1. Managing Compensation
Chapter 10
Managing Compensation
In order to attract and keep talented workers, organizations must manage their compensation programs well, and the programs must be aligned with organizational goals. Depending on the nature and needs of the industry, jobs, and individuals, many compensation plan types are best suited for specific types of needs. In this chapter, we’ll review the important aspects of managing compensation.
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2. Chapter Challenges Learn about the components of total compensation
Learn how to design a compensation system
Understand the difference between job and individual pay options
In this chapter, you will learn about the components of total compensation, learn how to design a compensation system, and understand the difference between job and individual pay options.
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3. Chapter Challenges Develop familiarity with compensation tools
Become familiar with the legal environment affecting compensation and pay system governance
Additionally, after reading and discussion of Chapter 10, you should develop familiarity with compensation tools, and become familiar with the legal environment affecting compensation and pay system governance.
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4. Managerial Perspective of Designing Compensation Programs
Who should be responsible for making salary decisions?
Should pay be dictated by what other employers are paying?
What types of activities should be rewarded with higher salaries?
What criteria should be used to determine salaries?
Which employee group should receive special treatment when scarce pay resources are allocated?
How does an employer balance ethical concerns for employees’ welfare versus the need to save on labor costs?
The questions listed on this slide are just some of the questions managers and HR personnel need to ask and answer when designing and administering compensation programs. The pay system is one of the most important mechanisms that firms and managers can use to attract, retain, and motivate competent employees to perform in ways that support organizational objectives.
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5. What Is Compensation?
Total compensation is the package of quantifiable rewards an employee receives for his or her labors. It includes three components: base compensation, pay incentives, and indirect compensation and benefits.
Base compensation pay is the fixed pay an employee receives on a regular basis, either in the form of a salary or as an hourly wage.
Pay incentives are designed within a compensation program to reward employees for good performance.
The last component of total compensation is the benefits, which are sometimes called indirect compensation. Benefits encompass a variety of programs, including health insurance, vacations, and unemployment compensation (42% of the workers’ compensation package). Compensation is the single most important cost in most firms. In 2014, private-industry employers spent an average of $29.67 per hour in employee compensation. For the same period, state and local government workers averaged $41.73 per hour. Personnel costs are as high as 60% of total costs in certain types of manufacturing environments and even higher in some service organizations.
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6. Designing Compensation Systems
Enable firm to achieve its strategic objective
Mold to the firm’s unique characteristics and environment
Internal equity: perceived fairness internally
External equity: perceived fairness externally
It is important to note that compensation affects a person economically, sociologically, and psychologically. For this reason, mishandling compensation issues is likely to have strong negative impact on employees and ultimately a firm’s performance. The wide variety of pay policies and procedures presents managers with a two-pronged challenge: to design a compensation system that (1) enables the firm to achieve its strategic objectives and (2) is molded to the firm’s unique characteristics and environment.
Additionally, when organizations are designing pay systems, the internal equity and external equity aspects should be considered.
Internal equity is the perceived fairness of the pay structure within a firm. External equity is the perceived fairness in pay relative to what other employers are paying for the same type of labor.
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7. Nine Criteria for Developing a Compensation Plan
In this chapter, we’ll look closer at these nine criteria for developing a compensation plan within organizations. However, looking over these various types of plans in one space gives an indication of how many varied plans an organization can have to choose from in determining the compensation strategies that best suit its needs. Note that although there appears to be an either/or choice of plans, some organizations institute policies that fall somewhere between the two poles.
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8. Compensation Systems: Equity
Distributive Justice Model
Labor Market Model
Balancing Equity
In considering internal versus external equity, managers can use two basic models: the distributive justice and the labor model.
The distributive justice model of pay equity holds that employees exchange their contributions or input to the firm (skills, effort, time, etc.) for a set of outcomes. Pay is one of the most important of these outcomes, but nonmonetary rewards, such as a company car, may also be significant.
In the labor market model of pay equity, the wage rate for any given occupation is set at the point where the supply of labor equals the demand for labor in the marketplace. In general, the less employers are willing to pay and the lower the pay workers are willing to accept for a given job, the lower the wage rate for that job.
Balancing equity: Ideally, a firm should try to establish both internal and external pay equity, but these objectives are often at odds. Sometimes firms use alternative forms of pay, such as bonuses, to offset the difference.
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9. Compensation System Design
Fixed vs. Variable Pay
Performance vs. Membership
Firms can choose to pay a high proportion of total compensation in the form of base pay or in the form of variable pay that fluctuates according to some pre-established criterion. On average, approximately 75% of firms offer some form of variable pay and this proportion continues to increase over the years. Fixed pay is the rule in the majority of U.S. organizations largely because it reduces the risk to employees and it is easier to administer.
