is not typically available. In order to examine pre-mandate trends, I made a public records request to all 482 cities in California for 1999-2012 payroll records and contracts of city managers, and to the California Public Employees' Retirement System (CalPERS) for 2001-2012 earnings records of employees who contributed to CalPERS pensions. The evidence suggests that compensation is sensitive to increased transparency. Comparing the evolution of wages in cities that previously did and did not disclose salaries, I find that salary disclosure reduced compensation of city managers by an average of approximately 7 percent. These cuts occurred both in cities where managers remained in their position, and in cities where managers changed. Interestingly, given the evidence on firms’ reluctance to cut nominal wages (Bewley 2012), these cuts were largely nominal. Wage cuts were substantially larger in cities where compensation was initially higher, particularly cities where the city managers were paid more than $200k annually prior to disclosure (the mean salary was $193k in 2009). There was no relative decline in the 50th, 75th, and 90th percentiles of the city wage distributions, on average, implying that reductions at the top of the wage distribution reflect pay compression. Importantly, this wage effect does not appear to be the result of citywide furloughs or budget cuts following the 2007 recession. I find no evidence of differential changes between new and previous disclosure cities in average earnings of municipal employees excluding the city manager, number of municipal employees, or the average income levels of residents. Additionally, the wage reductions came after furloughs peaked in California. 5 To assess whether these wage cuts were the result of greater accountability, I use the estimated relationship between wages and city characteristics in cities that voluntarily disclosed wages before the reform to predict wages in cities