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

2. 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.

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

4. 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.

5. 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.

6. 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.

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

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

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

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

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

12. 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.

13. 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.

14. 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.

15. 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.

16. 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.

17. 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.

18. 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.

19. 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.

20. 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.

21. 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.

22. 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.

23. 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.

24. 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.

25. 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.

26. 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.

27. 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.

28. 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.