compensation research past, present, and future

Human Resource Management Review 17 (2007) 191–207www.elsevier.com/locate/humres

Compensation research past, present, and future

James H. Dulebohn a,⁎, Stephen E. Werling b

a Michigan State University, School of Labor and Industrial Relations, 412 S. Kedzie Hall, East Lansing, MI 48824, USAb University of Texas at San Antonio, Division of Management and Marketing, University of Texas at San Antonio, 6900 North Loop 1604 West,

San Antonio, Texas 78249-0634, USA

Abstract

Past compensation research has largely reflected organizational characteristics and personnel practices that had an internal ratherthan an external focus. Internal labor markets typically characterized organizations followingWWII up until the 1980s. Consequentlycompensation research focused on issues related to managing compensation in this type of structure that emphasized areas such asinternal equity, job evaluation, and individual reactions to pay. Recent changes in the environment have resulted in a greater role ofexternal factors, such as external labor markets, market pricing, and external competitiveness, on compensation practice. Whilepractitioners today have more of an external focus in compensation system design, present compensation research has not keptpace. In the following paper we argue there is a need to redirect future compensation research to include a consideration of externalfactors.© 2007 Elsevier Inc. All rights reserved.

Keywords: Compensation; Labor markets; Market pricing; Pay models

Human resource management is the branch of organizational science that deals with the entire employmentrelationship and all the policies, decisions and practices associated with the relationship. Central to the relationshipbetween employers and employees is the compensation exchange or transaction process. The reason most people workis because they depend on salary or wages to exist. While intrinsic factors play a notable role in why employees seekand remain in employment relationships, compensation plays the central role.

From a general management perspective in addition to the significant cost of doing business associated withcompensating employees, the implications of compensation decisions are among the most important in remainingviable, achieving competitiveness and remaining competitive. From a human resource management perspective, thesuccess of major human resource activities are related to and/or are dependent on compensation policy and practice.The success in attaining goals in human resource planning related to attracting and recruiting human capital is directlylinked to compensation offered. Also, the ability to motivate workers and retain desired employees is largely influencedby compensation offered. As related to the effect on employees, critical employee attitudes, behaviors, continuedorganizational membership, and reciprocity toward the organization are strongly influenced by compensation.

The important role of compensation in managing organizations and controlling employees has been recognizedthroughout history. It was a central principle of modern management theory and practice, first articulated by FrederickTaylor and others in Scientific Management in the early 1900s. Taylor viewed compensation and performance-based

⁎ Corresponding author. Tel.: +1 517 432 3984.E-mail address: [email protected] (J.H. Dulebohn).

1053-4822/$ - see front matter © 2007 Elsevier Inc. All rights reserved.doi:10.1016/j.hrmr.2007.03.002

mailto:[email protected]

http://dx.doi.org/10.1016/j.hrmr.2007.03.002

192 J.H. Dulebohn, S.E. Werling / Human Resource Management Review 17 (2007) 191–207

pay as one of the primary tools management had at its disposal to control and motivate employees and as a means toincrease productivity and reduce turnover (Dulebohn, Ferris, & Stodd, 1995). Similarly, industrial leaders such asHenry Ford recognized the link between compensation, managerial control, retention and worker behavior and viewedpaying above the market, paying a $5.00 per day wage, to his assembly line workers in 1914, as central toorganizational success and profitability (Raff, 1988).

This manuscript examines research that has been conducted in compensation. It will be shown that past com-pensation research reflected organizational characteristics and personnel practices that had an internal rather than anexternal focus. As the environment and organizations have recently changed we argue the need to shift the focus ofcompensation research from one that is primarily focused on internal organizational criteria to include external factorssuch as the role of the external labor market and stakeholder concerns.

1. Background and context of compensation research until 1990's

Industrialization and growth of organizations in the US during the 20th century resulted in the use of organizationalmechanisms to improve and institutionalize managerial control. Within this context, organizations developed andwidely adopted practices to manage the employment relationship. These efforts have been labeled bureaucraticpersonnel practices (Baron, Dobbin, & Jennings, 1986). These practices included personnel departments, centralizedemployment, job analysis, job evaluation, employment testing, promotion systems, performance appraisal, andseniority provisions. According to Baron, Jennings, and Dobbin (1988), the goal of such bureaucratic personnelpractices was to rationalize the employment relationship as scientific management rationalized production procedures.While a number of these practices were concentrated in certain industries prior to WWII, during WWII there waswidespread diffusion of bureaucratic personnel practices. Job evaluation systems, for example, proliferated at a veryrapid rate between 1939 and 1945, even in small companies (Baron et al., 1986).

Along with specific personnel functions and practices, organizations rationalized the employment relationship andpersonnel management through the use of internal labor markets (ILM). Doeringer and Piore defined an ILM as “anadministrative unit, such as a manufacturing plant, within which the price and allocation of labor is governed by a set ofadministrative rules and procedures” (Doeringer & Piore, 1971, pp. 1–2). These rules and procedures differentiatedorganizational members who were a part of the ILM from those outside the organization and provided them withcertain benefits including guarantees of job security, promotion and career mobility opportunities, and due process andequity in treatment in the organization.

Primary characteristics of ILMs include a focus on ports of entry at the bottom of the organization hierarchy in thehiring process, progress along well defined job ladders, wage setting determined by way of a series of bureaucraticprocedures and the assignment of wages to jobs rather than to personal characteristics, rewarding employees forseniority, and promotion from within. The practice of using ILMs in firms resulted from organizational efforts to reduceturnover, standardize wage rates for different jobs, efficiently deploy labor, and these became standard practice duringand after World War II as organizations complied with government mandates for labor allocation and wage paymentpractices (Osterman, 1984).

ILMs and upward mobility are associated with the acquisition of skill or knowledge. Upward mobility is also seen asdriven by seniority. In the case of “firm ILMs” this skill is firm specific and occupation-specific in the case of“occupation ILMs” (Camuffo, 2002). This “skill specific” feature of ILMs assumes that individual firms, to a certaindegree, have unique aspects to their production systems, and management practices; employees' increased knowledgeof these, along with seniority in the company, are rewarded through promotion and periodic salary or wage increases.Those occupying higher levels are viewed as possessing more firm-specific knowledge. Firm-specific skills are alsoviewed as including client relationships, such as in banking and sales, where employees develop relationships withcustomers; employees who have these skills are viewed as essential to retain through job security and othermechanisms.

An objective of ILMs is long-term attachment of employees to a firm. ILMs went hand-in-hand with the pattern ofemployment in the US during much of the post-WWII period where employees typically spent the majority of theirworking years at a single organization. This employer attachment was fostered through firm-specific training, employercommitment to job security, promotion from within, and the use of defined benefit retirement plans that rewarded long-term employment. Once a worker joined a firm and acquired firm-specific skills, his/her value inside the firm washigher than at other firms or the external labor market.

