Pay Workers More So They Steal Less

Bigger paychecks for retail employees could generate significant payoffs for employers by reducing worker theft and raising the level of moral behavior in the workforce, a new study shows.

Tatiana Sandino, an associate professor in accounting and management at Harvard Business School, writes about the subject in a new paper: Can Wages Buy Honesty? The Relationship between Relative Wages and Employee Theft. She cowrote the study, published in the September issue of the Journal of Accounting Research, with Clara Xiaoling Chen, an assistant professor of accountancy at the University of Illinois at Urbana-Champaign.

“Our study suggests that an increase in wages will decrease theft, but won't fully pay off”

With this research, Sandino and Chen contribute to a growing body of knowledge about how wages affect employee behavior and social norms in the workplace. Previous research found firms offering wages higher than the local competition experienced both increased productivity and lower turnover, but did not address the issue of employee theft.

Employee theft comes with a huge price tag for US businesses, accounting for up to $200 billion in annual losses, according to one estimate cited in the paper. The problem is particularly severe in retail chains: According to the 2008 National Retail Security Survey, inventory-related employee theft contributed to a loss of $15.9 billion.

Intrigued by the size and scale of the loss, the researchers set out to find whether higher wages, relative to the differing pay scales in local markets, could help keep workers in check.

Can Pay Cut Crime?

One of the few empirical research studies on the subject, published in 1990, found that when groups of employees received a 15 percent pay cut, theft increased. But what if employees were paid more than workers in competing organizations? Would theft decrease? Before doing her research, Sandino hypothesized that higher compensation would discourage stealing for several reasons.

• First, employees receiving higher pay would feel more warmly toward their employers and would rather reciprocate than retaliate.
• Next, since higher-paid workers want to hold on to their jobs, they would not be as likely to steal as lower-wage workers might. In this case, not stealing is "not a matter of being loyal to your employer," Sandino says. "You are protecting a job that gives you better pay."
• And third, firms offering relatively higher wages could attract more honest workers to start with.

These arguments suggest that higher wages could produce or attract up-and-up employees who "will steal less and make sure that other employees are not stealing," Sandino theorized. However, higher wages could also be unrelated to theft if honesty only depended on the workers' moral values, if workers were unaware of wages paid by the competition, or if they overlooked wage deviations by reassessing the value of their own inputs.

For the study, the researchers used two data sets from chain stores and interviewed managers of nine convenience store chains. The first data set, for the year 1999, came from 76 stores in a midsize retail chain and was used to weigh cash shortage and inventory shrinkage, the two most important sources of financial loss in retail, as a percentage of overall sales. Another subsample of data from 251 stores within 31 retail chains provided information about the ratio of cash shortage to store sales. That data came from a survey conducted by the National Association of Convenience Stores in 2003 and 2004.

The study took into account the workers' different socioeconomic environments, the amount of monitoring that managers performed, and employee characteristics such as how many people typically worked in the stores.

Is There A Payoff?

As expected, Sandino and Chen confirmed that overpaying workers relative to market wages caused a drop in employee theft. A cost-benefit analysis proved that what companies saved in cash and inventory loss covered about 39 percent of the costs associated with wage increases. (So if a company increases wages by $1, it can expect to lose almost 40¢ less in cash and inventory.)

"Our study suggests that an increase in wages will decrease theft, but won't fully pay off," Sandino says. Therefore, an employer may find that it makes sense to raise employee wages if other benefits from wage increases—such as reduced employee turnover or higher employee productivity—translate into at least 61 percent of the cost of the wage increase.

The analyses also suggest that benefits are likely to be higher in situations where employees share a shift. Inventory losses are higher in stores where employees work together, either because it is more difficult to identify the person responsible for stealing or because coworkers create an atmosphere that encourages theft. Nevertheless, the incremental losses observed when employees work in groups are absent in firms that pay higher wages.

And what about the previous study that showed employee pilfering rose as wages decreased? Not supported in this research. Sandino admits that the sample in their study may not have been large enough to capture the effects of underpayment. Nevertheless, she explains: "Our findings are contrary to an argument in prior literature suggesting the effects of wages on employee behavior are a consequence of underpayment, where underpaid workers retaliate against their employers in proportion to their underpayment, but overpaid workers rationalize the overpayment away."

The research results dovetails with what CEOs of some big retail companies like Costco and the Container Store argue publicly: that good wages and benefits are linked to a company's low turnover and to happier, more honest workers.

What Businesses Can Learn

The study has important practical implications for business. For example, the Committee of Sponsoring Organizations of the Treadway Commission (COSO) framework, used by the majority of CFOs for internal corporate control, emphasizes that adequate human resource practices such as "competitive compensation programs" play an important role in preventing fraud.

According to Sandino and Chen, takeaways from the study are likely to apply to other types of retailers, including restaurants, department stores, and drugstores, as well as to other service or consumer product firms, where the payoffs from stealing are not disproportionately high relative to potential wage premiums, such as in casinos.

Ultimately, a company must decide whether raising wages makes fiscal sense.

"You can't just assume that our study shows that you should increase wages," Sandino concludes. But a company struggling to keep minimum-wage employees honest would be wise to consider it.