International Human Resource Management:

Chapter 6:

COMPENSATION MANAGEMENT

Introduction: One of the key components of IHRM is the compensation administration in MNCs. Today, compensation and employee benefits contribute to 40-50% of the total costs. Compensation is strategically reported and monitored at the broad levels and with the investors to assess the health of the organization. What is compensation management? Effective and efficient process of managing the earnings financial and non financial rewards of the employees in an organization based on their performance towards organizational goal is called compensation management. International Compensation is an internal rate of return (monetary or non monetary rewards / package) including base salary, benefits, perquisites and long term & short term incentives that valued by employees in accordance with their relative contributions to performance towards achieving the desired goal of an organization. It influences: Organizational culture Recruitment and selection of competent employees Motivation and performance

Objectives of compensation:
Compensation decisions are strategic decisions and play a key role in achieving performance and sustainable competitive advantages for national as well as international firms. Therefore the key objectives are: Attract employees who are qualified , experienced and interested in international assignments. Facilitate the movement of expatriates from one subsidiary to another, from home to subsidiary, and back from subsidiary to home. Provide a consistent and reasonable relationship between the pay levels of employees at headquarters, domestic affiliates and foreign subsidiaries. Be cost effective by reducing unnecessary expenses. Should be easily understood and easy to administer.

Components of Compensation:
components of international compensation comprises the base salary, incentives, benefits, allowances, foreign service inducement/ hardship premium, long term benefits and taxes etc.

Base Salary:
Base salary is the amount of money that an expatriate normally receives in the home country. In the united states, this was around $ 175,000 for upper-middle managers in the late 1990s, and this rate was similar to that paid to managers in both Japan and Germany. The exchange rates, of course, also affect the real wage. Expatriate salaries typically are set according to the base pay of the home countries. Therefore, a German Manager working for a US MNC and assigned to Spain would have a base salary that reflects the salary structure in Germany. The salaries usually are paid in Home currency, local currency, or a combination of the two. The base pay also serves as the benchmarks against which bonuses and benefits are calculated.

Benefits:
Alternatively known as indirect compensation, Benefits constitute a substantial portion of international compensation ( approx. one third of compensation for regular employees is benefits). Benefits include a suit of programmes such as: Entertainment, Festival celebrations, Gifts, Use of club facilities, provision of hospitality including food and beverage, employee welfare, use of health club, Conveyance tour and travel, Hotel Board and Lodging, vehicles, telephone and other telecommunication facilities, Sponsorship of children. Basically an employee tends to join and stay with an org. which guarantees an attractive benefits programme. Vacation along with holidays and rest breaks help employees mitigate fatigue and enhance productivity during the hours employees actually work.

Allowance:
It is an inevitable feature of International compensation. The most common allowance relates to the cost of living an adjustment for different in the cost of living between the home country and foreign country assignment. This allowance is designed to provide the expatriate with the same standard of living that he or she enjoyed in the home country. Spouse assistance, housing allowance, home leave allowance, relocation allowance and educational allowance are the popular in expats. Compensation. These allowances are often contingent upon tax equalization policies and practices in both the home and the host countries.

Incentives:
An additional payment (or other remuneration) to employees as a means of increasing output. Increasingly, MNCs these days are designing special incentive programmes for keeping expatriates motivated. In the process, a growing number of firms have dropped the ongoing premium for overseas assignments and replaced it with a one time, lump-sum premium.

The lump sum payment has at least three advantages: First, expatriates realizes that they are paid this only once and that too when they accept an overseas assignment. So the payment tends to retain its motivational value. Second: costs to the company are less because there is only one payment and no future financial commitment. This is so because incentive is a separate payment, distinguishable from a regular pay, and it is more rapidly for saving or spending. Third, less chances for pre mature repatriation.

Foreign Service / Hardship Premium:

This is often perceived as an inducement in the form of a salary premium to accept an overseas assignment. Generally, salary premiums vary from 540% of the base salary. Actual salaries depend upon the assignment, actual hardship, tax consequences and length of assignment. In addition, if the work week in the host country is longer than in the home country , the assignee will be paid for the extra hours worked. Certain countries are highly hostile to foreigners staying and working. Indians engaged in road construction work in Afghanistan, for example, face constant threat lives. In fact, ten such emigrants got killed in recent times (2006-2007). Expatriates in such environments are paid 2-3 times more than their domestic salaries.

