Chapter 10

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10

Compensation:An Overview

McGraw-Hill/IrwinHuman 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

In 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%)

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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:MotivationProductivitySatisfaction

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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 flowIt attracts and motivates employees

Compensation is a significant component of the 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 EquitableBalancedCost-effectiveSecureIncentive-providingAcceptable to the employee

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External Influences on Compensation

External influences include:The labor marketThe economyThe governmentUnions

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The Labor Market and Compensation

In times of full employment, wages may have to be higherPay may also be higher if few skilled employees are

in the job marketIn 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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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 onDiversity refers to any mixture of items characterized

by differences and similarities

The 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

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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

This increasingly educated population will not hesitate to ask for changes in pay and benefits

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Generation X has the higher percentage of members who have finished high school and college They value financial security, power, and status However, they don’t 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

Two other types present compensation challenges: Technological experts (nerds) Temporary or contingent workers

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

A productivity index used to determine a general level of wages:The Bureau of Labor Statistics’ “Output per Man-

hour in Manufacturing”

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For 70 years, productivity increased at 3 % per yearThe 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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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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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 OvertimeChild laborThe Equal Pay Act of 1963

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Wage and Hour Regulations

FLSA covers businesses with two or more employees engaged in: Interstate commerce The production of goods for

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

About 92 percent of

nonsupervisory wage earners are covered

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FLSA Exemption Guidelines

Exempt from minimum wage and overtime:Executive, administrative, and professional

employees, and outside sales personsEmployees at seasonal amusement or recreational

establishmentsEmployees of certain small newspapersSwitchboard operators of small telephone companiesSeamen employed on foreign vesselsEmployees engaged in fishing operationsFarm workers employed on small farmsCasual baby-sitters, companions to the elderly/infirm

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Exempt from overtime pay requirements only:Commissioned employees of retail and

service companiesAuto, truck, trailer, farm implement,

boat or aircraft workersParts clerks and mechanics servicing autos, trucks, or

farm implements who sell to the ultimate purchasersRailroad 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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Exempt from overtime pay requirements only:Announcers, news editors, and chief engineers of

certain non-metropolitan broadcasting stationsDomestic service workers who reside in their

employer’s residenceEmployees of motion picture theatersFarm 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

The 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

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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

A 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 weekMore 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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Four elements establish the equality of positions: SkillEffortResponsibilityWorking conditions

A 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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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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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 “women’s work” they are at the top of the pay scale there too

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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 women’s and men’s pay, women’s real wages must rise faster than men’s

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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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The Davis-Bacon Act of 1931 Requires the payment of minimum prevailing wages

of the locality to workers engaged in federally sponsored public works

The McNamara-O’Hara 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

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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

The 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

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Other Government Influences

The government requires employers to deduct funds from employees’ wages for: Federal income taxesSocial security taxesState 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 programsUnionized 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 wagesThe 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

Although union membership in the U.S. has declined, the influence on wages cannot be discounted

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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 firm’s 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, goal-directed 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 Maslow’s hierarchy of needs takes the form of a

pyramidPhysiologicalSafetySocialEsteemSelf-actualization

Lower-order needs motivate employees to earn money

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Pay and Motivation

Herzberg’s two-factor theory of motivation tries to find out what people want from work Dissatisfiers (hygiene factors) and satisfiers

(motivators) influence work behaviorHygiene 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 Vroom’s 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

These 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

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Pay and Motivation

Because different things motivate different individuals, and theorists don’t agree on what motivates, motivation

is a complicated and difficult, if not impossible, task

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Pay and Employees’ Satisfaction

Pay satisfaction refers to an employee’s 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

According to Edward Lawler:If employees believe that the amount they receive is

equal to what others receive, pay satisfaction resultsThe feedback loop between perception, fairness, and

work behavior leads to fluctuations in output

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Research 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

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

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Relative deprivation theory suggests that pay dissatisfaction is a function of six judgments: A discrepancy between what employees want and

what they receiveA discrepancy between a comparison

outcome and what they getPast expectations of receiving more

rewardsLow expectations for the futureA feeling of deserving or being entitled to more Not feeling personally responsible for poor results

Herzberg concluded that

pay simply prevents workers

from being demotivated

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Pay and Employees’ Productivity

In addition to motivation, high performance requires: AbilityAdequate equipmentGood physical working conditionsEffective leadership and managementHealthSafety

If pay is tied to performance, the employee produces a higher quality and quantity of work

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Incentive 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 workThe more money a person made, the harder he/she

would work This is the basis of the modern wage incentive plan

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Frederick W. Taylor built on Smith’s theoryHe used managers to design jobs properly and then

linked pay directly to measurable productivityWorkers who met production standards were paid

125 percent of base pay Those who failed to meet standards were paid a

very low wage

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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If 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

Research 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

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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

The pay decision relative to group B is the pay-structure decision Use job evaluations to set a value for each job

relative to all other jobs

The pay decision relative to group C is individual pay determination

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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:

HighLowComparable

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 strategyThe going rate is determined from pay surveysPay 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 hard-to-fill jobs

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Choice of a Strategy

Strategy also reflects the motivation and attitudes of the managerWith 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 organization’s ability to pay

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

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

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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 areaAn industryAn 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 associationsThe governmentUnionsCompetitors

Competitive salary information can acquired by: Purchasing or joining an existing survey Conducting a surveyDoing a telephone survey of competitorsCollecting information from proxy statements

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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?

Survey methods include:Personal interviewMailed questionnairesTelephone inquiries

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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 structureThe 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 usedSkills required to do the jobAmount and significance of responsibilitiesEffort requiredWorking 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

After 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

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Job Evaluation

Select and weigh the criteria (compensable factors) used to evaluate the job Factors most frequently used:

Education ExperienceAmount of responsibilityJob knowledgeWork hazardsWorking conditions

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Job Evaluation

Frequently used methods of job evaluation: Job rankingClassificationPoint systemFactor 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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Insert Exhibit 10-5 here

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A job classification system can be constructed quickly, simply, and cheaply It is also easy to understand and to communicate to

employees

Drawbacks 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

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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

Requires 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

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Factor Comparison

Developed by Eugene Benge, it permits job evaluation to be done factor-by-factorJobs are compared to a “benchmark” of five key

points:ResponsibilitiesSkillPhysical effortMental effortWorking 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:ComplexDifficult 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 curvesPay classesRate rangesJob classifications

At intervals of 50 points or so, a new pay class is marked off

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The Pay Curve

The next slide shows a single-rate pay systemAll jobs within a given labor class receive the same

rate of payIn this example, pay classes are determined by the

point value that was set through job evaluationA 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


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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 structureA 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

Minimum and maximum limit lines can be set by setting a percentage above or below the trend line

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The Pay Curve


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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 $5,000-5,400Step 2 $5,401-5,600Step 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

Delayering:A 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

Documents

Chapter 10