Compensation research past, present, and future

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

Compensation research past, present, and future James H. Dulebohn a,⁎, Stephen E. Werling b b

a Michigan State University, School of Labor and Industrial Relations, 412 S. Kedzie Hall, East Lansing, MI 48824, USA 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 rather than an external focus. Internal labor markets typically characterized organizations following WWII up until the 1980s. Consequently compensation research focused on issues related to managing compensation in this type of structure that emphasized areas such as internal equity, job evaluation, and individual reactions to pay. Recent changes in the environment have resulted in a greater role of external factors, such as external labor markets, market pricing, and external competitiveness, on compensation practice. While practitioners today have more of an external focus in compensation system design, present compensation research has not kept pace. In the following paper we argue there is a need to redirect future compensation research to include a consideration of external factors. © 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 employment relationship and all the policies, decisions and practices associated with the relationship. Central to the relationship between employers and employees is the compensation exchange or transaction process. The reason most people work is because they depend on salary or wages to exist. While intrinsic factors play a notable role in why employees seek and remain in employment relationships, compensation plays the central role. From a general management perspective in addition to the significant cost of doing business associated with compensating employees, the implications of compensation decisions are among the most important in remaining viable, achieving competitiveness and remaining competitive. From a human resource management perspective, the success 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 directly linked to compensation offered. Also, the ability to motivate workers and retain desired employees is largely influenced by compensation offered. As related to the effect on employees, critical employee attitudes, behaviors, continued organizational membership, and reciprocity toward the organization are strongly influenced by compensation. The important role of compensation in managing organizations and controlling employees has been recognized throughout history. It was a central principle of modern management theory and practice, first articulated by Frederick Taylor 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

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pay as one of the primary tools management had at its disposal to control and motivate employees and as a means to increase productivity and reduce turnover (Dulebohn, Ferris, & Stodd, 1995). Similarly, industrial leaders such as Henry Ford recognized the link between compensation, managerial control, retention and worker behavior and viewed paying above the market, paying a $5.00 per day wage, to his assembly line workers in 1914, as central to organizational success and profitability (Raff, 1988). This manuscript examines research that has been conducted in compensation. It will be shown that past compensation research reflected organizational characteristics and personnel practices that had an internal rather than an external focus. As the environment and organizations have recently changed we argue the need to shift the focus of compensation research from one that is primarily focused on internal organizational criteria to include external factors such 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 organizational mechanisms to improve and institutionalize managerial control. Within this context, organizations developed and widely adopted practices to manage the employment relationship. These efforts have been labeled bureaucratic personnel practices (Baron, Dobbin, & Jennings, 1986). These practices included personnel departments, centralized employment, job analysis, job evaluation, employment testing, promotion systems, performance appraisal, and seniority provisions. According to Baron, Jennings, and Dobbin (1988), the goal of such bureaucratic personnel practices 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 was widespread diffusion of bureaucratic personnel practices. Job evaluation systems, for example, proliferated at a very rapid 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 and personnel management through the use of internal labor markets (ILM). Doeringer and Piore defined an ILM as “an administrative unit, such as a manufacturing plant, within which the price and allocation of labor is governed by a set of administrative rules and procedures” (Doeringer & Piore, 1971, pp. 1–2). These rules and procedures differentiated organizational members who were a part of the ILM from those outside the organization and provided them with certain benefits including guarantees of job security, promotion and career mobility opportunities, and due process and equity in treatment in the organization. Primary characteristics of ILMs include a focus on ports of entry at the bottom of the organization hierarchy in the hiring process, progress along well defined job ladders, wage setting determined by way of a series of bureaucratic procedures and the assignment of wages to jobs rather than to personal characteristics, rewarding employees for seniority, and promotion from within. The practice of using ILMs in firms resulted from organizational efforts to reduce turnover, standardize wage rates for different jobs, efficiently deploy labor, and these became standard practice during and after World War II as organizations complied with government mandates for labor allocation and wage payment practices (Osterman, 1984). ILMs and upward mobility are associated with the acquisition of skill or knowledge. Upward mobility is also seen as driven 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 certain degree, have unique aspects to their production systems, and management practices; employees' increased knowledge of 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 also viewed as including client relationships, such as in banking and sales, where employees develop relationships with customers; employees who have these skills are viewed as essential to retain through job security and other mechanisms. An objective of ILMs is long-term attachment of employees to a firm. ILMs went hand-in-hand with the pattern of employment in the US during much of the post-WWII period where employees typically spent the majority of their working years at a single organization. This employer attachment was fostered through firm-specific training, employer commitment to job security, promotion from within, and the use of defined benefit retirement plans that rewarded longterm employment. Once a worker joined a firm and acquired firm-specific skills, his/her value inside the firm was higher than at other firms or the external labor market.

