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10
Compensation: An Overview

McGraw-Hill/Irwin Human Resource Management, 10/e

2007 The McGraw-Hill Companies, Inc. All rights reserved.

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Compensation
The

HRM function that deals with reward individuals receive in exchange for performing tasks The major cost of doing business for many organizations The chief reason why most individuals seek employment 2004, U.S. employers paid an average of $22.22 per hour worked $15.62 (73%) was straight-time wages and salaries Benefits accounted for $6.60 (7%)

In

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Compensation
Financial

compensation is either direct or indirect Direct compensation consists of wages, salaries, bonuses, or commissions Indirect compensation includes all financial rewards not included in direct compensation, such as insurance, vacation, and childcare services (benefits)

Non-financial

rewards, such as praise, self-esteem, and recognition, affect employee: Motivation Productivity Satisfaction

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Compensation
To

employees, pay is a necessity of life It also indicates his or her worth to an organization

Pay

often equals 50 percent or more of cash flow It attracts and motivates employees
is a significant component of the

Compensation

economy For the past 30 years, salaries and wages have equaled 60 percent of the gross national product of the U.S. and Canada

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Objective of Compensation

The

objective of compensation is to create a system of rewards that is equitable to both the employer and the employee The desired outcome is an employee who is attracted to the work and motivated to do a good job

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Objective of Compensation
Patton

suggests that to be effective compensation should be: Adequate Equitable Balanced Cost-effective Secure Incentive-providing Acceptable to the employee

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External Influences on Compensation

External

influences include: The labor market The economy The government Unions

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The Labor Market and Compensation

In

times of full employment, wages may have to be higher Pay may also be higher if few skilled employees are in the job market In depressions, pay can be lower

Differential

pay levels: Different skills seek different pay levels There may also be differences between government and private employees, exempt and nonexempt employees, and nations

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The Labor Market and Compensation

Styles

of managing and rewarding are changing in response to diversity Diversity is more than demographics; it means differing value, lifestyles, body types, and so on Diversity refers to any mixture of items characterized by differences and similarities easiest relationship to imagine between rewards and diversity has to do with benefits Changing demographics require employers to offer more, and more varied, benefits to motivate, satisfy, and retain employees

The

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The Labor Market and Compensation

The

increasing level of formal education will also impact reward systems In 2005, over 50 percent of all adult Americans have some college education 50 percent of all college students are over 25 More than half of all college graduates are women increasingly educated population will not hesitate to ask for changes in pay and benefits

This

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The Labor Market and Compensation

Generation

X has the higher percentage of members who have finished high school and college They value financial security, power, and status However, they dont always bring applicable job skills to the organization Designing a reward system that would motivate them is in conflict with the value that they actually bring other types present compensation challenges: Technological experts (nerds) Temporary or contingent workers

Two

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An International Labor Force

Compensation

specialists must base their compensation plan on a competitive, global marketplace

Global

wage differentials verging on the extreme Moving American employees to foreign locations Employing local (foreign) managers and workers Moving foreign workers to the U.S. Offshoring jobs, projects, and work

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Economic Conditions and Compensation

The

economic conditions of the industry and competitiveness affect an organizations ability to pay high wages The more competitive the situation, the less able the organization is to pay higher wages If a firm is very productive, it can pay higher wages

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Economic Conditions and Compensation

Productivity

can be increased through: Advanced technology More efficient operating methods A harder-working and more talented workforce A combination of these

productivity index used to determine a general level of wages: The Bureau of Labor Statistics Output per Manhour in Manufacturing

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Economic Conditions and Compensation

For

70 years, productivity increased at 3 % per year The percentage increase in average weekly earnings in the U.S. is closely related to: The percentage change in productivity Plus the percentage change in the consumer price index

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Government Influences & Compensation

The

government directly affects compensation through wage controls and guidelines Pay raises may be prohibited at certain times Laws establish minimum wage rates and work hours Discrimination is prohibited

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Wage Controls and Guidelines

Wage

freezes and guidelines were imposed several times in the past Wage freezes are government orders that forbid wage increases Wage controls limit the size of wage increases Wage guidelines are voluntary wage controls

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Wage Controls and Guidelines

Since

1942, three acts were passed to stabilize the economy: Wage Stabilization Act (1942): imposed to slow inflation during World War II, it set going rates of pay for key occupations Defense Production Act (1950): a similar wage freeze imposed during the Korean War Economic Stabilization Act (1970): granted the president the authority to impose wage and price controls in times of national necessity

