Why your boss is overpaid

My friend was due for a promotion at his workplace. His boss, however, had different ideas. So, my friend got just a 5 per cent salary hike. My friend feels cheated. He believes his boss is overpaid. He is not the only one who thinks that way. But why is this common at workplaces? Economists seem to have a rather perverse answer to this question. They call it tournament theory. What is it?

Consider Euro 2008 football championship. Spain won the tournament, beating Germany in the finals. Spain may not have been the best team in the championship. It does not matter too. In a tournament, what matters is whether one team is better than the other – not if it is the best. Relative performance matters. Economists argue that the workplace is no different. Why? It is difficult to measure your performance unless you are a carpenter shaping wood or a writer authoring articles like this one. You can then be paid piece-rate. And you will be paid more if you generate more pieces, with tolerable defects.

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Element of luck

But if you are, say, a software engineer, you do not enjoy this luxury. Your efforts may not be as easily measurable. So, your appraisal is about how well you have performed vis-À-vis your colleagues. Often, such appraisal has an element of luck.

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So, how can your employer motivate you without paying much? By overpaying your boss, argue economists. The more your boss is paid to do less work, the bigger the motivation for you to work hard and grab his chair. After all, your boss cannot survive for long at his level of incompetence!

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But why does the pay get fatter at the top? At the lower level, the potential for future promotions is greater. And that is a bigger motivation than a fat salary. As you move up the hierarchy, future promotions are not as important. A fat paycheck is. My friend seems to agree with this argument. He is, hence, working hard despite the unfair appraisal. His employer is fortunate.