Building Internally Consistent Compensation System

Equity Theory
Equity is commonly defined as anything of value earned through providing or investing
something of value. Fairness is achieved when the return on equity is equivalent to the
investment made. As it relates to compensation, fairness is achieved when pay equates to the
value of the work performed. Inequity, on the other hand, occurs when the value of the work
performed does not match the value of the compensation received.

Early studies indicate that inequitable treatment directly affects and influences employee
behavior and performance. In Equity Theory Towards a General Theory of Social Interaction
(he Academic !ress, "#$%&, '. (tacy Adams proposed that an employee continuously
monitors his or her inputs and outputs on the )ob, and perceives an equitable situation when
the ratio of his or her inputs and outputs are equal, to those of other employees. If this ratio is
not equal, the employee may feel angry (as a result of not being paid enough& or guilty (as a
result of being paid too much&. Either feeling could result in dissatisfaction or discomfort.
Fig. " is the schematic diagram of Equity heory.
Internal Equity
Internal equity e*ists when an employer pays wages commensurate with the relative internal
value of each )ob. his is established according to the employer+s perception of the
importance of the work performed.
,efore an organi-ation can estimate the importance of each )ob, however, it must first
determine the )ob.related factors that will be used for setting compensation levels . in short,
compensable factors. /ere are some typical compensable factors used for lower.level )obs0
Education required.
E*perience required.
!hysical demands.
1esponsibility for equipment2materials.
1esponsibility for the safety of others.
(upervisory2managerial responsibility.
3orking conditions.
Accident or health ha-ards.
!ublic contact.
4anual de*terity.
5etermining the relative internal value of )obs in a large or comple* organi-ation can be a
difficult process. 'ob.evaluation methods are often used to develop a )ob hierarchy that
reflects the relative value of )obs on the basis of skill, effort, responsibility, and working
conditions. A number of )ob.evaluation approaches have been developed. (uch approaches
include ("& )ob ranking, (6& classification, (7& point factors and (8& factor comparison.
External Equity
E*ternal equity e*ists when an employer pays a wage rate commensurate with the wages
prevailing in e*ternal labor markets. Assessing e*ternal equity requires measuring these labor
markets. here is, however, no single labor market for a particular )ob. (upply and demand
differ substantially among markets, resulting in significant variation in wages across labor
markets.
he following factors contribute to these wage differences among markets0
9eographic location.
Industry sector.
:nion status.
;rgani-ation si-e.
!roduct competition.
<ompany prestige.
Education and e*perience level of available work force.
=icensing or certification requirements called for by the )ob.
Fig.1: Schematic Diagram of Equity Theory
Individual Equity
Individual equity e*ists when an employer compensates individuals who are in similar )obs
on the basis of variations in individual performance, i.e. pay for performance. E*cellent
performers would receive more compensation than average performers.
Personal Equity
!ersonal equity involves no direct comparison of one individual+s compensation with
another+s. !ersonal equity e*ists when an employer pays a wage rate that satisfies an
employee+s own perception of his or her worth. he standards applied by each person relate
to that particular individual+s previous e*periences and his or her knowledge of the market
value of similar )obs.
Creating Internal Equity through o! "nalysis and o! E#aluation
o! E#aluation
'ob evaluation is the process of determining and quantifying the value of )obs. It is the
systematic scoring and comparison of )obs along organi-ationally determined dimensions of
)ob worth, such as, in the effort, responsibility, comple*ity, importance, skills and the
working conditions of a )ob.
'ob evaluation is a tool to compare )obs consistently and classify them into appropriate pay
ranges. he worth of each )ob within the organi-ation is determined through the 'ob
Evaluation process ()ob analysis, )ob descriptions, > )ob evaluations&. his establishes the
relative worth of a )ob in relation to the value of other )obs in the workplace. he process can
ensure that an organi-ation?s pay system is equitable, understandable, legally defensible, and
e*ternally competitive. 'ob evaluations can be used to help to attract desirable )ob candidates
and retain high performance employees due to fair and equitable pay scales.