A special case of fixed versus variable compensation requires a choice between performance and membership. A company emphasizes performance when a substantial portion of its employees’ pay is tied to individual or group contributions and the amount received can vary significantly from one person or group to another. The most extreme forms of performance-contingent compensation are traditional piece-rate plans and sales commissions.
Firms that emphasize membership-contingent compensation provide the same or similar wages to every employee in a given job, as long as the employee achieves at least satisfactory performance.
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10. Compensation Entitlements Are Going Out the Window
Shift to Variable Pay Plans Continues
Race to the Bottom: Mexico Lowers Wages to Snare International Auto Production
Making Wage Concessions at Airlines
Pensions Going Up in Smoke
Medical Doctors Being Squeezed
Documenting Pay Cuts Around the World
This slide shows the headlines representing the various risks employees bear with regard to their pay. In the past, workers could count on fixed pay and salaries, but with changing times, and thus compensation, within companies, employees do not have “guaranteed” pay.
Variable pay plans are increasing.
“Race to the Bottom”: New jobs are being relocated to other countries because workers are willing to work for lower wages. This was true for workers in Mexico City for Ford Motor Company.
Making wage concessions at airlines: Frontier Airlines cut wages by up to 20% for its executive management team from 2009 to 2011.
Pensions going up in smoke: Employees are increasingly facing the fact that pensions are going away or being reduced significantly.
Medical doctors being squeezed: Because of changes in Medicare, Medicaid, higher malpractice insurance, and lower payments of insurance companies, physician revenues have fallen sharply.
Documenting pay cuts around the world: A simple Internet search will yield several examples of how pay is being cut all over the world.
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11. Job-Based Pay Policies
Technology is stable
Jobs do not change often
Employees do not need to cover for one another frequently
Much training is required to learn a given job
Turnover is relatively low
Most traditional compensation systems assume that in setting base compensation, a firm should evaluate the value or contribution of each job, not how well the employee performs it.
Knowledge-based pay and skill-based pay are pay systems in which employees are paid on the basis of the jobs they can do or talents they have that can be successfully applied to a variety of tasks and situations.
The slides lists several situations or contexts for which job-based pay policies are best suited.
Employees are expected to move up through the ranks over time
Jobs are fairly standardized within the industry
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12. Individual-Based Pay Policies
The firm has educated workforce with ability to learn different jobs
The company’s technology and organizational structure change frequently
Employee participation and teamwork are encouraged
Opportunities for upward mobility are limited
These are examples of situations in which individual-based pay policies are best.
Opportunities to learn new skills are present
The costs of employee turnover and absenteeism are high
These plans are more common in manufacturing environments
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13. Compensation System Design
Elitism Pay System
Egalitarianism Pay System
Firms must decide whether to place most of their employees under the same compensation plan (egalitarian pay system) or to establish different compensation plans by organizational level and/or employee group (elitist pay system).
An elitist pay system is a pay system in which different compensation systems are established for employees or groups at different organizational levels. This pay system tends to result in a more stable workforce.
An egalitarian pay system is a pay system in which most employees are part of the same compensation system. These systems tend to reduce barriers between workers, and with these systems it is easier to deploy worker to other jobs.
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14. Compensation System Design
Above- vs. Below-Market Compensation
Monetary vs. Nonmonetary Rewards
Employees’ pay relative to alternative employment opportunities directly affects the firm’s ability to attract workers from other companies. Pay satisfaction is very highly correlated with pay level, and dissatisfaction with pay is one of the most common causes of employee turnover. The decision to pay above market for all employee groups allows the firm to hire the “cream of the crop,” and minimize turnover.
One of the oldest debates about compensation concerns monetary versus nonmonetary rewards. Unlike cash or payments that can be converted into cash in the future, nonmonetary rewards are intangible. Such rewards include interesting work, challenging assignments, and public recognition. Companies that want to emphasize monetary rewards prefer to reinforce individual achievement and responsibility. Those that want to emphasize nonmonetary rewards prefer to reinforce commitment to the organization.
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15. Compensation System Design
Open vs. Secret Pay
Centralized vs. Decentralized Pay
Firms vary widely in the extent to which they communicate openly about workers’ compensation levels and company compensation practices. At one extreme, some firms require employees to sign an oath that they will not divulge their pay to coworkers; the penalty for breaking the oath is termination. At the other extreme, every employee’s pay is a matter of public record. However, many organizations are somewhere in between.
Open pay fosters trust, fairness, and commitment, whereas secret pay leads to dissatisfaction with pay.
In a centralized pay system, pay decisions are tightly controlled in a central location, normally the HR department at corporate headquarters. In decentralized pay systems, pay decisions are delegated deep down into the firm, normally to managers of each unit. Centralized pay systems maximize internal equity, whereas decentralized pay systems are better for large, diverse organizations.
