Is the value of managers reflected in their remuneration?

Middle managers, who typically head up business units, are less visible than top managers or sales managers, whose salaries can amount to as much as 60% of the added value they generate for their companies. What’s more, middle managers don’t capture the value they create, and there are a number of reasons why. The first ties into non-economic motivators, such as reputation or corporate environment, which can prompt managers to stay put even if their pay isn’t proportional to the profit they generate; this in turn diminishes their credibility when they threaten to quit. A second obstacle is the low demand for middle managers on the labor market, which limits their chances to negotiate their salaries. The third barrier is linked to the difficulty in disentangling what part they actually play in generating profits for the company (something that both managers themselves and employers struggle to accurately assess). In fact, since the responsibilities of middle managers are integrated in the organization, often it’s complicated to evaluate the direct impact on profits generated by the company as a whole. Our research provides empirical proof of this phenomenon based on the case of a fast food chain.

The company in question runs an extensive chain of restaurants. In our analysis, we collected monthly data from 2007 to 2014 to compile our final database, which counted 441 managers and 394 stores for a total of 26,456 manager/store/month observations.
How much value do store managers create? And how much of this value do they recoup in the form of higher pay? Their day-to-day work involves running the store, managing and training personnel, and monitoring everything from cleaning to displaying merchandise. And their contribution to store performance can be substantial, depending on how they promote their products, train their staff, and directly control costs, supervise shifts and handle inventory. Their compensation package is portioned into a base wage plus a variable bonus, which rather than being stipulated in the collective employment agreement is instead negotiated on an individual basis. This bonus, on average 6% of total pay, is based on periodic targets for sales, profits, and service quality. In this particular case, company policy requires store managers to rotate continually to prevent them from becoming too entrenched in a single store. In fact, on average 23% of managers change stores every year.
In our study, we calculated value “creation” by store managers as the percentage of the store’s net profits that can be directly attributed to them. Then we measured the value they “captured” with their pay packages, which include fixed monthly wages and three-month bonuses, when applicable. Utilizing sophisticated econometric methods, we estimated that, all other conditions being equal, a stand-out store manager (someone with a higher-than-average standard deviation) generates 6.7% extra profit (which corresponds to nearly double the average amount a manager gets paid). But that same manager will only be able to capture a negligible portion of that extra profit (0.5%) in the form of higher pay.
Our study analyzed this last observation also in light of the fact that certain characteristics of managers (such as gender, age, and type of employment contract) can impact their salaries regardless of the performance of their stores. The mismatch between value generated and value captured by managers reflects multiple factors, both in terms of the demand side of the labor market and human resource management practices, as well as the supply side and labor market conditions. For example, a company may find it hard to disentangle what portion of a store’s profits are due to the store itself (size, location, etc.) and how much can be attributed to the manager, since both are highly interdependent. In this case, the use of a variable pay package based solely on store performance could lead to a mismatch between the manager’s value creation and value capture. Likewise, the same can also emerge when there are non-monetary forms of compensation at play (employer brand, company purpose, organizational climate, etc.) which offset the differential between value creation and value capture.

In the case we analyzed, our results show that the best middle managers only capture a small portion of the value they create. If this were to hold true across companies and industries, our finding suggests that human resource management systems can play a role in generating competitive advantage if they are effective in a number of ways. Specifically: a) attracting, growing, and retaining managers capable of creating value, which may mean improving recruitment, selection, training, and development processes; b) doing more accurate performance assessments to measure actual individual contribution to value creation; c) ensuring optimal allocation of the highest-performing managers to key roles; d) understanding what motivates managers and calibrating monetary and non-monetary compensation packages accordingly.
The mismatch we found between managers’ value creation and value capture also implies that companies can pursue different strategies based on their respective labor market, depending on whether or not there are competitors or alternative employment opportunities. In other words, when the labor market is competitive on the demand side, high-potential managers can capture a higher percentage of the value they create. But if the labor market is competitive on the supply side, companies will be more likely to keep that added value for themselves.