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Since the way to acquire firm-specific skills was to spend time in a firm, and workers were typically hired at low levels and promoted through the organizational hierarchy, limited inter-organization job mobility existed. Employees who gained more firm-specific knowledge, through on-the-job training, were often viewed as increasingly valuable to the 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 ports of entry used by many companies to bring new employees into their firms; employees who left a particular firm often found themselves at an employment disadvantage. These people would be less marketable only because they would demand 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 them with job security and structured promotion opportunities. Preference for younger workers gave a firm more years to capitalize its investment in worker training. This is not necessarily discriminatory. An example of this was IBM's view that 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 a huge departure by IBM from its long standing practice, as all previous CEOs following Thomas Watson, Sr., the company'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. Following Gerstner's arrival IBM implemented a massive downsizing, organizational restructuring, and growth in the use of nonpermanent, contingent employment relationship practices. The widespread willingness of companies to look for executive talent outside the firm also indicates a shift in focus on general or industry-specific human capital rather than firm 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 by economic variables such as supply and demand. In the ILM there is no market supply and demand curves for particular positions; an employee's wages are a function of the job she/he occupies (Wang & Holton, 2005). ILMs are interconnected to the external labor market in that movement between the two types of markets occurs at certain job classifications that represent ports of entry into the ILM. From a compensation perspective, ILMs emphasize the importance of internal equity or consistency in the pay among jobs rather than a concern with external equity or rates of pay for similar jobs in the external market. ILMs are often shielded from compensation of external labor markets and the main competition is internal in the form of job promotions and merit pay (Doeringer & Piore, 1971). Groshen and Levine (1998) argued, “one defining characteristic of 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 jobs associated with higher pay. Jobs are clustered based on knowledge, skill, ability and other characteristics required to perform the jobs. Jobs in a particular job cluster are similar in these factors and differ from jobs in other job clusters or wage 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 labor market. For each employee in an ILM, the following must hold. The wage here, in the firm, must be greater than or equal to the wage there, outside the firm, minus all switching costs such as relocation, pension loss, etc. Simply put, the wage 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 a wedge between the wage here and the wage there thus allowing the firm to extract economic values (rents) from workers inside. In a perfectly competitive labor market with no ILM's, workers would earn a wage equal to their marginal product. Workers seeking the highest wage are implicitly seeking their highest job match. ILM's drive up the value of workers' marginal product within the firm by providing firm-specific training. This training generally adds no value in the eyes of external labor market competitors. 1.1.1. Focus of compensation system design Within 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

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is that “wages are determined internally and may be quite free of market pressure;” only to the extent that the wedge between WAGE here and WAGE there is large and switching costs are high; in contrast, external labor markets mean that 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 had decreasing marketability after joining and gaining tenure in a firm, because of investment in firm-specific capital over time. In contrast, prior to joining a firm and gaining firm-specific skills, a worker has greater mobility and may have the choice to join a number of different firms. Consequently, after joining a firm the focus of workers and the primary concern of organizations is to ensure internal equity and internal consistency among the wages assigned to jobs, since the focal point of workers and compensation administration is inside the organization rather than on opportunities and wages in the external market. Economists have also posited that workers taking an entry-level position actually consider the present value of the total salary stream they will receive over their working lifetime, not just their immediate pay for the next 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 revenue product. Once workers join the firm they focus on wages but also track promotions, raises, and other dimensions of the pay stream. Further, ILM's often used deferred compensation, such as defined benefit plans, which served as a mechanism to retain employees. 1.1.2. Role of external labor market The 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 the ILM was entry-level jobs for which companies competed for workers entering their firms from the labor market. In addition, concerns such as competitiveness, turnover, and compliance to government regulation mandating equal pay for equal work were met with organizations comparing their wage rates for key or benchmark jobs with their competitors and the external market. Further, companies often used market data to determine whether their wages were high enough, relative to the market, to fend-off unionization efforts (Groshen & Levine, 1998). 1.1.3. ILM effect on wages Lazear (1979) stated that through ILMs organizations were able to pay workers 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, and providing retirement income security through defined benefit plans. Defined benefit plans are formula-based and endloaded in that they provide employees with a retirement benefit that is based on years of employment and final salary and benefit 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-firm mobility difficult and less desirable than remaining with the single 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 after World War II showed that pay varied widely for the same type of work across employers, even in the same geographical areas ( 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, changing employment relationships, and the dismantling of ILMs has resulted in an increase focus and role of the external labor markets 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 on aspects of pay, compensation practice, and reactions of employees to pay that represented internal organizational concerns. 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 conducted by a variety of disciplines including economics, psychology, sociology, and finance. The resulting research and theory by 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

