HOW CONSISTENT INTERNAL

COMPENSATION SYSTEM IS BUILT

MEANING AND OBJECTIVE
The term compensation as a substitute for wages or
salaries is of recent origin. It is strategic management of
wages and salaries. Compensation represents an
exchange between the employee and the organization.
Each gives something in return for something else.
The basic objective of compensation or wages is Equity.
(Forbes research team did a survey where they found
66% of employees cited concerns over salary and 65%
said they don’t feel valued)
INTERNAL EQUITY:
American capitalist J.P. Morgan is reputed to have had a rule that he
would not invest in a company whose:

CEO was paid more than 50% above the executives at the next
level.

Reason- if the CEO was paid more, he wouldn’t have a team but only
courtiers. One corrective approach for addressing excessive
compensation that we like is what we call the “internal pay equity
check”— following the Dupont and Intel models of checking for
“internal Pay” at various levels within a company to ensure that the
CEO’s compensation has not gotten out of line within the company.
Internal equity is the comparison of positions within your business to
ensure fair pay. You must pay employees fairly compared to
coworkers.
Employees must also perceive that they are paid fairly compared to
their coworkers. Otherwise, they might feel unvalued and leave. It is
easy for employees to find out how much other employees earn via
the Internet and word of mouth.
If an employee works hard but is paid less than her coworkers who do
not work as hard, she might become upset about her wages. When
you adopt a straightforward and honest payment system,
WHY IMPLEMENT IT:
Jeff Immelt and other CEOs are now speaking out for more boards to
implement internal pay
equity for two key reasons:
(1) restore fairness internally and to address growing internal
disaffection and disconnect between the CEO and a company’s senior
managers and
(2) as an important benchmark to avoid excesses, which is why ISS
guidelines were recently revised to focus on “pay equity disparity”
HOW TO USE IT:
By conducting an internal pay equity analysis – its CEO’s
compensation has gotten out of line.
At many companies, a quick glance at the cash
component may give the impression that the ratios are not out of line
and that a 1.5 or 2x ratio between the CEO and, say, the CFO exists.
This is why it is so important to check against all pay elements.
WHAT IS THE CORRECT RATIO:
Companies will have different structures and cultures, so one shoe may
not fit all. (J. Pierpont Morgan used a 1.5x ratio as the test for
companies he would invest in.)
A key reason for conducting an historical internal pay equity analysis -
going back several years - is to see what a Company’s ratios were
before they started getting out of line—and to ascertain what events
or elements may have gotten the company off track. For some
companies, this may require going back as long as 20 years. This
historic analysis can help a board determine what the proper ratio
should be for a particular CEO.
WHAT IS THE CORRECT AMOUNT:
Many boards grapple with the question “how much?” Internal pay
equity provides an objective way to address that difficult question.
For example, if a company has determined that the proper ratio
between its CEO’s total compensation and the CFO’s is 2x, but in fact,
when adding in the equity and other components, the CEO’s
compensation is above 2x - the board will now have an objective
“benchmark” to bring the CEO’s compensation back in line.
 HOW TO IMPLEMENT INTERNAL PAY
EQUITY:
It benchmarking tool that analyzes the historical relationship between the CEO’s pay against one or more layers
of the company’s workforce.

Internal Pay Equity Alternatives: There are many possible ways to establish an internal pay equity methodology,
including:

1) A numerical relationship between the CEO pay and that of other executive officers (e.g.

2) DuPont)

3) A numerical relationship between the CEO's pay and that of the company's overall workforce

4) (e.g. Intel)

5) A numerical relationship between the aggregate pay of all senior managers and that of company's

6) overall workforce

7) Organization structure and culture will influence the appropriate internal pay equity ratio. Here

8) are some examples of considerations to take into account:

9) High vs. low number of general managers (high number could lead to lower ratio)

10) Team-oriented vs. hierarchical (team-oriented would have a tighter ratio)

11) Presence of a COO (if COO is absent, ratio of CEO to 2nd highest paid may be higher)
Analyzing the Issues: Fred Cook, Founder of Frederic W. Cook & Co.,
provides these reasons as to why boards should use internal pay
equity:
It is fair
It is economical
It mitigates market biases
It leads to better employee relations and a stronger company
In addition, internal pay equity helps increase transparency and
might uncover unintended
consequences of historical executive compensation decisions.