Business Memo Mental Accounting

TO: The Director of Human Resources at McKinsey 

FROM: Enter Name, Accounting Special Consultant

DATE: April 21, 2021

SUBJECT: Structuring the Compensation Package

With reference to the principles of mental accounting, and the need for McKinsey to structure their compensation package to maximize the number of offers accepted, it is important to first understand the concept of transaction versus acquisition utility. According to Thaler (188), acquiring a product requires one to code it as a gain compared to the forgone money as a loss. As such, McKinsey should codify a compensation package in terms of acquisition utility and transaction utility where the former measures the value of what is to be obtained relative to the cost, while the latter measures the perceived value of the entire process (Thaler 188). The result of this mental accounting reasoning is that McKinsey will look for the best compensation package based on its need to maximize the number of offers accepted and will also manage to find transaction and acquisition utility from the process. Because of the utility that the company is looking to attain, setting the compensation ceiling and floor will be important towards its overall aim. McKinsey will have to use an amount they are willing to pay as compensation, an amount already in the budget, code it as important and proceed to provide what they were already willing to spend in order to maximize the number of offers accepted in recruitment.

To retain employees, mental accounting introduces the concept of the diversification heuristic. Thaler (202) describes the diversification heuristic as an observation where people prefer to diversify more given several choices at once, compared to when making the same decision sequentially. In line with this thinking, McKinsey should structure its compensation in a way that gives the employees several choices at once regarding their compensation preference without adding to the total compensation. McKinsey employees should be given different choices as part of their compensation package such as base pay, insurance benefits, and company stock options grouped together as one package or another one made up of different percentages of the same package to ensure that employees choose one of the two compensation packages as opposed to a single base pay that is higher in amount. The intention here is to create a sense of diversification, thus increasing overall satisfaction amongst the employees. Employees would proceed to pick one of the package options because they mentally account for the other additions to the base pay as separate incomes. By using this compensation structure, McKinsey will attain its agenda to retain employees through the diversification heuristic.