193J.H. Dulebohn, S.E. Werling / Human Resource Management Review 17 (2007) 191–207

Since the way to acquire firm-specific skills was to spend time in a firm, and workers were typically hired at lowlevels and promoted through the organizational hierarchy, limited inter-organization job mobility existed. Employeeswho gained more firm-specific knowledge, through on-the-job training, were often viewed as increasingly valuable tothe firm but also typically became less marketable to other firms that also functioned with their own ILMs.

It was generally more difficult to move from one organization to another than it is today, because of the limited portsof entry used by many companies to bring new employees into their firms; employees who left a particular firm oftenfound themselves at an employment disadvantage. These people would be less marketable only because they woulddemand higher wages and their value to external firms generally did not increase with possession of firm-specific skills.Further, as employees acquired firm-specific skills, outside jobs often become less attractive to them.

US employers generally preferred to hire younger workers at the entry level, train them on the job, and provide themwith job security and structured promotion opportunities. Preference for younger workers gave a firm more years tocapitalize its investment in worker training. This is not necessarily discriminatory. An example of this was IBM's viewthat hiring at managerial and professional levels of the company was inconsistent with IBM's selection practice,culture, and commitment to promotion from within. Selecting Louis V. Gerstner in April 1993 as CEO represented ahuge departure by IBM from its long standing practice, as all previous CEOs following Thomas Watson, Sr., thecompany's founder, had been insiders and long-time employees who had risen up from the bottom to lead the company.

This represented the beginning of the unraveling of IBM's ILMs and practice of life-long employment. FollowingGerstner's arrival IBM implemented a massive downsizing, organizational restructuring, and growth in the use of non-permanent, contingent employment relationship practices. The widespread willingness of companies to look forexecutive talent outside the firm also indicates a shift in focus on general or industry-specific human capital rather thanfirm specific.

1.1. Internal labor market compensation practices

ILMs differ from the external labor market. In the latter, wages, allocation of labor, and training are determined byeconomic variables such as supply and demand. In the ILM there is no market supply and demand curves for particularpositions; an employee's wages are a function of the job she/he occupies (Wang & Holton, 2005). ILMs are inter-connected to the external labor market in that movement between the two types of markets occurs at certain jobclassifications that represent ports of entry into the ILM.

From a compensation perspective, ILMs emphasize the importance of internal equity or consistency in the payamong jobs rather than a concern with external equity or rates of pay for similar jobs in the external market. ILMs areoften shielded from compensation of external labor markets and the main competition is internal in the form of jobpromotions and merit pay (Doeringer & Piore, 1971). Groshen and Levine (1998) argued, “one defining characteristicof an ILM is a company wage policy that diverges from that of the external labor market” (p. 1).

In ILMs, jobs at different levels in the job structure receive differential compensation with higher-level jobsassociated with higher pay. Jobs are clustered based on knowledge, skill, ability and other characteristics required toperform the jobs. Jobs in a particular job cluster are similar in these factors and differ from jobs in other job clusters orwage grades. Individuals move up in the organization through the development of skills, or acquiring seniority, etc.,required for other jobs in higher grades.

ILM's must hire entry-level labor at the market wage but this is not the only point of contact with the external labormarket. For each employee in an ILM, the following must hold. The wage here, in the firm, must be greater than orequal to the wage there, outside the firm, minus all switching costs such as relocation, pension loss, etc. Simply put, thewage in the firm has to be at least as good as the net value in the external labor market. Firms create ILM's to put awedge between the wage here and the wage there thus allowing the firm to extract economic values (rents) fromworkers inside. In a perfectly competitive labor market with no ILM's, workers would earn a wage equal to theirmarginal product. Workers seeking the highest wage are implicitly seeking their highest job match. ILM's drive up thevalue of workers' marginal product within the firm by providing firm-specific training. This training generally adds novalue in the eyes of external labor market competitors.

1.1.1. Focus of compensation system designWithin this context, the primary focus of compensation system design is on job evaluation that, as will be discussed

below, assigns internal worth to jobs based on the level of skill and other compensable factors. A characteristic of ILMs


is that “wages are determined internally and may be quite free of market pressure;” only to the extent that the wedgebetween WAGE here and WAGE there is large and switching costs are high; in contrast, external labor markets meanthat wages are determined by market forces that organizations have limited influence over (Lazear & Oyer, 2004).

Because of the limited ports of entry into firms using ILMs, that are typically entry level, workers generally haddecreasing marketability after joining and gaining tenure in a firm, because of investment in firm-specific capital overtime. In contrast, prior to joining a firm and gaining firm-specific skills, a worker has greater mobility and may have thechoice to join a number of different firms. Consequently, after joining a firm the focus of workers and the primaryconcern of organizations is to ensure internal equity and internal consistency among the wages assigned to jobs, since thefocal point of workers and compensation administration is inside the organization rather than on opportunities andwagesin the external market. Economists have also posited that workers taking an entry-level position actually consider thepresent value of the total salary stream they will receive over their working lifetime, not just their immediate pay for thenext few months.

Most economists see ILMs as enabling firms to extract value by underpaying workers in their early career years.They acknowledge that, at some point, long-service employees may be overpaid relative to their marginal revenueproduct. Once workers join the firm they focus on wages but also track promotions, raises, and other dimensions of thepay stream. Further, ILM's often used deferred compensation, such as defined benefit plans, which served as amechanism to retain employees.

1.1.2. Role of external labor marketThe focus on internal equity and the ILMs did not imply that external markets were irrelevant in influencing or

setting internal wage rates. The primary exception to de-emphasizing the external labor market and focusing on theILM was entry-level jobs for which companies competed for workers entering their firms from the labor market. Inaddition, concerns such as competitiveness, turnover, and compliance to government regulation mandating equal payfor equal work were met with organizations comparing their wage rates for key or benchmark jobs with theircompetitors and the external market. Further, companies often used market data to determine whether their wages werehigh enough, relative to the market, to fend-off unionization efforts (Groshen & Levine, 1998).

1.1.3. ILM effect on wagesLazear (1979) stated that through ILMs organizations were able to payworkers less than they are worth earlier in their

career by using deferred earnings, that involve paying workers more than they are worth later in their careers, andproviding retirement income security through defined benefit plans. Defined benefit plans are formula-based and end-loaded in that they provide employees with a retirement benefit that is based on years of employment and final salary andbenefit those with long-term employment at a single firm. The defined benefit pension plan that rewarded longevity,along with the other characteristics of ILMs, made inter-firmmobility difficult and less desirable than remainingwith thesingle employer (Osterman, 1984).

An effect of ILMs on compensation was that often organizations paid significantly different wages for similar jobs.For example, Gerhart and Rynes (2003) stated that, “investigations of actual labor markets by applied economists afterWorld War II showed that pay varied widely for the same type of work across employers, even in the same geographicalareas (p. 6). These authors cite an example of Boston truck drivers where there was a wage differential of nearly 100%for those working in two separate industries. As will be discussed later, changes in organizational structure, changingemployment relationships, and the dismantling of ILMs has resulted in an increase focus and role of the external labormarkets on organizational compensation systems and pay.

