What happens if employees' pay is not externally competitive, that is, it is lower than the market rate? Beyond its immediate demoralizing effect on existing employees, ultimately many will leave to seek higher pay, leaving the company with a reduced ability to generate sales, revenues, profits, and a future. Replacing departed employees will become increasingly difficult, as candidates take themselves out of consideration after learning they can earn higher salaries elsewhere.

What happens if a company's compensation falls on the other side of being externally competitive? That is, it is higher than the market rate, considering productivity performance. It's much more likely that the company will not remain competitive, that profits will be inadequate to sustain the company's growth, and ultimately adjustments to pay, and possibly benefits, will have to be made. Employees will justifiably see such actions as "take-aways."

How do we determine what's externally competitive? It's typical to conduct a periodic survey of similar companies that hire the same types of employees. The goal is to compare positions with similar duties, responsibilities, and experience levels, and their corresponding pay and other compensation. Ideally, we should also include some measure(s) of employee productivity, or in the case of the CEO, company performance measures such as return on equity in their industry. Result-oriented productivity measures, such as revenue per employee and profit per employee are preferred. A company may be willing to pay more for a higher level of performance or may need to pay less for a...