Internal and External Equity in Compensation Systems, Organizational Absenteeism and The Role of Explained Inequalities

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Internal and external equity in compensation systems, organizational

absenteeism and the role of explained inequalities
Article in Human Relations · March 2014

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HUM0010.1177/0018726714528730Human RelationsDella Torre et al.
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2015, Vol. 68(3) 409–440
Internal and external equity © The Author(s) 2015
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DOI: 10.1177/0018726714528730
organizational absenteeism and hum.sagepub.com
the role of explained inequalities
Edoardo Della Torre

University of Bergamo, Italy
Matteo Pelagatti
University of Milan-Bicocca, Italy
Luca Solari
University of Milan, Italy
Abstract
We investigate how the design of compensation systems influences workers’ behaviours
at the organizational level by building upon the consequences of equity theory at the
individual level. We identify four main gaps to fill in the existing equity-in-compensation
research: i) the simultaneous analysis of internal and external inequity; ii) the distinction
between inequitable and unequal compensation systems; iii) the organizational-level
(rather than individual) effects of inequitable systems; and iv) the inclusion of absenteeism
among the negative organizational outcomes of inequitable systems. The analysis of a
sample of about 1500 Italian manufacturing firms shows that both internal and external
equity are relevant factors in explaining the level of absenteeism. On the one hand,
external pay equity is associated with a lower level of absenteeism, and the relationship
becomes stronger when high pay levels are explained by past employees’ performances.
On the other hand, internal pay equity showed a more complex relationship, where
blue-collar employees seem to react more in terms of absence to internal inequity than
white-collars; moreover, performance-based pay policies (i.e. explained inequalities)
Corresponding author:
Edoardo Della Torre, Department of Management, Economics and Quantitative Methods, University of
Bergamo, via dei Caniana 2, Bergamo 24127, Italy.
Email: edoardo.dellatorre@unibg.it
Downloaded from hum.sagepub.com at Unimib Bicocca / Sage on March 4, 2015

410 Human Relations 68(3)
further enhance the extent blue-collar employees react to internal pay equity. These
results have important theoretical and practical implications, and confirm that the
organizational consequences of workers’ behaviours are not a mere reflection of
individual-level decisions.
Keywords
absenteeism, compensation, equality, equity, Italy, pay, performance pay, rewards
Introduction
Compensation systems have received close attention from researchers and practitioners
in Strategic Human Resources Management. The main reason for this concern is the role
that pay policies play in influencing workers’ behaviours and organizational perfor-
mance. As a consequence, scholars have developed different theories to illustrate how
these processes occur (see Boselie, 2010; Gerhart and Rynes, 2003; Gerhart et al., 1995).
In this article, we look at how the design of compensation systems influences firm-
level absenteeism at the organizational level by building upon the consequences of equity
theory (Adams, 1963, 1965) at the individual level. Equity theorists largely agree that
absenteeism (together with turnover and job performance decrements) is one of the main
strategies used by employees to reduce their efforts in response to situations of organiza-
tional inequity (Adams, 1963; Carrell and Dittrich, 1978; Cosier and Dalton, 1983;
Dulebohn and Werling, 2007). Despite this, management research has mainly focussed
on the effects of pay dispersion within organizations (internal inequity) on team or organ-
izational performance and turnover (e.g. Bloom, 1999; Bloom and Michel, 2002; Pfeffer
and Langton, 1993; Shaw and Gupta, 2007). Pay differentials across organizations
(external equity) on the one hand, and absenteeism on the other, have gone largely unex-
plored (see Dulebohn and Werling, 2007 for a review). Moreover, although equity theory
also assigns a great emphasis to the inputs (e.g. skills, effort, productivity) that individu-
als put into their work in order to determine whether or not inequity-related issues arise,
the existing literature in the equity-in-compensation field largely fails to include in its
framework the distinction between pay inequity and pay inequality explained by
employee performances (Kepes et al., 2009; Shaw et al., 2002; Trevor et al., 2012), that
is, inequalities that derive from differences among employee inputs and that are therefore
accountable as equitable pay policies.
Empirical studies on equity in pay systems and absenteeism are typically developed
at the individual level of analysis (e.g. De Boer et al., 2002; Geurts et al., 1993, 1999;
Sweeney and McFarlin, 2005; Van Yperen et al., 1996). We believe that there are impor-
tant advantages to be gained from considering the relationships between internal and
external equity in compensation systems, and absenteeism at organizational level. First,
this approach requires us to focus on the ‘actual’ (rather than the ‘perceived’) equity of
compensation systems. As noted by Werner and Mero (1999), this may be considered as
a limitation by equity scholars because equity theory is a perceptual theory. However,
our aim is not to test equity theory, but to build upon equity theory predictions to derive

Della Torre et al. 411
and test hypotheses in order to better understand and manage absenteeism at the organi-
zational-level. Focusing on ‘actual’ inequity makes it possible to enable management to
devise collective and organization-wide interventions that are more effective and less
‘resource-intensive’ than individual ones (Hausknecht et al., 2008; Werner and Mero,
1999). Second, this approach allows us to consider the impact of the larger organiza-
tional context that influences workers’ decisions: ‘as products of collective experiences,
they [workers] may have propensities and dimensionalities that are not duplicated in
their individual level analogues’ (Steel et al., 2002: 448, see also Dineen et al., 2007 and
Rentsch and Steel, 2003), thereby providing an ‘organizational’ explanation. More than
35 years ago, Carrell and Dittrich (1978) noted that, by focusing on the perceptions of
employees about their pay, equity theory does not include the employees’ perceptions
and evaluations about the overall compensation system of the organization where they
work. Since then, few efforts have been made to include the systemic dimension of com-
pensation policies in the research designs.
We illustrate these advantages through an analysis of a sample of 1500 Italian manu-
facturing firms that allows us to contribute to the equity-in-compensation field in four
ways. First, following the original formulation of Adams (1963) we consider the employ-
ees’ decision to ‘leave the field’ (i.e. to be absent) as one of the main reactions of workers
to situations of organizational inequity, thus extending the range of the negative conse-
quences of inequitable compensation systems beyond the well-studied decrease in perfor-
mance and increase in turnover to incorporate absenteeism. Second, we depart from the
traditional intra-organizational equity research based on individual level data and consider
the organizational level, thus providing evidence on the aggregated outcomes of workers’
reactions to inequitable situations. Third, we identify the specific importance of internal
and external pay equity, thus shedding some light on the different effects of the two
dimensions on workers’ behaviours. Finally, we include the distinction between inequita-
ble and unequal compensation systems in the theoretical framework, thus providing a
deeper understanding of how comparison processes take form at the collective level.
Equity in compensation systems

The literature in the field of organizational justice has a long history. A recent review
identifies four dimensions of justice in organizations:
Procedural justice reflects the perceived fairness of decision-making processes and the degree
to which they are consistent, accurate, unbiased, and open to voice and input . . . Distributive
justice reflects the perceived fairness of decision outcomes, especially the degree to which
outcomes are equitable . . . Interpersonal and informational justice reflect the perceived fairness
of the enactment and implementation of decisions . . . with the former reflecting the
respectfulness and propriety of communications and the latter reflecting the truthfulness and
adequacy of explanations . . . . (Colquitt et al., 2013: 200)
Distributive justice can be considered as the earliest dimension that has been addressed
by organizational literature, and equity theory represents its main theoretical foundation
(Colquitt et al., 2001).

The majority of equity theory predictions were developed during the 1960s and 1970s,
except for the pioneering work of Festinger (1954) on social comparison processes. In
his seminal paper, Adams (1963: 424) identified a situation of inequity ‘for Person when-
ever his [sic] perceived job inputs and/or outcomes stand psychologically in an obverse
relation to what he [sic] perceives are the inputs and/or outcomes of Other’. In a subse-
quent work that refined the previous formulation, Adams stated that:
Inequity exists for Person whenever he [sic] perceives that the ratio of his outcomes to inputs
and the ratio of Other’s outcomes to Other’s inputs are unequal, either (a) when he [sic] and
Other are in a direct exchange or (b) when both are in an exchange relationship with a third
party and Person compares himself [sic] to Other. (Adams, 1965: 268)
With regard to the design of compensation systems, equity theory research identified
three main concerns (Carrell and Dittrich, 1978). First, a compensation system is defined as
equitable if ‘employees perceive a fair, just, or equitable return for what they contribute to
their job’ (p. 202). Second, equity theory includes the concept of ‘social comparison’, that is,
the process developed by employees ‘to determine what their equitable return should be
after comparing their inputs (skill, education, effort, etc.) and outcomes (pay, promotion, job
status, etc.) with those of their co-workers (comparison person)’ (p. 203). Third, equity the-
ory assumes that if employees perceive the compensation system as inequitable, ‘they will
seek to reduce inequity by cognitive distortion of inputs and/or outcomes, by directly alter-
ing inputs and/or outcomes, or by leaving the organization’ (p. 203).
Despite the theoretical clearness of the formulation, empirical investigation in this field
is tricky, since equity, fairness and justice are ‘slippery’ concepts (Lazear and Shaw, 2007),
rather difficult to fully operationalize and measure. As an example, equity theory clearly
predicts that individuals make comparisons between their own input/output ratio and that
of other persons. However, what ‘input’ and ‘output’ are is often hard to determine:
In the laboratory settings [that were widespread in empirical analyses during the 1960s and
1970s: see Cosier and Dalton, 1983], subjects usually focus on their own effort as the salient
input and on their own salary as the salient output. But in everyday work situations many more
behaviours can be recognized and weighted in determining the input-outcome ratio, and many
of these can be assigned to either side of the ratio. (Weick, 1966: 419)
Internal equity, external equity and pay referents

There are several ways in which individuals may choose their referents for comparisons
(Sweeney and McFarlin, 2005), and several authors have elaborated on the relative
importance of each referent in determining individuals’ perceptions of equity (e.g. Blau,
1994; Brown, 2001; Dornstein, 1988; Goodman, 1974; Harris et al., 2008; Law and
Wong, 1998; Summers and DeNisi, 1990). Although Goodman’s (1974) original formu-
lation distinguished between three sets of referents (the other, the self and the system)
and although Blau (1994) elaborated on this typology to identify five pay referents cat-
egories (social, financial, historical, organizational and market), an easier and more
widely accepted distinction is between external and internal pay referents (i.e. the organ-
izational and market categories in Blau’s typology).

