Compensation Systems

8/2/2019 Compensation Systems

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Paul L. Schumann, Ph.D.

Professor of Management

MGMT 440: Human Resource Management

1 2008 by Paul L. Schumann. All rights reserved.


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Outline Compensation System Components

Compensation Equity Issues

Equity Theory

Pay Systems Market-Based Pay

Job Evaluation Pay Systems Job Ranking

Job Grading (Job Classification) Factor Comparison

Point Method

Pay Policy Issues

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Compensation System

Components

Source of figure: Fisher, Schoenfeldt, & Shaw (2006), Figure 11.1, p. 485

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Pay

Benefits


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Compensation Equity Issues Compensation equity: Is compensation judged to be

fair?

3 Compensation equity issues #1: Individual equity: compare the pay of individuals who

do the same job in the same organization and judge if itis fair

Example: A retail store has 2 Assistant Store Managers (2people doing the same job in the same organization)

If they are paid the same, is that perceived as being fair?

If they are paid differently, is the pay difference perceived asbeing fair?

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Compensation Equity Issues 3 Compensation equity issues (more)

#2: Internal equity: compare the pay of different jobs inthe same organization and judge if it is fair

Example: A retail store has an Assistant Store Manager and aStore Manager (2 different jobs in the same organization)

If they are paid the same, is that perceived as being fair?

If they are paid differently, is the pay difference perceived as

being fair?

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#3: External equity: compare the pay of the same job indifferent organizations and judge if it is fair

Example: Retail store X has a Store Manager and retail store Yhas a store manager (the same job in two differentorganizations)

Do the two stores pay their store managers the same or not?

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#3: External equity (more)

External equity pay policies:

Match the market (match the competition): the organizationsets pay for some of its jobs to be about the same as what otherorganizations pay for the same jobs

No advantage or disadvantage in costs or in attracting and

retaining employees

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#3: External equity (more) External equity pay policies (more)

Lead the market: the organization sets pay for some of its jobsto be higher than what other organizations pay for the same

jobs

Above average pay levels would tend to increase costs

Can the higher pay costs be offset by lower costs because of:

Lower turnover rates Easier to recruit larger numbers of well-qualified applicants,

allowing increased hiring standards (skim the cream) But we need to use valid selection methods to correctly identify the

well-qualified applicants

Otherwise, were paying more for poor performers (duds)

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#3: External equity (more) External equity pay policies (more)

Lag the market: the organization sets pay for some of its jobs to belower than what other organizations pay for the same jobs Below average pay levels would tend to decrease costs But the lower pay costs may be offset by higher costs because

of: Higher turnover rates Harder to recruit well-qualified applicants, requiring lower hiring

standards Can we provide employees with more of other things that

employees value to compensate for the below average pay? Example: More opportunities for growth & promotions Example: Some of pay is in the form of company stock

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Equity Theory Equity theory describes how an employee determines

if his or her pay is fair

An employee judges if his or her pay is fair by examining4 factors:

The employees pay (and other rewards)

The employees contributions

Other employees pay (and other rewards)

Other employees contributions

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Equity Theory Id feel underpaid

if: My

contributions

are the same asmy co-workers,but Im paid less

Im paid thesame as my co-

workers, but mycontributionsare greater thanmy co-workerscontributions

Figure adapted from: Fisher,Schoenfeldt, & Shaw (2006),Figure 11.2, p. 487

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Pay SystemsWe want to set pay in a way that takes into

consideration the 3 compensation equity issues: We want pay t0:

Implement the organizations external equity pay policy

Match, lead, or lag the market

Achieve internal equity

Appropriate pay differences across the jobs in the

organization Achieve individual equity

Appropriate pay differences across employees who performthe same job

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Pay Systems Methods of determining a range of pay for each job in

an organization: Market-Based Pay


Job Grading (Job Classification)

Factor Comparison

Point Method Once we have a pay range for each job, then we can

figure out where inside the pay ranges each employeeshould fall

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Market-Based PayAlternative names: Market-Based Pay = Market Pricing

= Rank to Market

Method (for each job title): Identify the relevant labor market

Local, regional, national, or international

Obtain market pay data in the relevant labor market Either use pay data collected by others:

http://www.salary.com/ http://www.bls.gov/bls/blswage.htm

http://www.google.com/Top/Business/Human_Resources/Compensation_and_Benefits/Compensation/