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disparate streams of compensation research, compensation appears to have been a less researched area than other employment 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 purpose of the review below is to provide some examples of the internal focus that has largely characterized prior compensation research in human resource management. We present some research on pay structure, job evaluation and internal equity as well as individual reactions to pay. This sampling of research will be followed by a discussion of changes in the environment and organizations that highlight the need to shift compensation research to include a focus on external factors. 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 characterized by hierarchies (Henderson, 2005). Organizational pay structures can be classified on a continuum as hierarchical to egalitarian; generally US organizations have tended towards hierarchical which fits with ILMs. Typically hierarchical pay structures have been defined in terms of pay grades, job evaluation points or pay policy lines. The customary approach for determining pay structures, in compensation system design has been through job evaluation. There are other approaches such as market-based or skill-based approaches, but up until recently job evaluation has been dominant 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 job content and value. Job evaluation is the foundation of internal equity or internal consistency because the process results in 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. Job evaluation evaluates and rates the job, not the worker. The practice of job evaluation began in the early 20th century and was widely adopted in the private sector during WWII in response to the National War Labor Board permitting wage increases only for the purpose of correcting demonstrated inequities in wage structures (Treiman, 1979) and by mid century 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 compensation systems. According to Lawler (1987), job evaluation is “an approach to thinking about work and people's relationships to 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 the mass 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 inherent characteristics and duties of the job and should exclude extraneous factors such as supply and demand of labor, local wage rates, and geographic location” (168). In spite of this primarily internal focus, the reality is that job evaluation depends to a certain degree on market wage rates; an assumption existed that there was an appropriate market rate for some jobs within the organization (i.e., key jobs) such as port-of-entry jobs and jobs with content common across competitor organizations. While the process of establishing pay structures was job evaluation, the compensation development and adjustment process also depended to some degree on obtaining market rates for those key jobs and using those wage rates to evaluate 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 going rates” for unique jobs; to soundly evaluate unique jobs through accurate interpolation and extrapolation relative to stable key job values” (p. 333). The literature on job evaluation commonly lists four types of job evaluation methods (Treiman, 1979). Ranking involves ranking jobs from top to bottom with respect to their worth or value to the firm. Classification involves an idealized hierarchical structure that is predetermined, with categories delineated on the basis of compensable factors

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such as skill and responsibility. Factor comparison involves selecting a set of compensable factors, choosing benchmark jobs, ranking benchmark jobs with respect to their total worth, and applying the compensable factors to evaluate all jobs based on the contribution of the factors to the total worth of the job. 1.3.1. Point-factor approach The 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 to evaluate their jobs. The point-factor approach involves selecting compensable factors to represent what the organization wishes to reward. For each factor, a scale is devised representing increasing levels of worth and each level is assigned a given number of points. Each job is rated on each factor separately and is assigned a point value based on the total amount of points. A hierarchical ordering of jobs is determined based on the summed values of the compensable factors observed in each job. 1.3.2. Job evaluation research Because 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 was primarily descriptive, providing information on effective use of job evaluation (c.f., Treiman, 1979). Empirical research accelerated in the 1970s and 1980s to investigate issues such as the reliability and validity of job evaluation and the appropriateness of job evaluation in determining comparable worth. Other research was conducted that compared the appropriateness 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 valid in determining the actual worth of a job (Arvey, Assino, & Loundsbury, 1977; Rynes, Weber, & Milkovich, 1989). For example, Chen, Orazem, Mattila, and Greig (1999), argued that job evaluation often failed to accurately measure the actual worth of the job due to factors such as unreliability in job analysis, job descriptions used as the basis for evaluating jobs, as well as using compensable factors to extrapolate market value to non‐key jobs. 1.3.3. Pay level research Similar 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 paid by a particular firm relative to that paid by its competitors. In spite of this, limited HR research has focused on examining factors organizations use that potentially affect their pay level determination such as the reliability of approaches used by firms to ascertain market rates of pay, how organizations decide which employers to survey and how they select benchmark 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 the pay 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 on subordinates played a role. This research, while important, fails to address the external comparative aspect of pay level that 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 to pay. Research on employee reactions and attitudes to pay has been a primary focus of industrial organizational psychologists and has contributed to human resource management practice. The primary motivation for this research has 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 not until the 1960s that systematic pay satisfaction research began. The premise for this research was the expectation that

