The equity theory of compensation says that wages and salaries directly influence employee behavior and performance. In 1976, John Stacey Adams, an author and behavioral psychologist, expanded this theory by stating that employees decide whether compensation is fair by comparing work efforts and pay against those of fellow employees. The challenge this poses to a small-business owner who must balance budget realities against the need to pay employees fairly makes wage and salary surveys that consider external and internal factors vital to accomplishing both objectives.
Labor Market Differences
External factors are those used to define the labor market. Labor markets differ according to factors such as geographic location, degree of competition, and the education and experience levels of the workforce. This makes using the right labor market just as important as deciding on which factors to include in a wage and salary survey. For example, if your business has locations in both metropolitan and rural areas and you define the labor market using just the rural definition, you will most likely set wages too low to attract and retain employees in the metropolitan location.
Structure, Industry and Size
Organizational structures, the type of business and size are important considerations. To make accurate wage and salary comparisons, each of these factors must relate closely to your business. For example, a sole proprietor, a nonprofit organization and a corporation all use different pay structures. Similarly, a convenience store and a software development company also use different pay structures. If you run a modest-size business and compare your wage and salary ranges to a large corporation in the same industry as your own, you’ll most likely find that you are paying your employees much less than their counterparts.
Internal factors determine the relative worth of different jobs to the company. While a small-business owner with only a few employees might evaluate every job, large businesses most often select representative key jobs. Regardless, internal factors are compensable characteristics of a job for which a business is willing to pay. These most often include the job title, duties and requirements. Each factor receives a monetary scale ranking according to its importance in the job, with total points used to determine the optimal wage or salary.
Putting It All Together
A comprehensive wage and salary survey -- and equitable wage distributions -- must consider both external and internal factors. In an article entitled “Pay Equity: Internal and External Considerations,” the authors suggest that employees start to perceive pay inequities when there's a pay differential -- either external or internal -- approaching 15 percent to 20 percent. This makes it vital to get external data from reputable sources such as the U.S. Department of Labor, trade associations and the local Chamber of Commerce to conduct accurate job evaluations.