Long term Benefits:

The most common long term benefits offered to employees of MNCs are Employee Stock Option Schemes (ESOS). Traditionally E-SOS were used as means to reward top management or key people of the MNCs. Some of the commonly used stock option schemes are: Employee Stock Option Plan (ESOP)- a certain nos. of shares are reserved for purchase and issuance to key employees. Such shares serve as incentive for employees to build long term value for the company. Restricted Stock Unit (RSU) This is a plan established by a company, wherein units of stocks are provided with restrictions on when they can be exercised. It is usually issued as partial compensation for employees. The restrictions generally lifts in 3-5 years when the stock vests

Employee Stock Purchase Plan (ESPP) This is a plan wherein the company sells shares to its employees usually, at a discount. Importantly, the company deducts the purchase price of these shares every month from the employees salary

Hence, the primary objective for providing stock options is to reward and improve employees performance and /or attract / retain critical talent in the Organization Taxes: The final component of the expatriates remuneration relates to taxes. MNCs generally select one of the following approaches to handle international taxes: 1. Tax equalization: Firms withhold an amount equal to the home country tax obligation of the expatriate, and pay all taxes in the host country. 2. Tax protection: The employee pays up to the amount of taxes he or she would pay on remuneration in the home country. In such a situation, the employee is entitled to any windfall received if total taxes are less in the foreign country than in the home country.

Taxes

Salary

International Compensation Incentives Benefits

Allowances

Long term Benefits

Fig. components of International compensation

Factors influencing these components : Remuneration or compensation varies country to country and one MNC to another. Mainly based on two factors: External and Internal.
External Factors Domestic Labour Market Cost of living Labour Union Govt. Legislation Society Economy Internal Factors Business strategy Job Evaluation and Performance Appraisal The employee

Remuneration/ Compensation

International

Parent Nationality Labour market characteristics Local Culture Home and Host Countries Governments Roles Industry Types Competitors Strategy

Goal orientation Capacity to pay Competitive Strategy Org. Culture Int. Workforce composition Lab. Relations Subsidiary role

However, these factors can be classified in five categories: 1. Prosperity & Spending Power Of the company (a related factor is the different Tax and social security System in the country. 2. Cultural Difference 3. Policy & Strategies (in productivity and Performance evaluation) 4. Situations on the relevant Labour market & Labour capital ratios 5. Institutional Frameworks within which wage Bargaining takes place

Compensation Philosophy: Since compensation is a crucial factor, having its bearing on performance and satisfaction, it is advisable that international business should have a clear cut compensation philosophy

Now the question comes what is Compensation Philosophy? Compensation philosophy is the set of values and beliefs that an organization has with regard to monetary and non monetary benefits payable to employees. Any compensation philosophy should cover the following aspects: Goals of the organizational compensation system Percentage of compensation linked to individual performance and base salary. Role of performance appraisal in disbursing compensation The positioning of compensation of employees relative to market

Therefore, Compensation philosophy or the set of values and beliefs Combined with a set of guidelines that further assist in compensation administration of MNCs.

Theories of compensation:
There are (generally) 4 theories in the context of international compensation: 1. Contingency theory. 2. Resource based theory. 3. The Agency theory and 4. Equity theory 1. Contingency theory (most popular) : Expats compensation should be based on particular contingencies or situation prevailing in a host country. The compensation Phil. In every organization is normally de centralized and allows units to localize the compensation structure 2. Resources based theory: Human resource is the greatest asset of the MNCs in its competitive advantage needs good pay and st. salary band for cont. motivation. The organizations follow this theory, remain market sensitive and are constantly reviewing compensation to retain their position in the hiring and retaining the talents 3. The Agency Theory: This theory focused on the divergent interests and goals of org.s stakeholders and the way that employees compensation can be used to align these interests & goals. According to this theory, there exists a principle agency relationship between the MNCs HQ and its Subsidiaries for Expats Compensation. 4. Equity Theory: Equity theory suggests that there should be a fair balance between an expatriates contribution to an MNC and what he / she receives as compensation. Of late, the equity principle is sought to be compromised with a new approach to compensation Person based rather job centric .

Compensation practices in different countries: The overall compensation package often varies from country to country due to legally mandated benefits, taxes, cost of living, cultures and employee expectations. What is Cost of living? An inflationary indicator that measures the change in the cost of a fixed basket of products and services, including housing, electricity, food, and transportation. The cost-of-living index is published monthly. also called cost-of-living index. also called Consumer Price Index (CPI).
Hourly Wages in Different Countries*
COUNTRY $/HOUR

Norway Germany (former West) Switzerland Belgium Sweden United States France Britain Japan Australia Canada Italy Spain Israel Korea Portugal Taiwan Brazil Mexico China Sri Lanka

31.5 5 31.25 27.87 27.73 25.18 21.97 21.13 20.37 20.09 20.05 19.28 18.35 14.96 11.73 10.28 6.23 5.84 2.67 2.48 0.63 0.49

However, As we observed, there are , some common elements in compensation package including base salary, benefits, allowances, incentives and taxes; let see the compensation systems in the different countries: Criterion America Japan Russia Middle East Orientation Components Performance oriented BS,VB,LTI, VBC - Seniority - based Job level based Nationality group and job level