Fig. $: Schematic Diagram of o! E#aluation %rocedures.
&ethods of o! E#aluation
'ob evaluation requires information to distinguish among )obs, usually on the basis of work
activities and2or )ob required worker characteristics. he most utili-ed evaluation
methodologies are0 1anking, <lassification, Factor <omparison and !oint 4ethod.
". Ranking involves creating a hierarchy of )obs by comparing )obs on global factors that
presumably are common to all the )obs being evaluated.
6. he Classification method defines categories of )obs and slots )obs into these classes.
7. Factor Comparison involves )ob.to )ob comparisons on several specific factors.
8. he Point ethod compares )obs on rating scales which are comprised of specified factors.
Each of these methods is based on one or a combination of two general approaches0
("& an analysis of the )ob as a whole or (6& an analysis of the )ob?s individual components.
Fig. 6 shows the schematic diagram of 'ob Evaluation !rocedures.
Steps in the o! E#aluation %rocess
'ob evaluations typically follow these steps0
". 1eview the choices of )ob evaluation methods such as )ob ranking, classification, factor
comparison and point factor analysis and select the method most appropriate to meet the
organi-ation?s needs.
6. 9ather information on each )ob within the organi-ation, analy-ing )ob content to make sure
it is clear and understandable@ )ob content can be revealed utili-ing )ob questionnaires, )ob
descriptions, interviews and2or work site visits.
7. Ensure that each )ob description lists pertinent accountabilities and responsibilities@ revise
or e*pand )ob descriptions using the information collected.
8. Evaluate each position utili-ing the chosen method and link the ranked )ob to the
organi-ation?s e*isting compensation system or to a newly developed pay structure. he
point system evaluates the skill, effort, responsibility and working conditions involved in the
)ob@ here, each of these factors is subdivided into sub factors to provide standards against
which each )ob is rated to determine its relative worth.
A. <reate the appropriate pay grades and pay ranges in the pay structure and along with
policies and procedures setting out employee progress within the range.
%. !eriodically review the )ob evaluation system itself, developing procedures for evaluating
and modifying the system and the resulting compensation decisions.
o! "nalysis
'ob Analysis is a process to identify and determine in detail the )ob duties and requirements
and the relative importance of these duties for a given )ob. 'ob Analysis is a process where
)udgments are made about data collected on a )ob.
he purpose of )ob analysis is to provide the information necessary for preparing )ob
descriptions and evaluating )obs. his information may be obtained through workplace
observation and2or interviews, questionnaires, and activity logs.
&ethods of o! "nalysis
here are five main methods (employed individually or in combination& that can be used to
obtain )ob information0
". !"ser#ation$ the researcher watches the employee perform the )ob, recording data on a
standardi-ed form. his method is only useful for simple, usually manual tasks for which the
employee can be directly observed.
6. Inter#iews0 a sample of employees carrying out a given )ob and2or their supervisors are
asked a series of questions about the )ob, the essential tasks of the )ob, and the abilities
required to perform it well.
7. %uestionnaires0 a standard questionnaire about the essential tasks of the )ob is
administered to the employee and2or supervisor@ these may vary as to whether they are open
or closed, organi-ation.specific.
8. &cti#ity 'ogs$ employees identify every activity in the course of work and the time spent
on it during a set period.
A. Functional (o" &nalysis$ using the generic descriptions, the analyst can choose and adapt
it to the needs of the organi-ation.
o! Descriptions
4aking use of the information collected in )ob analysis, standardi-ed )ob descriptions outline
. )hat physical, mental, and interactional activities a )ob entails,
. *ow a worker utili-es methods, procedures, tools, and information sources to carry
out a given )ob, and
. )hy the )ob was developed (the necessary role it plays in the organi-ation?s meeting
its ob)ectives&.
he well written, detailed )ob descriptions provide the foundation of any internally consistent
compensation system.
o! E#aluation &ethods
he methods and practices of ordering )obs or positions with respect to their value or worth to
the organi-ation. he four most commonly used methods of )ob evaluation are0 "& 1anking@
6& <lassification@ 7& Factor <omparison@ and 8& !oint 4ethod.