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http://www.salary.com/http://www.bls.gov/bls/blswage.htmhttp://www.google.com/Top/Business/Human_Resources/Compensation_and_Benefits/Compensation/http://www.google.com/Top/Business/Human_Resources/Compensation_and_Benefits/Compensation/http://www.google.com/Top/Business/Human_Resources/Compensation_and_Benefits/Compensation/http://www.google.com/Top/Business/Human_Resources/Compensation_and_Benefits/Compensation/http://www.bls.gov/bls/blswage.htmhttp://www.salary.com/


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Market-Based Pay Method (more):

Obtain market pay data in the relevant labor market (more)

Or perform a market pay (wage & salary) survey:

Identify a sample of organizations in the relevant labor marketthat have the job title

Contact each organization and ask how much they pay the jobtitle (minimum, average, maximum)

Avoid anti-trust (pay-fixing) concerns:

Use an independent consultant to collect the pay data Collect pay data that is several months old (e.g., 3 months)

Include at least 5 employers for each job title

Have the consultant report only averages (e.g., average minimumpay for the job title, average maximum pay for the job title)

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Market-Based Pay Method (more):

Use the market pay data on the average minimum payand the average maximum pay directly to set the payrange (min to max) for the job title

If the external pay policy is:

Match the market, then set the pay range for the job to beabout the same as the market pay range for the job

Lead the market, then set the pay range for the job to be a bithigher than the market pay range for the job

Lag the market, then set the pay range for the job to be a bitlower than the market pay range for the job

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Market-Based Pay Strengths:

Not too complicated

Weaknesses: Assumes all jobs with the same job title in different organizations

are truly identical Example: We have to assume that all Store Manager jobs in every retail

store are identical

Assumes market pay differences correctly capture internal equityissues Example: We have to assume that we want the pay difference between

our Store Managers and Assistant Store Managers to be the same as inother retail stores

Hard to use with unique jobs If the job is unique to our organization, then we cant find comparable

jobs in other organizations, so we cant get market pay data

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Job Evaluation Pay Systems An alternative to market-based pay is to use a pay system

based on job evaluation

Job evaluation: systematically determine the relative value

of jobs with an organization to create an internal hierarchyof jobs, and then use the hierarchy to set pay ranges for thejobs Which job has the highest value to the organization and so

should be paid the most?

Which job has the second highest value and so should be paidsecond highest?

Etc.

There are 4 job evaluation pay systems

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Job Evaluation Pay Systems


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Job Evaluation:

Job Ranking Method:

Review the job descriptions

Rank the jobs in order of relative worth or importance to the

organization Frequently done by a committee of managers

Use the rank ordering to set pay for each job Pay the highest ranked job the most, etc.

Weaknesses: The rank ordering tells us that one job is worth more than

another, but not how much more

While the ranking takes care of internal equity, its notobvious how to take into consideration external equity

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Job Evaluation:

Job Grading (Job Classification) Method:

Create a sequence of job grades Example: US Government GS system has 15 job grades: GS1 GS15

For each job grade, define the job grade in words Example: Define each job grade in terms of:

Skill & knowledge

Responsibilities

Physical effort

Working conditions Use the job descriptions to classify each job into one job grade

Example (from the US Government GS pay system):

Carpenter = GS9

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Job Evaluation:

Job Grading (Job Classification) Method (more)

Select a set of benchmark (key) jobs

Jobs with well-known, stable job content

Jobs that are common in many organizations

Jobs that represent the full range of job grades

Jobs for which market pay data is available

Collect market pay data for the benchmark jobs

Use the market pay data to set the pay range for the jobgrades

Example: http://www.opm.gov/oca/08tables/html/gs.asp

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http://www.opm.gov/oca/08tables/html/gs.asphttp://www.opm.gov/oca/08tables/html/gs.asp


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Job Evaluation:

Job Grading (Job Classification) Strengths:

The sequence of job grades allows us to deal withinternal equity

The use of market pay data to set the pay range for eachjob grade allows us to deal with external equity

Weaknesses: The classification of jobs into pay grades is subjective

Example: Carpenter = GS9, not GS8 or GS10 (are we sure?) The method relies heavily on job titles in setting pay

Example: We have to assume that all Carpenter jobs areidentical

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Job Evaluation:

Factor Comparison Method:

Define a set of compensable factors Compensable factors: the characteristics about jobs that are

used to set pay Example: skill, effort, responsibility, & working conditions

Select a set of benchmark (key) jobs Jobs with well-known, stable job content

Jobs that are common in many organizations

Jobs that represent the full range of jobs being evaluated

Jobs that represent the range of each compensable factor

Example: jobs with various skill levels, effort levels, etc.


