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Employee Compensation

Employee Compensation

Equity compensation is pay to a stakeholder in a company that comes in the form of ownership in a company. This could come in the form of options, shares or restricted stock.


There are many forms an employee can be compensated and underlying employee incentive alignment techniques used by employers.

Employees generally work to compensate the disutility created by working. The higher the compensation, the more an employee will endure disutility in return. However, the exchange of work time for non-work time is not a linear relationship and appears to exhibit marginally declining returns. For example, when someone is paid a very large sum of money, he may not work 50% longer if he only receives 50% more income. He may require 150% more income to work 50% longer. Finding the equilibrium to maximise employee output and compensate employees is a tricky relationship involving short term, long term incentives as well as understanding value drivers and the components of disutility.

Efficiency Theory

One theory proposed by Economists Shapiro and Stiglitz, within the field of labour market economics, is called the efficiency wage. They purport that by paying employees a salary higher than the commanding market clearing wage employers are able to incentive employees to work harder. The efficiency wage refers to the identification of the non-shirking condition, NSC, which encourages the employee to keep working. One common example cited is the compensation of investment bankers. It is thought that the perceived high salaries motivate the employees to continue to work as they understand that they are being paid higher than the market salary for the value of output of their work. At first instance, this appears to be a complex relationship but can be explained very easily when one understands that the labour market demand and supply curves are a result of derived demand from product markets.

Wage set as a function of derived demand from the product market for the good or service

The wage a person is given is thought to reflect the value reflected by the employee's input to the overall product to which he or she contributes, hence, the value of a football player is much higher than the value of an accountant. This is because an accountant delivers to the customer a value for auditing financial statements and this service has a price in the market. In the same way a footballer delivers value to the franchise he is a member of through branding, ad sales, and success of the team in the sports league - all of which can add a significant revenue to the club if the footballer is at the top of the field, such as Ronaldo or Messi. Hence, the value of is transferred into the labour market for footballers as it also does in the market for accountants, resulting in, some cases, significantly different salaries.




Further reading


Efficiency Wage (1984)


Academic paper

Documentaries, videos and podcasts



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