CBC, MW ( BA+OT), VB BS, NMB Moderate linkage

Link with Excellent linkage performance Basis Increase of Annual increase

FB, BS, HA,AA, FA, AF/VT, SF, VB Incentives. Poor linkage Moderate Linkage

Influencing Cultural variables

merit Seniority and age, Seniority in Job Level performance Job level ratings, spring wage negotiation Achievement Hierarchy; Patience Material Material Possessions orientation Possessions Status seniority Material possession

BS- Basic Salary, VB Variable bonus, LTI Long tern incentives, CBC Compulsory benefit contributions, VBC-Voluntary benefit contribution, MW Monthly wage, BA Basic Allowance, OT Overtime, FB Fixed Bonus, NMB Non monetary benefits)

Approaches to expatriate are compensation:

Working within the components described above, MNCs seek to tailor remuneration packages to fit with the specific siuation. For example, senior level managers, in Japan are paid four times more than their juniors staff members. This is sharp contrast to the US, where the gap is much higher. Many senior level managers in Europe are paid much less than their US counterparts. In designing an expatriates remuneration, firms generally follow a number of approaches. The most common are two: 1. The Balance-sheet or Home net system 2. The local Going rate system or localization system

Balance-Sheet Approach: Which involves ensuring that the expatriates is made whole and does not lose money by taking the foreign assignment. The basic objective is to maintain the home country living standard, plus offer some financial inducement Thus, it links the salary of expatriates and TCNs to home country salary structure. The key assumption is that foreign assignees should not suffer financially due to transfers. The salary package is divided into four parts: GOODS AND SERVICES FOOD, PERSONAL CARE, CLOTHING, HOUSEHOLD FURNISHING, RECREATION HOUSING: Major cost associated with host country INCOME TAXES Parent country and Host country income taxes RESERVE CONTRIBUTIONS TO SAVINGS, PAYMENTS FOR BENEFITS, PENSION CONTRIBUTIONS, INVESTMENTS, EDUCATION EXPENSES, SOCIAL SECURITY TAXES When costs associated with the host country assignment exceed equivalent costs in the parent country, the firm and expatriates, together meet these costs to ensure that parent country equivalent purchasing power is achieved. For example, if US national is posted in India and suppose the dollar exchange rate is $ 1 = Rs. 50/- and COLA Index is 5, then the break up of the annual pay will be :

Item

Amount in $ per year in US 1,00,000 10,000

Paid in India 60,000 Nil

in

Paid in Rs. In India 20,000,00 5,00,000

Base pay Cost of allowance Overseas allowance Hardship allowance Housing deduction Income deduction Total pay

living

20,000 5,000 -10,000 tax -30,000 $ 95,000

20,000 5,000 10,000

Nil Nil Nil Nil Rs. 25,00,000

- 30,000 $ 45,000

Advantages: Expatriate is guaranteed his home country spending power. Easy to communicate to employees Disadvantages: Three problems faced in applying this system are: 1. Recalculating the salary from gross to net and vice versa. 2. In grossing up the net income in the host country, there should be strictly identical items (same car and housing). This is the difficulty. 3. Can result in disparities between expatriates of different countries

2. Going Rate Approach:

In this, expatriates are paid according to the host country salary structures. Based on local market rates the base salary is linked to the salary structure in the host country. Base pay and benefits may be supplemented by additional payments for lowpay countries. Advantages Equality with local nationals Simplicity Identification with the host country Equity among different nationalities

Disadvantages Variation between assignments for same employees Variation between expats of same nationality in different locations ( Indian expatriated to the US may be compensated better than those assigned to a developing country)Potential re-entry problems ( on return to home country, the expats. finds that his or her compensation is lower than that of the host country. The Standard Policy of Compensation management required: A) The knowledge of employment and taxation laws: customs, cost of living index, environment, employment practices of various countries. The knowledge of labour markets and industry norms regarding benefits and compensations. The knowledge of foreign exchange rate fluctuations and monitoring rate of inflation or cost of living Index in different countries. The knowledge and clear conception about the vision and mission of the company, its corporate philosophy regarding managing human resources, its corporate strategy of growth or stability and strategy of its business units regarding cost, leadership, differentiation and innovation

B)

C)

D)

Conclusion: Higher basic salary with lower benefits and incentives or Lower salary with higher level of benefits and incentives , may not motivated the expatriates and therefore, required high degree of expertise / standard policies for MNCs specially in the field of compensation management. The policy decisions should be consistent with the overall strategy structure and business needs of the multinationals. The policy should be attract and retain the best staff in those areas where the firm has greatest needs and opportunities and where its core competencies. The policy must facilitate the transfer of international employees in a cost effective manner. The policy should give due consideration to equity case of administration. Prepared by Dr. Shyamal Gomes ------------------xxxxxxxxx----------------------