Internal and External Equity Comparison
Internal and External Equity Comparison
Evidence shows that human resource is an essential concept in the management and success of a business establishment. Compensation is one way of ensuring that the human resource remains satisfied with their job, consequently reducing the risk of high turnover rates. An organization can adopt two major equity compensation systems; internal and external compensations. Internal equity compensation involves determining the compensation of employees based on their performance and roles in an organization (Gomez-Mejia, Berrone & Franco-Santos, 2014). The comparison of the fairness of compensation is contrasted against the job groups within the organization. Employees perceive that they are being fairly compensated if the value of the compensation is relative to the kind of work that they undertake.
Contrastingly, external equity compensation involves the comparison of compensation against two or more organizations (O’Connor, Rafferty & Sheikh, 2013). Employees feel that they are being fairly compensated if the pay they receive averages the market price of the kind of work done. Designing a compensation plan involves the consideration of a variety of factors, including the educational level, skills, experience, and responsibilities and duties of the employee. The following are compensation plans, based on the internal and external equity approaches.
Internal Equity Compensation Plan
Advantages and Disadvantages
Internal Equity Comparison
O’Connor, Rafferty and Sheikh (2013) proposes that the compensation plan that an organization chooses should exude two important factors; motivation of the workers, and costs of labor. Remuneration should balance between these two factors, else, the staff will be disgruntled, or the organization will cut into its revenues by providing unmatched remuneration. Utilizing the internal equity comparison comes with various benefits. Internal equity facilitates a culture of fairness in the organization. Palomino and Peyrache (2013) observed that when employees perceive fairness in the organization from similar remuneration, they are likely to achieve job satisfaction, consequently reducing the risk of high turnover rates.
Internal equity is also associated with reduced discrimination lawsuits for organizations. This is because the internal equity compensation system encourages fairness of compensation for similar roles and duties in an organization. As a result, such an organization runs a very low-risk of attracting legal reprimand from disgruntled employees (O’Connor, Rafferty & Sheikh, 2013). Also, internal equity compensation ensures that an organization maintains consistent remuneration standards. However, this form of remuneration may lead to exploitation of staff, if other organizations offer more competitive rates for similar positions. This form of remuneration also makes it difficult to align remuneration with the macro-economic factors that affect the process of compensation.
External Equity Compensation
External equity compensation also has its benefits over the internal equity compensation. External equity allows for a broader range of comparison across various organizations, hence helps an individual to keep up with the competition in the market place. Unlike the internal equity where the employees may remain blind to the marketplace remuneration rates, external equity is more informative on the state of the marketplaces, hence giving an employee the comprehensive view of expected remuneration rates (Palomino & Peyrache, 2013). Consequently, this information facilitates not only informed decision-making process, but it also helps an employ make informed negotiations when seeking jobs.
An organization that utilizes the external equity compensation remains competitive when hiring qualified and experienced personnel (Palomino & Peyrache, 2013). This is because employees always compare the compensation offered by other organizations, and if an organization falls below the market rates, it is prone to lose experienced and qualified employees. Gomez-Mejia, Berrone and Franco-Santos (2014) also observed that using this compensation approach facilitates research for the organization. An organization, and employees, stays on top of current news relating to compensation. External equity compensation also assists an organization in the pricing of products because the employers can effectively integrate labor costs into the price of the product.
How each Plan Supports Each Organization’s Total Compensation Objectives; Relationship of the Organizations’ Financial Situation to its Plan
The compensation objective of the organization that employs the internal equity in its total compensation plan is fairness. The organization seeks to ensure that each employee is compensated in accordance to the duties and responsibilities accorded to the staff members. Adopting the internal equity ensures that similar duties are compensated similarly. This arouses a sense of trust among the employees and the employer and/or management. This plan further supports the financial situation of the organization, which is to increase its productivity, and consequently, its revenue.
The compensation objective of the organization that employs the external equity in its total compensation plan is competitiveness. The organization seeks to recruit the best and highly qualified employees, and competitive compensation rate is one approach of attracting such employees. This organization intends to increase its market share, hence increasing its sales. Highly qualified employees can help the organization achieve its financial objectives.
References
Gomez-Mejia, L. R., Berrone, P., & Franco-Santos, M. (2014). Compensation and
organizational performance: Theory, research, and practice. London: Routledge.
O’Connor, M., Rafferty, M., & Sheikh, A. (2013). Equity compensation and the sensitivity of
research and development to financial market frictions. Journal of Banking & Finance,
37(7), 2510-2519.
Palomino, F., & Peyrache, E. (2013). Internal versus external CEO choice and the structure of
compensation contracts. Journal of Financial and Quantitative Analysis, 48(04), 1301
1331.