'an(ing
his method is one of the simplest to administer. 'obs are compared to each other based on
the overall worth of the )ob to the organi-ation. he +worth+ of a )ob is usually based on
)udgements of skill, effort (physical and mental&, responsibility (supervisory and fiscal&, and
working conditions.
"d#antages
(imple.
Bery effective when there are relatively
few )obs to be evaluated (less than 7C&.
Disad#antages
5ifficult to administer as the number of
)obs increases.
1ank )udgements are sub)ective.
(ince there is no standard used for
comparison, new )obs would have to be
compared with the e*isting )obs to
determine its appropriate rank. In
essence, the ranking process would
have to be repeated each time a new )ob
is added to the organi-ation.
'an(ing &ethods
". )rdering . (imply place )ob titles on 7*A inch inde* cards then order the titles by
relative importance to the organi-ation.
6. *eighting
7. %aired Comparison
+rouping
After ranking, the )obs should be grouped to determine the appropriate salary levels.
Classification
'obs are classified into an e*isting grade2category structure or hierarchy. Each level in the
grade2category structure has a description and associated )ob titles. Each )ob is assigned to the
grade2category providing the closest match to the )ob. he classification of a position is
decided by comparing the whole )ob with the appropriate )ob grading standard. o ensure
equity in )ob grading and wage rates, a common set of )ob grading standards and instructions
are used.
he standards identify and describe those key characteristics of occupations which are
significant for distinguishing different levels of work. hey define these key characteristics in
such a way as to provide a basis for assigning the appropriate grade level to all positions in
the occupation to which the standards apply.
"d#antages
(imple.
he grade2category structure e*ists
independent of the )obs. herefore, new
)obs can be classified more easily than
the 1anking 4ethod.
Disad#antages
<lassification )udgments are sub)ective.
he standard used for comparison (the
grade2category structure& may have
built in biases that would affect certain
groups of employees (females or
minorities&.
(ome )obs may appear to fit within
more than one grade2category.
Attempt should be made to define the grades2categories so that they do not overlap one
another. ;verlaps in the descriptions and factors used to identify the grade would lead to
problems when assigning )obs to the grades where there is overlap between them. he
9rades2<ategories should be e*amined for inherent biases against females and minorities.
Factor Comparison
A set of compensa"le factors are identified as determining the worth of )obs. ypically the
number of compensable factors is small (8 or A&. E*amples of compensable factors are0
". (kill
6. 1esponsibilities
7. Effort
8. 3orking <onditions
De*t, benchmark )obs are identified. ,enchmark )obs should be selected as having certain
characteristics.
". equitable pay (not overpaid or underpaid&
6. range of the factors (for each factor, some )obs would be at the low end of the factor
while others would be at the high end of the factor&.
he )obs are then priced and the total pay for each )ob is divided into pay for each factor. (ee
e*ample matri* below0
o! E#aluation: Factor Comparison
he hourly rate is divided into pay for each of the following
factors0
'ob
,ourly
'ate
.
!ay for
S(ill
!ay for
Effort
!ay for
'esponsi!ility
!ay for *or(ing
Conditions
(ecretary #C.CC 8A.CC 6C.CC 6C.CC A.CC
Admin
Assistant
""C.CC AA.CC 6A.CC 6A.CC A.CC
(upervisor "AC.CC %C.CC 7A.CC 8C.CC "A.CC
4anager 6"C.CC #C.CC 7A.CC $C.CC "A.CC
his process establishes the rate of pay for each factor for each benchmark )ob. (light
ad)ustments may need to be made to the matri* to ensure equitable weighting of the factors.
he other )obs in the organi-ation are then compared with the benchmark )obs and rates of
pay for each factor are summed to determine the rates of pay for each of the other )obs.
"d#antages
he value of the )ob is e*pressed in
monetary terms.
