CHAPTER 11: COMPENSATION Copyright © 2005 South-Western. All rights reserved. footer

Importance of Compensation Impacts employer’s ability to attract & retain employees Ensure optimal levels of employee performance in meeting organization’s strategic objectives Compensation’s components Direct compensation in wages or salary Base pay (hourly, weekly, monthly) Incentives (sales bonuses &/or commissions) Indirect compensation in form of benefits Legally required benefits (e.g., Social Security) Optional (e.g., group health benefits) Copyright © 2005 South-Western. All rights reserved.

Exhibit 11-1 Compensation System Copyright © 2005 South-Western. All rights reserved.

Fairness of pay differentials between different jobs in organization Internal Equity Fairness of pay differentials between different jobs in organization Established by job ranking, job classification, point systems or factor comparisons Copyright © 2005 South-Western. All rights reserved.

External Equity Fairness of organizational compensation levels relative to external compensation Assessed by collecting wage & salary information to guide in setting organization’s pay strategy to lead, meet or lag labor market wages Copyright © 2005 South-Western. All rights reserved.

Individual Equity Fairness about pay differentials among individuals in same job Established by using Seniority-based pay systems: Reward longevity Merit-based pay systems: Reward employee performance Incentive plans: Employees receive part of compensation based on performance Skills-based pay systems: Compensation based on employees possessing skills that firm values Team-based pay plans: Encourage cooperation & flexibility Copyright © 2005 South-Western. All rights reserved.

Exhibit 11-2 Equity Theory Copyright © 2005 South-Western. All rights reserved.

Exhibit 11-3 Equity & Work-Related Outcomes Copyright © 2005 South-Western. All rights reserved.

Exhibit 11-4 Classification System – Federal Government Copyright © 2005 South-Western. All rights reserved.

Exhibit 11-4 Point System Method Copyright © 2005 South-Western. All rights reserved.

Exhibit 11-7 Comparison of Job Evaluation Methods Copyright © 2005 South-Western. All rights reserved.

Collect wage & salary information to determine market wage rates External Equity Collect wage & salary information to determine market wage rates Also consider other forms of compensation Determine pay strategy relative to market Copyright © 2005 South-Western. All rights reserved.

External Equity Lag policy Market policy Lead policy Lower wages than competitors, compensates employees through other means Opportunity for advancement Incentive plans Good location Good working conditions Employment security Market policy Wages equal to competitors Neutralizes pay as factor Lead policy Higher wages than competitors to ensure organization becomes employer of choice Copyright © 2005 South-Western. All rights reserved.

Individual Equity Basing pay on seniority Merit pay systems Incentive pay Returns financial rewards to employees responsible for creating them Allows organizations to adjust compensation expenses based on organization performance Variety of forms Tied to employee’s, work unit’s, or organization’s results Copyright © 2005 South-Western. All rights reserved.

Skill-based pay systems Individual Equity Skill-based pay systems Base compensation on acquisition & mastery of skills Give employees incentives to learn Promote flexibility Easily linked with training programs & strategic needs Copyright © 2005 South-Western. All rights reserved.

Individual Equity Team-based pay plans Can be less time-consuming than administering individual reward systems May impact group dynamics Can adversely impact & intensify conflict Need decentralized decision-making system Need high level of communication with employees Employees should have voice & provide input into design Team members need to feel system is fair & equitable Copyright © 2005 South-Western. All rights reserved.

Legal Issues in Compensation Title VII of Civil Rights Act of 1964 Protects workers rights to fair treatment Equal Pay Act of 1963 Requires equal pay for equal work Comparable worth Argues that standards of equal pay for equal work should be replaced with doctrine of equal pay for equal value Objective, measurable data to support assessment of value of different jobs is lacking No basis in current law for arguments of comparable worth Copyright © 2005 South-Western. All rights reserved.

Legal Issues in Compensation Fair Labor Standards Act of 1938 Regulates minimum wage Sets overtime policy Establishes exempt classes for managers & other professional employees Copyright © 2005 South-Western. All rights reserved.

Executive Compensation No real average or standard Typical annual compensation for senior executives 20% salary 30% annual incentives 50% long-term incentives Copyright © 2005 South-Western. All rights reserved.

Executive Compensation Stock Grants Require organization meet specific financial goals Stock Options Provide opportunity to purchase shares at some future date, at price determined when options are awarded Focus employee attention on creating shareholder value Do not have to be reported as expenses Can create culture obsessed with improving stock performance at expense of other concerns Can prompt executives to engage in creative accounting practices Copyright © 2005 South-Western. All rights reserved.

Key Strategic Issues in Compensation Determining compensation relative to market Balance between fixed & variable compensation Deciding whether or not to utilize team-based versus individual pay Creating appropriate mix of financial & non-financial compensation Developing cost-effective compensation program resulting in high performance Copyright © 2005 South-Western. All rights reserved.

Reading 11.1 Compensating Teams Reasons for tailoring compensation to individuals Motivation comes from within individual as opposed to group Development of skills & behaviors is individual undertaking Fairness in dealing with teams does not mean equal pay for all Team compensation is not payoff but means of nurturing behavior that benefits team Copyright © 2005 South-Western. All rights reserved.

Reading 11.1 Compensating Teams Look for ways to add on incentives & recognition for team participation Reward behaviors & activities rather than results Other ways of saying “thank you” constitute best incentive over long run Nonmonetary recognition Gifts of appreciation after fact Be careful about anything that may be viewed as “buying” Copyright © 2005 South-Western. All rights reserved.

Reading 11.1 Compensating Teams Management often overlooks powerful intrinsic rewards that come from Team participation Being part of corporate decision-making process Let team decide who gets what from awards basket Copyright © 2005 South-Western. All rights reserved.

Reading 11.2 Executive Compensation: New Perspectives CEOs in larger firms generally earn more Mixed empirical evidence on relationship between executive compensation & firm performance Copyright © 2005 South-Western. All rights reserved.

Reading 11.2 Executive Compensation: New Perspectives Classifications of firm strategy: Prospector firms emphasize long-term incentives Defender firms are more likely to emphasize fixed pay Analyzer Reactor Significant relationship between organizational strategy & executive compensation Firm size continues to be major determinant of executive compensation Copyright © 2005 South-Western. All rights reserved.

Reading 11.2 Executive Compensation: New Perspectives Earnings per share is significant predictor of short-term executive compensation earned as annual bonuses Predictors of long-term executive compensation earned through stock option exercise Share price growth Return on stocks Market measures of firm performance Copyright © 2005 South-Western. All rights reserved.

Reading 11.3: New Thinking for New Millennium Strategic approaches to make compensation systems more effective Pay person for individual worth (knowledge, skills and competencies) rather than for value of job they perform Reward excellence through pay for performance compensation that establishes clear relationship between significant amount of pay & attainment of organizational objectives Individualize pay system to give employees choices in how they are rewarded & what reward they receive Copyright © 2005 South-Western. All rights reserved.