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16. Compensation Tools Job-Based-Approach Pay Systems
Skill-Based-Approach Pay Systems
Compensation tools can be grouped into two broad categories depending on the unit of analysis used to make pay decisions: job-based approaches and skill-based approaches.
Job-based approaches include the most traditional and widely used types of compensation programs. These plans assume work gets done by people who are paid to perform well-defined jobs. The compensation system’s primary objective is to allocate pay so that the most important jobs pay the most. Pay grades are groups of jobs that are paid within the same pay range. Pay grade systems are job-based pay structures.
Skill-based-approach pay systems are far less common. It is assumed that workers should be paid not according to the job they hold, but rather by how flexible or capable they are at performing multiple tasks. Under this type of plan, the greater the variety of job-related skills workers possess, the more they are paid.
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17. Key Steps in Creating Job-Based Compensation Plans
There are three key components of developing job-based compensation plans: achieving internal equity, achieving external equity, and achieving individual equity. This slide summarizes how these are interrelated and the steps involved in each component. The large majority of U.S. firms rely on this or similar schemes to compensate their workforce.
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18. Achieving Equity
Internal Equity Step 1: Conduct Job Analysis Step 2: Write Job Descriptions Step 3: Determine Job Specifications Step 4: Rate Worth of All Jobs Using Predetermined System Step 5: Create a Job Hierarchy Step 6: Classify Jobs by Grade Levels External Equity Step 1: Identify Benchmark or Key Jobs Step 2: Establish Pay Policies
Job-based compensation assesses the relative value or contribution of different jobs to an organization. The first part of this process, job evaluation, is composed of six steps intended to provide a rational, orderly, and systematic judgment of how important each job is to the firm. We’ve discussed some of these concepts already, so you should be familiar with them. However, here are the six steps:
Step 1: Conduct Job Analysis
Step 2: Write Job Descriptions
Step 3: Determine Job Specifications
Step 4: Rate Worth of All Jobs Using Predetermined System
Step 5: Create a Job Hierarchy
Step 6: Classify Jobs by Grade Levels
To achieve external equity, firms often conduct market surveys. The purpose of these surveys is to determine the pay ranges for each grade level. The Bureau of Labor Statistics also provides pay information on thousands of types of jobs. Using market surveys to link job-evaluation results to external wage/salary data generally requires two steps: Step 1: benchmarking and Step 2: establishing a pay policy.
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19. Evaluating Job-Based Compensation Plans
Do not take into account the nature of the business
This plan is more subjective and arbitrary
These plans are less appropriate at higher levels within an organization
With job descriptions becoming more generalized, these plans are more difficult to evaluate
These plans tend to be more bureaucratic, mechanistic, and inflexible
The job-evaluation process tends to be biased against women
Wage and salary data are not definitive
Employees’ perceptions of equity are what count
High-tech skilled employees tend to not be loyal to one firm
Job-based compensation programs are rational, objective, and systematic, all features that minimize employee complaints. They are relatively easy to set up and administer. However, they have several significant drawbacks. This slide lists the main drawbacks.
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20. The Legal Environment Fair Labor Standards Act The Equal Pay Act
Exempt/Nonexempt Employees
Minimum Wage
Overtime Pay
The Equal Pay Act
Comparable Worth
OFCCP
Internal Revenue Code
The legal framework exerts substantial influence on the design and administration of compensation systems. The key federal laws that govern compensation criteria and procedures are the Fair Labor Standards Act (FLSA), the Equal Pay Act, and the Internal Revenue Code. In addition to these, each state has its own set of regulations that complement federal law. Labor laws may also limit managerial discretion in setting pay levels.
Exempt employees are not covered by the FLSA. These employees are salaried and not hourly wage earners. Nonexempt employees are hourly and are covered under the FLSA standards.
The current minimum wage is $7.25.
Overtime pay for nonexempt workers is usually time and one half the standard wage for each hour worked over 40 hours in one workweek.
We’ve discussed the EPA in Chapter 3. However, some exemptions are available for seniority and job performance.
Comparable worth is a pay concept or doctrine that calls for comparable pay for jobs that require comparable skills, effort, and responsibility and have comparable working conditions.
The OFCCP was established to evaluate compensation in an effort to monitor compliance with EEO laws
The Internal Revenue Code is the code of tax laws that affects how much of their earnings employees can keep and how benefits are treated for tax purposes.
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21. Summary and Conclusions
What Is Compensation?
Designing Compensation Systems
Compensation Tools
The Legal Environment and Pay System Governance
To summarize, compensation is actual salary or wages, incentives, and all benefits associated with the complete compensation package for individuals. We learned about a variety of different pay systems. In summary, we reviewed what compensation is, designing compensation systems, compensation tools, the legal environment, and pay system governance.
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22. Pearson Education, Inc. Copyright
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