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compensation and work-related outcomes were mediated by attitudes toward pay (Williams, McDaniel, & Nguyen 2006). Pay satisfaction represents an attitude and has been defined by Miceli and Lane (1991) as the “amount of overall positive or negative affect (or feelings) that individuals have toward their pay” (p. 246). Pay satisfaction has been hypothesized 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 social exchange and equity (cf., Homans, 1961). Homans (1961) defined equity in the context of an exchange relationship. He conceptualized 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, less costs, when compared to the other party in the exchange relationship. Investments represent the relevant attributes brought by the individual to the exchange relationship. The two primary theories underlying pay satisfaction research have been equity theory and discrepancy theory (Lawler, 1971) that represent an extension of equity theory. 1.5.1. Equity theory Building 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 inequity focused 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 own input–outcome ratios to a referent or comparison other. Individuals perceive equity or fairness when the ratio or balance of their outcomes to their inputs is equal (Adams, 1963, 1965; Walster, Walster, & Berscheid, 1978). In contrast, inequity exists when the ratios are perceived as unequal. The importance of equity theory is that it represented initial 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 of inequity distress or psychological uneasiness that motivates individuals to engage in actions that will remove the dissonance 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 the magnitude of inequity experienced” ( p. 283). Workers will attempt to achieve equity through actions such as altering inputs, altering outcomes, adjusting their evaluations of their inputs and outputs, using a different comparison other, by using 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 an outcome 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 other are both in an exchange relationship with a third party such as an employer. Thus, within an employment context, the focus 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 of employees taking action to restore equity (Gerhart, Minkoff, & Olsen, 1995). Research has found that when subjects perceived that they have been overpaid they have tried to improve their work and when they have been underpaid they have 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 than for reactions to overpayment inequity (Adams & Freeman, 1976; Mowday, 1991; Sweeney, 1990). 1.5.2. Discrepancy theory Discrepancy 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 subtracting the 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 the organization, discrepancy theory differs from equity theory in its inclusion of additional variables an individual considers in evaluating pay outcomes including job characteristics such as job level, level of responsibility, and job

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difficulty and the factor “valence" found in expectancy theory (Lawler, 1971). These are considered job inputs that contribute 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. In addition, discrepancy theory includes valence and posits if the valence of the outcome is low then the individual will not react as strongly as if the valence is high. A strong reaction to discrepancy resulting from high valence is expected to have an effect on the individuals' behavior resulting in actions to alleviate the discrepancy. The discrepancy model has received support from empirical research (Dyer & Theriault, 1976; Gerhart & Milkovich, 1992; Rice, Phillips, & McFarlin, 1990). 1.5.3. Multidimensionality of pay satisfaction While 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 and administration, and benefit satisfaction. While other researchers have proposed other models than Heneman and Scwab'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 satisfaction theory and the focus of research has been on organizational members' satisfaction with their pay, pay satisfaction's antecedents and outcomes, and has informed compensation practice with respect to the importance of adjusting individuals' 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 has characterized much of the research in compensation. It is our opinion that this approach has been totally appropriate and it, 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 practice within ILMs and the foundational nature of establishing internal worth of jobs in designing pay structures and compensation systems. Research on individual reactions to pay, as illustrated by equity, discrepancy, and pay satisfaction research has contributed to compensation practice in identifying how employee attitudes toward pay are formed. 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 all levels 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 social contract between employers and workers is being shredded. It is still unclear what will replace it.… This means that the old 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 (with life-long employment, predictable advancement, pay tied to promotions and jobs, and organizational membership) is being replaced by a much less stable employment relationship where workers are more exposed to external labor market forces. The question arises, what has caused these changes? There have been macro changes such as globalization, the movement 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 organizational structures 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 of the market on ways business is conducted. Organizations have responded to these changes in a number of ways. First, they have reduced hierarchical levels, a change that has also been associated with the increased use of peripheral or contingent employment rather than core or permanent employment. Organizations have also dismantled wage structures that were associated with ILMs and

