How To Deal With Pay Inversion?

Published by MBA Skool Team, Published on September 05, 2012

Consider the employee who has worked hard for 20 years in an organization , received high evaluations and suddenly the company hires a new, less experienced, less qualified worker and pays him a higher salary. This unfortunate phenomenon happening in many organizations (especially during recessionary times) is called pay inversion.

The article gains its relevance in the face of impending economic crisis.

Pay inversion occurs when employees who are similarly or less qualified than current employees are paid more for the same job but note that the definition of inversion excludes paying new hires more because they have greater experience or skills or clearly exhibit the potential to rapidly outperform current employees

Pay inversion: Economic vs Motivational theories

Principle of economic theories

Principle of Motivational theories

Greater supply of a product forces the price downward

Behaviours followed by favourable consequences are repeated

Greater demand for a product forces the price upward

Behaviours followed by unfavourable consequences are diminished

Labour shortages cause greater demand for high-quality labour

Employees must believe that their level of performance is linked to company rewards

Companies must pay higher salaries to new employees during market shortages

Pay compression links salary level to market conditions, not performance

External labour market pay-scale outpaces companies’ internal pay-scale

Higher contributing but lesser paid existing employees feel inequity and are de-motivated from pay compression

New employees’ higher salaries cause pay compression for existing employees

De-motivated employees will reduce productivity and citizenship behaviour and increase counterproductive behaviours and/or quit

Although they are no perfect solutions to the inversion problem but we would try to provide a strategy to deal with the same.

Our strategy provides for paying market rates for new employees but base future rewards of each employee including new hires on his or her total contribution to the organization. By paying market rates, a firm can hire new employees and achieve its goal of being competitive in the hiring market for the current year. And, by basing future rewards on overall organization contributions, the firm may be able to motivate employees to excel into remain loyal, thereby achieving the goal of high  organizational efficiency.

There are two important advantages to this approach. First, it recognizes the economic reality of the market place. Second, it is consistent with motivational theory if the firm defines both performances and compensation broadly. Reinforcement theory states that organizations should reward employees based on their performance, by broadly defining performance as the total contribution employees make to the organization rather than traditional output measures, employees could also be rewarded for job and organizational knowledge, past contributions, organizational citizenship behaviours and loyalty.  In addition, equity theory states that employees’ fairness calculation considers all the rewards receive.

Thus, if companies also take a comprehensive view of compensation, they can offer employees more rewards thereby improving employees’ equity ratio. We describe employees’ total compensation as consisting of a beginning salary and three other components: salary rises, non-salary monetary awards and non-monetary rewards.

Salary rises: First, firms could base raises on total contribution to the organization. Using a broad definition of contribution, even if new employees are performing well based on traditional output measures, they are most likely making a smaller total contribution than established employees since as already stated total contribution employees make includes job and organizational knowledge and existing employees are expected to outperform new employees on these parameters. As a result, base raises for established employees would turn out to be higher. The key to making this approach successful is to all employees, particularly the new ones, that the firm bases pay raises on a broad definition of performance.

Second, companies may address inversion by allocating a specific amount of the raise budget to inversion-affected employees until the impact of the high, market-driven beginning salary is erased and salaries reflect total contribution to organization. Although this approach does not eliminate inversion instantly, it may generate goodwill among current employees by showing that the company values them, recognizes the problem and is doing something about it.

Non-salary monetary rewards: Companies may also boost inverted employees’ total compensation by providing additional non-salary monetary rewards. For example, firms can grant stock options to current, underpaid highly productive employees.

Non-monetary rewards: In granting non-monetary rewards, anything that shows appreciation or recognition of employees’ contributions can help offset the negative effects of inversion. Examples include choice of work assignments, verbal or written praise, additional work/life balance options, and first choice of vacation times, offices and working conditions.

Of course, no single non-monetary reward is likely to be so significant that it would overcome a big salary deficit. In addition, according to expectancy theory companies must make sure that the rewards they offer are valued by employees. Otherwise, they will not be motivated. However, in the long run, the accumulation of these non-monetary rewards, especially in combination with the monetary rewards discussed above, could restore equity in the mind of current employees.

This article has been authored by Arijit Mukherjee and Vipul Khanna from XLRI.


Views expressed in the article are personal. The articles are for educational & academic purpose only, and have been uploaded by the MBA Skool Team.

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