External equity refers to the employee’s perception of being treated in the same way
as employees in the same job but at a competing organization, while internal equity
refers to the employee’s perception of being treated in the same way as employees within
a focal organization (Werner and Mero, 1999). For internal equity, the comparison may
occur with employees in the same job (employee equity) or at the same organizational
level (horizontal or lateral equity), or employees at a different organizational level (verti-
cal equity) (Bloom, 1999; Trevor et al., 2012; Werner and Mero, 1999).
The focus of compensation research has for long been primarily on internal equity,
and empirical analyses on the effects of compressed or dispersed internal pay structures
on employees’ performances and attitudes are the core of the equity approach to compen-
sation (e.g. Bloom, 1999; Cowherd and Levine, 1992; Evan and Simmons, 1969;
Heyman, 2005; Pfeffer and Langton, 1993; Trevor et al., 2012). However, the demise of
external equity by research is surprising given that organizations keep investing on
expensive compensation surveys that allow them to compare their compensation policies
across organizations in the same industry or in the same labour market.
On reviewing compensation literature, Dulebohn and Werling (2007) note that firms’
compensation strategies to attract, motivate and retain employees have been influenced
by the prevalence of internal labour markets; because the primary objective of compen-
sation scholars is to help organizations and individuals to design better compensation
systems, the attention paid to the internal consequences of these systems can be attrib-
uted to this trend (Dulebohn and Werling, 2007). At a theoretical level, the internal focus
can be attributed to the statements of equity theory. In its original formulation by Adams
(1965), ‘person’ and ‘other’ (i.e. the individual and the referent) should be both in an
exchange relationship with a third party (i.e. an employer); and Festinger’s social com-
parison theory states that individuals prefer more similar others (i.e. their colleagues) for
social-comparison purposes (Festinger, 1954; see also Weick, 1966). These theoretical
statements have induced scholars to focus on internal pay equity. Specifically, empirical
evidence suggests that both the horizontal and the vertical dimension of internal equity
are important in determining employee pay satisfaction and performance (see Brown et al.,
2003; Harris et al., 2008; Ronen, 1986; Trevor et al., 2012 for horizontal equity; see
Bordia and Blau, 1998; Cowherd and Levine, 1992; Harris et al., 2008; Martin, 1981;
Sweeny and McFarlin, 2005 for vertical equity). For instance, Harris and colleagues
(2008) showed that among individuals with similar experience and job (horizontal
equity) upward comparison significantly predicts pay level satisfaction, and Cowherd
and Levine (1992) found that pay differentials between lower-level employees and
upper-echelon managers (vertical equity) are related to business-unit product quality.
Despite the large amount of research focusing on internal pay equity, the effects of
pay differentials between blue-collars (i.e. employees who perform manual tasks, e.g. a
metal-worker) and white-collars (i.e. employees who perform non-supervisory clerical
tasks, e.g. a pay-roll officer) have gone largely neglected. It is our understanding that
comparing these two occupational groups may represent a significant empirical advance-
ment for the equity-in-compensation field since this kind of comparison can be consid-
ered as an horizontal comparison (i.e. a comparison between employees that are at the
same organizational level), given that both white-collars and blue-collars are generally
located at the basis of the organizational hierarchy, and cover the lowest levels in the

social structure of the organization (although among both blue- and white-collars some
jobs may require high technical/professional skills). Moreover, both blue-collars and
white-collars are generally excluded from advanced human resource management prac-
tices like talent management that might provide a rationale for inequity between supervi-
sors, managers and all other employees, thereby making the comparison less
meaningful.
Alongside providing a more meaningful comparison within organizations, there are
several important theoretical and empirical reasons for a more systematic integration of
the external context into equity-in-compensation research. At the theoretical level, the
recent economic changes (e.g. globalization, trade liberalization, deindustrialization,
decrease in unionization), together with ‘a market penetration into the internal labour
markets of organizations’ (Dulebohn and Werling, 2007: 198), suggest that the focus
should be more on the external than the internal context of pay structures. At the empiri-
cal level, existing empirical research seems to support the importance of external equity
by demonstrating that it impacts even more than internal equity on employees’ pay satis-
faction and performances (e.g. Brown, 2001; Dornstein, 1988; Ronen, 1986), and sug-
gesting that external equity can compensate for the negative effects of internal inequity
(e.g. Bloom and Michel, 2002; Brown et al., 2003).
In this article we consider both internal (horizontal: blue-collars versus white-collars)
and external (blue- and white-collars in one firm versus blue- and white-collars in com-
peting firms) equity in compensation systems as factors that may affect HR outcomes.
Equity, equality and work-related outcomes

According to equity theorists, the main consequence of an inequitable compensation
system consists in the negative reactions of employees, who will seek to restore equity
by cognitive or direct distortions of their inputs and/or outcomes, or by quitting the
organization and looking for a more equitable one (Carrell and Dittrich, 1978). In other
words, ‘perceived inequity generates a negative emotional state (i.e. feelings of resent-
ment) that, in turn triggers various withdrawal reactions’ (Geurts et al., 1999: 254). As
outputs (i.e. pay setting and pay structure) are a management prerogative, the easiest way
for employees to modify their input/output ratio is to alter inputs (i.e. the effort put in the
job) or ‘to fly out’ to another organization (Werner and Mero, 1999).
Several empirical findings are available on the relationship between internal and
external equity and work-related outcomes (several of them do not use equity theory
explicitly, but provide related concepts and constructs), such as organizational and
individual performance (e.g. Bloom, 1999; Cowherd and Levine, 1992; Evan and
Simmons, 1969; Shaw et al., 2002; Trevor et al., 2012), turnover (e.g. Batt, 2002;
Bloom and Michel, 2002; Shaw and Gupta, 2007; Trevor et al., 1997) and absenteeism
(e.g. De Boer et al., 2002; Geurts et al., 1999; Geurts et al., 1993; Pfeifer, 2010; Van
Yperen et al., 1996).
Overall, the findings support the theory, although some puzzling evidence emerges
especially in relation to internal equity (i.e. pay dispersion). On concluding his survey on
the effects of wage dispersion, Guthrie (2007: 355) states that the effects are ‘unequivo-
cally equivocal’; he recognizes that this result may be reasonable because both compressed

and hierarchical structures may violate the principles of equity theory (see also Bloom,
1999). Specifically, it has been shown that the effects of hierarchical pay structures may
depend on the presence and the incidence of performance-based pay policies; at high levels
of performance-based pay, pay dispersion and wide pay differentials may have positive
effects on the workforce performance (Kepes et al., 2009; Shaw et al., 2002). Trevor and
colleagues (2012) further elaborated on this point by distinguishing ‘dispersion in explained
pay’ (i.e. inequality) from ‘dispersion in unexplained pay’ (i.e. inequity). They report that
the existing literature frequently confuses ‘inequality’ with ‘inequity’, and they theorize
that in highly interdependent work settings the effects of horizontal pay dispersion (i.e. pay
differences among employees within the same job or organization level) on team perfor-
mance depend on whether or not pay differences are input-based (i.e. derive from differ-
ences in ‘productivity-relevant employee inputs’ and therefore are not sources of inequity
but, on the contrary, configure an equitable situation). In this study, we adopt this distinc-
tion by including in our analysis the possible role of explained inequalities in influencing
the firm level of absenteeism.
Another issue to be considered is that management literature has been mainly con-
cerned with the relationships among pay systems equity, organizational performance
and employee turnover, while absenteeism is an outcome more researched within the
psychological literature (e.g. De Boer et al., 2002; Geurts et al., 1993; Sweeney and
McFarlin, 2005).
Our literature review emphasizes the presence of four main gaps in the existing
equity-in-compensation research: i) the simultaneous analysis of internal and external
equity; ii) the distinction between inequitable and unequal compensation systems; iii) the
organizational-level effects of inequitable systems; and iv) the inclusion of absenteeism
among the negative organizational effects of inequitable systems. In the next section we
specify our hypotheses in order to fill these gaps.
Hypotheses
Internal and external equity and absenteeism
Although presenteeism per se does not necessarily have a positive impact on individual
and firm performance (Baker-McClearn et al., 2010), absenteeism is almost universally
considered to be one of the most detrimental behaviours that employees can use to restore
the balance between their inputs and outputs in situations of organizational inequity.
Equity theory predicts that pay inequity generates pay dissatisfaction (Sweeney and
McFarlin, 2005) and employees’ dissatisfaction is related to absenteeism outcomes
(Williams et al., 2006). According to Adam’s (1963) original formulation of equity the-
ory, ‘leaving the field’ is one possible reaction of Person to situations of inequity and
‘this may take the form of quitting his [sic] job or obtaining a transfer or a reassignment,
or of absenteeism’ (p. 428). Adams also theorized that the adoption of this kind of reac-
tion (i.e. absenteeism) ‘will vary not only with the magnitude of inequity present, but
also with Person’s tolerance of inequity and his [sic] ability to cope with it flexibly’
(1963: 428). Here, the concept of ‘group absence norm’ or ‘absence culture’ (Gellatly
and Luchak, 1998; Johns and Nicholson, 1982; Harrison and Martocchio, 1998;