1.2. Compensation research

Compensation research from WWII until the 1990s was consistent with the practice of ILMs in its primary focus onaspects of pay, compensation practice, and reactions of employees to pay that represented internal organizationalconcerns. As an interdisciplinary field, HRM has historically drawn research contributions from different disciplines(Ferris, Barnum, Rosen, Holleran, & Dulebohn, 1995). Along these lines, compensation research has been conductedby a variety of disciplines including economics, psychology, sociology, and finance. The resulting research and theoryby different disciplines to compensation often was descriptive and purposed to answer questions organizations had,often in the context of administering organizational pay. While human resource management has benefited from


disparate streams of compensation research, compensation appears to have been a less researched area than otheremployment related issues such as turnover and manpower (i.e., HR) planning (Opshal & Dunnette, 1966). Further,research has often viewed compensation as an outcome or dependent variable, rather than the primary object of interest(Gerhart & Milkovich, 1992).

A number of scholars have provided comprehensive reviews of compensation research (Gerhart &Milkovich, 1992;Gerhart & Rynes, 2003; Rynes & Gerhart, 2000) and this is not the objective of the following discussion. The purposeof the review below is to provide some examples of the internal focus that has largely characterized prior compensationresearch in human resource management. We present some research on pay structure, job evaluation and internal equityas well as individual reactions to pay. This sampling of research will be followed by a discussion of changes in theenvironment and organizations that highlight the need to shift compensation research to include a focus on externalfactors.

1.3. Pay structure, job evaluation and internal equity

Pay structure refers to an ordering of pay rates for jobs or groups of jobs within an organization and are characterizedby hierarchies (Henderson, 2005). Organizational pay structures can be classified on a continuum as hierarchical toegalitarian; generally US organizations have tended towards hierarchical which fits with ILMs. Typically hierarchicalpay structures have been defined in terms of pay grades, job evaluation points or pay policy lines. The customaryapproach for determining pay structures, in compensation system design has been through job evaluation. There areother approaches such as market-based or skill-based approaches, but up until recently job evaluation has beendominant and has been a characteristic practice of ILMs.

Job evaluation is the process of establishing the relative worth of jobs within a single organization based on jobcontent and value. Job evaluation is the foundation of internal equity or internal consistency because the process resultsin establishing organizational pay differentials and a job structure where jobs are ranked according to their worth.Worth is based on job content. Job evaluation differs from job analysis, which needs to precede job evaluation. Jobevaluation evaluates and rates the job, not the worker. The practice of job evaluation began in the early 20th century andwas widely adopted in the private sector during WWII in response to the National War Labor Board permitting wageincreases only for the purpose of correcting demonstrated inequities in wage structures (Treiman, 1979) and by midcentury was used by most US organizations.

As part of the practice of ILMs, the cornerstone of designing compensation systems was establishing internal equity.Although used as a major component of ILMs, job evaluation is more than an exercise in designing compensationsystems. According to Lawler (1987), job evaluation is “an approach to thinking about work and people's relationshipsto their organizations. Indeed, it was originally developed to be supportive of traditional bureaucratic management”(p. 21). Part of this process involved paying the job (i.e., for job content), not the person, (i.e., for personal attributes).The widespread adoption of job evaluation was viewed as the best approach to align rates of pay in industrial jobs in themass production economy that existed during the 20th century (Figart, 2000).

Job evaluation represents an internal versus external market orientation and was promoted as such. For example,Dunn and Rachel (1971) asserted that when doing job evaluation, organizations should only consider “the inherentcharacteristics and duties of the job and should exclude extraneous factors such as supply and demand of labor, localwage rates, and geographic location” (168). In spite of this primarily internal focus, the reality is that job evaluationdepends to a certain degree on market wage rates; an assumption existed that there was an appropriate market rate forsome jobs within the organization (i.e., key jobs) such as port-of-entry jobs and jobs with content common acrosscompetitor organizations.

While the process of establishing pay structures was job evaluation, the compensation development and adjustmentprocess also depended to some degree on obtaining market rates for those key jobs and using those wage rates toevaluate the validity of the job evaluation system and the wages paid to non-key jobs throughout the job structure.According to Fox (1962), “The primary purpose, then, of a program of job evaluation is to provide “synthetic goingrates” for unique jobs; to soundly evaluate unique jobs through accurate interpolation and extrapolation relative tostable key job values” (p. 333).

The literature on job evaluation commonly lists four types of job evaluation methods (Treiman, 1979). Rankinginvolves ranking jobs from top to bottom with respect to their worth or value to the firm. Classification involves anidealized hierarchical structure that is predetermined, with categories delineated on the basis of compensable factors


such as skill and responsibility. Factor comparison involves selecting a set of compensable factors, choosingbenchmark jobs, ranking benchmark jobs with respect to their total worth, and applying the compensable factors toevaluate all jobs based on the contribution of the factors to the total worth of the job.

1.3.1. Point-factor approachThe fourth method, the point-factor approach, was by far the most widely used approach in companies with,

according to Lawler (1987), over 95% of the major U.S. corporations in the mid-1980s using the point method toevaluate their jobs. The point-factor approach involves selecting compensable factors to represent what theorganization wishes to reward. For each factor, a scale is devised representing increasing levels of worth and each levelis assigned a given number of points. Each job is rated on each factor separately and is assigned a point value based onthe total amount of points. A hierarchical ordering of jobs is determined based on the summed values of thecompensable factors observed in each job.

1.3.2. Job evaluation researchBecause of the centrality of job evaluation to pay structure and compensation system development, much

compensation research up until the 1990s was on job evaluation, particularly the point method. Initial research wasprimarily descriptive, providing information on effective use of job evaluation (c.f., Treiman, 1979). Empirical researchaccelerated in the 1970s and 1980s to investigate issues such as the reliability and validity of job evaluation and theappropriateness of job evaluation in determining comparable worth. Other research was conducted that compared theappropriateness of different approaches to job evaluation to establish job worth (cf., Gomez‐Mejia, Page, Tornow,1982). Researchers in general concluded that job evaluation, as a judgmental process, is often unreliable and not validin determining the actual worth of a job (Arvey, Assino, & Loundsbury, 1977; Rynes, Weber, & Milkovich, 1989). Forexample, Chen, Orazem, Mattila, and Greig (1999), argued that job evaluation often failed to accurately measure theactual worth of the job due to factors such as unreliability in job analysis, job descriptions used as the basis forevaluating jobs, as well as using compensable factors to extrapolate market value to non‐key jobs.

