Should You Raise Your Employees' Pay? There is a benefit to paying efficiency wages. But make sure the cost is right for your business.

By Scott Shane

Opinions expressed by Entrepreneur contributors are their own.


Walmart, McDonald's and Aetna have all recently announced that they will raise the pay of their hourly workers. Should your small businesses follow suit?

To answer this question, forget thinking that giving workers a raise will get you some good public relations. The PR will probably go to the big boys who get most of the media attention. Besides, if giving workers a raise is "the right thing to do," it was probably the right thing to do a few years ago when you didn't do it. So that message rings a bit hollow.

Your decision to raise worker pay should be based on careful analysis of how it affects your company's bottom line. While it might seem counterintuitive, paying "efficiency wages" – the term economists use for higher-than-market wages – can boost productivity and enhance profits. When companies pay more than the prevailing wage, their employees tend to work harder and are less likely to quit, and the companies can attract the best workers in the industry.

Whether paying efficiency wages makes sense for your business depends on several factors, four of which are particularly important.

It's difficult to tell if your employees are shirking.

People don't work as much or as hard as they have agreed to work. If you cannot pay piece rates or commissions to encourage your people not to shirk, and you can't easily judge how much effort they are putting in, then paying efficiency wages makes sense. If you pay your employees more than they can get at a comparable job down the street, your employees won't risk getting caught shirking and losing their wage premium.

You want to be selective in your hiring.

If some people are better workers than others because they have better skills or more experience, and you want to ensure you have the best workers, then paying efficiency wages make sense. The best workers will be attracted by the higher pay you offer. As a result, you will attract a wider pool of potential hires. This bigger pool of potential employees will allow you to be choosier about whom you hire.

Related: Why Small Businesses Are Turning to Online Lenders

Worker morale is important to your business's success.

In some businesses, employee morale can make or break a company. For example, retail customer-service workers who don't smile or act pleasantly to customers can drive down sales to a point where a business goes under. If employee morale is a key success factor for your business, then paying efficiency wages makes sense. Higher wages boost employee satisfaction, and that higher morale translates into the kind of smile-and-act-pleasant-to-others behavior to which customers respond positively.

Employee turnover is costly.

Businesses that spend a lot of time on recruiting and training and that have a steep employee learning curve need to keep turnover down to control costs. If that's the situation with your business, then paying efficiency wages can help. If you pay workers more than your competitors, they won't be very likely to quit and take a job down the street.

Several big companies have announced that they are raising worker pay. Whether your small business follows suit should depend less on the public relations value of the move and more on your analysis of the effect on your bottom line. If employee turnover is costly, worker morale matters to your success, you want to be selective in your hiring, and you cannot easily keep your employees from shirking, then paying efficiency wages is worth considering.

Related: How the Decline in Community Banks Hurts Small Business

Scott Shane

Professor at Case Western Reserve University

Scott Shane is the A. Malachi Mixon III professor of entrepreneurial studies at Case Western Reserve University. His books include Illusions of Entrepreneurship: The Costly Myths That Entrepreneurs, Investors, and Policy Makers Live by (Yale University Press, 2008) and Finding Fertile Ground: Identifying Extraordinary Opportunities for New Businesses (Pearson Prentice Hall, 2005).

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