It’s been a long time since my last post. Perhaps too long. Things have been busy at Gridstone Research, the startup I work for and blogging had to take a back seat for a while.
So to make up for it, here’s a meaty subject. Why do people in different professions get paid what they get paid? It’s an interesting subject and I thought I would find some research on it on the internet, but I couldn’t. There’s a lot of data on what people get paid in different professions, but the question we are trying to answer is why.
Let’s first clarify the question at hand. We are not dealing with executive compensation here, although that is quite an interesting (and topical) subject in of itself. We also know that in any profession the higher you sit in the organization chart the more you get paid (generally). What we want to compare here is compensation in different professions – investment banking or software sales or retail bank front office – taking out the effect of position and years of experience. We will ignore stock option related windfalls, which are anyway becoming rare. And for this piece, we assume that we are comparing professions in the same city, so there is no cost of living impact on wages.
After all the assumptions in the last para, you are still left with a significant variation in compensation both at entry level (out of college or business school) or at any time marker after that. The question is why? What makes some jobs worth large amounts of money while others are so-so?
Here’s my hypothesis. If the person in a job can directly impact the company’s profit in a significant, measurable way that job will get paid more than someone in a job that doesn’t.
That sounds almost like a truism. But let’s examine more closely what it means. An example will make it clearer.
Take the job of a Portfolio Manager (PM) at a Mutual Fund. The PM decides which stocks to buy, hold or sell for the Fund. He almost entirely determines how the Mutual Fund performs. If the Fund performs well, its shareholders make higher returns than other comparable funds. The word spreads and more money pours into the Fund swelling the management fee that the Fund Management firm charges. The average mutual fund in the US had assets of $1.05B and expenses of 1.25% in 2005. A 25% increase in assets increases the firm’s fees by over $3 million which should largely drop to the bottom-line. As you can see, the correlation between the PM’s decisions and the business outcomes are very high. Also, and importantly, there are few if any other things that matter. Unlike in a manufacturing company where many people contribute to the value and quality of the product, the PM might depend upon the recommendations of the Fund’s Analysts who research companies, but he makes his own final decisions. Random events or luck play a minor role, especially if these events impact the benchmark as well.
The PM’s job therefore fits our criteria perfectly. He directly impacts the firm’s profits in a significant, measurable way. Not surprisingly, the Portfolio Manager for a Mutual Fund in the US is a highly paid job. Many of them take home over $ 1 million.
Sales people in most industries that sell to businesses tend to get paid more. What predictions can one make about compensation in the Sales profession using my hypothesis? A Sales professional will be paid more when Gross Profit (or Contribution) per Sales professional is higher (significant impact to profit). A salesman for Boeing should therefore be one of the highest paid salesmen in any industry. Also Revenue Producers will be paid more in the Professional Services industries where the Partner or the Banker is the product himself. The client often knows and trusts the Partner or Banker and will give him the deal because of him and not the company he works for (direct impact). Therefore, Management Consultants, Lawyers and Investment Bankers all get paid oodles of cash.
A school teacher’s job is a tough one. They mold young minds. A good teacher can be a glorious thing for a young student. What can be more important than this job to both individuals and society? Yet school teachers are paid very little in almost every country. I have often struggled with this paradox. Why wouldn’t we pay school teachers more and get the best we can for our children?
Let’s take a school teacher’s job and evaluate it against the criteria in our hypothesis. A school teacher definitely directly impacts the outcomes for particular students. This impact can be undoubtedly significant. You might decide to become a writer because of a superb English teacher, or totally lose interest in Biology because of lousy one. However, a school teacher in the US typically works for a public (government) school and not for a business. And the outcomes for students discussed above are not exactly measurable outcomes. So a school teacher’s job doesn’t fit the criteria in our hypothesis on a couple of counts. So school teacher salaries will predictably be low, attracting average talent and with lower incentives to excel.
On the other hand, consider the teachers in Delhi’s IIT coaching classes. Their outcomes are very measurable – the students’ JEE rank. The students’ JEE rank drives both the enrollment in the coaching classes and the fees per student. No wonder these teachers can take home as much as Rs. 15 lakhs a year, a salary that an ordinary school teacher in India can only dream of.
I think the hypothesis in general works. But like most things in the complex world of business, it’s hard to make rules stick. There are always eddy currents that produce exceptions. If you find any, let me know.