Nicholson and Johns, 1985) acquires importance, as the Person’s tolerance of inequity
may be influenced by group’s tolerance of (and reaction to) inequitable situations. In
other words, the group may elaborate a set of shared understandings about absence legiti-
macy (Johns and Nicholson, 1982), which will differ according to the level of equity that
characterizes the compensation system. Such a set of shared beliefs may, in turn, affect
the decision of the individual to react to inequitable situations with withdrawal behav-
iours. In this way, the absence decision is no more a private behaviour only; it is influ-
enced by the collective absence culture established by the members of the organization
(Gellatly and Luchak, 1998; Martocchio, 1994; Nicholson and Johns, 1985). This implies
that in research at the organizational level, we need to consider absenteeism as different
from the simple aggregation of private (individual) reactions to the relative (individual)
inequity situation (Dineen et al., 2007; Rentsch and Steel, 2003). Dineen and colleagues
(2007) investigated the relationship between foci of satisfaction (internal, i.e. team mem-
bers, and external, i.e. job) and absenteeism and found strong evidences that for internal
satisfaction the mean team satisfaction is strongly negatively related to absenteeism,
only when team satisfaction dispersion is lower and that such relationship is weaker and
rather similar to individual level findings when dispersion is higher. Following this
approach, we can expect that, in firms with overall inequitable pay systems, employees
will develop a shared feeling of dissatisfaction and are less likely to generate an absence
culture that discourages individuals from calling in sick, while in firms with overall equi-
table pay systems such culture will be generated and consequently employees will be less
absent from work (even if they perceive to be in a deprived situation). Therefore, firms
with inequitable pay systems will report higher levels of absenteeism than firms with
equitable pay systems.
As explained in the following methods section, since we capture the level of equity of
the firm’s compensation system through the pay ratios between white-collars and blue-
collars (internal pay ratio), and between blue- and white-collars of the firm and blue- and
white-collars of all the firms in the same industry (external pay ratio), we will express
our hypotheses with reference to these specific constructs for ease of interpretation. This
definition of the internal pay ratio implies the relationship between the equity and absen-
teeism to be non-linear, as inequity arises either at high level of the ratio (i.e. when white-
collars are overpaid with regard to blue-collars) or at low level of the ratio (i.e. when
blue-collars are overpaid with regard to white-collars):
Hypothesis 1: Internal pay ratio has a non-linear relationship with absenteeism: absen-
teeism will be higher at low and high levels of the pay ratio.
Hypothesis 2: External pay ratio has a negative relationship with absenteeism.
According to equity scholars, the availability of information about referent’s pay (and
performance) is one of the preconditions for using a group and/or an individual as a ref-
erent, and blue- and white-collars could encounter greater difficulties than managerial
employees in collecting information about what happens on the market (Goodman,
1974). From this point of view, one could easily expect that for non-managerial employ-
ees the preferred level of comparison is with their colleagues and that internal pay

differentials assume greater relevance than external pay levels. However, we can also
reasonably assume that while employees have not official and systematic information
about what might happen in other firms, they know whether their employer is generally
leading, matching or lagging behind the market pay-line. Moreover, in highly unionized
contexts (as it is the case for the Italian manufacturing sector that we are investigating),
employees can easily access information about the inputs and outputs in other firms
through unions’ representatives. Finally, we should acknowledge the patterned nature of
the development of the Italian manufacturing sector, which together with the limited
extension of the country, and the presence of strong local cultures and bonds, may allow
an easier comparison by workers living in the same local area. Existing empirical find-
ings support this expectation, showing that external reference groups are more signifi-
cant than internal reference groups in explaining pay level satisfaction, job attitudes and
behavioural propensities (e.g. Brown, 2001; Dornstein, 1988; Ronen, 1986; Scholl et al.,
1987). Brown (2001) adopted Blau’s approach (1994) to study pay referents for the pub-
lic sector research employees and found that, contrary to her hypothesis, market pay
referents were the most significant group in determining the employees pay level satis-
faction. Similarly, Sweeney and McFarlin (2005) studying two different samples of pub-
lic sector workers found that both internal and external pay referents were strongly
significant in influencing pay satisfaction, but the size effect was higher for external
referents in both of the two samples (however, since this was not the focus of their study,
they did not test for the significance of the differences in coefficients). More consistently
with our empirical field of analysis, Dornstein (1988) analysed the relevance of the wage
reference groups for blue- and white-collars in four industrial plants and found that ‘the
employing organization emerges as a relatively less significant frame of reference for
both groups [i.e. blue- and white- collars] when compared with the extra-organizational
categories’ (p. 228).
Moreover, at firm-level, internal pay inequity assumes that there are some employees
who benefit from the inequity situation (i.e. who have an input/output ratio lower than
that of their colleagues). According to equity theory, overpaid employees should behave
in a way that reduces the inequities by being more present at work then their colleagues,
thus partially offsetting the higher level of absenteeism of individuals that are in deprived
situations. For example, in a situation of inequity where white-collar employees are
overpaid with respect to blue-collars, the latter may react by ‘leaving the field’ (Adams,
1963), that is, increasing their absences from work to reduce their input/output ratio, and
the former may augment their effort by being more present, so that their input/output
ratio increases. If this is the case, internal equity could become irrelevant at firm level
because the increased effort of overpaid employees offsets the reduced effort of under-
paid employees.
However, social comparison processes may be different for blue- and white-collars.
Dornstein (1988) provided evidence that pay satisfaction for blue-collars is negatively
related to comparisons with others in dissimilar occupations, while for white-collars it is
comparisons with similar others (i.e. white-collars), which we could not test for in our
analysis, that more strongly influence pay satisfaction. Moreover, the empirical evidence
is stronger for reactions to underpayment inequity than it is for reactions to overpayment
inequity (Dulebohn and Werling, 2007; Harris et al., 2008), and it also shows that upward

comparison (i.e. comparison of oneself with others who are better off in terms of pay) is
more influential than downward comparison in determining pay level satisfaction (Harris
et al., 2008). Therefore, we can expect that at firm level, internal inequity is related to the
level of absenteeism (as in Hypothesis 1), but also, because equity theory presumes that
some positive effects on overpaid employees exist, that the relationship is mitigated by
the increased effort of employees who benefit from the inequity situation.
On the contrary, as to external equity recent empirical findings demonstrate the con-
sistency across occupational groups of firms’ strategies for leading, matching or lagging
the market pay level (Yanadori and Kang, 2011). Therefore, it is likely that when a pay
system is externally (in)equitable it is (in)equitable for the large majority of the employ-
ees involved in that system. In those cases, dissatisfaction becomes a shared feeling in
the firm, and withdrawal behaviours should be present regardless of the relative position
of single employees in the internal pay structure:
Hypothesis 3: External pay ratio has a stronger relationship with absenteeism than
internal pay ratio.
We also expect firms leading the market in terms of pay levels to show lower levels of
absenteeism even if their pay system is internally inequitable. Indeed, existing evidence
shows that, at the individual level, high pay levels may compensate for the negative
effects of pay dispersion (Bloom and Michel, 2002; Brown et al., 2003). Brown and col-
leagues’ analysis of acute care hospitals showed that pay levels (referred to the market
pay line) act as moderators between hierarchical pay structures and various indicators of
hospitals’ performances: specifically, high pay levels reduce the negative effects of non-
egalitarian wage structures (Brown et al., 2003).
Receiving pay higher than that of other employees in the same job but with a different
employer increases the degree of employee satisfaction and reduces the potential depri-
vation feeling of employees in the low tiers of the internal pay structure. Moving to the
organizational level, pay levels that are, on average, higher than those of other similar
firms make internal inequity become non-relevant. Conversely, an internally equitable
pay structure is not enough to compensate for the negative effects of paying individuals
less than what other similar firms do:
Hypothesis 4: External pay ratio moderates the relationship between internal pay ratio
and absenteeism: at a high level of external pay ratio the relationships between inter-
nal pay ratio and absenteeism will be weaker than at a low level of external pay
ratio.
Explained inequality and absenteeism