1.3.3. Pay level researchSimilar to job evaluation research, prior compensation research on pay level also was representative of an internal

rather than external focus. Gerhart and Milkovich (1992), describe pay level in terms of the average compensation paidby a particular firm relative to that paid by its competitors. In spite of this, limited HR research has focused on examiningfactors organizations use that potentially affect their pay level determination such as the reliability of approaches used byfirms to ascertain market rates of pay, how organizations decide which employers to survey and how they selectbenchmark jobs, as well as the effects of different approaches to weighting and combining wage survey data (Gerhart &Milkovich, 1992). Instead, most HR pay level theory and research, up through the 1990s focused on the variants of thepay of jobs within the organization and psychological determinants of supervisor pay decisions (Rynes & Gerhart,2000). Rynes &Gerhart’s (2000) review of pay level research found that factors such as individual productivity, gender,race, group performance, likelihood of leaving, decision‐maker idiosyncrasies, and supervisor dependency onsubordinates played a role. This research, while important, fails to address the external comparative aspect of pay levelthat is particularly important in light of the growing influence of external labor markets and external competitiveness.

1.4. Individual reactions to pay

A third focus of compensation research, highlighting the internal orientation, has been on individual reactions topay. Research on employee reactions and attitudes to pay has been a primary focus of industrial organizationalpsychologists and has contributed to human resource management practice. The primary motivation for this researchhas been the assumption that pay affects employees’ overall level of job satisfaction and primary work behaviors(Oshagbemi, 2000). The following discussion briefly examines some of the theory and research on pay satisfaction.

1.5. Pay satisfaction

While pay has been consistently viewed as a primary motivator in modern approaches to management, it was notuntil the 1960s that systematic pay satisfaction research began. The premise for this research was the expectation that


compensation and work-related outcomes were mediated by attitudes toward pay (Williams, McDaniel, & Nguyen2006). Pay satisfaction represents an attitude and has been defined by Miceli and Lane (1991) as the “amount of overallpositive or negative affect (or feelings) that individuals have toward their pay” (p. 246). Pay satisfaction has beenhypothesized to be related to work-related outcomes such as absenteeism and turnover (Heneman & Schwab, 1985;Williams et al., 2006).

Pay satisfaction research has its roots in research on cognitive dissonance theory and theoretical work in socialexchange and equity (cf., Homans, 1961). Homans (1961) defined equity in the context of an exchange relationship. Heconceptualized individual evaluations of equity employing “quasi-economic terms” (Adams, 1965, p. 272). Homans(1961) asserted that equity results when an individual obtains rewards that are proportional to his or her investments, lesscosts, when compared to the other party in the exchange relationship. Investments represent the relevant attributes broughtby the individual to the exchange relationship. The two primary theories underlying pay satisfaction research have beenequity theory and discrepancy theory (Lawler, 1971) that represent an extension of equity theory.

1.5.1. Equity theoryBuilding on Homans, Adams (1963, 1965) developed a general theory of social inequity to explain causes and

consequences of the absence of equity in human exchange relationships. Adams' (1963, 1965) theory of inequityfocused on the wage exchange relationship, more specifically the causes and effects of wage inequity. Adams (1963)posited that individuals evaluate the fairness of their outcomes using an equity rule whereby they compare their owninput–outcome ratios to a referent or comparison other. Individuals perceive equity or fairness when the ratio orbalance of their outcomes to their inputs is equal (Adams, 1963, 1965; Walster, Walster, & Berscheid, 1978). Incontrast, inequity exists when the ratios are perceived as unequal. The importance of equity theory is that it representedinitial conceptualization and informed subsequent research on how individuals form attitudes toward pay.

Adams asserted that perceptions of unequal ratios (resulting from either under or over payment) result in a state ofinequity distress or psychological uneasiness that motivates individuals to engage in actions that will remove thedissonance and restore perceptions of equity. According to Adams (1965), “the presence of inequity will motivate [the]Person to achieve equity or to reduce inequity, and the strength of motivation to do so will vary directly with themagnitude of inequity experienced” (p. 283). Workers will attempt to achieve equity through actions such as alteringinputs, altering outcomes, adjusting their evaluations of their inputs and outputs, using a different comparison other, byusing psychological justifications, or by withdrawing from the organization (e.g., engaging in negative behavior)(Adams, 1965). In contrast, perceptions of a balance between input and output ratios result in evaluations that anoutcome distribution is equitable and this evaluation contributes to satisfaction. Adam's theory focused less on the“reality" of the compensation than on the perception of the compensation.

Adams (1963, 1965) placed the referent as a primary factor in the evaluation of equity. Adams described the“referent other” as any other or group with whom the individual compares his/herself when the individual and the otherare both in an exchange relationship with a third party such as an employer. Thus, within an employment context, thefocus of equity is generally on internal comparisons with other(s) inside the organization.

An abundance of research has been conducted on equity theory (e.g., Deutsch, 1985; Goodman & Friedman, 1971;Lawler, 1968; Prichard, 1969; Weick, 1966). The research has generally supported the theory's predictions ofemployees taking action to restore equity (Gerhart, Minkoff, & Olsen, 1995). Research has found that when subjectsperceived that they have been overpaid they have tried to improve their work and when they have been underpaid theyhave decreased their inputs or engaged in negative behavior (Cowherd & Levine, 1992; Pfeffer & Langton, 1993;Pfeffer & Davis-Blake, 1992). Research support for reactions to underpayment inequity has been more consistent thanfor reactions to overpayment inequity (Adams & Freeman, 1976; Mowday, 1991; Sweeney, 1990).

1.5.2. Discrepancy theoryDiscrepancy theory represents an extension of equity theory. The theory hypothesizes that pay satisfaction is a

function of the discrepancy between perceived pay level and the amount the employee believes he/she should receive(Gerhart & Milkovich, 1992; Lawler, 1971). Specifically, employees' pay satisfaction is evaluated by their subtractingthe amount they perceived they are paid from the amount they believe they should be paid.

While similarities exist such as the ratio comparison with a referent other and the applicability of a focus inside theorganization, discrepancy theory differs from equity theory in its inclusion of additional variables an individualconsiders in evaluating pay outcomes including job characteristics such as job level, level of responsibility, and job


difficulty and the factor “valence" found in expectancy theory (Lawler, 1971). These are considered job inputs thatcontribute to an employee's perception of what he/she should be paid (Wahba & Shapiro, 1978).

When comparing outcomes with a referent other, the individual takes into account these input characteristics. Inaddition, discrepancy theory includes valence and posits if the valence of the outcome is low then the individual willnot react as strongly as if the valence is high. A strong reaction to discrepancy resulting from high valence is expectedto have an effect on the individuals' behavior resulting in actions to alleviate the discrepancy. The discrepancy modelhas received support from empirical research (Dyer & Theriault, 1976; Gerhart & Milkovich, 1992; Rice, Phillips, &McFarlin, 1990).