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Wage Controls and Guidelines

The

use of wage freezes, controls, and guidelines is controversial Advocates believe that such restrictions reduce inflation Critics argue that it disrupts resource allocation and the market process

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Wage and Hour Regulations

The

Fair Labor Standards Act (FLSA) of 1938 is the basic pay regulation act It was passed to counteract the abuses encountered by production workers in the manufacturing sector There are four provisions: Minimum wage Overtime Child labor The Equal Pay Act of 1963

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Wage and Hour Regulations

FLSA

covers businesses with two or more employees engaged in: About 92 percent of Interstate commerce nonsupervisory The production of goods for wage earners are covered interstate commerce The handling, selling, or working on goods or materials that have been moved in, or produced for, interstate commerce FLSA is administered by the Dept. of Labor, which also acts as the enforcement agency

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FLSA Exemption Guidelines

Exempt

from minimum wage and overtime: Executive, administrative, and professional employees, and outside sales persons Employees at seasonal amusement or recreational establishments Employees of certain small newspapers Switchboard operators of small telephone companies Seamen employed on foreign vessels Employees engaged in fishing operations Farm workers employed on small farms Casual baby-sitters, companions to the elderly/infirm

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FLSA Exemption Guidelines

Exempt

from overtime pay requirements only: Commissioned employees of retail and service companies Auto, truck, trailer, farm implement, boat or aircraft workers Parts clerks and mechanics servicing autos, trucks, or farm implements who sell to the ultimate purchasers Railroad and air carrier employees, taxi drivers, certain employees of motor carriers, seamen on American vessels, and local delivery employees paid on trip rate plans

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FLSA Exemption Guidelines

Exempt

from overtime pay requirements only: Announcers, news editors, and chief engineers of certain non-metropolitan broadcasting stations Domestic service workers who reside in their employers residence Employees of motion picture theaters Farm workers

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Minimum Wage
The

minimum wage provision of FLSA establishes an income floor for low-paying jobs The provision has been amended several times since 1938, when the minimum wage was 25 cents per hour The latest change was to $5.15 per hour in September, 1997 typical minimum-wage worker is female, over age 25, and employed part-time 3 in 5 minimum-wage workers are women One-third are teenagers on their first job

The

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Minimum Wage
Employees

under 20 years of age may be paid an opportunity wage of 1/3 of the minimum wage during the first 90 consecutive days of employment Certain fulltime students, student learners, apprentices, and disabled employees may be paid less than minimum wage under special certificates issued by the Dept. of Labor Workers who receive tips must be paid at least $2.13 per hour

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Minimum Wage
The

minimum wage is a controversial provision Classical economists contend that a rise in the minimum wage is offset by an immediate rise in unemployment Others hold that the minimum wage harmlessly raises the wages of the lowest-paid workers

change in minimum wage causes a 5.3 percent increase in wage costs for employees earning less than the new minimum Retailing, food, and lodging are the businesses most likely to be affected

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Overtime Pay
Virtually

all hourly (nonexempt) employees must receive overtime compensation for working: More than 40 hours per week More than 8 hours per day The law requires time and a half

Salaried

employees do not receive overtime pay A salaried employee is one who regularly receives a predetermined amount constituting all or part of her/her compensation

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Overtime Pay
Distinguishing

between exempt and nonexempt workers is not always easy Exempt employees are in managerial, administrative, or professional positions and are paid on a salaried basis

If

federal and state law conflict, the one that is the most generous to the employee applies Violation of the overtime provision can result in having to pay for uncompensated overtime, civil penalties, and liquidated damages

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Child Labor
Child

labor is any economic activity performed by an individual under the age of 15 This provision: Forbids employing minors under 14 in nonagricultural jobs Restricts hours of work Limits occupations for 14- and 15-year-olds Forbids 16- and 17-year-olds from being employed in hazardous occupations

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Equal Pay Act of 1963 (EPA)

EPA

is an amendment to the FLSA Its goal is to guarantee that women holding the same jobs as men will be treated with respect and fairly compensated regarding all rewards of work Comparisons cannot be made between individuals holding the same job at different companies Employers may pay workers of one gender more than another on the basis of any factor other than sex

