Twenty-six states have increased or will increase their minimum wage in 2023 as inflation continues to cut into the cost of living.
Wage increases are known to create a complex ripple effect in the workplace, particularly for employees in the immediate pay levels above entry-level workers. And companies that fail to properly accommodate minimum wage hikes in their salary planning could hurt employee morale and performance and indirectly lower executive pay.
When employers raise the base pay for entry-level workers, one would assume senior employees’ wages would also increase. But what tends to happen is that companies raise senior employees’ wages by a smaller margin, if at all. That can lead to wage compression: when the salaries of less experienced workers become closer to those of more tenured colleagues.
“We certainly are seeing that salary compression at entry levels...where the difference between the starting salary and that third or fourth level up used to be $5, and now it's only $3,” says Jan Koors, senior managing director at the executive compensation advisory firm Pearl Meyer. She notes the same can happen in the mid-manager and senior individual contributor ranges, especially in a tight labor market where companies hand out higher salary offers to lure talent.
Couple that with salary transparency laws that now affect one in four U.S. workers, and such compressions could hurt productivity and morale. To be clear, the issue is not that minimum wage-earning employees are getting paid more but that more senior earners don’t see a corresponding pay bump. Employers must think critically about pay decisions and train managers to explain wage variances. “Frontline managers are going to have to become much more facile with their ability to explain why the compensation programs work the way they do,” Koors says.
The impact on CEO pay
Minimum wage increases are unlikely to directly lead to a compensation boost for C-suite members, though some links have been found before, depending on company size and industry. One white paper from Duke University analyzing the Fair Minimum Wage Act of 2007 found that a 10% increase in the share of employees entitled to a minimum wage increase led to a 6.5% increase in total CEO pay for companies most reliant on minimum wage labor. CEO pay increases were most pronounced at smaller companies, companies with lower CEO-employee pay ratios, and younger CEOs, the paper found.
But broadly speaking, minimum wage increases can impact other factors that influence CEO pay, such as employee productivity and overall performance. In some instances, higher minimum wages can boost worker productivity, which may support a company’s reason for increasing executive pay. And this trend may continue in light of new SEC rules requiring companies to disclose executive pay relative to a firm’s financial performance. A Northwestern University Kellogg School of Management study of a major U.S. retailer found that raising the minimum wage led to a 4.5% increase in goods sold across all workers. Lower productivity workers were motivated by the increase, resulting in less turnover and 19% fewer terminations for such workers, though there was no change among higher performers.
“The more reliable and tenured and educated my workforce is, the more productivity I have, the higher performance as a company I have,” Koors says. “As an executive, I get the benefit of increased financial performance, which influences my bonus, and increased stock price performance, which influences the value of my equity holdings.”
But the opposite can also hold true. Higher wages tend to create higher employer expenses, possibly cutting into profits. The same Kellogg study found that profits per hour decreased by 16% after the $1 minimum wage increase.
“We really don't see a connection between minimum wage increases and higher executive pay. If anything, it may be a bit to the contrary,” says Andy Goldstein, managing director at the advisory firm Willis Towers Watson. “As the wage structure goes up across a company by virtue of these minimum wage increases, it puts pressure on overall company profits because their costs are going to be higher and therefore could have the impact of reducing bonuses.”
The inflationary impact
Most of Goldstein’s clients are spending more on wage increases today than in the last decade, and they’re trying to recover that cost through higher-priced goods and services. That can lead to a damaging inflationary effect, resulting in the need for even higher minimum wages.
“There's legitimate concern and desire for people to earn a living wage, and these minimum wage increases are an attempt to do that, but they obviously come at a cost,” says Goldstein. He adds that while hourly wages in recent years “have definitely risen at a faster pace than they historically have, it's not enough to make up for the higher cost of inflation.”
Some employers are getting creative with this balancing act. Goldstein notes a “renewed effort” to use bonuses and other variable compensation, like commission, profit sharing, or referral bonuses, to minimize fixed cost increases like higher hourly pay or salaries.
Some companies have welcomed raising the minimum wage due to a tight labor market. In January, Walmart raised its starting minimum hourly wage to $14 from $12. Walmart U.S. CEO John Furner said the increase was meant to “ensure we have attractive pay in the markets we operate.” Others, including Home Depot and Delta Airlines, have pledged to raise their hourly workers’ wages in 2023.
As more companies inevitably follow suit, they will have to keep in mind the potential impact on company performance and non-entry-level workers.