1.5.3. Multidimensionality of pay satisfactionWhile initial pay satisfaction research viewed pay satisfaction as the unidimensional construct of satisfaction with

pay level, Locke (1976) proposed that pay satisfaction might be a multidimensional construct. Heneman and Schwab(1979) posited that pay satisfaction consisted of the four separate dimensions of pay level, raise, structure andadministration, and benefit satisfaction. While other researchers have proposed other models than Heneman andScwab's four factor approach, the multidimensionality nature of pay satisfaction has been well supported (e.g., Judge,1993; Miceli & Lane, 1991; Scarpello, Huber, & Vandenberg, 1988). Further, the applicability of pay satisfactiontheory and the focus of research has been on organizational members' satisfaction with their pay, pay satisfaction'santecedents and outcomes, and has informed compensation practice with respect to the importance of adjustingindividuals' pay level as a primary intervention to pay dissatisfaction.

1.6. Summary of compensation research

The prior presentation of a sample of compensation research, highlights the “within organizational” focus that hascharacterized much of the research in compensation. It is our opinion that this approach has been totally appropriate andit, along with other areas of compensation research, has been consistent with the need to inform compensation practice.Specifically, the attention given to job evaluation and internal equity issues was supportive of compensation practicewithin ILMs and the foundational nature of establishing internal worth of jobs in designing pay structures andcompensation systems. Research on individual reactions to pay, as illustrated by equity, discrepancy, and paysatisfaction research has contributed to compensation practice in identifying how employee attitudes toward pay areformed.

2. Economic changes and the dismantling of internal labor markets 1980 to the present

Scholars have argued that beginning in the 1980s, internal labor markets began to unravel. Throughout the U.S.economy, employers abandoned their practice of employment security, began the practice of laying off employees at alllevels through downsizing, and increasingly employed different forms of short-term employment including temporary,contingent, outsourced, and contractual employment. As commented in The Economist (2000), “The old socialcontract between employers and workers is being shredded. It is still unclear what will replace it.… This means that theold model of a career, in which an employee worked his way up the ladder in a single company, is becoming rarer”(Career Evolution, p. 89). As noted by Capelli (1999), the ILM that Whyte's 1950 “organization man” enjoyed (withlife-long employment, predictable advancement, pay tied to promotions and jobs, and organizational membership) isbeing replaced by a much less stable employment relationship where workers are more exposed to external labormarket forces.

The question arises, what has caused these changes? There have been macro changes such as globalization, themovement from a manufacturing to a knowledge and service-based economy, trade liberalization, deindustrialization,decrease in unionization, the movement of production overseas, changes in technology, and changes in organizationalstructures and reductions in organization size, and changes in approaches to production. Finally, according to Beneria(2001), there has been a market penetration into the internal labor markets of organizations with a growing influence ofthe market on ways business is conducted.

Organizations have responded to these changes in a number of ways. First, they have reduced hierarchical levels, achange that has also been associated with the increased use of peripheral or contingent employment rather than core orpermanent employment. Organizations have also dismantled wage structures that were associated with ILMs and


replaced these with pay structures that are more closely linked to the changing external labor market. Lawler (1994)observed the trend of organizations moving from being job-based to being competency-based where pay is moreindividual and organizations pay the person rather than the job; such an approach requires a closer tie to external labormarkets when determining compensation than was the case in ILMs. While limited research has been conducted on themovement from job-based to person-based forms of compensation, Lawler's article underscores a growing importanceof the external market forces on compensation practice. Also, with respect to compensation, in reducing their long-termobligation to employees, organizations in the US have adopted defined contribution pensions in place of defined benefitplans as well as reduced or eliminated their provision of retiree health care to former employees (Dulebohn, 2002).

The movement to a knowledge-based and service economy has produced winners and losers among workers, thewinners being those who are highly skilled and possess knowledge that employers want. The changes listed above haveredefined the type of knowledge that organizations view as valuable and need to be competitive. Firm-specificknowledge has diminished in relation to general knowledge that is possessed by “knowledge workers.” Camuffo(2002) described this change as follows:

Tacit knowledge transferred by means of traditional on-the-job training and learning-by-doing becomes lessimportant. Information technology allows knowledge codification…and favors reductions of information costs.This lowers the transaction-specific nature of information, knowledge and capabilities, and reduces coordinationcosts for market-type relationships, leading on the one hand to more open and less sticky employment relations,and on the other hand, to process of labor evaluation more closely tied to competitive rules. (286)

This change has contributed to a greater focus on the external labor market by both organizations and workers.

Organizations now hire at all levels of the organization those workers that have the skills and knowledge they need tomaximize their competitiveness rather than limiting hiring to entry level and training those workers and promoting fromwithin. Workers with the right skills are able to move from organization to organization and not be affected through nothaving particular firm-specific skills. Attendant pay practices by organizations now include paying workers for theirskills and productivity rather than paying for jobs that was the central focus of job evaluation and ILMs. According toCamuffo (2002), “talentedworkers can jump from firm to firm to take advantage of a better “match” in the ever-changingmarket without paying a heavy price through the loss of valuable firm-specific experience (286).

In highlighting the growing importance of external labor markets on compensation practice, we are not arguing thatILMs or the characteristics have completely disappeared from US organizations. Some organizations continue toprovide characteristics of ILMs, described above, to some of their workers including promotion and career mobilityopportunities along well defined job ladders, promotion from within, and rewards for seniority. These practices may beapplied to certain occupations and individuals that are viewed as essential to the organization. Along these lines,organizations currently place importance on succession planning, leadership development, talent acquisition andretention and to achieve these objectives continue practices traditionally associated with ILMs.

2.1. General failure of compensation research to include an external focus

While the changes in the economy and marketplace have long been recognized, compensation research has not keptpace or shifted to address these changes. An examination of most compensation and human resource managementtextbooks as well as human resource andmanagement journals demonstrates a continued internal focus on pay practices,individual reactions to pay, and even job evaluation. A disconnect exists between the science of human resourcemanagement and the actual practice of compensation in the real world. For example, compensation consultants rarelyuse the traditional point method job evaluation when they design compensation systems; instead their focus is on theexternal labor market, salary surveys, and issues of external competitiveness. Yet job evaluation research continues to beconducted (e.g., Morgeson, Campion, &Maertz, 2001) and continues to be presented as the foundation of compensationsystem development in most teaching material (e.g., Henderson, 2005; Milkovich & Newman, 2005).

3. General recommendations for future compensation research

The dramatic and rapidly changing marketplace, the movement away from ILMs, and the increased importance ofthe external environment on businesses highlight the need for the academic community to increase and redirect


compensation research. The changes in the external marketplace and within organizations suggest the need for a re-evaluation of the past assumptions concerning compensation to determine if they accurately apply to the moredynamic marketplace. The changes also suggest the need to conduct studies to determine if past research findingsapply to the current business environment. Most importantly, future research must evaluate the utility of currentdecision-making models and techniques in light of the changing marketplace and the importance of accuratecompensation decisions to organizations. It is expected that this research will identify the need to develop and testnew, substantially different prescriptive and predictive decision-making models to meet the demands of a dynamicmarketplace.