The

gender pay gap in 2001 averaged 26 percent The average woman made 74 percent of the earnings of the average white male

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Equal Pay Act of 1963 (EPA)

Four

elements establish the equality of positions: Skill Effort Responsibility Working conditions

difference in wages includes additional forms of compensation, such as: Vacations and holiday pay, leave of absence, overtime, lodging, food, and reimbursement for clothing or other expenses

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Equal Pay Act of 1963 (EPA)

When

filing a claim under EPA, the plaintiff must prove that one man or one woman is making more for doing the same job The doctrine of comparable worth attempts to prove that employers systematically discriminate by paying women less than their work is intrinsically worth

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Equal Pay Act of 1963 (EPA)

Comparable

worth means different things to different people Comparable worth relates to jobs that are dissimilar in their content, but of equal value to the organization and society (nurse and plumber) Women appear to be concentrated in lower-paying, predominantly female jobs When men take womens work they are at the top of the pay scale there too

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Equal Pay Act of 1963 (EPA)

The

notion of value is important in examining the differentials between men and women Water is more valuable than diamonds, but diamonds cost more This is because the supply of water is abundant relative to demand When secretaries, librarians, and cashiers are in short supply, employers will have to pay them more

To

close the gap between womens and mens pay, womens real wages must rise faster than mens

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Equal Pay Act of 1963 (EPA)

The

Walsh-Healy Act of 1936 Requires firms doing business with the federal government to pay wages at least equal to the industry minimum It parallels the Fair Labor Standards Act on child labor, and requires time-and-a-half for any work performed after eight hours a day Certain industries are exempt

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Equal Pay Act of 1963 (EPA)

The

Davis-Bacon Act of 1931 Requires the payment of minimum prevailing wages of the locality to workers engaged in federally sponsored public works McNamara-OHara Service Contract Act Requires employers who have contracts with the federal government of $2,500 or more per year, or who provide services to federal agencies as contractors or subcontractors, to pay prevailing wages and fringe benefits to their employees

The

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Equal Pay Act of 1963 (EPA)

Civil

Rights Act of 1964 and the Age Discrimination Act of 1967 Ensure that people of similar ability, seniority, and background receive the same pay for the same work Federal Wage Garnishment Act of 1970 Limits what can be deducted from pay to reduce debts Prohibits an employer from firing an employee if he/she goes into debt only once and has pay garnished Employers may deduct whatever is required for alimony, child support, taxes, or bankruptcy court rulings

The

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Other Government Influences

The

government requires employers to deduct funds from employees wages for: Federal income taxes Social security taxes State and local income taxes

Other

ways government influences compensation: If the government is the employer, it can legislate pay levels by setting statutory rates The government may create jobs for certain categories of workers, thus reducing the supply of workers and affecting pay rates

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Union Influences
Unions

exert influence on compensation programs Unionized workers work longer hours and make more than non-unionized workers Unions tend to be pacesetters in demands for pay, benefits, and improved working conditions

There

is supportive interaction between unions and the government The Davis-Bacon Act requires employers with government contracts to pay prevailing wages The Wagner Act makes it illegal to change wage rates during a union organizing campaign

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Union Influences
The

union is more likely to increase the compensation of its members when: It is financially and competitively strong It has the finances to support a strike It has the support of other unions Employment is low The economy is strong

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Union Influences
Unions

prefer fixed pay for each job category, or rates that reflect seniority rather than merit increases Unions press for time pay rather than merit pay when performance is tied to technology union membership in the U.S. has declined, the influence on wages cannot be discounted

Although

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Internal Influences on Compensation

Internal

factors that affect pay include: The size and age of the organization The labor budget Who makes pay decisions for the organization

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The Labor Budget

The

labor budget sets the amount of money available for annual employee compensation The budget does not normally state the amount of money allocated to each employee Rather, it states how much is available for the unit or division Discretion in allocating pay is left to the department heads and supervisors

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Who Makes Compensation Decisions

Compensation

decisions are influenced from the top to the bottom of the organization In publicly held organizations, stockholders and the board greatly influence pay, especially at the top of the organization

Top

management determines: How much of the firms budget is earmarked for pay The form of pay to be used (time based vs. incentive) Other pay policies
As the firm grows, compensation specialists, general managers, and job incumbents may also have input

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Who Makes Compensation Decisions

