Theories Used to Set Employee Compensation

According to Otten (2008), three different theories are used to set employee compensation and they include value theory, agency theory, and symbolic theory. Value theory assumes that executive compensation should be set based on market forces and the value that executives’ services bring to the market. For instance, The Ken Blanchard Companies determines how much to pay its executives using value theory. The company prefers value theory of setting executives pay to agency and symbolic theories because it believes that aligning values to executives pay creates a high performance and helps a company to realize a competitive advantage (The Ken Blanchard Companies, 2010).

Agency theory assumes that pay levels and structures for executives are determined based on the problems faced by an agency. This theory focuses more on how to pay executives than how much they should receive. Companies that use agency theory to set executive compensation tend to align executives pay with organizational problems. For instance, The National Nuclear Corporation, a Chinese State-Owned Enterprise prefers agency theory to value and symbolic theories because it helps to align the interests of shareholders with those of executives (Mengistae and Xu, 2009).

The symbolic approach to setting executives pay assumes that executives should be paid according to the roles, status, and expectations of executives. Companies that use symbolic theory argue that executives pay should reflect on the executives’ dignity, status, and expectation. For instance, Barrick Gold Corporation prefers symbolic theory to value and agency theories because it believes that aligning executives pay to their constructed beliefs helps to enhance their performance (Shmuel, 2013).

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