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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 more individual and organizations pay the person rather than the job; such an approach requires a closer tie to external labor markets when determining compensation than was the case in ILMs. While limited research has been conducted on the movement from job-based to person-based forms of compensation, Lawler's article underscores a growing importance of the external market forces on compensation practice. Also, with respect to compensation, in reducing their long-term obligation to employees, organizations in the US have adopted defined contribution pensions in place of defined benefit plans 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, the winners being those who are highly skilled and possess knowledge that employers want. The changes listed above have redefined the type of knowledge that organizations view as valuable and need to be competitive. Firm-specific knowledge 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 less important. Information technology allows knowledge codification…and favors reductions of information costs. This lowers the transaction-specific nature of information, knowledge and capabilities, and reduces coordination costs 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 to maximize their competitiveness rather than limiting hiring to entry level and training those workers and promoting from within. Workers with the right skills are able to move from organization to organization and not be affected through not having particular firm-specific skills. Attendant pay practices by organizations now include paying workers for their skills and productivity rather than paying for jobs that was the central focus of job evaluation and ILMs. According to Camuffo (2002), “talented workers can jump from firm to firm to take advantage of a better “match” in the ever-changing market 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 that ILMs or the characteristics have completely disappeared from US organizations. Some organizations continue to provide characteristics of ILMs, described above, to some of their workers including promotion and career mobility opportunities along well defined job ladders, promotion from within, and rewards for seniority. These practices may be applied 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 and retention 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 kept pace or shifted to address these changes. An examination of most compensation and human resource management textbooks as well as human resource and management 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 resource management and the actual practice of compensation in the real world. For example, compensation consultants rarely use the traditional point method job evaluation when they design compensation systems; instead their focus is on the external labor market, salary surveys, and issues of external competitiveness. Yet job evaluation research continues to be conducted (e.g., Morgeson, Campion, & Maertz, 2001) and continues to be presented as the foundation of compensation system 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 of the external environment on businesses highlight the need for the academic community to increase and redirect

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compensation research. The changes in the external marketplace and within organizations suggest the need for a reevaluation of the past assumptions concerning compensation to determine if they accurately apply to the more dynamic marketplace. The changes also suggest the need to conduct studies to determine if past research findings apply to the current business environment. Most importantly, future research must evaluate the utility of current decision-making models and techniques in light of the changing marketplace and the importance of accurate compensation decisions to organizations. It is expected that this research will identify the need to develop and test new, substantially different prescriptive and predictive decision-making models to meet the demands of a dynamic marketplace. 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 consultants or mandated by government agencies. The recommendations, therefore, for future research focus on those areas of research related to improving the applied decision-making process. There are several general recommendations to improve future research based on the past and current research, coupled with the changes in the competitive marketplace and the expectation of various stakeholders. The partial list of recommendations provides general guidelines for addressing 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 theoretical contrast to the internal focus of compensation that has characterized much of the compensation research in HRM. This model represents a more macro level approach and describes how employers make decisions about compensation and on “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 relevance of factors they have identified. The Gerhart and Milkovich (1992) model of compensation decisions and consequences provides a framework that accounts for external factors that are now central to compensation system design and decision-making. The model highlights that organizations no longer operate within the confines of ILMs that afforded the luxury of simply considering compensation from an internal perspective. A review of the literature suggests an absence of research that accounts for factors they have identified, that are consistent with the movement away from ILMs, and the growing importance of external factors on compensation decision-making and practice. The model includes a number of external and organizational factors that represent determinants of compensation decision-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, economic conditions, regulation, and globalization. Factors such as these are posited to influence pay decisions and practices and represent the inclusion of important external factors, which during the past 20 years have played a more significant role in organizational decision-making, function and action. An inclusion in compensation research of these and other factors in their model can help explain why organizations make different compensation decisions and the impact of these decisions 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 specific circumstances 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 been on the internal factors, or ILMs, and more recently and less so on organizational factors such as performance and strategy. As noted, this emphasis on internal factors is especially evident in the volume of research on job evaluation techniques and the presentation of job evaluation as the cornerstone of compensation system design presented in the mainstream textbooks. Conversely there is a general lack of research on external labor market factors and techniques for balancing relevant internal and external labor factors. This is especially troublesome given the dynamic nature of the labor markets and current trends in business.