Without theoretically and empirically grounded decision-making models to address the competitive changes,organizations are sometimes left with untested models and practices designed by potentially self interested consultantsor mandated by government agencies. The recommendations, therefore, for future research focus on those areas ofresearch related to improving the applied decision-making process. There are several general recommendations toimprove future research based on the past and current research, coupled with the changes in the competitive marketplaceand the expectation of various stakeholders. The partial list of recommendations provides general guidelines foraddressing the needs of organizations, employees, and other interested stakeholders.

3.1. Testing of proposed models

Gerhart and Milkovich (1992), in their model of compensation decisions and consequences, provide a theoreticalcontrast to the internal focus of compensation that has characterized much of the compensation research in HRM. Thismodel represents a more macro level approach and describes how employers make decisions about compensation andon “compensation itself rather than on compensation as a means of testing particular theories of motivation” (p. 483).Because of the growth in importance of external factors and external labor markets, there is a need to test the relevanceof factors they have identified.

The Gerhart and Milkovich (1992) model of compensation decisions and consequences provides a framework thataccounts for external factors that are now central to compensation system design and decision-making. The modelhighlights that organizations no longer operate within the confines of ILMs that afforded the luxury of simplyconsidering compensation from an internal perspective. A review of the literature suggests an absence of research thataccounts for factors they have identified, that are consistent with the movement away from ILMs, and the growingimportance of external factors on compensation decision-making and practice.

The model includes a number of external and organizational factors that represent determinants of compensationdecision-making. Contingency factors included in the model include organization factors such as business strategy,human resource strategy, product market, technology, and size as well as external factors such as competition, economicconditions, regulation, and globalization. Factors such as these are posited to influence pay decisions and practices andrepresent the inclusion of important external factors, which during the past 20 years have played a more significant rolein organizational decision-making, function and action. An inclusion in compensation research of these and other factorsin their model can help explain why organizations make different compensation decisions and the impact of thesedecisions on individuals, groups, organizational units, and organizational outcomes.

3.2. Balanced perspective

The compensation literature identifies four factors that organizations should consider when determining wages:internal, external, individual and organizational/environmental factors (Milkovich & Newman, 2005; Wallace & Fay,1983). These and other authors indicate that the importance of each of the factors may vary depending on the specificcircumstances and that organizations should take a balanced perspective on the factors.

In spite of this general call for a balanced perspective, as noted above, the primary emphasis in the literature has beenon the internal factors, or ILMs, and more recently and less so on organizational factors such as performance andstrategy. As noted, this emphasis on internal factors is especially evident in the volume of research on job evaluationtechniques and the presentation of job evaluation as the cornerstone of compensation system design presented in themainstream textbooks. Conversely there is a general lack of research on external labor market factors and techniquesfor balancing relevant internal and external labor factors. This is especially troublesome given the dynamic nature ofthe labor markets and current trends in business.


The general lack of balance in the research especially applies to the individual component of wage models. Whilethere is a substantial amount of research on pay satisfaction and descriptive research on determinates of pay differencesbetween men and women, there are very few articles that address the pay determination process at the individual level.This is in spite of the fact that, ultimately, based on current organizational practice and the role of external labormarkets, the final pay decision is primarily an individual decision rather than a job or market level decision. Thereforewe strongly argue that future research develop and test a combined model of wage determination that matches thetheoretical foundations discussed in the literature, such as presented in the Gerhart and Milkovich (1992) model, whichspecifically places emphasis on the external labor market, as well as an inclusion of individual wage determination.

3.3. Level of analysis

Based on the previous research, it is clear that the compensation research suffers from two methodological barriers,identified by Heneman (1969), that restrict advancement of the research in the field. Heneman (1969) defined the firstproblem as a level of analysis problem due to the lack of vertical synthesis across levels of analysis. Vertical synthesisrefers to the linkage between variables at different levels within a system and the expectation that variables maybehave differently at different levels, requiring models that show how behaviors at one level impacts other levels. Thesecond barrier is a narrow definition of a broad operational problem. The narrow definition barrier occurs whenresearchers define a problem based on individual interests or a particular perspective, rather than on a broaderperspective.

Wallace (1983) specifically discussed the level of analysis barriers as they relate to the research on comparableworth and pay equity, suggesting that the lack of agreement over the level of analysis severely hinders resolution of theproblem. Wallace noted that various authors use the narrow, equal job content, as defined by the Equal Pay Act of 1963,to evaluate equity; the comparable worth proponents focus on dissimilar jobs with comparable value as the unit ofanalysis; while others use occupations and occupational attainment as the appropriate level of analysis. Beyond theWallace review, Title VII of the Civil Rights Act of 1964 and the related court cases emphasize the individual as theappropriate unit of analysis when evaluating pay discrimination. In addition, research on the pay differential betweenmen and women includes a broad range of individual, organizational, market and industry level factors that assist inexplaining at least some of the pay differential across groups.

The impact of the second barrier, the narrow definition of a problem, is especially evident in the compensationliterature that focuses on-the-job unit of analysis, which was appropriate in ILM oriented organizations and the oldeconomy, but may not be appropriate in a dynamic marketplace. As noted earlier, the primary unit of analysis in theprevious compensation literature is the job and the appropriate pay grade assignment. Yet, the ultimate pay decision,either in ILMmodel or in a more dynamic external labor market model, is not the pay grade assignment, but the pay foran individual employee.

This lack of agreement on the appropriate unit of analysis, the lack of a vertical synthesis across levels of analysis,and the narrow definition of pay determination as a predominately job level issue, severely limit the ability to resolveproblems such as pay inequities, or develop a comprehensive wage determination model to improve the overall qualityof organizational decision-making. Future research must first recognize that the ultimate compensation decision is thepay of an individual employee, and then provide a fully vertically integrated model of pay determination that considersthe impact of the various levels of analysis on the individual decision.

3.4. Evaluation criteria

A primary emphasis in the compensation literature over the past several decades has been on pay satisfaction.More recently however organizations have received more pressure from external stakeholders to justify thewages for employees, especially for executives. In some instances, the requirements of external stakeholdersmay clearly outweigh the interest or satisfaction of the employee. The new OFCCP guidelines (InterpretativeStandards for Systemic Compensation Discrimination) on pay discrimination, the reporting requirements of theSarbanes-Oxley Act, the IRS requirements for executive compensation in not-for-profit organizations, andstockholder challenges of executive pay levels provide examples of the need to consider external stakeholdersatisfaction with wages, independent of employee satisfaction or attitudes toward pay. Future research mustexpand the evaluation criteria to consider the views of other stakeholders and other organizational objectives


beyond employee satisfaction. The research must also analyze the impact of competing stakeholders' views onthe pay determination process.