The existing individual-level literature shows that the negative effects of inequity are
stronger in work group settings, and especially in work groups where the tasks are highly
interdependent (e.g. Bloom, 1999; Shaw et al., 2002), that is, where employees fre-
quently interact in order to achieve group goals. Generally speaking, pay compression in

work groups is seen as the preferred compensation approach for the effectiveness of the
work group, because it reduces the incentives to engage in sabotage or other non-
cooperative behaviours (Lazear and Shaw, 2007).
However, on analysing National Hockey League players, Trevor and colleagues
(2012) found that when pay dispersion is explained by differences in employee
inputs, the effects on team performance are positive, while when it is unexplained it
has no or detrimental effects (Trevor et al., 2012). These results are consistent with
previous empirical findings showing that a hierarchical pay structure can work in
organizational contexts characterized by the presence of individual incentives, while
in contexts characterized by the absence of individual incentives and by close inter-
dependence among jobs, it is the wage compression model that is more effective
(Shaw et al., 2002).
Plausibly, moving from group performance to absenteeism, these relationships should
also hold in contexts of low interdependence or where the level of interdependence is
unknown. Kepes and colleagues (2009), in their analysis of a sample of motor carriers (a
context where jobs are quite independent), found that the accident frequency ratio was
negatively associated with the pay range width when such pay range was highly based on
performance pay policies, while the relationship was positive when performance pay
was low. From our perspective, if the high level of pay differentials within the firm is not
explained by the differences in the levels of previous employee performance, the result
may be general employee discouragement from putting more effort into the job (i.e. it
will reduce their presence at work). By contrast, when pay differentials are the result of
performance-related pay increases, employees will seek to increase their effort and the
organizational consequence should be a low level of absenteeism:
Hypothesis 5: Performance-related pay policies moderate the relationships between

internal pay ratio and absenteeism: when the performance-related component of pay
is high, the relationships between internal pay ratio and absenteeism is weaker than
when the performance-related component of pay is low.
The same process holds for external equity as well, assuming the strategy of the firm on
this issue to be consistent across the organization (Yanadori and Kang, 2011). On the one
hand, if the low level of pay is the consequence of the poor past performances of the
employees, then the effects in terms of organizational absenteeism should be lower than
in cases in which low pay levels cannot be explained by the employees’ performance. On
the other hand, if the higher levels of pay are explained by the past level of individual
performance, then the employees should be incentivized to invest more effort in the job
and thus will be more present at work, while if they are unexplained by past perfor-
mances employees are less likely to be more present at work:
Hypothesis 6: Performance-related pay policies moderate the relationship between

external pay ratio and absenteeism: when the performance-related component of pay
is high, the relationship between external pay ratio and absenteeism is stronger than
when the performance-related component of pay is low.

Data and empirical procedure

Sample
The data used for the analysis were collected in the annual labour-market survey con-
ducted by the General Confederation of Italian Industry (Confederazione Generale
dell’Industria Italiana, Confindustria) in 2009. As the largest Italian employers’ associa-
tion, Confindustria’s membership consists of around 150,000 manufacturing and service
firms. The questionnaire used for the survey is organized into three parts. The first covers
the contractual and socio-demographic characteristics of the labour force (e.g. types of
contract, sex, qualifications, education, origin, hiring, terminations). The second part
collects information on working time and absences from work, distinguishing among the
causes of absence (e.g. sickness, accident, parental leave, strike action, time off for trade-
union activities). The third part gathers information on the levels and composition of pay
in absolute values (seniority pay, variable pay, merit pay, other bonuses). The question-
naire was sent to the HR manager or to the owner of each company by the local associa-
tions of Confindustria (which is organized alongside administrative grouping at the
province level), which then collected the replies and sent them to the central Confindustria
research unit. The Research Department of Confindustria checked the quality of the data
for each questionnaire in terms of consistency of the information collected and then
elaborated the results and released a descriptive report (Confindustria, 2010; see also
Battisti and Vallanti, 2013 for the description of the Confindustria survey).
The survey collected information on 3667 manufacturing firms. The matching with
the AIDA (Analisi Informatizzata delle Aziende Italiane) database of Bureau Van Dijk to
obtain data sheet balance reduced the number of usable records to 2051 firms. The AIDA
database is the Italian section of the AMADEUS database and collects financial informa-
tion on more than 500,000 Italian companies. The matching between the two databases
was performed by Confindustria through the VAT number of the companies that took
part in the survey. Among the 2051 firms, 34 were excluded because they had not (or
they did not report data on) blue-collars and/or white-collars at the time of the survey. We
also excluded from the analysis all the firms that showed missing values for one or more
of the variables included in the analysis. The final sample is of 1462 firms.
Given their membership in Confindustria, all the firms in the sample applied a
national, industry level, collective agreement to regulate work. The distribution of firms
by sector and size shows that metalworking firms, as well as those of a small size (fewer
than 50 employees), represented around 50 percent of the sample. In terms of representa-
tiveness within the Italian manufacturing sector, the sample shows an over-presence of
medium and large firms as well as an over-presence of metalworking firms (which is,
however, the largest manufacturing sector in the Italian manufacturing economy).
Measurement
All the variables were in percentage terms, except for the control variables of firm size
(number of employees), labour productivity (Euros), personnel costs (Euros) and pres-
ence of a workplace collective wage agreement (dummy variable). This methodological

choice was consistent with that taken by other studies on the relations between the char-
acteristics of pay systems and workers’ behaviour (e.g. Shaw and Gupta, 2007). The
absenteeism and pay variables refer to the average at firm level for blue- and white-collar
workers.
Absenteeism. The survey collected information about the amount of total contractual work
hours and lost hours for blue- and white-collars. The information about lost hours is very
specific and it is disaggregated across different reasons like hours lost for holidays, sick-
ness, accidents, paid time-off for union representatives, parental leaves and strikes. This
allowed us to adopt as a measure of absenteeism the percentage – aggregated at firm level
– of working hours lost by blue- and white-collars for reasons other than holidays and
parental leaves. By adopting such a measure of absenteeism we also address the call by
Rentsch and Steel (2003) to adopt measures of absences more specific than the total time
lost or the absence frequency. We excluded holidays and parental leaves as they are not
related to withdrawal behaviours; the use of parental leaves and holidays should reason-
ably not differ in firms with inequitable versus equitable compensation systems. On the
contrary, all the other motives of absence (sickness, accidents, paid time-off for union
representatives and strikes) may conceal employee withdrawal behaviours. We are aware
that the employees may become affected by a serious illness or injury, or may use paid
time-off for union activities in a proper manner, but these motives of absence are without
any doubt more apt than holidays (usually 25–28 days per year, depending on the collec-
tive bargaining in each sector) and parental leaves (five months compulsory and fully
paid, plus seven months optional with reduced pay) to capture the employees reactions to
inequitable situations, as in those cases, even when they have good reasons to be absent,
employees can easily lengthen or reduce their days (or hours in case of union activities) of
absence according to their level of satisfaction with the organization. In addition, it has
been shown that the generosity of institutional workers’ insurance schemes against
absence is an important determinant of levels of absenteeism (Frick and Malo, 2008). In
Italy, the social security system and collective bargaining ensure economic coverage for
the worker, which is substantially equal to 100 percent of the wages lost because of sick-
ness absence (see Scoppa, 2010). In such a context, the choice to ‘leave the field’ as a
response to a situation of organizational inequity has no economic consequences for the
employees and therefore absenteeism is an easy option for them in order to restore an
equitable situation. Given the rigidity of the labor market, moreover, absenteeism in this
form could be an easier and less risky substitute for turnover.
External pay ratio. To measure external equity, we used the ratio between the firm’s aver-
age pay level for blue- and white-collars and those of other firms in the same industry
(chemicals, rubber, textile, metal machinery, food, construction and other manufactur-
ing). This measure is consistent with the definitions provided by Brown and colleagues
(2003), that is, the ‘firm’s average compensation relative to that of the other, competing
organizations’ (Brown et al., 2003: 752). We do not have direct information on the aware-
ness of employees about their level of pay with respect to that of employees in similar
jobs in other firms, but we can reasonably assume that employees know whether their
employer is leading, matching or lagging the market pay-line. Moreover, this is a highly

unionized sample and through unions’ representatives the employees can easily access
information about the level of pay in other firms. Finally, the limited size of the country,
the patterned distribution of economic activity and the strong cultural and social bonds,
might make it easier to collect information at least locally.
Internal pay ratio. The internal equity between white-collar employees and blue-collar
employees is expressed as the pay differential of the white-collars versus the blue-col-
lars. The questionnaire asked respondents to report the annual average pay of manual
workers (i.e. blue-collars) and clerical workers (i.e. white-collars; supervisors and man-
agers were specifically excluded from this category). The descriptive statistics reported
in Table 1 show that on average white-collar employees earn 34 percent more than blue-
collar employees. As said, such a measure for the internal equity between white- and
blue-collar employees implies the relationship between equity and absenteeism to be
non-linear, as inequity arises either when white-collars are overpaid with regard to blue-
collars or when blue-collars are overpaid with regard to white-collars. Therefore, the
internal pay ratio has also been squared before running the regression analysis (as well
as the external pay ratio in order to exclude non-linear relationship for pay levels).
Performance-related pay. We operationalize performance-related pay policies through

