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Managing Compensation

Chapter 10

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• Identify the compensation policies and practices that are most appropriate for a particular firm

• Weigh the strategic advantages and disadvantages of the different compensation options

• Establish a job-based compensation scheme that is internally consistent and linked to the labor market

• Understand the difference between a compensation system in which employees are paid for the skills they use and one in which they are paid for the job they hold

• Make compensation decisions that comply with the legal framework

Chapter 10 Overview

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• Total compensation – The package of quantifiable rewards an employee receives for his or her labors. Includes three components: base compensation, pay incentives, and indirect compensation/benefits

What Is Compensation?

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Challenge is to design a compensation system that:

1. Enables the firm to achieve its strategic objectives

2. is molded to the firm’s unique characteristics and environment

Designing a Compensation System

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There are nine criteria for developing compensation plans:

1. Internal vs. external equity:• Internal equity – The perceived fairness of

the pay structure within a firm.• External equity – The perceived fairness in

pay relative to what other employers are paying for the same type of labor.

Designing a Compensation System (Cont.)

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Designing a Compensation System

Two basic models for determining internal vs. external equity:

• The Distributive Justice Model• Labor Market ModelHow to balance internal and

external equity

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Designing a Compensation System (Cont.)

2. Fixed versus Variable Pay:• Fixed Pay – most common in the USA as it

reduces risk to the employee and is easy to administer

• Variable Pay – 75% of companies use some type of variable pay, 10% of US workers wages consist of variable pay

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Designing a Compensation System (Cont.)

3. Performance vs. Membership:• Performance – Substantial part of pay is

tied to individual or group contributions and can vary from person to person or group to group

• Membership – Same or similar wage to every employee in a given job

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Designing a Compensation System (Cont.)

4. Job vs. Individual pay• Job based pay – assumes in setting base

pay a company should evaluate the value or contributions of each job, not how well an employee performs the job

• Individual pay – knowledge based-pay or skill-based pay where employees are paid on the basis of the jobs they can do or talents they have

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Designing a Compensation System (Cont.)

4. Job vs. Individual payJob-based pay is best where:• 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• Employees are expected to move up through the

ranks over time• Jobs are fairly standardized within the industry

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Designing a Compensation System (Cont.)

4. Job vs. Individual Pay (Cont.)Individual-based pay is best where:• The firm has a relatively educated workforce with both

the ability and the willingness to learn different jobs• The company’s technology and organizational structure

change frequently• Employee participation and teamwork are encouraged

throughout the organization• Opportunities for upward mobility are limited• Opportunities to learn new skills are present• The costs of employee turnover and absenteeism in

terms of lost production are high

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5. Egalitarian vs. Elitist• Egalitarian pay system – A pay plan in

which most employees are part of the same compensation systems.

• Elitist pay system – A pay plan in which different compensation systems are established for employees or groups at different organizational levels.

Designing a Compensation System (Cont.)

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6. Below-market vs. Above-market compensation7. Monetary vs. Nonmonetary rewards8. Open vs. Secret pay9. Centralization vs. Decentralization of pay

decisions

Designing a Compensation System (Cont.)

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Two broad categories depending on the unit of analysis used to make pay decisions:• Job-based compensation plans• Skills-based compensation plans

Compensation Tools

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1. Job-based compensation plans• Most traditional and widely used• Assumes work gets done by people who

are paid to do well-defined jobs• Objective is to allocate pay so that the

most important jobs pay the most

Compensation Tools (Cont.)

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1. Job-based compensation plans – 3 key components:

Compensation Tools (Cont.)

Internal Equity

External EquityIndividual

Equity

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1. Job-based compensation plans• Achieving Internal Equity:

Job Evaluation = process of evaluating the relative value or contribution of different jobs in an organization – The ultimate goal of job evaluation is to

provide a rational, orderly & systematic judgment of how important each job is to the firm

Compensation Tools (Cont.)

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1. Job-based compensation plans• Achieving Internal Equity – 6 steps :

– Step 1: Conduct job analysis – gathering and organizing of information concerning the tasks, duties and responsibilities of specific jobs

– Step 2: Write job description– Step 3: Determine job specifications –

worker characteristics, that an employee must have to perform a job successfully

Compensation Tools (Cont.)

1. Job-based compensation plans• Achieving Internal Equity – 6 steps (Cont.): • Step 4: Rate worth of all jobs using a

predetermined system using a system such as a point factor system:• Uses compensable factors – work related criteria that

an organization considers most important in assessing relative value of different jobs– Hay compensable factors – 3 compensable factors (know-

how, problem solving, accountability)– Management Association of America (MAA) – 3 units (hourly

blue collar, non-exempt clerical technical service and professional management)

Compensation Tools (Cont.)

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1. Job-based compensation plans• Achieving Internal Equity – 6 steps (Cont.): • Step 5: Create a job hierarchy• Step 6: Classify jobs by grade levels

Compensation Tools (Cont.)

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Compensation Tools (Cont.)1. Job-based compensation plans• Achieving External Equity:

– Market Surveys – purpose to determine pay ranges for each grade level. Most companies purchase surveys.

Compensation Tools (Cont.)1. Job-based compensation plans• Achieving External Equity:

– 2 steps:• Step 1: Identify benchmark or key

jobs – a job that is similar in content across firms

• Step 2: Establish a pay policy – decision whether to pay above, below or at market rate

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1. Job-based compensation plansAchieving Individual Equity: Within-

Pay-Range Positioning Criteria

• Individual equity – The perceived fairness of individual pay decisions.

Compensation Tools

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Market Salary Data for Selected Benchmark Office Jobs

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Compensation Tools1. Job-based compensation plans• Evaluating job-based compensation plans• Suggestions for practice

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Compensation Tools2. Skill-based compensation plans• Uses skills as the basis for pay• Skills can be depth, horizontal, vertical

Advantages:• Creates flexible workforce• Promotes cross-training• Employee control over pay

Disadvantages:• Small % use it• Higher compensation and

training costs• Skills may become rusty• Elaborate and time

consuming process

• The Fair Labor Standards Act (FLSA)– Exempt/Non-exempt employees– Minimum wages – overtime

• The Equal Pay Act– Comparable worth

• OFCCP– Role of the Office of Federal Contract

Compliance• Internal Revenue Code

The Legal Environment andPay Systems Governance