<an be applied to a wide range of )obs.
<an be applied to newly created )obs.
Disad#antages
he pay for each factor is based on
)udgements that are sub)ective.
he standard used for determining the
pay for each factor may have build in
biases that would affect certain groups
of employees (females or minorities&.
%oint &ethod
A set of compensa"le factors are identified as determining the worth of )obs. ypically the
compensable factors include the ma)or categories of0
". (kill
6. 1esponsibilities
7. Effort
8. 3orking <onditions
hese factors can then be further defined.
". (kill
". E*perience
6. Education
7. Ability
6. 1esponsibilities
". Fiscal
6. (upervisory
7. Effort
". 4ental
6. !hysical
8. 3orking <onditions
". =ocation
6. /a-ards
7. E*tremes in Environment
Each factor is then divided into levels or degrees which are then assigned points. Each )ob is
rated using the )ob evaluation instrument. he points for each factor are summed to form a
total point score for the )ob.
'obs are then grouped by total point score and assigned to wage2salary grades so that
similarly rated )obs would be placed in the same wage2salary grade.
An e*ample is given below, where Skills is the factor, knowledge is the sub.factor. his
sub.factor measures the level of e*perience, formal education and basic skills necessary to
meet the requirements of the )ob. (kills and knowledge may be learned from both on.the.)ob
or off.the.)ob e*periences and2or education.
+ 'e#el ,$ 'ob calls for little or no acquired knowledge. 'ob tasks may require knowledge in
one area E
+ 'e#el -$ 'ob tasks call for some acquired knowledge. :nderstanding of the )ob tasks may be
acquired through some specific courses E
+ 'e#el .$ 'ob tasks call for a higher level of acquired knowledge obtained through higher
levels of required schooling or self.study E
+ 'e#el /$ 'ob tasks call for some speciali-ed acquired knowledge. :nderstanding of the tasks
is acquired progressively through required schooling E
+ 'e#el 0$ 'ob tasks call for speciali-ed acquired knowledge. :nderstanding of the tasks may
be acquired progressively through highest levels of required schooling
" Basic *eighting Formula
he formula is based on a total of "CCF ("CCC points&. he "CCF ("CCC points& are divided
among the four factors.
Factor Formula -1../ di#ided !et0een four factors1
Factors !ercentages !oints
(kill 7AF 7AC
Effort 6CF 6CC
1esponsibility 7AF 7AC
3orking <onditions "CF "CC
otal Balue for the (ystem "CCF "CCC
he basic formula is e*panded by dividing the percentage given to each factor between its
sub.factors. For e*ample0
Su!2Factor Formula -1../ di#ided !et0een ten su!2factors1
Factors %ercentages %oints
(kill 7AF 7AC
Gnowledge "AF "AC
Interpersonal skills2<ontacts "6F "6C
!roblem solving2'udgement HF HC
Effort 6CF 6CC
4ental Effort "6F "6C
!hysical Effort HF HC
1esponsibility 7AF 7AC
!ersonnel, !olicies and !ractices "6F "6C
Information 1esources "CF "CC
Financial 1esources HF HC
4aterial 1esources AF AC
3orking <onditions "CF "CC
Environment "CF "CC
otal Balue for the (ystem "CCF "CCC
3e#els Formula -%ercentages di#ided among four to si4 le#els1
S(ill -56/ di#ided !et0een three su!2factors1
(ub.factors 3eight !oints !oints for =evels
" 6 7 8 A
Gnowledge "AF "AC 7C %C #C "6C "AC
Interpersonal skills2<ontacts "6F "6C 68 8H $6 #% "6C
!roblem solving2'udgement HF HC "% 76 8H %8 HC
"d#antages
he value of the )ob is e*pressed in
monetary terms.
<an be applied to a wide range of )obs.
<an be applied to newly created )obs.
Disad#antages
he pay for each factor is based on
)udgments that are sub)ective.
he standard used for determining the
pay for each factor may have built.in
biases that would affect certain groups
of employees (females or minorities&.