Both

large and small organizations now involve more individuals in determining pay At Whirlpool Corporation, top managers and compensation specialists jointly establish financial and operating goals Com-Com Industries allows workers to set compensation rates through a volunteer committee of 10 to 15 members

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Pay and Motivation

Motivation

is the set of attitudes and values that predisposes a person to act in a specific, goaldirected manner This behavior has two components: The direction of behavior The strength of the behavior

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Pay and Motivation

In

motivating employees, most of the focus has been on money From Aristotle through Frederick W. Taylor, philosophers, scientists, industrial engineers, and managers believed money was the only motivator Beginning in the 1930s, sociologists, psychologists, and human relations theorists proposed that cognitive and acognitive processes affected the relationship between pay and motivation

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Pay and Motivation

Needs

theorists say that all human behavior stems from needs or drives, which are biological in origin Maslows hierarchy of needs takes the form of a pyramid Physiological Safety Social Esteem Self-actualization Lower-order needs motivate employees to earn money

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Pay and Motivation

Herzbergs

two-factor theory of motivation tries to find out what people want from work Dissatisfiers (hygiene factors) and satisfiers (motivators) influence work behavior Hygiene factors include pay, working conditions, supervision, and so on; they do not motivate Motivators include achievement, recognition, responsibility, advancement, growth, and the work itself Motivators become operational only when dissatisfiers are removed

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Pay and Motivation

Herzberg

concludes that changing pay will not

motivate However, dissatisfaction results if: Pay is inadequate, Of the wrong type, or Is mismatched to employees needs

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Pay and Motivation

Social

comparison theories suggest that motivation is influenced by how fairly an employee thinks he/she is being paid The key to understanding social comparison theories is the idea of perceived fairness Does the employee think he/she is being paid fairly?

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Pay and Motivation

Per

Tolman and Vrooms expectancy theory, motivation depends on the expectation that effort will produce performance Various outcomes have different levels of desirability (valence) A direct application of expectancy theory to compensation is the idea of earning days of vacation or sick leave By becoming senior employees, other desired outcomes are achieved, such as annual raises
This concept is the instrumentality of goal-directed behavior

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Pay and Motivation

According

to reinforcement, behavior modification, and other social-behaviorist theories: Motivation results from the direct interaction of the individual with the external environment theories were developed by Pavlov, Watson, Thorndike, and Skinner They hold that if pay, benefits, services, or rewards are received after performing certain tasks, then the desired behavior will be repeated

These

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Pay and Motivation

Because different things motivate different individuals, and theorists dont agree on what motivates, motivation is a complicated and difficult, if not impossible, task

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Pay and Employees Satisfaction

satisfaction refers to an employees liking for, or dislike of, the compensation package There is no proof that worker satisfaction leads to increased productivity The clearest indication of satisfaction may be patterns of absenteeism and turnover to Edward Lawler: If employees believe that the amount they receive is equal to what others receive, pay satisfaction results The feedback loop between perception, fairness, and work behavior leads to fluctuations in output

Pay

According

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Pay and Employees Satisfaction

by Simons found that the pay components that lead to satisfaction differ by type of worker: Industrial workers prefer interesting jobs more than high pay Hotel workers prefer high wages above all else

Research

Other

predictors of pay satisfaction include: Pay desired versus pay earned Feelings of being entitled or deserving Relative deprivation

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Pay and Employees Satisfaction

deprivation theory suggests that pay dissatisfaction is a function of six judgments: A discrepancy between what employees want and what they receive A discrepancy between a comparison Herzberg concluded that outcome and what they get pay simply prevents workers Past expectations of receiving more from being rewards demotivated Low expectations for the future A feeling of deserving or being entitled to more Not feeling personally responsible for poor results

Relative

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Pay and Employees Productivity

addition to motivation, high performance requires: Ability Adequate equipment Good physical working conditions Effective leadership and management Health Safety pay is tied to performance, the employee produces a higher quality and quantity of work

In

If

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Pay and Employees Productivity

wages were supported by early economists on the basis of the hungry man theory Adam Smith (1776) modified this to the economic man theory Instead of physiological needs, money became the motivator for work The more money a person made, the harder he/she would work This is the basis of the modern wage incentive plan

Incentive

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Pay and Employees Productivity