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The general lack of balance in the research especially applies to the individual component of wage models. While there is a substantial amount of research on pay satisfaction and descriptive research on determinates of pay differences between 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 labor markets, the final pay decision is primarily an individual decision rather than a job or market level decision. Therefore we strongly argue that future research develop and test a combined model of wage determination that matches the theoretical foundations discussed in the literature, such as presented in the Gerhart and Milkovich (1992) model, which specifically 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 first problem as a level of analysis problem due to the lack of vertical synthesis across levels of analysis. Vertical synthesis refers to the linkage between variables at different levels within a system and the expectation that variables may behave differently at different levels, requiring models that show how behaviors at one level impacts other levels. The second barrier is a narrow definition of a broad operational problem. The narrow definition barrier occurs when researchers define a problem based on individual interests or a particular perspective, rather than on a broader perspective. Wallace (1983) specifically discussed the level of analysis barriers as they relate to the research on comparable worth and pay equity, suggesting that the lack of agreement over the level of analysis severely hinders resolution of the problem. 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 of analysis; while others use occupations and occupational attainment as the appropriate level of analysis. Beyond the Wallace review, Title VII of the Civil Rights Act of 1964 and the related court cases emphasize the individual as the appropriate unit of analysis when evaluating pay discrimination. In addition, research on the pay differential between men and women includes a broad range of individual, organizational, market and industry level factors that assist in explaining 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 compensation literature that focuses on-the-job unit of analysis, which was appropriate in ILM oriented organizations and the old economy, but may not be appropriate in a dynamic marketplace. As noted earlier, the primary unit of analysis in the previous compensation literature is the job and the appropriate pay grade assignment. Yet, the ultimate pay decision, either in ILM model or in a more dynamic external labor market model, is not the pay grade assignment, but the pay for an 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 resolve problems such as pay inequities, or develop a comprehensive wage determination model to improve the overall quality of organizational decision-making. Future research must first recognize that the ultimate compensation decision is the pay of an individual employee, and then provide a fully vertically integrated model of pay determination that considers the 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 the wages for employees, especially for executives. In some instances, the requirements of external stakeholders may clearly outweigh the interest or satisfaction of the employee. The new OFCCP guidelines (Interpretative Standards for Systemic Compensation Discrimination) on pay discrimination, the reporting requirements of the Sarbanes-Oxley Act, the IRS requirements for executive compensation in not-for-profit organizations, and stockholder challenges of executive pay levels provide examples of the need to consider external stakeholder satisfaction with wages, independent of employee satisfaction or attitudes toward pay. Future research must expand the evaluation criteria to consider the views of other stakeholders and other organizational objectives

