In pinpointing the worst thing you can do to an employee, we’re excluding things that are illegal, unethical, immoral, or unsafe. Otherwise, the worst thing for an employee is obvious to us though perhaps not to others: paying her or him significantly more than a free-market wage.

What? The worst thing you can do is to pay someone too much? We can see people’s hands going up volunteering to receive that type of harsh treatment. But the results are often devastating for the employee.

We’ll define a free-market wage as the amount of money the employee could reasonably expect to earn after losing his or her current job and being forced to find work. It is what the free market would pay a person with the education, experience, and skill set of the employee in question.

We are talking about situations in which employees are paid 50% or 100% more than they could get elsewhere. If you think that doesn’t happen, think again. We’re aware of a company that has to pay low-skilled employees working on a government job $12.50 per hour while their other employees, doing exactly the same work for private-sector customers, are paid $8.00 per hour. The reason: the government requires that the workers on its jobs be paid on a union wage scale. If the workers making $12.50 per hour were to lose these jobs, could they find jobs paying as much? Not likely ― they are making 56% more than the free-market wage.

When an employee is significantly overpaid, several things happen. In most cases, employees do not recognize that they are overpaid. It’s human nature: most of us believe we are worth more than we are paid. At the least, we think we are paid fairly. It’s a very unusual person who recognizes that his or her compensation is well above what he or she could earn elsewhere and adjusts his or her lifestyle to compensate.

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The second thing that happens is that overcompensated employees, not recognizing the precariousness of the situation, build a lifestyle that cannot be sustained by less than their current income. For most, even if they know they can’t replace their income, they behave as though they can. People stretch to buy the biggest house for which the bank will approve a loan. They buy new cars with debt and leverage themselves to the hilt. Spending on “extras” chews up cash, and savings are minimal. Often it takes the current level of income just to service the debt.

Then, the unthinkable happens. The goose that laid the golden eggs is gone. It could be a plant closing or a layoff, or perhaps a company could replace the overpaid employee at a substantial savings to the business. For example, a company that operated call centers wanted to be on Fortune magazine’s list of best places to work in America. To achieve that, it offered above-market-rate compensation, extremely generous benefits, three to five weeks of vacation, and numerous other perquisites such as fun days. The company made Fortune’s list. Then, the economy turned down and things got tight. A bright, young analyst figured out that the company could save millions by outsourcing its expensive call-center operations, and the party was over.

Paying significantly above market rates to employees who cannot justify the premium through increased output is not only irresponsible, it’s an abrogation of the company’s fiduciary responsibility to its shareholders.

Most people who find themselves out of work will try to replace the income they have just lost. They believe they can, because they think they are worth what they were making. Refusal to accept lower-paying jobs lengthens unemployment and makes matters worse. They try to hang on to the lifestyle they built, not realizing they will never again attain their former level of income. We’ve seen cars repossessed, foreclosures on homes, broken marriages, and even suicide.

Of course, blue-collar workers are not the only ones subject to this phenomenon. Many white-collar workers and elite athletes have met the same fate. Having worked very hard for years to make it to the pinnacle of their sport, they proceed to build a lifestyle that requires their current level of income to sustain it. The minimum salary of an NFL player is currently about $375,000 per year. Unfortunately, the average number of seasons a player spends in the NFL is three and a half, and most have no prospect of making that kind of money once their playing days end. Too often, when the ride is over, their world comes crashing down and they find themselves destitute. The list of former star athletes who met with financial ruin includes such household names as Mike Tyson, Scottie Pippen, Lawrence Taylor, Dorothy Hamill, Rollie Fingers, Bjorn Borg, and Johnny Unitas.

It may sound odd, but yes, in our years of experience, we have found that the most unfair thing an employer can do is to pay an employee significantly more than a free-market wage. Doing so sets the employee up for financial ruin when the gravy train comes to an end. We’ve seen it time and time again.

Doug and Polly White are principals at Whitestone Partners, a management-consulting firm that helps small businesses build the infrastructure they need to grow profitably. They are also co-authors of let go to GROW: why some businesses thrive & others fail to reach their potential (Palari Publishing, 2011).

 

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