two components of the annual pay: merit pay and variable pay. Merit pay is expressed as
the percentage incidence of stable individual performance-related pay in gross annual
pay. This measure was in line with the definition given by Gerhart and colleagues: ‘an
increase to base salary (often on an annual basis) that is based on (subjective) perfor-
mance appraisal ratings, usually by an employee’s supervisor’ (2009: 260). Variable pay
is the percentage incidence in gross annual pay of the variable performance-related pay.
In the Italian manufacturing sector the variable performance-related pay for non-mana-
gerial/non-supervisory employees (i.e. blue- and white-collars) is negotiated at the com-
pany-level with trade unions and, as a consequence, generally has a collective (rather
than individual) nature, that is, it is mainly linked to the unit’s or group’s performance
(Checchi, 2002). Individual variable incentives for blue- and white-collars are quite
uncommon in Italy. Therefore, in our analysis this measure mainly captures the incidence
of collective variable pay. Finally, we do not operationalize bonuses and other premiums
as types of performance-related pay policies because the questionnaire asked respond-
ents to report jointly on the company-wide bonuses and the extra month’s pay (which is
a permanent payment provided by some of the national or workplace collective agree-
ments; it is not related to individual or collective performance). As we cannot distinguish
between company-wide bonuses and extra month’s pay, we consider this measure unable
to fully represent a performance pay policy. Moreover, company-wide bonuses are typi-
cally based on the company’s economic performance (profits), not on the individual/
group/unit job performance.
Explained inequalities. In order to test Hypotheses 5 and 6, the internal pay ratio and
external pay ratio were made to interact with performance-related pay policies, that is,
merit pay and variable pay. This choice permits us to capture inequalities explained by
previous individual employees performance (pay ratios interacting with merit pay) and

Table 1. Means, standard deviations and correlations.a,b
Mean SD 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20.
1. Absenteeism 6.0% 4.5%

Della Torre et al.
2. Internal pay ratio 34.0% 27.7% .10

3. External pay ratio 100.0% 19.0% –.08 .14
4. Merit pay 12.0% 10.0% –.03 .15 .20
5. Variable pay 2.2% 3.9% .06 –.07 .34 –.09
6. Bonuses and other premia 2.8% 4.1% .06 .01 .26 –.08 .06
7. Seniority pay 4.6% 5.0% .07 –.02 –.05 .31 –.04 –.02
8. Personnel costs (EUR mln) 7.3 13.1 .16 .07 .13 –.09 .18 .17 –.02
9. Labour productivity (EUR tnd) 67.9 98.7 –.04 –.01 .15 .00 .09 .05 –.02 .12
10. No. of employees 244 1366 .07 .01 .03 –.08 .08 .05 .00 .29 .67
11. Temporary 8.4% 9.8% –.04 –.08 –.01 .00 –.03 –.04 –.05 –.09 .07 –.04
12. Part time 4.9% 6.6% .00 .04 –.05 .11 –.03 –.09 –.01 –.12 –.06 –.06 –.02
13. Foreign 6.2% 11.4% .07 .03 –.11 .01 –.05 –.09 –.05 –.15 –.03 –.06 .09 .01
14. Women 24.4% 18.6% .00 .08 –.08 .06 –.05 –.05 –.02 –.07 –.06 –.03 .11 .35 –.07
15. Graduates 8.8% 10.6% –.06 .01 .27 .10 .09 .07 –.05 .26 .18 .10 .12 –.06 –.14 .09
16. Blue-collars 60.9% 20.7% .19 .00 –.36 –.22 –.02 –.03 .02 –.12 –.18 –.05 –.14 –.04 .20 –.15 –.69
17. White-collars 32.9% 17.0% –.23 .02 .33 .26 –.01 –.03 –.01 .01 .12 –.01 .13 .08 –.16 .15 .51 –.92
18. Supervisors 4.1% 6.4% .00 –.04 .20 –.01 .08 .11 –.04 .29 .21 .17 .08 –.08 –.15 .07 .62 –.56 .24
19. Involuntary turnover 4.6% 21.4% .03 –.02 –.02 .01 –.02 –.01 –.01 –.01 .07 –.01 .20 .03 .40 .04 .05 –.02 .02 .01

20. Workplace collective 0.6 0.5 .19 .03 .15 –.09 .28 .21 .02 .32 .07 .12 –.12 –.05 –.18 –.06 .12 –.05 –.02 .15 –.05
agreement (dummy)
21. Employment rate 64.4% 4.6% –.02 .07 .08 .07 .01 –.03 –.08 –.04 –.05 –.03 –.07 .06 .13 .11 –.05 –.06 .08 –.04 .00 .04
n = 1462.
aVariables from 1 to 7 refer to blue- and white-collar workers only.
bCoefficients equal to or greater than .06 in absolute values are significant at p < .05; coefficients equal to or greater than .07 in absolute values are significant at
p < .01; coefficients equal to or greater than than .09 in absolute values are significant at p < .001.
423
inequalities explained by previous collective employees’ performance (pay ratios inter-

acting with variable pay). The use of performance-based pay policies to capture employ-
ees’ inputs is common in the compensation literature that addresses equity issues (e.g.
Brown et al., 2003; Kepes et al., 2009; Shaw et al., 2002).
Control variables. We considered several control variables to test the validity of the rela-
tionships that emerged from the regression analysis. First, as our objective was to verify
the net relationships of internal and external equity with absenteeism, we inserted con-
trols about the incidence of the different components of the pay system (other than merit
and variable pay) that may be directly related to absenteeism. These were measured as
the percentage incidences of seniority pay and bonus and other premiums. Moreover,
there is evidence that other factors may have a relationship with the level of absenteeism.
These include: the size and the business sector of the firm (Barmby and Stephan, 2000;
Winkelmann, 1999); the presence of unions and collective bargaining agreements (Dal-
ton and Perry, 1981; Leigh, 1984); the composition of the workforce by gender and
occupational group (Barmby and Stephan, 2000); the level of education and the national-
ity of the workers (Avery et al., 2007); the proportion of temporary and part-time work-
ers (Winkelmann, 1999); and the conditions on the local labour market (Hausknecht et
al., 2008). Finally, controls were inserted also with regard to balance sheet data that
included personnel costs and labour productivity.
Data analysis
In order to test our hypotheses, we estimated a battery of regressions on an increasing set
of explanatory variables. Since our response variable, the rate of absenteeism, takes val-
ues in the [0,1] interval, we based our analysis on the fractional logit model (FLM) of
Papke and Wooldridge (1996).1 The estimates are also compared with those of more
traditional linear and Tobit models to make sure that our results are robust to the model
choice.
The FLM is a logistic regression model where the response variable can take values
in the whole interval [0,1] and not only on its boundaries. Thus, if Yi is a random variable
taking values in the unitary interval, then the FLM models its conditional expectation as
E[Yi | X1,i , , X k ,i ] = G ( β 0 + β1 X1,i +  + β k X k ,i ) ,
where G ( x ) = 1 / (1 + exp(− x) ) is the (S-shaped) logit function. Papke and Wooldridge

(1996) avoid further specification of the conditional distribution of Yi and propose to
estimate the regression coefficients by maximizing the standard log-likelihood of the
logistic model in a quasi-maximum-likelihood fashion (see White, 1982). The standard
errors of the estimates are then obtained by using the Huber-White sandwich formula and
are robust to heteroskedasticity (White, 1980) and distributional misspecification (White,
1982).

The introduction of the explanatory variables in the model followed six steps. We ran
Model 1 only with control variables; in Model 2 we added the single components of the
pay structure; we inserted in Model 3 all our variables for internal and external equity
(i.e. internal and external pay ratios); Model 4 introduced the squared terms for internal
and external pay ratio; we inserted the interaction between internal and external pay
ratios in Model 5; and finally Model 6 tested for the interactions between internal and
external pay ratios and performance-related pay. In Models 1 to 4, controlling for perfor-
mance-pay variables, we analysed the impact of inequities unexplained by previous per-
formance (Hypotheses 1 through 4). In Model 4, alongside the squared term for internal
pay ratio, we also inserted the squared term for external pay ratio in order to exclude the
presence of a non-linear relationship for external equity (see Brown et al., 2003). In
Models 5 and 6 we considered also the role of inequalities that derive from previous
individual performances (i.e. explained inequality) by inserting the interaction between
internal and external pay ratios with merit pay (i.e. the incidence of permanent perfor-
mance-related pay on annual gross pay) and variable pay (i.e. the incidence of variable
performance-related pay on annual gross pay).
In order to avoid multicollinearity problems owing to the multiplicative terms, all
the pay variables have been mean-centred before calculating the interaction effects and
running the analysis (Aiken and West, 1991). We further monitored the variance infla-
tion factors (VIFs) to check the possible occurrence of multicollinearity in our analy-
sis; all the relevant variables remained well below the accepted threshold of 10 (Belsley
et al., 1980)
Results
The descriptive statistics set out in Table 1 show that the average level of absenteeism of
blue- and white-collars is 6 percent of the annual workable hours and that performance
pay policies represent 17 percent of the their gross annual pay: more specifically, merit
pay accounts for 12 percent, variable pay for 2.2 percent, and bonus pay for 2.8 percent.
These results about pay policies, particularly the low incidence of variable pay, are con-
sistent with the findings of a recent comparative study showing that Italian firms rank
lowest in terms of adoption of practices able to attract talent, and in terms of indicators
and incentives for the systematic evaluation of workers’ performance and definition of
their economic reward (Bloom et al., 2008). The explanations may largely be found in
the strong centralization of the Italian pay system, which fixes standard pay levels for
every skill grade and professional level through sectorial collective bargaining – with
narrow margins of manoeuvre left for managers and workers to define firm-level pay
policies. However, pay policies exhibit rather large standard deviations. This indicates
that there is some variation in the pay settings, with some firms not applying pay policies
(or only to a very limited extent) and others applying them extensively.
The analysis of the correlations shows that the level of absenteeism has significant
relationships with all the pay policies considered, except for merit pay. Nevertheless,
only in the case of external pay ratio is the relation negative. Among pay variables, the
strongest correlations are between merit pay and seniority pay, meaning that the older the
workforce the higher the incidence of the permanent performance-pay component, and

