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

Copyright © 2005 South-Western. All rights reserved.1–21–2 Importance of Compensation Impacts employer’s ability to attract & retain employeesImpacts employer’s ability to attract & retain employees Ensure optimal levels of employee performance in meeting organization’s strategic objectivesEnsure optimal levels of employee performance in meeting organization’s strategic objectives Compensation’s componentsCompensation’s components –Direct compensation in wages or salary Base pay (hourly, weekly, monthly)Base pay (hourly, weekly, monthly) Incentives (sales bonuses &/or commissions)Incentives (sales bonuses &/or commissions) –Indirect compensation in form of benefits Legally required benefits (e.g., Social Security)Legally required benefits (e.g., Social Security) Optional (e.g., group health benefits)Optional (e.g., group health benefits) Impacts employer’s ability to attract & retain employeesImpacts employer’s ability to attract & retain employees Ensure optimal levels of employee performance in meeting organization’s strategic objectivesEnsure optimal levels of employee performance in meeting organization’s strategic objectives Compensation’s componentsCompensation’s components –Direct compensation in wages or salary Base pay (hourly, weekly, monthly)Base pay (hourly, weekly, monthly) Incentives (sales bonuses &/or commissions)Incentives (sales bonuses &/or commissions) –Indirect compensation in form of benefits Legally required benefits (e.g., Social Security)Legally required benefits (e.g., Social Security) Optional (e.g., group health benefits)Optional (e.g., group health benefits)

Copyright © 2005 South-Western. All rights reserved.1–31–3 Exhibit 11-1 Compensation System

Copyright © 2005 South-Western. All rights reserved.1–41–4 Internal Equity Fairness of pay differentials between different jobs in organizationFairness of pay differentials between different jobs in organization Established by job ranking, job classification, point systems or factor comparisonsEstablished by job ranking, job classification, point systems or factor comparisons Fairness of pay differentials between different jobs in organizationFairness of pay differentials between different jobs in organization Established by job ranking, job classification, point systems or factor comparisonsEstablished by job ranking, job classification, point systems or factor comparisons

Copyright © 2005 South-Western. All rights reserved.1–51–5 External Equity Fairness of organizational compensation levels relative to external compensationFairness 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 wagesAssessed by collecting wage & salary information to guide in setting organization’s pay strategy to lead, meet or lag labor market wages Fairness of organizational compensation levels relative to external compensationFairness 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 wagesAssessed 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.1–61–6 Individual Equity Fairness about pay differentials among individuals in same jobFairness about pay differentials among individuals in same job Established by usingEstablished 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 Fairness about pay differentials among individuals in same jobFairness about pay differentials among individuals in same job Established by usingEstablished 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.1–71–7 Exhibit 11-2 Equity Theory

Copyright © 2005 South-Western. All rights reserved.1–81–8 Exhibit 11-3 Equity & Work-Related Outcomes

Copyright © 2005 South-Western. All rights reserved.1–91–9 Exhibit 11-4 Classification System – Federal Government

Copyright © 2005 South-Western. All rights reserved.1–10 Exhibit 11-4 Point System Method

Copyright © 2005 South-Western. All rights reserved.1–11 Exhibit 11-7 Comparison of Job Evaluation Methods

Copyright © 2005 South-Western. All rights reserved.1–12 External Equity Collect wage & salary information to determine market wage ratesCollect wage & salary information to determine market wage rates Also consider other forms of compensationAlso consider other forms of compensation Determine pay strategy relative to marketDetermine pay strategy relative to market Collect wage & salary information to determine market wage ratesCollect wage & salary information to determine market wage rates Also consider other forms of compensationAlso consider other forms of compensation Determine pay strategy relative to marketDetermine pay strategy relative to market

Copyright © 2005 South-Western. All rights reserved.1–13 External Equity Lag policyLag policy –Lower wages than competitors, compensates employees through other means Opportunity for advancementOpportunity for advancement Incentive plansIncentive plans Good locationGood location Good working conditionsGood working conditions Employment securityEmployment security Lag policyLag policy –Lower wages than competitors, compensates employees through other means Opportunity for advancementOpportunity for advancement Incentive plansIncentive plans Good locationGood location Good working conditionsGood working conditions Employment securityEmployment security Market policyMarket policy –Wages equal to competitors –Neutralizes pay as factor Lead policyLead policy –Higher wages than competitors to ensure organization becomes employer of choice