3.5. Market-based versus job evaluation-based approaches to compensation system design

Since the 1990s, job evaluation has fallen into general disfavor among consultants and HR practitioners who docompensation system design and has been replaced by market-based approaches (Heneman & LeBlanc, 2002).Increasingly organizations are basing the valuation of jobs on external market considerations and data. Thisapproach to valuing of jobs is referred to as market pricing, which is the evaluation of jobs based on the valueassigned to jobs by the external labor market as determined by supply and demand, product market, geographiclocation, and industry. Placing primary emphasis on the external market rather than internal job evaluation is acorollary to the dismantling of ILMs, organizational change, new approaches to the employment relationship byemployers and responses to a more competitive environment.

An example of the shift to market pricing was highlighted in a broad 2003 survey, sponsored by the Hay Group,of HR professionals in large organizations. The results indicated that 59% of companies reported they relied onmarket pricing exclusively to establish salaries for all their jobs, while giving minor consideration to internal equity(Barcellos, 2005). In contrast, only 2% reported that they used internal job evaluation exclusively and 17% said theirapproach involved leading with internal job evaluation and following this with some market pricing (Barcellos,2005).

Those survey results suggest at least three possible approaches: market pricing only, internal job (or job-basedapproach) evaluation only, and a hybrid approach combining market pricing and job evaluation. Consequently,research questions that exist regarding what approach is most appropriate and in what situations and for what jobs? Ageneral consensus exists today among consultants that a primary market pricing approach is most appropriate. This isbased on factors such as market rates for jobs often change more rapidly than the rates paid inside organizations and toremain competitive and obtain talent acquisition and retention goals, organizations need to anchor rates for jobs to themarket. An examination of the prevalence and utility of job evaluation approaches, hybrid, and market-based onlyapproaches is needed.

3.6. Comparative approaches to compensation system design

Criticisms exist for both job evaluation as well as market pricing approaches with respect to issues such as reliabilityand validity. Considerable research attention has been given to job evaluation methods, some on market pricing, but ourreview found no research directly comparing job evaluation, market pricing and hybrid approaches; and no researchinvestigating the long-term impact of the approaches. With the expressed criticisms and the trend toward marketpricing, research is sorely needed that compares the two primary approaches. For example, examination needs to beconducted that compares the effect, over time, of using a job evaluation only approach (focusing on internal equity withannual adjustments to the overall pay structure) versus a market pricing approach. Longitudinal research in this areawould answer questions such as: What if any discrepancies exist over time between pay structures generated throughjob evaluation versus market pricing; and what is the impact on the organization's ability to attract and retain qualifiedemployees if the resulting pay structure is not consistent with the market?

It is expected that the job evaluation approach, with annual structure adjustments, will work best in organizations,such as local governments, that operate in an industry with a more traditional, internal labor market focus, with limitedentry points, limited employee mobility, and limited external market pressures. The lack of significant external marketpressure and consistency of pay practices within the industry provides the stability that matches the more traditionalmarketplace and the basic assumptions of the job evaluation process. This means that there will be a relatively constantrelationship between the job evaluation results and the market rates for the benchmark jobs, thus maintaining aconstant job hierarchy and pay structure. The limited external market pressure means that wage inflation should berelatively constant across most jobs, allowing the annual structure adjustments and individual increases based on thecost of living to match the average wage inflation thus maintaining competitive wages. Finally, the internal labormarket focus will continue to match the employees' career expectations, thus maintaining low turnover and few equitycomplaints. The only weakness in the approach will be in those limited areas where there is significant externalpressure.


Proposition 1. Organizations in an industry with limited port-of-entry jobs and a less competitive marketplace, suchas local governments, that practice a job evaluation approach to compensation design, with an annual structureadjustment, will:

a. Experience relatively few equity complaints, and limited turnover, for most jobs and;b. Experience equity complaints and possible turnover in the limited jobs where market competition exists.

Conversely, it is expected that the job evaluation approach will be less effective in organizations, such as healthcareproviders, that operate in an industry where there are regular changes in jobs and in the internal job structure; and/orwhere the external market pressures create substantial variances in wage inflation across jobs. These dynamics createsituations where the stable relationships required by the job evaluation approach do not exist; and where the standardstructure adjustments and individual increases based on the cost of living either do not maintain the competitive wagesnecessary to attract and retain employees, or result in overpayment of employees in jobs with very low wage inflation. Forexample, the structure adjustments and cost of living increaseswould underpay employees in jobswith relatively highwageinflation, such as pharmacists and physical therapists, or require an adjustment to the job evaluation process. Conversely,the same adjustments and increases for jobs with low wage inflation, such as file clerks and food service workers, wouldresult in over payments to the employees relative to the external marketplace, resulting in inefficient resource allocations.

Proposition 2. Organizations, in a competitive marketplace, that practice a job evaluation approach to compensationdesign, with an annual structure adjustment, will:

a. Misallocate financial resources by over compensating employees in jobs with limited wage inflation; andb. Underpay employees in jobs in a tight labor market and with high wage inflation, resulting in turnover, higher labor

costs, and loss productivity due to job openings.

3.7. Identifying the market wage

Rynes and Milkovich (1986) pointed out that often an incorrect assumption is “in any given market, there is a singlemarket wage for any particular type of work” (p. 76). Citing findings from previous studies (Dunlop, 1957) they notethat as much as a 100% spread in the wages for some jobs across industries, different localities, and within a geographicarea. While most current information supports the existence of different wages, or wage dispersion, in the marketplace,there is no recent research investigating the extent of the market differentials in a more dynamic marketplace. Thisresearch may be enlightening given the changes in the marketplace that are directly related to the assumptions of theclassical economic model. The availability of wage information, more open discussions of wages in organizations, thechanging career expectations and related job movement culture, the tight labor markets for skilled workers, and otherfactors that closely match the assumptions of the classical economic model may create specific situations where there isless variance in the market rates. For example, the availability of wage information on the internet, may reduce some ofthe variance in wages by providing employees and employers with basic information that was not readily availablebefore the 1990's. This information, coupled with the free movement of employees in a tight labor market also reduceswage dispersion by forcing low wage organizations to increase wages in order to attract and retain employees. Thefollowing propositions are based on the changes in factors related to the classical economic model.

Proposition 3. Jobs, such as nursing, with defined entry requirement, free movement during a career, a highlycompetitive environment, and the availability of wage information will have less wage dispersion across organizationsthan jobs with more traditional characteristics.

Proposition 4. The availability market information and freedom of movement in a tight labor market will result insimilar pay structures and limited variance in wages across competing organizations; and produce wage dispersionpatterns that are similar to those found in unionized setting with patterned negotiation strategies.

