Compensation is integral to an organization. It influences several decisions related to attraction, development and retention of employees because of its alleged direct and indirect effect on employee performance. It is considered vital for getting the best employees, keeping them motivated, and enabling them to continue their association with the organization. 

Compensation can impact performance only when employees have the requisite talent for a job position. Talent is the composition of specific capabilities and competence that an employee brings to a job. It comprises all the attributes that indicate the potential of an employee to perform well, e.g. knowledge, skills and abilities along with relevant work experience. It is then easy to assume that talent would be the overall deciding factor for compensation, apart from industry standards and the financial capability of the organization. But is this assumption correct? 

How is compensation decided?

Let us consider the first time when compensation is determined for an employee, i.e. when s/he applies as a candidate for a job. At this time, compensation is influenced, to a large extent, by the existing demand-supply dynamics for the talent in the job market. It is common knowledge that organizations can be willing to offer a much higher salary (fixed or variable percentage hike over the salary in the current organization) to experienced candidates if the demand for their talent exceeds the supply. Besides, candidates themselves may drive up their own price tag through salary negotiations, leading to a compensation offer higher than the initially planned offer.

Salary negotiations are common phenomena during recruitment for lateral positions in most of the organizations. Candidates negotiate for a higher salary on the basis of expectations of a standard hike, applicable to the job position and industry. They also negotiate for a non-standard hike on account of alternate job offers. Organizations, on several occasions, concede to candidates’ offer due to dire need for the talent. They may also do so because of the desire to close an offer, as considerable time and effort has already been spent with a candidate, or additional costs would have to be incurred to close a job position with other candidates. Also, there is a lingering uncertainty about finding the right candidates in the near future.

For such reasons, final compensation offered to a candidate can diverge from the initial compensation planned for the job position. A related implication is that candidates with equivalent talent may not be offered equivalent compensation. This is because a) job market for a specific talent changes over time and b) candidates differ in their willingness, ability or feasibility (e.g. due to an unfavorable personal situation) to negotiate. This can result in salary variation for two employees with comparable talent doing the same job in the same organization, or inequitable compensation.

Impact of inequitable compensation 

Inequitable compensation can have serious negative fallouts. Employees who lose out in compensation at the time of recruitment, may feel cheated and exploited. They may get dissatisfied with their job and disengaged with the work, and have low commitment for the organization. They would thus perform at suboptimal level. They would also be likely to quit the organization whenever they find better job opportunities.

As a corollary, we might say that employees who gain from market driven and negotiation-based compensation at the time of recruitment, would be highly satisfied, committed and engaged, leading to high job performance. But is that really the case?  Individual performance is driven by two kinds of motivation: extrinsic and intrinsic. Extrinsic motivation is an external incentive to invest time and effort in a job, and may take the form of salary and recognition. Intrinsic motivation is an internal drive to perform well in a job, and may be related to beliefs, interest, empowerment and challenge associated with the job. Extrinsic motivation can help employees perform initially. However, if they lack intrinsic motivation, they cannot achieve their full potential and may not be able to even sustain their performance over time. In short, they would not be able to do justice to their salary. Besides, they would be on a perpetual look out for higher-paying job opportunities because monetary considerations are important to them.  

It is evident from the above arguments that differential salaries can be a major cause of poor performance and turnover amongst both categories of employees. There can also be far reaching consequences for the organization over time. Artificially hiked salaries for some employees can considerably increase the overall costs of the organization impacting its profits and capacity to reinvest in the business, thus lowering the potential for growth and advancement. It can also lead to limited scope for increments (within a salary band) and bonus, affecting the morale of the whole workforce, and further increasing the possibility of turnover. Frequent turnovers increase recruitment costs since the organization needs to search for and find candidates to fill open positions more often. Urgency to fill positions can once again lead to offers higher than the market rate. To prevent turnover, organizations may also adopt a policy of raising salary when employees declare to quit. This can not only raise retention costs, but also intensify salary disparity leading to all the associated consequences.

So what should organizations do?

Organizations need to adopt a more rational and unbiased approach in determining compensation for new talent during the recruitment process. More often than not, these decisions are influenced by an estimate of the need of the candidate for a job vis-à-vis the need of the organization for the candidate, and not purely the level of talent. If a candidate has had a career break, has personal constraints or has no alternate job offer at hand, s/he is at the receiving end of the bargain, and may not even be selected. On the other hand, if a candidate seems to be well settled and doing well in the current job, and enjoys alternate job offers, s/he dictates the terms of the bargain, and is still likely to be selected.  A candidate with a higher “market value” is perceived as more desirable, just like highly priced products. But this market value may have little to do with the talent of the candidate. Organizations need to be wary of such tendencies and power play, and should make a conscious effort to estimate the candidate’s potential based on talent, and probability of long term stay in the organization, for deciding candidature and compensation.

For effectively managing talent over time, organizations need to focus on factors that can promote employee satisfaction, commitment and engagement in the long term. These factors include challenging and fulfilling jobs, appropriate training and development, well thought out performance management system, recognition, work life balance, and a conducive work culture, along with bonus and incentives. Research has clearly indicated their significance for performance and retention.

There is no doubt that a good salary is vital for attracting, motivating and retaining the best talent. Individuals work for an organization to attain the desirable standard of living, comfort and luxuries in life, and financial security for the future. However, it is as important to them to be compensated in a fair manner, have opportunities for learning and growth, enjoy their work, be recognized for their worth, and feel comfortable in the organization. Thus, organizations need to not only focus on equitable compensation for talent, but also consider mindful non-monetary investment in talent, for a sustainable and mutually beneficial relationship with employees.