Adams’ equity theory posits that the level of reward an individual receives compared to their own sense of contribution (and likewise for their co-workers) influences their performance.
When employees believe a situation is fair, they are more likely to act in a way that rewards or benefits the organization. When they believe a situation is not fair, they become dissatisfied, unmotivated, and may resign.
Fairness arises from an equitable relationship between inputs and outputs and whether one believes they are compensated comparably to others.
Understanding Adams’ equity theory
Adams’ equity theory was developed by behavioral and organizational psychologist J. Stacy Adams in the 1960s.
Adams’ equity theory is a process model of motivation.
The theory posits that the level of reward an individual receives compared to their own sense of contribution (and likewise for their co-workers) influences their performance.
Adams based his motivational theory on three key assumptions:
Individuals make contributions in the form of inputs and expert certain rewards (outcomes) in return, and
To determine whether the exchange is valid, the individual compares their input and rewards with the input and rewards of others.
Individuals in an inequitable solution (whether perceived or otherwise) may attempt to reduce that inequity. This occurs via cognitive distortion of the inputs and outputs in the individual’s mind. In some cases, however, the individual will alter the inputs and rewards directly or choose to leave the company.
In the workplace, the theory believes that equity and motivation are intricately linked.
When employees believe a situation is fair, they are more likely to act in a way that rewards or benefits themselves and the organization.
Employees who identify a situation that is not equitable, on the other hand, may feel stressed or demotivated.
The most obvious example is someone who becomes dissatisfied after realizing that a peer is paid more money to do the same amount of work.
Inputs and outputs in Adams’ equity theory
Some of the inputs and outputs that contribute to equality and indeed inequality in the workplace are listed below.
Inputs
Inputs comprise the contributions an employee makes toward an organization. This includes:
The number of hours worked per week.
Experience and industry-related skills.
Social and conversational skills that contribute to a positive culture. Examples include company functions and birthday celebrations.
The ability to work under pressure and meet strict deadlines.
Commitment and enthusiasm to their role.
Personal sacrifices.
Loyalty to superiors or the organization.
Outputs
Outputs describe what the employee receives as a result of their inputs. Some of the most obvious examples include:
Salary or wages.
Annual vacation time.
Work-related trips.
Pensions and insurance.
Recognition and promotion.
Job flexibility.
Learning and career development.
The relationship between inputs, outputs, and fairness
Earlier, we mentioned that desirable employee and organizational performance is more likely in situations perceived to be fair and equitable.
But how does fairness arise, exactly?
Fairness arises from an equitable relationship between inputs and outputs. Employees want the outputs they receive to seem fair in relation to the inputs provided and this must also hold for the inputs and outputs of others.
The interaction of inputs and outputs can also be explained in three types of exchange relationships:
Overpaid inequity
When an employee perceives that their outcomes are above what is fair (when compared to co-workers).
These individuals may increase their effort to match their compensation or develop a sense of entitlement and reduce their input.
Underpaid inequity
When an employee perceives that their outcomes are less than is fair (when compared to co-workers).
As we noted, these individuals lose motivation and purpose.
Equity
The sweet spot where the employee considers that the relationship between their inputs and outputs is equal when compared to others.
The circle of competence describes a person’s natural competence in an area that matches their skills and abilities. Beyond this imaginary circle are skills and abilities that a person is naturally less competent at. The concept was popularised by Warren Buffett, who argued that investors should only invest in companies they know and understand. However, the circle of competence applies to any topic and indeed any individual.
Economic or market moats represent the long-term business defensibility. Or how long a business can retain its competitive advantage in the marketplace over the years. Warren Buffet who popularized the term “moat” referred to it as a share of mind, opposite to market share, as such it is the characteristic that all valuable brands have.
The Buffet Indicator is a measure of the total value of all publicly-traded stocks in a country divided by that country’s GDP. It’s a measure and ratio to evaluate whether a market is undervalued or overvalued. It’s one of Warren Buffet’s favorite measures as a warning that financial markets might be overvalued and riskier.
Venture capital is a form of investing skewed toward high-risk bets, that are likely to fail. Therefore venture capitalists look for higher returns. Indeed, venture capital is based on the power law, or the law for which a small number of bets will pay off big time for the larger numbers of low-return or investments that will go to zero. That is the whole premise of venture capital.