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beyond employee satisfaction. The research must also analyze the impact of competing stakeholders' views on the 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 do compensation 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. This approach to valuing of jobs is referred to as market pricing, which is the evaluation of jobs based on the value assigned to jobs by the external labor market as determined by supply and demand, product market, geographic location, and industry. Placing primary emphasis on the external market rather than internal job evaluation is a corollary to the dismantling of ILMs, organizational change, new approaches to the employment relationship by employers 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 on market 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 their approach 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-based approach) 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? A general consensus exists today among consultants that a primary market pricing approach is most appropriate. This is based on factors such as market rates for jobs often change more rapidly than the rates paid inside organizations and to remain competitive and obtain talent acquisition and retention goals, organizations need to anchor rates for jobs to the market. An examination of the prevalence and utility of job evaluation approaches, hybrid, and market-based only approaches 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 reliability and validity. Considerable research attention has been given to job evaluation methods, some on market pricing, but our review found no research directly comparing job evaluation, market pricing and hybrid approaches; and no research investigating the long-term impact of the approaches. With the expressed criticisms and the trend toward market pricing, research is sorely needed that compares the two primary approaches. For example, examination needs to be conducted that compares the effect, over time, of using a job evaluation only approach (focusing on internal equity with annual adjustments to the overall pay structure) versus a market pricing approach. Longitudinal research in this area would answer questions such as: What if any discrepancies exist over time between pay structures generated through job evaluation versus market pricing; and what is the impact on the organization's ability to attract and retain qualified employees 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 limited entry points, limited employee mobility, and limited external market pressures. The lack of significant external market pressure and consistency of pay practices within the industry provides the stability that matches the more traditional marketplace and the basic assumptions of the job evaluation process. This means that there will be a relatively constant relationship between the job evaluation results and the market rates for the benchmark jobs, thus maintaining a constant job hierarchy and pay structure. The limited external market pressure means that wage inflation should be relatively constant across most jobs, allowing the annual structure adjustments and individual increases based on the cost of living to match the average wage inflation thus maintaining competitive wages. Finally, the internal labor market focus will continue to match the employees' career expectations, thus maintaining low turnover and few equity complaints. The only weakness in the approach will be in those limited areas where there is significant external pressure.

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Proposition 1. Organizations in an industry with limited port-of-entry jobs and a less competitive marketplace, such as local governments, that practice a job evaluation approach to compensation design, with an annual structure adjustment, 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 healthcare providers, that operate in an industry where there are regular changes in jobs and in the internal job structure; and/or where the external market pressures create substantial variances in wage inflation across jobs. These dynamics create situations where the stable relationships required by the job evaluation approach do not exist; and where the standard structure adjustments and individual increases based on the cost of living either do not maintain the competitive wages necessary to attract and retain employees, or result in overpayment of employees in jobs with very low wage inflation. For example, the structure adjustments and cost of living increases would underpay employees in jobs with relatively high wage inflation, 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, would result 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 compensation design, with an annual structure adjustment, will: a. Misallocate financial resources by over compensating employees in jobs with limited wage inflation; and b. 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 single market wage for any particular type of work” (p. 76). Citing findings from previous studies (Dunlop, 1957) they note that as much as a 100% spread in the wages for some jobs across industries, different localities, and within a geographic area. 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. This research may be enlightening given the changes in the marketplace that are directly related to the assumptions of the classical economic model. The availability of wage information, more open discussions of wages in organizations, the changing career expectations and related job movement culture, the tight labor markets for skilled workers, and other factors that closely match the assumptions of the classical economic model may create specific situations where there is less variance in the market rates. For example, the availability of wage information on the internet, may reduce some of the variance in wages by providing employees and employers with basic information that was not readily available before the 1990's. This information, coupled with the free movement of employees in a tight labor market also reduces wage dispersion by forcing low wage organizations to increase wages in order to attract and retain employees. The following 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 highly competitive environment, and the availability of wage information will have less wage dispersion across organizations than jobs with more traditional characteristics. Proposition 4. The availability market information and freedom of movement in a tight labor market will result in similar pay structures and limited variance in wages across competing organizations; and produce wage dispersion patterns 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 market wage for a particular job through salary surveys is largely a judgmental and sampling process involved with collecting and interpreting wage data from different employers on the particular job(s). While virtually all large organizations use

