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¶ … human resources. One is determining the levels of pay and benefits within the organization. Most companies are smart enough to understand the value of internal equity, since employees talk to each other, and it is difficult to discriminate internally in terms to pay, by law. Internal equity is practiced most strongly at companies that have strict policies with respect to pay scales. These are typically based on a combination of hierarchy, experience and ability. In some circles, the concept of internal pay equity specifically applies to all levels of the organization, from the CEO on down. A good example of a company that practices strong internal pay equity is Costco. Former CEO Jim Sinegal famously only made $200,000 per year and the new CEO makes less than a million, offering what is at least pay equity for a company in the United States.
Internal pay equity is important because it signals that pay is strictly based on merit throughout the organization. People within the organization are more apt to feel that their pay is commensurate with their contribution to the company. If there is no internal pay equity, that indicates that the company may have problems. Workers might see that others who contribute roughly the same to the company are paid much more, and this can negatively affect motivation. So internal pay equity is something that creates positive motivation and facilitates a stronger team...
The competition for workers in such companies is considered perhaps to be across companies, which means that pay must be set in line with other companies in the same industry. This is something you see at high levels -- competition for top executives makes their pay more in line with those of other firms than in line with internal standards (Aggarwal & Samwick, 1999).
External pay equity is also reflected at entry levels, often, because entry level workers tend to move between companies frequently, and have skills sets that are largely interchangeable. This makes them price-takers, and firms in a given industry will leverage that to compete with each other on pay. This is reflected, for example, in the number of low-paying service sector jobs -- all companies in these sectors pay roughly the same wage in order to balance between cost control and competitiveness as an employer. In either case, there is usually a disconnect between these wages at the bottom and wages further up the management ladder, because as managerial skill sets increase, they become more valuable and transferable internally rather than externally. McDonalds is a good example of a company that practices external wage equity both at the executive levels…
References
Aggarwal, R. & Samwick, A. (1999). Executive compensation, strategic competition, and relative performance evaluation: Theory and evidence. The Journal of Finance. Vol. 54 (6) 1999-2043.
Executive Press. (2014). Internal pay equity methodologies. Compensation Standards.com. Retrieved April 13, 2014 from http://www.compensationstandards.com/nonmember/files/IntPay.htm
Martocchio, J.J. (2009). Strategic compensation: A human resource management approach (5th ed.). Upper Saddle River, NJ: Pearson Education.
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