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Internal and External Equity Compensation

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Compensation packages are one of the most valuable pieces of the puzzle when an organization creates a program designed to attract and retain suitable employees. A well designed compensation package can ensure that employees are not only attracted to beginning work at an organization, but are also willing to stay within a corporation over time. A higher retention rate for employees can increase productivity and reduce costs for an organization over time. Two of the factors that affect a company’s compensation plan are internal and external equity. In this paper, internal and external equity is explored, including the advantages and disadvantages of both, and an explanation of how these types of plans support an organizations total compensation objective and how they relate to the organization’s financial situation. Internal equity refers to the equality that exists between employees who work in similar positions within the organization. It also takes into account that an employee is compensated based on the values of their jobs within the organization. (Lederer & Weinberg, 1995).

In developing a compensation package based on internal equity requires a corporation to develop and evaluate the compensable factors that will go into setting and individual employee’s pay. (Romanoff, et. Al 2012). After determining compensable factors (such as skills required, educational requirements, etc.), companies should look at the external job market to look at how the company’s compensation package relates to similar organizations in the market. (Frye, 2004). Intel and DuPont are two companies that utilize internal equity. At Intel, compensation for the CEO is determined by comparing the top five executive’s cash compensation relative to the 100 highest paid employees at the company, checking for internal consistency. (Vivient, 2005). This lines up well with Intel’s objective of adjusting the relationship between the pay of executive officers and the CEO’s pay. The advantages of internal equity can be seen in Intel. When employees are aware of what their fellow employees are paid at their particular “level” within the company, a check and balance system based on internal equity can help to keep internal dissatisfaction in check, especially between high ranking executives’.

However, this does have some disadvantages, as it can risk losing employees to competition, and may thus be harmful in the future. (Armstrong, 2007). Another disadvantage is that it may discourage employee motivation, who knows that they will be paid according to the internal equity policy, rather than merit or individual performance (Mathis & Jackson, 2008). While here are potential risks, overall the plan has been beneficial to Intel, which remains lucrative in the competitive technology industry. External equity is found in organizations in which an employee in an organization’s pay is equal to prevailing rates in that organizations industry or sector. (Lederer & Weinberg, 1995). Both PepsiCo and Coca Cola utilize external equity compensation analysis. The process of developing a pay scale based on external equity requires a detailed and updated study on market wages and compensation. In addition to wages, other aspects to compensation, such as employee stock options must also be considered. (Singer & Francisco, 2009). This has given both companies the advantage of being able to retain highly qualified employees over time, as a pay structure based on external equity will find employees less attracted to other companies, as compensation packages will be similar across the market. (Heneman, 2002).

Additionally, by creating equity in relation to the market, companies have a higher retention rate, which can lead to employee loyalty (Mathis & Jackson, 2008). The disadvantages to this system is that it can lead to inflated wages that do not take into account the economic environment as a whole, and can also lead to internal dissatisfaction if there are wage discrepancies between individuals working at the same level in the organization. While this may be sustainable short term, should an organization’s performance fall in the market, whether due to internal factors or market condition, the organization still has to abide by its compensation package (Mathis & Jackson, 2008). In conclusion, both types of compensation plans help to support an organization’s objectives, because in analyzing the compensation plans and tailoring them to either the organization and/or market, companies are trying to ensure that they attract and retain good employees. A company will be well served to choose the type of compensation plan best fit to their place in the market.


Armstrong, M. (2007). A handbook of employee reward management and practice. Kogan Page Publishers Heneman, R.L. (2002). Strategic reward management: design, implementation, and evaluation. Lederer, J.L. & Wienberg, C.R. (1995). Equity-based pay: the compensation paradigm for the re-engineered corporation. The Chief Executive. Retrieved February 9, 2013, from http://findarticles.com/p/articles/mi_m4070/is_nl102/ai_17015394/ Mathis, R.L. & Jackson, J.H. (2008). Human resource management (12th ed.). USA: Cengage learning. Romanoff, K. et al (2012). Pay Equity: Internal and external considerations. Retrieved February 9, 2013, from http://theperfectpayplan.typepad.com/Pay_Equity_Article.pdf Vivient Consulting, (2005) What other executives earn affects CEO comp at Pier 1, Rent-A-Center BASE and BONUS newsletter. Retrieved February 9, 2012, from http://www.vivient.com/graphics/Base_and_bonus_June_2005.pdf

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