Presentation on internal & external equity compensation system

Introduction
Compensation is the package of quantifiable rewards an

employee receives for his or her labors. Includes three components: base compensation, pay incentives, and indirect compensation/benefits.
`Compensation forms such as bonuses, commissions and

profits sharing plans are incentives designed to encourage

employees to produce results beyond normal expectation.

Objectives of compensation planning

Attract talent.
Retain talent.

Ensure equity.
New and desired behavior. Controls costs. Comply with legal rules. Ease of operation.

Designing a compensation system

To design compensation system two pronged challenge are

presented: a. Enables the firm to achieve its strategic objectives. b. Is molded to firms unique characteristics and environment. To develop a compensation plan following nine criteria are

considered:

1. Internal versus External Equity.

2. Fixed versus Variable Equity. 3. Performance versus membership. 4. Job versus Individual pay. 5. Egalitarianism versus Elitism. 6. Below- market versus Above-Market compensation 7. Monetary versus Nonmonetary awards. 8. Open versus Secret Pay. 9. Centralization versus Decentralization of Pay decisions.

Equity theory
It suggest that individuals determine whether they are being

treated fairly by comparing their own outcomes/inputs ratio with the outcomes/inputs ratio of some one else.
It also suggests that individual will usually make some attempt

to relieve the tension created by any perceived inequity & employee may perceive the ratio of his/her rewards & contribution to be less favourable then the ratio prevailing for others.

Internal versus External Equity

Internal Equity: It refers to the perceived fairness of the pay structure

within a firm.
External Equity: It refers to the perceived fairness in pay relative to what other employers are paying for the same type of labor. In considering internal versus external equity , managers can use two basic models:

1.The Distributive Justice Model.

2.The labor market Model.

The Distributive justice Model

The model suggests that the pay equity holds that employees

exchange their contribution or input to the firm for the set of

outcomes . This social-psychological perspective suggests that employees are constantly: (a) comparing what they bring to the firm to what they receive in return and (b) comparing this input/outcome ratio with that of others employees within the firm.

The labor market Model

This model suggests that , the wage rate for any given occupation is set at the point where the supply of labor

equal the demand for labor in the market place.

Individual equity
It refers to comparision among individuals in the same job
with the same organisation. i.e. each individuals pay is fair in comparision to others doing the same / similar job.

Balancing equity
A firm should try to establish both internal & external pay

equity, but these objectives are often at odds. Therefore to

balance internal & external equity, firms have to determine which employee groups pay will be adjusted upward to meet

market rates & which groups pay will remain at or under

market.
In general, emphasing externally equity is more appropriate for

newer smaller firms in rapidly changing market. Even emphasis on internal equity is more appropriate for older,

larger & well established firms,

Case study
A dilemma for magnolia state bank
Magnolia state bank, serving a small community, has successfully bid to takeover the insolvent city bank and trust in a large city 50milies away. The president of Magnolia state is anxious to examine the comparability of

the wage plan of the newly acquired branch with that of

the Magnolia headquarters location .

Tellers and clerks, the majority of the work force at Magnolia receive a starting wage of $250 a week ($13000per year), which can increase to $315 a week ($16380 per year) with experience. The cost of living in Magnolia and Magnolia state

bank stands virtually alone as a prestigious employer with

good working conditions. In fact, the low wage structure at Magnolia state bank is part of the competitive strategy that has allowed the bank to maintain its position as the sole bank in the community .

City bank and trust is one of many banks in the large, nearby city. The cost of living is higher and there are numerous reputable employers competing for available talent. As a result, city bank and trust found that it must start clerks and tellers at $340 ($17680), with ranges upto $425 ($22100) to attract and retain

employees with needed skills.

Questions?
1.Could Magnolia state bank justify continuing the approximate 35 % wage differences that exist between Magnolia & the newly acquired branch? 2. If yes, how would you, as president of Magnolia state bank , explain the differences to employees in Magnolia? Given what you know about equity theory, how would employees be likely to respond? How would you address employee concerns?

3. If no, how would you proceed to merge the system? What

effect would wage reductions have on attracting & retaining employees at the city branch? What effect would wage increases have on the competitive position of the bank in Magnolia ?