Naturally, as the leader of your company, you support a culture of trust, caring and openness, because you know this generates deep-seated employee commitment and facilitates exceptional performance. 

And, do you apply this philosophy when it comes to paying people? Odds are, you've concluded that compensation is just one of those things that's best kept secret. That's a problem.

What's wrong with the post office?

Certainly, there are several good reasons to hold pay close to the vest. If employees knew how much their bosses and peers make, they might feel jealous or underappreciated. You could avoid that unpleasantness by giving everyone with a certain seniority or rank the same pay--basically, the civil service model. But that creates its own problems. Top talent may decide to pack up and head to an organization that offers better rewards for better performance. (Which is why the Post Office, say, has never been known as a mecca for great business talent.)

So, is pay secrecy is the only practical policy?

The truth is, we don’t know. Pay transparency, while perhaps one of the most fascinating issues in management, is also one of the least researched.  What we do know is that a policy of secrecy doesn’t keep employees from wondering how much their bosses and peers make. It only means they have to guess at the answer.

Employees think they know, but don't.

And they usually guess wrong. You have to go back to the 1960s or 1970s for decent studies, but several of them found that under conditions of pay secrecy, employees tend to think their superiors make less than they really do and  that their peers make more than they really do.  

There are a couple problems with this. Top talent who underestimate the pay of a superior may become disheartened. They may think, “If that's all I have to look forward to, why should I hang around here?”

And employees who think their peers make more than they do are likely to demand more for themselves when salary or raise conversations come up. You've probably dealt with employees who are convinced that they get less than peers, and you know it can complicate pay negotiations.

But that’s not all.  It turns out that pay secrecy may actually harm employees' performance.  A recent study by Peter Bamberger of Tel Aviv University and his PhD student Elena Belagolovsky (now a colleague of mine at Cornell) found that pay transparency worked significantly better than pay secrecy at keeping employees engaged.

Secrecy doesn't help.

Their analysis suggested that under conditions of pay secrecy, employees felt that they were not being treated fairly  and therefore that greater effort wasn’t worth it.The demotivating effect was especially strong among talented workers. Bamberger and Belagolovsky's research further suggests that when there is some pay transparency, top workers are more motivated to achieve.

Does this mean you should immediately broadcast everyone's salary in an email blast?  Of course not.  But the research does suggest a middle ground: You can provide aggregated pay information (e.g., the range of pay or median for a given role in the firm). Employees who earn more than the median will feel appreciated. Those who earn less will want to know why--which is a good opportunity for you to explain how you view compensation, and more important, what those workers need to do to earn more. Remember what matters to your employees isn't that their pay be equal but that the system for awarding it seems fair.

Pay culture in entrepreneurial companies ranges from paranoid secrecy to complete transparency. It's up to leaders like you to set the tone. The key is to give your people the sense that they will be dealt with fairly. You'll find it easier to leave that impression if the criteria by which you give awards are clear.