between external pay ratio and variable pay, meaning that the firms that lead the market
in terms of pay level base their pay strategy on variable pay. The relationships between
absenteeism and internal and external pay ratios are strongly significant (r = .10 and p <
.001 for internal pay ratio; r = -.08 and p < .01 for external pay ratio).
The regression results reported in Table 2 indicate that the inclusion of the variables
capturing the characteristics of the compensation system increases the variance explained
by the models by 7 percent (change in R2 from Model 1 through Model 6). This result is
consistent with the findings of previous research performed at the organizational level.
For instance, Brown and colleagues (2003), on analysing the effects of pay level and pay
dispersion on three measures of hospital performance, found that their OLS models
increased the variance explained by 2 percent, 4 percent and 7 percent depending on the
measure of organizational performance considered. The only pay component that shows
significant association with the level of absenteeism is seniority pay (Model 2); the
higher is its incidence on annual gross pay, the higher the level of absenteeism.
The results do not provide support for Hypothesis 1, while they corroborate
Hypothesis 2 (Models 3 and 4). External pay ratio is negatively associated with absentee-
ism, while the relationship is mainly linear for internal pay ratio, with the curvilinear
effect also significant but running in the opposite direction (downward) of what was
hypothesized (see also Figure 1 to see the relationship graphically). The analysis also
leaves Hypotheses 3 and 4 unsupported. As for Hypothesis 3, Model 4 shows that the
coefficients and the level of significance are higher for internal pay ratios compared with
external pay ratio; however, the significance test (at 5% level) on the equality of the coef-
ficients does not reject the null hypothesis that the coefficients are equal (χ2 = 3.090, p =
.079). As for Hypothesis 4, Model 5 shows that the relationship between internal pay
ratio and absenteeism is not moderated by external pay ratio.
Finally, Model 6 reports that when internal and external pay ratios are allowed to
interact with performance-based pay components (i.e. merit pay and variable pay), the
variance explained by the model strongly increases. Specifically, it is merit pay that is the
performance-pay component that shows significant interaction with pay ratios (p < .001
for the interaction with external ratio; p < .05 for the interaction with internal pay ratio),
while the variable pay interaction does not reach significance (at p < .05). In fact, the
interaction between internal pay ratio and variable pay, though running in the expected
direction, is only marginally significant (p < .10). The results imply that individual per-
formance has an effect, while collective performance does not show the same pattern of
interaction. To better understand the pattern of the significant interactions (i.e. internal
and external pay ratios with merit pay), the results are graphically represented in Figure 1
and Figure 2, where the relationship between internal (Figure 1) and external (Figure 2)
pay ratio are plotted for different degrees of merit pay incidence. Figure 1 shows that the
interaction with internal pay ratio is positive at all levels (low, moderate and high) of
merit pay. The three slopes are all significant (p < .001), but the moderation effect is
weaker at low level of merit pay. This means that the relationship between internal pay
ratio and absenteeism becomes stronger at high levels of the merit pay component.
Hypothesis 5 is therefore not supported. Figure 2 shows that at high level of the merit pay
component the negative relationship between external pay ratio and absenteeism is
stronger than at low level of the merit pay component (that is not significant), thus cor-
roborating Hypothesis 6.

Table 2. Fractional logit regression results for absenteeism.
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6
B t B t B t B t B t B t
No. of employees (× thousand) .03† 1.84 .03† 1.90 .03† 1.67 .03† 1.66 .03† 1.66 .03 1.64
Della Torre et al.
Personnel costs (× milliard) 5.40*** 3.65 5.52*** 3.74 5.13*** 3.48 4.74** 3.21 4.76** 3.23 4.78** 3.24
Labour productivity (× million) –.66* –2.14 –.68* –2.20 –.60* –1.97 –.60* –1.97 –.60* –1.97 –.57† –1.90
Temporary .12 .57 .15 .72 .18 .88 .22 1.07 .23 1.08 .21 .99
Part time .17 .55 .15 .50 .15 .49 .25 .81 .25 .82 .14 .47
Foreign .57** 3.09 .59** 3.22 .55** 3.01 .52** 2.89 .53** 2.90 .53** 2.93
Women .33** 2.60 .31* 2.51 .23† 1.86 .22† 1.71 .22† 1.71 .20 1.59
Workplace collective agreement .29*** 6.81 .29*** 6.63 .28*** 6.44 .27*** 6.06 .27*** 6.04 .26*** 5.97
Employment rate −.31 −.73 −.22 −.51 −.20 −.47 −.21 −.49 −.22 −.51 −.15 −.34
Graduates .23 .77 .25 .84 .21 .70 .18 .59 .19 .63 .20 .68
Blue-collars .33 .51 .34 .53 .24 .38 .23 .36 .26 .41 .12 .20
White-collars −.87 −1.35 −.88 −1.38 −.85 −1.35 −.85 −1.34 −.81 −1.29 −.93 −1.49
Supervisors .44 .56 .46 .60 .52 .68 .54 .71 .56 .73 .44 .57
Involuntary turnover .05 .54 .04 .49 .05 .58 .05 .59 .05 .57 .06 .62
Industry dummies yes 8.83 yes 8.93 yes 7.66 yes 7.03 yes 6.79 yes .23
Seniority pay .95* 2.53 .94* 2.50 .97* 2.57 .99** 2.63 .44 1.09
Merit pay .17 .80 .13 .61 .14 .63 .12 .57 .09 .39
Variable pay .07 .15 .69 1.27 .72 1.29 .66 1.19 .28 .39

Bonuses and other premia .21 .43 .53 1.06 .63 1.25 .60 1.18 .53 1.05
Internal pay ratio .26*** 3.79 .72*** 4.97 .71*** 4.90 .79*** 5.39
External pay ratio −.30* −2.16 −.35* −2.06 −.32† −1.83 −.39* −2.18
Internal pay ratio (squared) −.35*** −3.46 −.33** −3.19 −.41*** −3.79
External pay ratio (squared) .19 1.05 .11 .55 .00 .01
Internal pay ratio*External pay ratio −.22 −.78 .12 .38
(Continued)
427
428
Table 2. (Continued)
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6
B t B t B t B t B t B t
Internal pay ratio*Variable pay −2.59† −1.87

Internal pay ratio*Merit pay 1.39* 2.26
External pay ratio*Variable pay −.65 −.69
External pay ratio*Merit pay −4.60*** −4.00
R2 .12*** .14* 2.55 .15*** 8.43 .16*** 7.15 .16 .62 .19*** 5.64
†significantat .10 level; *significant at .05 level; **significant at .01 level; ***significant at .001 level.
For the row Industry dummies the t-ratio columns contain the Wald statistic for the hypothesis that the seven Industry dummies coefficients are all equal to zero
(the distribution under the null is Chi-Square with 6 d.f.); for the row R2 the t-ratio columns contain the F statistic for the hypothesis that the R2 increment is zero.

Human Relations 68(3)
MERIT PAY
7.0% Low (1 SD below standard mean)
Moderate (sample mean)
High (1 SD above sample mean)
Absenteeism
6.0%
5.0%
4.0%
1 SD below Sample mean 1,SD0above
3
sample mean sample mean
Internal pay rao
(white- to blue-collars)
Figure 1. Relationship between internal pay ratio and absenteeism for different degrees of
merit pay.
Note: the comparison is made using the linear model (the correlation between the linear and the fractional
logit model predictions is 0.97). SD = standard deviation.
7.5%
MERIT PAY
Low (1 SD below sample mean)
7.0% Moderate (sample mean)
High (1 SD above sample mean)
Absenteeism
6.5%
6.0%
5.5%
- 1 SD below Sample mean 1,SD above
sample mean sample mean
External pay rao
Figure 2. Relationship between external pay ratio and absenteeism for different degrees of
merit pay.
Note: the comparison is made using the linear model (the correlation between the linear and the fractional
logit model predictions is 0.97). SD = standard deviation.