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Job Evaluation:

Factor Comparison Method:

Rank the benchmark jobs on the basis of eachcompensable factor

Example: Rank the jobs from least skilled to most skilled

Collect market pay data for the benchmark jobs

For each benchmark job, allocate market pay across thecompensable factors

Example: If market pay for a benchmark job is $15, how muchof that $15 is for skill, how much for effort, how much forresponsibilities, and how much for working conditions?

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Job Evaluation:

Factor Comparison Method (more)

For each benchmark job, compare the factor rankings tothe pay rankings & make adjustments as needed to bring

the rankings into agreement Example: Make sure that the job ranked as having the greatest

skill requirements also has the greatest amount of pay for theskill compensable factor

Construct a job comparison scale, and slot the

benchmark jobs onto the pay scale for each compensablefactor Example: For the skill compensable factor, create a skill pay

scale that shows where each benchmark job falls on the scale

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Job Evaluation:

Factor Comparison Method (more)

Slot all the non-benchmark jobs into their proper placeson the pay scale for each compensable factor

Determine the pay for each job by adding up the payfrom each compensable factor

Example: Pay = pay from skill + pay from effort + pay fromresponsibility + pay from working conditions

Example: Fisher, Schoenfeldt, & Shaw (2006), Table 11.7, p.498

Job 4: Pay = $3.50 for skill + $2.50 for effort + $3.75 forresponsibilities + $1.25 for working conditions = $11.00

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Job Evaluation:

Point Method Method:

Define a set of compensable factors Compensable factors: the characteristics about jobs that are used to

set pay Example: 11 compensable factors:

(1) Education(2) Experience(3) Knowledge(4) Physical demands(5) Mental demands(6) Responsibility for equipment & work processes

(7) Responsibility for materials & products(8) Responsibility for safety(9) Responsibility for the work of others(10) Working conditions(11) Job hazards

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Job Evaluation:

Point Method Method (more)

Define a factor scale for each compensable factor Factor scale: define in words the different levels (or degrees) of the

compensable factor Example: Factor scale for the Knowledge factor:

1st Degree Knowledge: reading & writing; simple arithmeticwith whole numbers only; following instructions

2nd Degree Knowledge: arithmetic with decimals & fractions;use of formulas, charts, graphs, or diagrams

3rd Degree Knowledge: mathematics with complex formulas,

drawings, or diagrams; precision measuring instruments 4th Degree Knowledge: advanced trades mathematics; advanced

use of complex formulas, drawings, or diagrams 5th Degree Knowledge: higher-level engineering math;

advanced use of complex engineering theories & practices

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Job Evaluation:


Assign pointsto each degree

of eachcompensablefactor Example:

Source of table: Fisher, Schoenfeldt, &Shaw (2006), Table 11.4, p. 495

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Job Evaluation:


Perform the job evaluation: evaluate each job todetermine the number of points to assign to that job on

each compensable factor Usually done by a committee of managers

Use the job descriptions as the source of job information

Add up the number of points from each compensable factor to

get the total points for the job Jobs with more total points have more of the things we value in

setting pay

This should take care of internal equity

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Job Evaluation:


Select a set of benchmark (key) jobs: Jobs with stable job content

Jobs that are common in lots of organizations Jobs that can be defined with precision

Jobs that are performed similarly across differentorganizations

Jobs that represent the range of jobs being evaluated


Identify the relevant labor market for each benchmarkjob Local, regional, national, or international

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Job Evaluation:


For each benchmark job, collect market pay data in therelevant labor market Either use pay data collected by others, or Collect pay data yourself by performing a pay survey (wage & salary

survey): Identify a sample of organizations in the relevant labor market

that have the benchmark job Contact each organization & collect pay data for the job title

(minimum pay & maximum pay) Avoid anti-trust (pay-fixing) concerns:

Use an independent consultant to collect the pay data Collect pay data that is several months old (e.g., 3 months) Include at least 5 employers for each job title Have the consultant report only averages (e.g., average minimum

pay for the job title, average maximum pay for the job title)

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Job Evaluation:


Estimate the market pay lines Estimate 2 simple regressions using the benchmark jobs as the

data points Minimum pay line: regress minimum pay (dependent variable)

on points (independent variable)