W. Taylor built on Smiths theory He used managers to design jobs properly and then linked pay directly to measurable productivity Workers who met production standards were paid 125 percent of base pay Those who failed to meet standards were paid a very low wage

Frederick

Some

argue that tying pay to performance destroys the intrinsic rewards a person gets from doing the job well
The importance of money varies from person to person

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Pay and Employees Productivity

an organizations has an incentive pay system but pays for seniority, the motivation of pay is lost The key is be be sure that compensation systems are directly connected to expected behaviors on the relationship between pay, employee satisfaction, and productivity continues, but with contradictory results It can still be concluded, however, that pay is an important outcome to employees

If

Research

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Compensation Decisions
Pay

for a position is set relative to three groups: Group A: employees working on similar jobs in other organizations Group B: employees working on different jobs within the organization Group C: employees working on the same job within the organization

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Compensation Decisions
The

decision to examine pay relative to group A is called the pay-level decision Be competitive in the marketplace Use the pay survey to help with decisions pay decision relative to group B is the paystructure decision Use job evaluations to set a value for each job relative to all other jobs pay decision relative to group C is individual pay determination

The

The

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The Pay-Level Decision

Managers

compare the pay of people working inside the organization to those outside it There are three pay-level strategies:
High Low

Comparable

High-pay

strategy: Managers pay at higher-than-average levels to attract and hold the best employees Companies using this strategy are called pacesetters

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The Pay-Level Decision

Low-pay

strategy: The manager pays at the minimum level needed to hire enough employees This strategy may be used because this is all the organization can pay

Comparable-pay

strategy:

The most frequently used strategy The going rate is determined from pay surveys Pay is set at the current market rate in the community or industry, 5 percent or so

Any pay strategy may have to be modified for hardto-fill jobs

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Choice of a Strategy
Strategy

also reflects the motivation and attitudes of the manager

With

a high need for recognition, the high-pay strategy might be chosen If ethically oriented, a low-pay strategy will not be chosen willingly
Two

other factors affect a pay-level strategy: How easily a company can attract/retain personnel The organizations ability to pay

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Choice of a Strategy
Factors

affecting the attraction and retention of human resources include: The availability of qualified labor Job security Level of benefits

Factors

affecting the ability to pay include: Cost of labor Profit margins Stage of the firm

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Choice of a Strategy
Many

external factors also affect the process, such as government and unions This is compounded by employees job preferences, which include pay and nonpay aspects Many employees do not understand all these factors

An

organization has a great deal of room for maneuvering in the pay-level decision To help make the decision, managers use a pay or wage survey, market pricing, or bench-marking

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Pay Surveys
Pay

surveys collect data about compensation paid to employees by all employers in: A geographic area An industry An occupational group

They

help gauge market rates for various positions Obtaining valid, reliable information is critical

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Who Conducts Pay Surveys?

Pay

surveys are conducted by: Professional and consulting enterprises Trade associations The government Unions Competitors salary information can acquired by: Purchasing or joining an existing survey Conducting a survey Doing a telephone survey of competitors Collecting information from proxy statements

Competitive

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Usefulness of Surveys
Critical

issues affecting the usefulness of surveys: Are the jobs covered? Who will be surveyed? Which method will be used? methods include: Personal interview Mailed questionnaires Telephone inquiries

Survey

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The Best Surveys

Use

clear, concise job descriptions Give clearly written instructions Include a good sample of organizations (names identified) Use a consistent sample of participants for each iteration Provide data on base pay, bonuses, total compensation Provide 25th, 50th, and 75th percentile data for both base and total compensation Include information on benefits List numbers of incumbents for each job surveyed Are completed by human resource professionals Are reviewed by compensation professionals

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The Pay Structure Decision

The

next step is to construct an internal pay hierarchy or pay structure The traditional way was to make a systematic comparison between the worth of one job and the worth of another, using job evaluation

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Job Evaluation
Job

evaluation is a process by which the relative worth of various jobs is determined for pay purposes It relates the amount of pay for each job to the extent to which it contributes to organizational effectiveness It is subject to job evaluator errors

Because

computing contributions to organizational effectiveness is difficult, proxies are used Skills required to do the job Amount and significance of responsibilities Effort required Working conditions

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Job Evaluation
The

first step in using job evaluation effectively is to involve employees and/or the union Employees should be allowed to express their perceptions of the relative merits of their jobs This gives management an opportunity to explain the job evaluation process to those most affected by it the program is off to a cooperative start, a committee evaluates the jobs Job evaluation is usually performed by analyzing job descriptions and sometimes job specifications