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wage surveys, Rynes and Milkovich (1986) noted the dearth of research investigating employers' and consultants' wage surveying 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 and labor markets, how they decide what organizations to include in their salary surveys, the impact of various statistical analysis on wage survey results, and the effect of differences in wage rates resulting from decisions made through the process. The research results would have a direct impact on the credibility of the survey data, on organizational pay practices, and on the expected outcomes of the decisions. The following examples and propositions provide an introduction into the type practices that require formal research. The availability of pay structure information on organizational websites has lead to some organizations to collect and use pay range information rather than actual wages to establish market estimates. This practice assumes that the organizations actually follow their pay ranges and that there is a relatively normal distribution of wages within the pay range. Yet there are numerous factors that may impact the accuracy of the assumptions and the resulting market estimates including red circle rates, outdated pay structures, long-term or highly qualified employees whose pay causes a shift in the distribution within the range, and other similar factors. Any variance between the average range estimate and the actual wages may cause an organization to underpay employees, impacting the ability to attract and retain employees in a tight labor market, or in overpaying employees, negatively impacting the labor costs relative to the competition. 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 the minimum, average and maximum wages. Most organizations, and websites that provide survey data, such as salary.com, adjust or age the market estimates in published surveys to reflect competitive rates at the current or a future implementation date using the CPI or an average wage 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 the resulting market estimates using different change factors or on using a common factor for all jobs, the time limitations for 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 organizational outcomes. Market data for physical therapists from 2004 adjusted for three years at a CPI inflation rate of 2.5% will result in an overall adjustment of 7.7%, while an actual wage inflation rate of 8.0% over the same time period results in a 26% change. The difference of 18.3% may be enough to reduce the employees' pay satisfaction and potentially increase turnover in a tight labor market. Proposition 6. The practice of aging market data using a single differential estimate will result in statistically underpredicting the actual average wages for jobs in a tight labor market after approximately two years, resulting in higher turnover, lost productivity, etc.; and over estimates the wages for jobs with limited actual wage inflation, resulting in a misallocation 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 specific problem or decision, and to provide models that assist in improving the accuracy of the decision-making process. A need exists to develop individual pay decision-making models because of the shift from an internal to an external focus and from a job focus to a person focus. The prior emphasis on job evaluation focused on determining pay rates for jobs rather than individuals. The need today is to determine pay for individuals based on market considerations as well as the skills, knowledge, and human capital they provide to the organization. Further, the lack of sophisticated decisionmaking models and continued reliance on judgmental decision-making (as was the case with job evaluation) may be at least partially to blame for the continuing evidence of pay inequities and in relatively undocumented financial inefficiencies in organizations. Future individual decision-making models must include a more quantitative approach to address these issues in the competitive marketplace. Research on individual decision-making clearly indicates that mechanical or quantitative

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decision-making is always equal to or better than judgmental approaches (Gatewood & Feild, 2001). In addition, prior compensation research provides numerous examples of structured, quantitative decision-making models, such as the Improshare and Scanlon gain-sharing programs, piece rate incentive programs, sales commission, and the balance sheet approach to expatriate pay. In spite of these research findings and examples, the compensation research does not include the same level of quantitative sophistication in the individual base pay determination process, which represents the single largest financial decision in most organizations. We propose the following propositions related to testing the effects of individual pay model decision approaches: Proposition 7. Individual pay decision models that are structured, more quantitative, and that include a broad range of job related factors will improve employee pay satisfaction; and reduce grievances, union activity, and charges of pay discrimination. Proposition 8. Individual pay decision models that are structured, more quantitative, and that include a broad range of job related factors will increase managerial satisfaction with the pay determination process and increase the efficiency of the financial resource allocations. Proposition 9. Individual pay decision models that are structured, more quantitative, and that include a broad range of 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 followed organizational structure and the use of ILMs. Consequently, much of the past research conducted on compensation reflected organizational characteristics and personnel practices that had an internal rather than an external focus. This included a focus on compensation issues and practices such as job evaluation, internal equity, pay level, and individual reactions to pay. The internal focus that characterized much of the research in compensation was appropriate up until the 1990's or so that witnessed tremendous organizational change. Change factors included globalization, the shift 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 organizational structures and reductions in organization size, and changes in approaches to production. All of these 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 labor market exerting a stronger influence on organizations and actual compensation practice. In spite of these changes, present compensation research has not kept pace with compensation practice that has shifted to a more external focus on external labor markets, market pricing, and concern with issues such as external competitiveness and stakeholder interests. The overall theme of this paper has been on the need for organizational scientists and compensation researchers to shift away from a primary internal focus in compensation research to include an external focus. This shift is needed to stay aligned with current organizational practice and compensation practitioners who have largely moved away from using job evaluation as the cornerstone of compensation system design and have adopted market pricing. In light of this change in compensation practice, as researchers we believe a disconnect exists between present compensation research and practice. Future compensation research, in order to be relevant to organizational practice, needs this external reorientation. As has been noted elsewhere in this special issue, while compensation represents one of the most important human resource 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 on internal compensation issues. While compensation research needs to include an external focus, consistent with current compensation practices and organizational needs, future research should also continue examining compensation concerns that exist within organizations such as individual reactions to pay.

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