Maximum pay line: regress maximum pay (dependentvariable) on points (independent variable)

Use the market pay lines to determine the pay ranges foreach job (both benchmark & non-benchmark jobs) This takes care of external equity

Optional: create pay grades

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Job Evaluation:

Point Method Example of a website that implements the Point Method (this website

would be a good resource to use for the Compensation element ofyour Team Project):http://data.bls.gov/PDQ/outside.jsp?survey=nc Important note: The website uses pop-ups, so change your browser

setting to allow pop-ups from this website before starting In Box 1, select the area based on the relevant labor market for the job

title In Box 2, select the occupation that includes the job title In Box 3, click the Get help choosing a Work Level button

This will pop open a new window where you perform the job evaluation using 9compensable factors: Knowledge, Supervision Received, Guidelines, Complexity,

Scope and Effect, Personal Contacts, Purpose of Contacts, Physical Demands, &Work Environment Perform the job evaluation, then click Accept Level (this will pop you back to

the other page); suggestion: use a committee to do the job evaluation

In Box 4, click Get Data (this will pop open a new window with theresults)

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http://data.bls.gov/PDQ/outside.jsp?survey=nchttp://data.bls.gov/PDQ/outside.jsp?survey=nchttp://data.bls.gov/PDQ/outside.jsp?survey=nc


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Pay Policy Issues Periodically update the pay ranges Jobs above or below the desired pay range:

Green circle jobs:jobs whose current pay is below the payrange for the job Develop & implement a plan to give these jobs slightly larger pay

increases to catch the job up with the pay range

Red circle jobs:jobs whose current pay is above the pay rangefor the job Develop & implement a plan to give these jobs slightly smaller pay

increases to allow the pay range to catch up with the job

Compression: the pay differences across jobs shrink overtime Can mess up internal equity because the pay differences

across jobs gets too small

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Pay Policy Issues

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Broadbanding: combineadjacent pay ranges tocreate a smallernumber of pay rangesin which each pay

range is wider May help with red &

green circle jobs &with compression

Frequentlyimplemented as part

of restructuring &downsizing

Source of figure: Fisher, Schoenfeldt, & Shaw(2006), Figure 11.7, p. 511


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Pay Policy Issues Set the pay for each employee doing each job (where theemployee falls inside the pay range for the employees job) Methods:

Seniority: Each employee moves up their pay range by the same

amount (usually determined as a percentage pay increase) Creates incentives for a stable, experienced workforce Typically used with unionized jobs, when merit pay isnt accepted

by employees, when it is hard to measure job performance, orwhen there are very minor differences in job performance acrossemployees (e.g., assembly line)

Merit Pay: Each employee moves up their pay range based on theirjob performance (creates incentives for improved job performance) Skill-based Pay: Each employee moves up their pay range based on

the skills & knowledge mastered by the employee (incentives to addskills)

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Pay Policy Issues Legal issues in pay Fair Labor Standards Act (FLSA)

4 Primary provisions: Minimum wage:

9/1/97: $5.15 7/24/07: $5.85 7/24/08: $6.55 7/24/09: $7.25

Overtime pay Restrictions on employment of children

Recordkeeping requirements http://www.dol.gov/esa/whd/flsa/

Minimum wage set by state laws http://www.dol.gov/esa/minwage/america.htm

Example: Minnesota (for large employers): $6.15

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http://www.dol.gov/esa/whd/flsa/http://www.dol.gov/esa/minwage/america.htmhttp://www.dol.gov/esa/minwage/america.htmhttp://www.dol.gov/esa/whd/flsa/


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Pay Policy Issues Equal Pay Act: equal pay for equal work Forbids sex discrimination in pay when the employees

perform the same job in the same organization If a man and a woman are both doing the same job in the same

organization, dont pay them differently because of their sexes Pay differences based on other factors is okay (e.g., seniority, job

performance, etc.)

Comparable worth: equal pay for equal worth If a man and a women are doing different jobs, but the

company evaluates that both jobs are of equal value to thecompany, then they should be paid the same Example: If a companys job evaluation determines that a secretarial

job (held mostly by women) and a maintenance job (held mostly bymen) make contributions of equal value to the company, then thetwo jobs should be paid the same

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Outline Compensation System Components

Compensation Equity Issues

Equity Theory

Pay Systems Market-Based Pay


Job Grading (Job Classification)

Factor Comparison

Point Method

Pay Policy Issues

Documents

Compensation Systems