In setting compensation, companies consider internal equity (where the compensation system is perceived internally to be fair) and external equity (where the compensation for any particular position is competitive with the external market). Most companies focus primarily on external equity when it comes to executive pay. If they find that a competitor is paying its CEO or chief financial officer a certain amount, they think their pay has to be comparable or higher. Few companies are content to be average; many strive to be at the 75th percentile or beyond. This has created a ratchet effect that has led to rapidly rising executive compensation in recent decades. If external equity is not tempered with internal equity, it can lead to a system that is perceived to be unfair internally, which is a huge de-motivator.
Authors: John Mackey, Rajendra Sisodia
Source: strategy+business
Subjects: Compensation, Corporate Governance, Human Resources
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