The second issue relates to estimating the market rate through the salary survey process. Determining the marketwage for a particular job through salary surveys is largely a judgmental and sampling process involved with collectingand interpreting wage data from different employers on the particular job(s). While virtually all large organizations use


wage surveys, Rynes andMilkovich (1986) noted the dearth of research investigating employers' and consultants' wagesurveying practices, and called for research related to the various practices. This absence of research has continued.

Therefore, research needs to be conducted that examines how employers and consultants define their product andlabor markets, how they decide what organizations to include in their salary surveys, the impact of various statisticalanalysis on wage survey results, and the effect of differences in wage rates resulting from decisions made through theprocess. The research results would have a direct impact on the credibility of the survey data, on organizational paypractices, and on the expected outcomes of the decisions. The following examples and propositions provide anintroduction into the type practices that require formal research.

The availability of pay structure information on organizational websites has lead to some organizations to collectand use pay range information rather than actual wages to establish market estimates. This practice assumes that theorganizations actually follow their pay ranges and that there is a relatively normal distribution of wages within the payrange. Yet there are numerous factors that may impact the accuracy of the assumptions and the resulting marketestimates including red circle rates, outdated pay structures, long-term or highly qualified employees whose pay causesa shift in the distribution within the range, and other similar factors. Any variance between the average range estimateand the actual wages may cause an organization to underpay employees, impacting the ability to attract and retainemployees in a tight labor market, or in overpaying employees, negatively impacting the labor costs relative to thecompetition.

Proposition 5. Surveys that collect pay range information from the published pay structures, rather than actual pay,will produce market estimates that are practically and statistically different from actual wages with respect to theminimum, average and maximum wages.

Most organizations, and websites that provide survey data, such as salary.com, adjust or age the market estimates inpublished surveys to reflect competitive rates at the current or a future implementation date using the CPI or an averagewage inflation values for most jobs. While the mainstream compensation textbooks (Milkovich & Newman, 2005;Henderson, 2005) urge the use of wage inflation rather than the CPI, there is no research on the accuracy of theresulting market estimates using different change factors or on using a common factor for all jobs, the time limitationsfor using dated survey data, or on the impact of the estimates or organizational outcomes. The process of aging the data,while somewhat simplistic, has a significant impact on compensation decisions and the resulting organizationaloutcomes. Market data for physical therapists from 2004 adjusted for three years at a CPI inflation rate of 2.5% willresult in an overall adjustment of 7.7%, while an actual wage inflation rate of 8.0% over the same time period results ina 26% change. The difference of 18.3% may be enough to reduce the employees' pay satisfaction and potentiallyincrease turnover in a tight labor market.

Proposition 6. The practice of aging market data using a single differential estimate will result in statistically under-predicting the actual average wages for jobs in a tight labor market after approximately two years, resulting in higherturnover, lost productivity, etc.; and over estimates the wages for jobs with limited actual wage inflation, resulting in amisallocation of financial resources.

3.8. Individual pay decision-making models

The ultimate purpose of applied research is to increase the understanding of the critical factors that affect a specificproblem or decision, and to provide models that assist in improving the accuracy of the decision-making process. Aneed exists to develop individual pay decision-making models because of the shift from an internal to an external focusand from a job focus to a person focus. The prior emphasis on job evaluation focused on determining pay rates for jobsrather than individuals. The need today is to determine pay for individuals based on market considerations as well as theskills, knowledge, and human capital they provide to the organization. Further, the lack of sophisticated decision-making models and continued reliance on judgmental decision-making (as was the case with job evaluation) may be atleast partially to blame for the continuing evidence of pay inequities and in relatively undocumented financialinefficiencies in organizations.

Future individual decision-making models must include a more quantitative approach to address these issues in thecompetitive marketplace. Research on individual decision-making clearly indicates that mechanical or quantitative

http://salary.com


decision-making is always equal to or better than judgmental approaches (Gatewood & Feild, 2001). In addition, priorcompensation research provides numerous examples of structured, quantitative decision-making models, such as theImproshare and Scanlon gain-sharing programs, piece rate incentive programs, sales commission, and the balance sheetapproach to expatriate pay. In spite of these research findings and examples, the compensation research does notinclude the same level of quantitative sophistication in the individual base pay determination process, which representsthe single largest financial decision in most organizations. We propose the following propositions related to testing theeffects of individual pay model decision approaches:

Proposition 7. Individual pay decision models that are structured, more quantitative, and that include a broad rangeof job related factors will improve employee pay satisfaction; and reduce grievances, union activity, and charges ofpay discrimination.

Proposition 8. Individual pay decision models that are structured, more quantitative, and that include a broad rangeof job related factors will increase managerial satisfaction with the pay determination process and increase theefficiency of the financial resource allocations.

Proposition 9. Individual pay decision models that are structured, more quantitative, and that include a broad rangeof job related factors will result in greater satisfaction and fewer negative actions from external stakeholders,including government agencies, stockholders, and other interested groups.

4. Conclusion

This paper briefly traced the history of compensation research and discussed how that research closely followedorganizational structure and the use of ILMs. Consequently, much of the past research conducted on compensationreflected organizational characteristics and personnel practices that had an internal rather than an external focus. Thisincluded a focus on compensation issues and practices such as job evaluation, internal equity, pay level, and individualreactions to pay.

The internal focus that characterized much of the research in compensation was appropriate up until the1990's or so that witnessed tremendous organizational change. Change factors included globalization, the shiftfrom a manufacturing to a knowledge and service-based economy, trade liberalization, deindustrialization,decrease in unionization, the movement of production overseas, changes in technology, and changes inorganizational structures and reductions in organization size, and changes in approaches to production. All ofthese had a direct and/or indirect effect on the employment relationship as well as compensation practice.Overall, there has been a dismantling of ILMs and a market penetration into organizations with the external labormarket exerting a stronger influence on organizations and actual compensation practice. In spite of thesechanges, present compensation research has not kept pace with compensation practice that has shifted to a moreexternal focus on external labor markets, market pricing, and concern with issues such as externalcompetitiveness and stakeholder interests.

The overall theme of this paper has been on the need for organizational scientists and compensation researchers toshift away from a primary internal focus in compensation research to include an external focus. This shift is needed tostay aligned with current organizational practice and compensation practitioners who have largely moved away fromusing job evaluation as the cornerstone of compensation system design and have adopted market pricing. In light of thischange in compensation practice, as researchers we believe a disconnect exists between present compensation researchand practice. Future compensation research, in order to be relevant to organizational practice, needs this externalreorientation.

As has been noted elsewhere in this special issue, while compensation represents one of the most important humanresource management activities, it has historically been under-researched in comparison to other activities. Therefore,our recommended redirection of compensation research does not imply an abandonment of research focusing oninternal compensation issues. While compensation research needs to include an external focus, consistent with currentcompensation practices and organizational needs, future research should also continue examining compensationconcerns that exist within organizations such as individual reactions to pay.


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