Companies aren’t complying with minimum wage requirements — why do they take the risk?
New MIT Sloan research reveals how misaligned incentive structures in the U.S. and U.K. contribute to minimum wage noncompliance.
Penalties for noncompliance are low
Cambridge, MA, May 23, 2024 (GLOBE NEWSWIRE) — Labor laws are meant to protect workers’ health and livelihoods. However, according to an April report from the Education & The Workforce Committee Democrats, the penalties companies face for violating the laws — including the minimum wage law — rarely match the severity of their offenses.
In fact, according to Anna Stansbury, the Class of 1948 Career Development Assistant Professor at the MIT Sloan School of Management, it often makes more financial sense for companies to violate wage law than to comply.
In a new working paper, Stansbury used cost-benefit analysis to demonstrate how current minimum wage enforcement structures in the United States and the United Kingdom incentivize noncompliance and quantify the policy changes needed to protect workers.
Wage theft is widespread in both the US and the UK
In the United States, the Fair Labor Standards Act (FLSA) sets out a nationwide minimum wage, as well as overtime protections. While some states set their own higher minimum wages that supersede federal law, 40% of the country’s workers live in the 21 states where the FLSA minimum wage prevails. In the United Kingdom, the same minimum wage statute applies country-wide.
While the scope of unidentified noncompliance is difficult to measure, surveys and spot checks suggest wage theft is a significant problem in both countries. In the U.S., random inspections have found that as many as 40% of fast-food restaurants and 85% of garment industry employers were underpaying workers.
But why is noncompliance so widespread when it carries legal and financial risk? To answer that question, Stansbury drew on two decades of data on wage violation cases and penalties to compare the profits a firm might realize from breaking the law to the potential costs of being caught.
Penalties for noncompliance are low
In the U.S., all companies caught violating the FLSA must pay affected employees back wages — but usually, that’s where enforcement ends. In about a third of cases, the U.S. Department of Labor (DOL) requires companies to pay additional “liquidated damages” equivalent to wages owed. In just 6.5% of cases, repeated or “willful” violators face civil monetary penalties, typically ranging from 2 cents to 29 cents per dollar of wages owed.
As Stansbury pointed out, the penalties for companies that commit wage theft are far lower than those individuals would face for thefts of equivalent value. Shoplifting goods worth $2,500 or more can potentially lead to imprisonment in every state — but while criminal charges for corporate wage theft are possible, they are vanishingly rare. Between 1994 and 2020, the DOL prosecuted only 38 criminal cases, none resulting in prison sentences. Criminal prosecution is also unusual in the U.K., and while penalties are more common, companies’ financial risk remains low.
Discovery of violations remains rare
Both the U.S. and the U.K., Stansbury explained, using a two-track mechanism to enforce the minimum wage. Violations may be discovered during inspections — conducted by the DOL in the U.S. — or employees may report violators or pursue court action.
However, insufficient resources pose a barrier to enforcement in both countries. In the United States, Stansbury found that the DOL rarely catches companies breaking the law and that reports from affected employees are unlikely to make up the gap.
“Often, workers don’t realize they’re being underpaid,” Stansbury said. “For example, workers might not know that they should be paid for cleaning up after their shift, or they may be incorrectly classified as contractors instead of employees.”
Stansbury noted that concerns about retaliation can also be a major barrier to reporting. “Workers at the bottom of the labor market have less power. Besides the risk of losing their jobs, employers can punish them in other ways, like by giving them fewer shifts.”
Misaligned costs and benefits
With companies unlikely to be caught and even more unlikely to face meaningful consequences for violations, paying below minimum wage comes with low risks and high potential benefits.
According to Stansbury’s cost-benefit analysis, a typical U.S. firm would need to expect a 48% to 83% probability of a failed DOL inspection or a 25% likelihood of court action to incentivize compliance — an order of magnitude higher than current levels. Even in the fast food industry, which inspectors often target, Stansbury estimated that each firm has only around a 1.4% chance of being caught violating minimum wage laws in any given year.
While the odds of being caught are higher in the U.K., they remain well below the threshold required to make compliance the financially beneficial choice for companies. And under these conditions, raising the minimum wage will only make noncompliance more profitable.
This misalignment doesn’t just hurt workers — it also harms companies that choose not to break the law.
“If companies do not have a financial incentive to comply with the minimum wage, it creates a race to the bottom dynamic,” explained Stansbury. “companies that want to comply with the law and pay their workers fairly may be outcompeted. Enforcement is not just beneficial for the underpaid workers, but also enables ethical companies to compete in the labor markets.”
Realigning incentives through policy change
Reducing wage violations and creating a level playing field for ethical companies will require a two-pronged approach, Stansbury said.
“If penalties are very low, then enforcement probabilities need to be implausibly high — and if enforcement probabilities are low, then penalties need to be disproportionately punitive,” she explained. “For an effective enforcement system, you need action on both fronts.”
Data show that these actions are practical. In several states, recent minimum wage increases were paired with higher penalties for violations and expanded enforcement, effectively reducing noncompliance.
“In the U.S., it should be standard practice to require the firm to pay back wages and liquidated damages — meaning the firm pays twice the cost of the wages,” Stansbury argued. “Both countries should also impose much larger penalties on the worst violators and increase their use of criminal prosecution.”
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CONTACT: Matthew Aliberti MIT Sloan School of Management 7815583436 bayerc@mit.edu