After

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Job Evaluation
Select

and weigh the criteria (compensable factors) used to evaluate the job Factors most frequently used: Education Experience Amount of responsibility Job knowledge Work hazards Working conditions

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Job Evaluation
Frequently

used methods of job evaluation: Job ranking Classification Point system Factor comparison

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Ranking of Jobs
Ranking

is the system used primarily in smaller, simpler organizations The evaluator rank-orders whole jobs, from the simplest to the most challenging The ranking may not occur at equal intervals If an organization has many jobs, this system is clumsy to use and the ratings may be unreliable Ranking is the least frequently used method of job evaluation

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Classification or Grading System

Classification

or grading groups a set of jobs Sets are then ranked by difficulty or sophistication It is a job-to-standard comparison

The

evaluator first decides how many classifications the job structure has to be broken into Then, definitions are written for each class After the classes are defined, job are compared with the definition and placed into the proper classification

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Classification or Grading System

Insert

Exhibit 10-5 here

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Classification or Grading System

A

job classification system can be constructed quickly, simply, and cheaply It is also easy to understand and to communicate to employees include: More detailed than job ranking Assumes a rigid relationship between job factors and value Can be difficult to decide how many classifications there should be

Drawbacks

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Point System
The

greatest number of job evaluation plans use the point system More sophisticated than ranking/classification systems Relatively easy to use evaluators to assign points on the basis of: Skill required Physical and mental effort needed Degree of dangerous/unpleasant working conditions Amount of responsibility
When these are summed, the job has been evaluated

Requires

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Factor Comparison
Developed

by Eugene Benge, it permits job evaluation to be done factor-by-factor Jobs are compared to a benchmark of five key points: Responsibilities Skill Physical effort Mental effort Working conditions

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Factor Comparison
Insert

exhibit 10-6 here

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Factor Comparison
Advantages: A

step-by-step, formal method of evaluation Shows how differences in rankings translate into dollars and cents Is easy to explain to subordinates
Disadvantages:
Complex Difficult

to show how such a system is developed Relies on the subjective judgments of a committee

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Pay Classes, Rate Changes, Classifications

The

pay-structure process is completed by establishing: Pay curves Pay classes Rate ranges Job classifications intervals of 50 points or so, a new pay class is marked off

At

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The Pay Curve

The

next slide shows a single-rate pay system All jobs within a given labor class receive the same rate of pay In this example, pay classes are determined by the point value that was set through job evaluation A pay class (pay grade) is a grouping of jobs that are similar in terms of difficulty and responsibility

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The Pay Curve

Insert

Exhibit 10-7 here

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The Pay Curve

The

next slide shows how data from a wage and salary survey are combined with job evaluation information to determine pay structure A compensation trend line is derived by establishing the general pay pattern The trend line can then be determined The pay rate for any job can be ascertained by calculating the point value of the job and then locating that value on the trend line and maximum limit lines can be set by setting a percentage above or below the trend line

Minimum

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The Pay Curve

Insert

Exhibit 10-8 here

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The Pay Curve

Although

it is possible for a pay class to have a single pay rate, the more likely condition is a pay range Pay ranges are usually divided into a series of steps:
Step 1 $5,000-5,400 Step 2 $5,401-5,600 Step 3 $5,601-5,850

These

steps are in effect raises within the pay range Within-grade increases are typically based on seniority, merit, or both
The pay structure should be periodically evaluated and adjusted

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Delaying and Broadbanding

Broadbanding

approaches are an attempt to: Improve efficiency Reduce the complexities of job-based pay structures
A

Delayering:

reduction in the total number of job levels Increases flexibility by allowing employees to move among a wider range of job tasks without having to adjust pay with each move

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Delaying and Broadbanding

Broadbanding: More

emphasis on individual performance Multiple salary grades and ranges are collapsed into a few wide levels (bands) Entry-level employees start at the range minimum; movement upward is based on performance (merit) Allows managers to reward top performers while saving money on mediocre employees
When shifting pay decisions to managers, the firm must guard against abuse: favoritism can result in unfair use

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The Individual Pay Decision

How

does the organization determine what two people doing the same job should make? The decision is called individual pay determination This topic will be covered in Chapter 11