Copyright © 2005 South-Western. All rights reserved.1–14 Individual Equity Basing pay on seniorityBasing pay on seniority Merit pay systemsMerit pay systems Incentive payIncentive 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 Basing pay on seniorityBasing pay on seniority Merit pay systemsMerit pay systems Incentive payIncentive 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.1–15 Individual Equity Skill-based pay systemsSkill-based pay systems –Base compensation on acquisition & mastery of skills –Give employees incentives to learn –Promote flexibility –Easily linked with training programs & strategic needs Skill-based pay systemsSkill-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.1–16 Individual Equity Team-based pay plansTeam-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 Team-based pay plansTeam-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.1–17 Legal Issues in Compensation Title VII of Civil Rights Act of 1964Title VII of Civil Rights Act of 1964 –Protects workers rights to fair treatment Equal Pay Act of 1963Equal Pay Act of 1963 –Requires equal pay for equal work Comparable worthComparable 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 Title VII of Civil Rights Act of 1964Title VII of Civil Rights Act of 1964 –Protects workers rights to fair treatment Equal Pay Act of 1963Equal Pay Act of 1963 –Requires equal pay for equal work Comparable worthComparable 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.1–18 Legal Issues in Compensation Fair Labor Standards Act of 1938Fair Labor Standards Act of 1938 –Regulates minimum wage –Sets overtime policy –Establishes exempt classes for managers & other professional employees Fair Labor Standards Act of 1938Fair 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.1–19 Executive Compensation No real average or standardNo real average or standard Typical annual compensation for senior executivesTypical annual compensation for senior executives –20% salary –30% annual incentives –50% long-term incentives No real average or standardNo real average or standard Typical annual compensation for senior executivesTypical annual compensation for senior executives –20% salary –30% annual incentives –50% long-term incentives

Copyright © 2005 South-Western. All rights reserved.1–20 Executive Compensation Stock GrantsStock Grants –Require organization meet specific financial goals Stock OptionsStock 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 Stock GrantsStock Grants –Require organization meet specific financial goals Stock OptionsStock 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.1–21 Key Strategic Issues in Compensation Determining compensation relative to marketDetermining compensation relative to market Balance between fixed & variable compensationBalance between fixed & variable compensation Deciding whether or not to utilize team-based versus individual payDeciding whether or not to utilize team-based versus individual pay Creating appropriate mix of financial & non- financial compensationCreating appropriate mix of financial & non- financial compensation Developing cost-effective compensation program resulting in high performanceDeveloping cost-effective compensation program resulting in high performance Determining compensation relative to marketDetermining compensation relative to market Balance between fixed & variable compensationBalance between fixed & variable compensation Deciding whether or not to utilize team-based versus individual payDeciding whether or not to utilize team-based versus individual pay Creating appropriate mix of financial & non- financial compensationCreating appropriate mix of financial & non- financial compensation Developing cost-effective compensation program resulting in high performanceDeveloping cost-effective compensation program resulting in high performance

Copyright © 2005 South-Western. All rights reserved.1–22 Reading 11.1 Compensating Teams Reasons for tailoring compensation to individualsReasons 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 Reasons for tailoring compensation to individualsReasons 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.1–23 Reading 11.1 Compensating Teams Look for ways to add on incentives & recognition for team participationLook for ways to add on incentives & recognition for team participation Reward behaviors & activities rather than resultsReward behaviors & activities rather than results Other ways of saying “thank you” constitute best incentive over long runOther 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”Be careful about anything that may be viewed as “buying” Look for ways to add on incentives & recognition for team participationLook for ways to add on incentives & recognition for team participation Reward behaviors & activities rather than resultsReward behaviors & activities rather than results Other ways of saying “thank you” constitute best incentive over long runOther 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”Be careful about anything that may be viewed as “buying”

Copyright © 2005 South-Western. All rights reserved.1–24 Reading 11.1 Compensating Teams Management often overlooks powerful intrinsic rewards that come fromManagement 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 basketLet team decide who gets what from awards basket Management often overlooks powerful intrinsic rewards that come fromManagement 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 basketLet team decide who gets what from awards basket

Copyright © 2005 South-Western. All rights reserved.1–25 Reading 11.2 Executive Compensation: New Perspectives CEOs in larger firms generally earn moreCEOs in larger firms generally earn more Mixed empirical evidence on relationship between executive compensation & firm performanceMixed empirical evidence on relationship between executive compensation & firm performance CEOs in larger firms generally earn moreCEOs in larger firms generally earn more Mixed empirical evidence on relationship between executive compensation & firm performanceMixed empirical evidence on relationship between executive compensation & firm performance

Copyright © 2005 South-Western. All rights reserved.1–26 Reading 11.2 Executive Compensation: New Perspectives Classifications of firm strategy: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 compensationSignificant relationship between organizational strategy & executive compensation Firm size continues to be major determinant of executive compensationFirm size continues to be major determinant of executive compensation Classifications of firm strategy: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 compensationSignificant relationship between organizational strategy & executive compensation Firm size continues to be major determinant of executive compensationFirm size continues to be major determinant of executive compensation

Copyright © 2005 South-Western. All rights reserved.1–27 Reading 11.2 Executive Compensation: New Perspectives Earnings per share is significant predictor of short-term executive compensation earned as annual bonusesEarnings per share is significant predictor of short-term executive compensation earned as annual bonuses Predictors of long-term executive compensation earned through stock option exercisePredictors of long-term executive compensation earned through stock option exercise –Share price growth –Return on stocks –Market measures of firm performance Earnings per share is significant predictor of short-term executive compensation earned as annual bonusesEarnings per share is significant predictor of short-term executive compensation earned as annual bonuses Predictors of long-term executive compensation earned through stock option exercisePredictors 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.1–28 Reading 11.3: New Thinking for New Millennium Strategic approaches to make compensation systems more effectiveStrategic 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 Strategic approaches to make compensation systems more effectiveStrategic 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