Table 3 reports the estimates of the linear, Tobit and fractional logit regressions for
Model 6. The t-ratios and, thus, the p-values are very close, except for the interaction
term ‘Internal pay ratio*Variable pay’, which is significant (at p < .05) in the Tobit
regression only. The fractional logit model yields the best fit with a coefficient of deter-
mination (R2) of 0.19 against the 0.15 of the other two models. However, the correlations
among the predictions of the three models are extremely high: all above 0.97. The same
happens also for the estimates of Models 1 through 5 (which we do not report but are
available upon request).
Discussion and implications

Findings
The results described in the previous section demonstrate that the actual equity of pay
systems contributes to explaining the level of absenteeism. We only found empirical sup-
port for two out of six of our hypotheses derived from extending equity theory predic-
tions at an organizational level of analysis, and the results suggest some interesting
points to be discussed, as well as having important implications for managers and
researchers.
The relationships between external and internal pay ratios with the level of absentee-
ism are both significant across all the models (except for external pay ratio in Model 5).
For external pay ratio the relationship runs in the expected direction (the higher the pay
ratio, the lower the absenteeism), while for internal pay ratio the relationship is the oppo-
site of what was hypothesized. Specifically, for internal pay ratio (i.e. the pay differential
between white-collars and blue-collars) the relationship is mainly linear, with a slight
downward concavity (see Figure 1).
We propose two explanations for these results. First, the linear main effect suggests
that blue-collars are more reactive than white-collars to situations of organizational ineq-
uity. The results show that when pay differentials are in favour to blue-collar employees
(i.e. when the pay ratio assumes negative values) the levels of absenteeism are the low-
est, while when pay differentials are in favour to white-collar employees (i.e. when the
pay ratio assumes positive values), the levels of absenteeism are the highest. This sug-
gests that occupational groups react to organizational inequity differently; such diversity
in the reactions may be related to the different propensity of the occupational groups to
develop (either tolerant or intolerant) group absence norms (Johns and Nicholson, 1982).
The existing equity-in-compensation literature is lacking of studies that systematically
address the issue of how the various occupational groups differently react to organiza-
tional inequity and future studies could usefully develop this line of inquiry. From the
management perspective, compensation practitioners should consider that designing a
pay structure with high pay differentials in favour of white-collars with the expectation
that their positive behaviour will compensate for the withdrawal behaviour of (deprived)
blue-collars may have detrimental effects on organizational outcomes.
Second, the downward curvilinear effect suggests that too egalitarian pay structures
may generate negative reactions among both blue- and white-collars. In other words, a
compressed pay structure acts as a disincentive for employees in putting effort into the

Table 3. Comparison of the estimates for the linear, Tobit and fractional logit regressions.
Linear regression Tobit Fractional response
Estimate Std error t-ratio p-value Estimate Std error t-ratio p-value Estimate Std error t-ratio p-value
No. of employees (× thousand) .00 .00 1.86 .062 .00 .00 1.84 .066 .03 .02 1.64 .101
Della Torre et al.
Personnel costs (× milliard) .34 .10 3.43 .001 .34 .10 3.46 .001 4.78 1.47 3.24 .001
Labour productivity (× million) −.03 .02 −2.04 .041 −.03 .02 −1.97 .049 −.57 .30 −1.90 .058
Temporary .01 .01 1.22 .221 .01 .01 1.19 .235 .21 .21 .99 .321
Part time .01 .02 .67 .500 .01 .02 .66 .510 .14 .31 .47 .641
Foreign .03 .01 2.57 .010 .03 .01 2.63 .009 .53 .18 2.93 .003
Women .01 .01 1.75 .079 .01 .01 1.79 .074 .20 .13 1.59 .111
Workplace collective .01 .00 5.60 .000 .01 .00 5.63 .000 .26 .04 5.97 .000
agreement
Employment rate −.01 .03 −.55 .581 −.01 .03 −.50 .614 −.15 .43 −.34 .734
Graduates .01 .02 .37 .713 .01 .02 .38 .706 .20 .30 .68 .495
Blue-collars .01 .04 .22 .828 .01 .04 .17 .866 .12 .62 .20 .844
White-collars −.05 .04 −1.33 .184 −.05 .04 −1.36 .174 −.93 .62 −1.49 .137
Supervisors .03 .04 .62 .532 .03 .04 .58 .561 .44 .76 .57 .567
Involuntary turnover .00 .01 .60 .551 .00 .01 .58 .565 .06 .09 .62 .538
Industry dummies 7.23 .300 7.69 .261 8.11 .230
Seniority pay .04 .03 1.52 .129 .04 .03 1.52 .128 .44 .41 1.09 .275
Merit pay .02 .01 1.54 .122 .02 .01 1.58 .115 .09 .22 .39 .700

Variable pay .01 .04 .30 .767 .01 .04 .33 .743 .28 .72 .39 .696
Bonuses and other premia .04 .03 1.23 .218 .04 .03 1.28 .200 .53 .50 1.05 .294
Internal pay ratio .04 .01 5.31 .000 .04 .01 5.35 .000 .79 .15 5.39 .000
External pay ratio −.02 .01 −2.22 .026 −.02 .01 −2.23 .026 −.39 .18 −2.18 .030
Internal pay ratio (squared) −.02 .01 −3.83 .000 −.02 .01 −3.94 .000 −.41 .11 −3.79 .000
External pay ratio (squared) .00 .01 .27 .786 .00 .01 .29 .768 .00 .24 .01 .992
Internal pay ratio*External pay .00 .02 .22 .829 .00 .02 .19 .849 .12 .30 .38 .701
ratio
431
(Continued)
432
Table 3. (Continued)
Linear regression Tobit Fractional response
Estimate Std error t-ratio p-value Estimate Std error t-ratio p-value Estimate Std error t-ratio p-value
Internal pay ratio*Variable pay −.16 .08 −1.95 .051 −.16 .08 −1.98 .047 −2.59 1.39 −1.87 .062
Internal pay ratio*Merit pay .08 .03 2.28 .023 .08 .03 2.33 .020 1.39 .62 2.26 .024
External pay ratio*Variable pay −.05 .05 −.86 .390 −.05 .05 −.90 .368 −.65 .93 −.69 .488
External pay ratio*Merit pay −.25 .07 −3.83 .000 −.25 .07 −3.71 .000 −4.60 1.15 −4.00 .000
R2 .15 .15 .19

Human Relations 68(3)
job. This contrasts with some existing empirical evidence showing that at organizational
level pay compression is more effective than pay dispersion (e.g. Bloom, 1999), thus
confirming the complexity of the relationship between this dimension of compensation
systems and organizational outcomes.
We did not find support for our hypothesis that external pay differentials are more
strongly related to absenteeism than internal pay ratio. This result is in contradiction with
some previous research (e.g. Brown, 2001; Dornstein, 1988), while it is consistent with
the findings reached by Werner and Mero (1999) who hypothesized the opposite rela-
tionship, that is, that internal equity is more strongly related to changes in employees’
performance than is external equity, and they did not find empirical support for it, either
in overpayment or underpayment situations. Overall, the empirical findings on this
aspect of equity processes are still poor and, to our knowledge, our study is the first to
address them at organizational level. Despite the large literature on equity-in-compensa-
tion, we know very little about how different pay referents impact on specific employees
tactics to reduce inequity (see Scholl et al., 1987 for an interesting exception), particu-
larly if the focus is on the aggregated (rather than individual) workers reactions. Future
studies that address this aspect at organizational level are particularly welcomed, since
this is a key issue in terms of management implication of compensation research. It is
only by knowing how different pay referents (e.g. internal or external, similar or dissimi-
lar) impact on different aggregated employees’ reactions (e.g. productivity, turnover,
absenteeism) that managers can design and develop compensation systems able to reduce
specific undesired outcomes accordingly to specific organizational needs.
Our findings also demonstrate that the relationship between pay equity and firm level
absenteeism depends on whether or not pay inequalities are explained by previous levels
of employee performance. It is precisely the permanent component of performance-
related pay policies (i.e. merit pay) that is significant in the interaction with internal and
external pay ratios. In both cases, this may result from the peculiarities of the Italian
manufacturing context, where the variable component of pay is often the result of a col-
lective agreement signed at company level (Checchi, 2002), while individual variable
incentives are uncommon, especially for non-managerial employees. By contrast, the
permanent merit pay component is defined at individual level by negotiation between the
employee and the management. Thus, it is likely that our results capture the variance
explained by individual and collective performance components rather than by perma-
nent and variable components.
Some important differences do exist between internal and external pay ratios regard-
ing the role of performance pay policies. As to external pay ratio, the results show a nega-
tive relationship between explained external inequality (i.e. the merit pay–external pay
ratio interaction) and the level of absenteeism. In systems where high pay levels are
explained by previous employees performances, the level of absenteeism is significantly
lower; while in systems where they are not performance-based, their relationship with
absenteeism is non-significant (see Figure 2). This is an important finding for the equity
field, suggesting that high pay levels induce employees to put more effort into the job to
restore equity only if their high level of pay is related to their performance; while if over-
payment is unrelated to performance, employees are not motivated to restore equity by
being more present at work, because they expect that their pay will increase

independently from their efforts. In the management perspective, paying employees

