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Thursday, May 23, 2013

What is a fair Pay?

Knowledge@Wharton has really so-so article about what is fair vs unfair pay. But this post is not about why the article lacks depth per se but it is about what really decides fair vs unfair pay. And to this end, we will rely on the model discussed in Understanding Firms - A Manager's model of the Firm.

We will take two aspects from the book, first relates to ESK (Effort-skill-knowledge) profile for every job and second relates to profile of employee when she works on Firm's transaction chain, namely scout, commando, bureaucrat. As I explained in the book, employees perform dual functions. They work IN the firm's transaction chains and they work ON firm's transaction chains. In the first function, their work is classified as ESK profile. In the second function, their work is classified into "roles" such as scouts, commandos and bureaucrats. 

First about ESK profile
First it is common-sense to understand that an E-dominated job will pay vastly lower than K dominated job and S-dominated job will lie somewhere in between. Now, any given job has a combination of ESK requirements and thus has a ESK profile. It is here that the confusion starts. You can immediately see that this is a 3-D surface plot and the nature of surface is not clear. 

Thus a job with high effort and knowledge requirement cannot be equal to effort job + knowledge job. In other words, when you expect a high-knowledge job to supply effort, you pay higher for the same effort than when it is supplied by someone who does not offer the high-knowledge part. Thus it makes sense to carve out the E-type part and make someone else do that job. This is the benefit of specialization.

Let us think of an example. (With reference to Ironman) A scientist at Stark industries who is as brilliant as Tony himself will have a high K profile. But when you compare Tony and that scientist, Tony Stark comes with equally high K profile along with strong E and S profile as well. That makes Tony Stark more valuable than that scientist. (We are assuming this comparison way before Tony becomes Ironman.)

Another example can be that of surgeon. A surgeon works in S-K profile with both equally highly demanding. Therefore it is only fair his compensation is quite high.

Next about employee roles
When you consider employee roles, there is even more confusion. Usually, employees have a favoured mode of operations, that is to say they have a natural inclination to be either scout OR commando OR bureaucrat. However, considering the bargaining power equation across the transaction chain and the nature of transaction on which the employee is working demands a certain role from the employees. When employee supplies such a role to such a transaction, she contributes positively to firm's bargaining power. 

Any addition to firm's bargaining power is easier to perceive in terms of financial returns and is thus rewarded substantially. However, the share of rewards are not commensurate with the contribution to the bargaining power by various employees. Thus, a person winning a deal often gets more credit than a person who creates conditions within delivery side to win such a deal.

In our earlier example of Ironman, when Tony Stark is faced with a problem of lack of resources (in the cave for example), he re-wires the entire transaction chain, creating it all by himself, operating in a strong scout-commando combo-role. This makes Tony Stark truly superior to all other employees. Now Tony Stark gets higher compensation not only because he can be scout-commando but because he knows that he needs to be scout-commando and supplies that role. Thus it is not the role per se, but the aptness of the role to the situation that is valuable.

What firm values vs. what is valuable to the firm
We know and understand that firm pays more for what it values more. But there is a difference between what a firm values and what is valuable to the firm and firms do not always value what is valuable to it.  

Quite often, employees know what is valuable to the firm but firm is unable to recognize it. This is because of lacunae in leadership rather than anything else. In this case, the employee making a valuable contribution feels that he is unfairly compensated.

Some times the reverse is also true, that employees think certain this is valuable but in larger scheme of things it is not that valuable to the firm. This is problem of expectation matching at employees side but even this is a lacunae in leadership.

Relativity of fair compensation
Fair compensation also depends on relativity. Whatever the firm's stated policy, the employees know who is paid what in approximate. Further, employees also know the relative performance of people in the team. If firm rewards are not in line with relative performance a feeling of unfairness develops. No one compares his compensation with that of CEO directly, you compare your compensation with someone who has performed better than you and to some other who has done relatively poorly. If the compensation satisfies the hierarchy of performance employees feel it is fair.

Secondly, employees also compare compensation of others with others. So they will compare compensation of A(a not-so-high-performer in their eyes) with that of B(a star in their eyes) and check if the fairness holds. If they feel this is unfair then they ascribe unfairness to their own compensation even though in isolation they may feel their compensation is fair. To make this point clearer, employee is happy to receive his compensation for the year but becomes unhappy when he goes out and interacts with others.

Thus, fair compensation is not as simple as K@W makes it sound. It is way more complex. But you know better now!