Question

Discuss the equity theory and its implications in managing employee compensation.

Answer 1

The equity theory suggests that people often evaluate the fairness of their position in the organization by comparing their situations with others. An employee, consciously or otherwise, compares her own outcomes (e.g. pay, benefits, working conditions), 'O' and Inputs 'I' (e.g. effort, experience, skill) with those of the peers. If the ratio O/I seems less than the peers, the employee either a) re-adjusts her inputs in order to keep the balance, b) increase outputs by involving in unethical and illegal activities such as misappropriation of company's budget into personal account by various ways, and b) leaving the organization in search of a higher equity environment. The reverse, i.e. increasing input or reducing outcome if the self-equity ratio is found higher than that of the peers, is, however, utopian and hardly happens.

The main implication of the equity theory for managing employee compensation is that to an important extent, employees evaluate their pay by comparing it with what others get paid, and their work attitudes and behaviors are influenced by such comparisons. These behavioral change can sometimes be very damaging for the organization as they include intentional slackness in work, stealth, or high attrition rate. Another implication is that employee perceptions are what decide their evaluation. The fact that management believes its employees are paid well compared with those of other companies does not necessarily translate into employees' beliefs. Employees may have different information or make different comparisons than management.