more than what other firms do is an effective strategy conditionally on the inclusion of
individual performance-pay policies in the compensation system design.
Consistently with this view, another possible explanation for such a result may be
found by resorting to efficiency wage theories. According to such theories, one reason
for firms to pay their employees above the market pay line is to incentivize them to avoid
shirking behaviours (such as, for example, absenteeism) and to put a greater amount of
effort into their work because of the greater risks associated with losing their current jobs
and the related wage premium (Gerhart and Rynes, 2003; Yellen, 1984). This incentive
effect becomes particularly effective in firms that rely strongly on individual perfor-
mance to determine pay levels, because in such contexts the negative consequences
related to poor performances become more apparent to the employees. This explanation
suggests that compensation theorists should develop research frameworks able system-
atically to integrate different theoretical perspectives in order to gain better understand-
ing of the effects of pay on workers’ behaviours.
In regard to internal pay ratio, the positive relationship between explained internal
inequality (i.e. the merit pay–internal pay ratio interaction) and the level of absenteeism
is surprising. The negative organizational outcomes of having high pay differentials in
favour of white-collars increase when compensation systems are based on individual
performance. Again, such result may be explained by the research context. As reported
in Table 1, merit pay incentives are mainly targeted to white-collar employees (r =.26
and r = -.22 between merit pay and white- and blue-collars, respectively). This increases
the negative reactions of blue-collar employees, both because pay differentials with
white-collar employees became larger when the merit pay component is high, and
because their perception to be treated unequally is augmented by their exclusion from
merit pay policies. From a practical perspective, this suggests that having a target-differ-
entiation strategy for performance-related pay that excludes certain occupational groups
a priori (e.g. blue-collars) may have high detrimental effects at organizational level
because of the negative reaction of excluded groups.
To conclude, from a theoretical perspective the main challenge seems to be the devel-
opment of new frameworks of analysis able to integrate the various existing theories into
a single research design. The equity theory and the efficiency wage theory have long
been considered as alternative (and mutually exclusive) approaches. Our results suggest
that the two approaches could usefully be jointly adopted by future research aimed at
analysing the effects of pay levels on workers’ behaviours (on this point see also Trevor
et al., 2012). From the practitioners’ perspective, the state of the art suggests that HR
managers should bear in mind that the effects of explained and unexplained inequalities
in pay systems seem to vary according to various aspects, including the characteristics of
the employees, that of the professional groups and that of the firms (e.g. hockey team-
players or blue-collars in manufacturing firms), and the critical outputs to be considered
(e.g. absenteeism, productivity or turnover). Moreover, because our findings are partially
interpretable through institutional lenses (related at the specific national context), man-
agers should also take these contextual processes into account when they define human
resource management policies, particularly if they are in international contexts.

Limitations
Our study has some limitations, which should be overcome by future research on the role
of equity in the design of effective compensation systems.
First, the variables that we employed to measure ‘explained inequalities’, that is,
merit pay and variable pay, are only indirect measures of employees’ inputs. Although
the existing literature considers them as good proxies for employees’ inputs (see Brown
et al., 2003), future studies should be based on more direct information concerning previ-
ous employees’ (or organizational) performance and effort, as well as their skills, their
knowledge, their expertise, their seniority and all the other inputs that may be relevant to
defining the ‘actual’ equity of the compensation system. Again, in regard to these varia-
bles, we lacked information about the presence of other HR and organizational practices
that may influence the relationships between pay equity and work-related outcomes, thus
enabling analysis of the phenomenon from the perspectives of fit, alignment and contin-
gency (Gerhart et al., 2009; Kroumova and Lazarova, 2009). As an example, we can
expect high investments in training policies to play a significant role in reducing the
negative inequity implications of having pay levels below the mean of the market,
because employees perceive their deprived pay conditions to be temporary and owing to
the firm’s economic investment in the development of their competencies. In the same
way, firms with aggressive competitive strategies that invest in the recruitment of highly
competitive employees may have positive returns from designing a highly dispersed
compensation system. This represents a promising line of inquiry for equity scholars.
A second limitation of our study is that it fails to detect how the ascertained relation-
ships vary across time (Weick, 1966). Earlier equity theorists considered the perception
of equity to be a ‘transitory phenomenon’ that ‘diminishes over time’ (Carrell and
Dittrich, 1978: 205), and they suggested closer investigation of how equity perceptions
vary ‘at any event that triggers a comparison’ (Cosier and Dalton, 1983: 313), for exam-
ple, a promotion or a salary increase. These claims remained unexplored in empirical
research, notwithstanding their potentially important theoretical and practical implica-
tions, and should therefore be included in future research designs.
Conclusion
This article has adopted an equity perspective to investigate the relationship between
compensation systems’ characteristics and absenteeism at the organizational level. The
results showed that both internal and external equity are relevant factors in explaining the
level of absenteeism. On the one hand, external pay equity is associated with a lower
level of absenteeism and the relationship becomes stronger when pay levels are explained
by past employees’ performances. On the other hand, internal pay equity showed a more
complex relationship, where blue-collar employees seem to react more in terms of
absence to internal inequity than white-collars; moreover, performance-based pay poli-
cies (i.e. explained inequalities) further enhance the extent to which blue-collar employ-
ees react to internal pay equity. These findings suggest several fertile grounds for future
research in the equity-in-compensation field, including the impact of inequitable com-
pensation policies on different occupational groups, the role of distinct pay referents in

influencing different kinds of employees’ withdrawal behaviour and the role of the insti-
tutional context in affecting employees’ reaction to (potentially) equitable pay policies.
Acknowledgements
We are grateful to the Associate Editor, Neil Conway, and three anonymous reviewers for their
thoughtful and supportive comments on earlier versions of this article.
Funding
This research received no specific grant from any funding agency in the public, commercial, or
not-for-profit sectors.
Note
1 We thank an anonymous referee for drawing our attention to this class of models.
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Edoardo Della Torre is Assistant Professor of Organization Theory and Human Resource
Management at the University of Bergamo, Italy. He obtained his PhD in Labour Sciences at the
University of Milan. Dr Della Torre’s research interests include high performance work systems,
human capital, HRM outcomes and HRM practices in smaller firms. His research has been pub-
lished in European Management Review, International Journal of Human Resource Management
and International Journal of Entrepreneurial Venturing. He is also Visiting Professor at the IESEG
School of Management of the Catholic University of Lille, France, and at the Johannes Kepler
University of Linz, Austria. [Email: edoardo.dellatorre@unibg.it]
Matteo Pelagatti is Assistant Professor of Economic and Business Statistics at the Department of
Economics, Management and Statistics, University of Milan-Bicocca, Italy, and has received the
habilitation as Associate Professor. Dr Pelagatti’s research interests include theoretical and applied
statistics and econometrics, robust and nonparametric statistical procedures, financial and energy
markets, with a strong focus on time series analysis. His research has been published in Journal of
Econometrics, Journal of Applied Econometrics, Studies in Nonlinear Dynamics and Econometrics,
Energy Economics, PLoS ONE and Journal of Statistical Software. [Email: matteo.pelagatti@
unimib.it]
Luca Solari is Professor of Organization at the University of Milan, Italy. Dr Solari’s primary
research explores the evolution of human resources management and management in contempo-
rary organizations with a particular focus on the impact of new, available social technologies. He
has been Visiting Professor at EDHEC, Nice, France and at the Orfalea College of Business at
Calpoly State University, San Luis Obispo, CA, USA. He has published extensively both in Italian
and in English on topics related to evolution and change in organizations and populations of organ-
izations. He has published in Industrial and Corporate Change, International Journal of Human
Resource Management and Organizational Dynamics. [Email: luca.solari@unimi.it]
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Internal and External Equity in Compensation Systems, Organizational Absenteeism and The Role of Explained Inequalities

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Internal and External Equity in Compensation Systems, Organizational Absenteeism and The Role of Explained Inequalities

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Internal and external equity in compensation systems, organizational

Article in Human Relations · March 2014

Edoardo Della Torre Matteo Pelagatti

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Unobserved Component Models View project

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the role of explained inequalities

Edoardo Della Torre

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Equity in compensation systems

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Internal equity, external equity and pay referents

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Equity, equality and work-related outcomes

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Explained inequality and absenteeism

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Hypothesis 5: Performance-related pay policies moderate the relationships between

Hypothesis 6: Performance-related pay policies moderate the relationship between

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Data and empirical procedure

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Performance-related pay. We operationalize performance-related pay policies through

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1. Absenteeism 6.0% 4.5%

2. Internal pay ratio 34.0% 27.7% .10

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inequalities explained by previous collective employees’ performance (pay ratios inter-

E[Yi | X1,i , , X k ,i ] = G ( β 0 + β1 X1,i +  + β k X k ,i ) ,

where G ( x ) = 1 / (1 + exp(− x) ) is the (S-shaped) logit function. Papke and Wooldridge

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Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

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Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

Internal pay ratio*Variable pay −2.59† −1.87

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Discussion and implications

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Linear regression Tobit Fractional response

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Linear regression Tobit Fractional response

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independently from their efforts. In the management perspective, paying employees

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Boselie P (2010) Strategic Human Resource Management. A Balanced Approach. Maidenhead:

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