Foreign direct investment occurs when an individual or business purchases an interest of 10% or more in a company that operates in a different country. According to the International Monetary Fund (IMF), this percentage implies that the investor can influence or participate in the management of an enterprise. When the interest is less than 10%, on the other hand, the IMF simply defines it as a security that is part of a stock portfolio. Foreign direct investment (FDI), therefore, involves the purchase of an interest in a company by an entity that is located in another country.
Micro-investing is the process of investing small amounts of money regularly. The process of micro-investing involves small and sometimes irregular investments where the individual can set up recurring payments or invest a lump sum as cash becomes available.
Meme stocks are securities that go viral online and attract the attention of the younger generation of retail investors. Meme investing, therefore, is a bottom-up, community-driven approach to investing that positions itself as the antonym to Wall Street investing. Also, meme investing often looks at attractive opportunities with lower liquidity that might be easier to overtake, thus enabling wide speculation, as “meme investors” often look for disproportionate short-term returns.
Retail investing is the act of non-professional investors buying and selling securities for their own purposes. Retail investing has become popular with the rise of zero commissions digital platforms enabling anyone with small portfolio to trade.
Accredited investors are individuals or entities deemed sophisticated enough to purchase securities that are not bound by the laws that protect normal investors. These may encompass venture capital, angel investments, private equity funds, hedge funds, real estate investment funds, and specialty investment funds such as those related to cryptocurrency. Accredited investors, therefore, are individuals or entities permitted to invest in securities that are complex, opaque, loosely regulated, or otherwise unregistered with a financial authority.
Startup valuation describes a suite of methods used to value companies with little or no revenue. Therefore, startup valuation is the process of determining what a startup is worth. This value clarifies the company’s capacity to meet customer and investor expectations, achieve stated milestones, and use the new capital to grow.
Profit is the total income that a company generates from its operations. This includes money from sales, investments, and other income sources. In contrast, cash flow is the money that flows in and out of a company. This distinction is critical to understand as a profitable company might be short of cash and have liquidity crises.
Double-entry accounting is the foundation of modern financial accounting. It’s based on the accounting equation, where assets equal liabilities plus equity. That is the fundamental unit to build financial statements (balance sheet, income statement, and cash flow statement). The basic concept of double-entry is that a single transaction, to be recorded, will hit two accounts.
The purpose of the balance sheet is to report how the resources to run the operations of the business were acquired. The Balance Sheet helps to assess the financial risk of a business and the simplest way to describe it is given by the accounting equation (assets = liability + equity).
The income statement, together with the balance sheet and the cash flow statement is among the key financial statements to understand how companies perform at fundamental level. The income statement shows the revenues and costs for a period and whether the company runs at profit or loss (also called P&L statement).
The cash flow statement is the third main financial statement, together with income statement and the balance sheet. It helps to assess the liquidity of an organization by showing the cash balances coming from operations, investing and financing. The cash flow statement can be prepared with two separate methods: direct or indirect.
The capital structure shows how an organization financed its operations. Following the balance sheet structure, usually, assets of an organization can be built either by using equity or liability. Equity usually comprises endowment from shareholders and profit reserves. Where instead, liabilities can comprise either current (short-term debt) or non-current (long-term obligations).
Capital expenditure or capital expense represents the money spent toward things that can be classified as fixed asset, with a longer term value. As such they will be recorded under non-current assets, on the balance sheet, and they will be amortized over the years. The reduced value on the balance sheet is expensed through the profit and loss.
Financial statements help companies assess several aspects of the business, from profitability (income statement) to how assets are sourced (balance sheet), and cash inflows and outflows (cash flow statement). Financial statements are also mandatory to companies for tax purposes. They are also used by managers to assess the performance of the business.
Financial modeling involves the analysis of accounting, finance, and business data to predict future financial performance. Financial modeling is often used in valuation, which consists of estimating the value in dollar terms of a company based on several parameters. Some of the most common financial models comprise discounted cash flows, the M&A model, and the CCA model.
Business valuations involve a formal analysis of the key operational aspects of a business. A business valuation is an analysis used to determine the economic value of a business or company unit. It’s important to note that valuations are one part science and one part art. Analysts use professional judgment to consider the financial performance of a business with respect to local, national, or global economic conditions. They will also consider the total value of assets and liabilities, in addition to patented or proprietary technology.
A financial option is a contract, defined as a derivative drawing its value on a set of underlying variables (perhaps the volatility of the stock underlying the option). It comprises two parties (option writer and option buyer). This contract offers the right of the option holder to purchase the underlying asset at an agreed price.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
