Compensation

The Importance of Compensation

Impacts an employers ability to attract and retain
employees.
Ensure optimal levels of employee performance in
meeting the organizations strategic objectives.
Compensations components
Direct compensation in the form of wages or salary
Base pay (hourly, weekly, and monthly)
Incentives (sales bonuses and or commissions)

Indirect compensation in the form of benefits

Legally required benefits (e.g., Social Security)
Optional (e.g., group health benefits)

Theory Behind Compensation

Equity Theory
Comparing inputs and outputs of a similar co-worker
Perceived inequity affects employee effort

Expectancy Theory
People are motivated by intrinsic and extrinsic outcomes they
desire.
People will only be motivated if outcome is possible.
People will only be motivated if outcome is contingent.

Equity Theory
Internal equity
Comparison of my input / reward ratio with that of similar
others.
Employees may seek to address imbalance by changing
their inputs.
Fairness of pay differentials between different jobs in the
organization can be established by job ranking, job
classification, point systems and factor comparisons.

External equity
Fairness of organizational compensation levels relative to
similar jobs in other organizations.

Monkeys Demand Equal Pay

A recent study shows brown capuchin monkeys refused to play
along when they saw another monkey get a better payoff for
performing the same work.
The monkeys were trained to trade a granite token for a piece of
cumber. When the reward was the same for both monkeys, they
took the cucumber 95 percent of the time.
But it was a different story when one monkey was given something
better -- namely, a grape. Then, the other monkey often pitched
a fit -- either throwing the token, refusing to eat the cucumber or
giving it to the other monkey.
Associated Press 2003

Equity Theory
Fairness about pay differentials among
individuals who hold the same job can be
established by using:
Seniority-based pay systems that reward longevity.
Merit-based pay systems that reward employee
performance.
Incentive plans that allow employees to receive part of
their compensation based on their job performance.
Skills-based pay systems.
Team-based pay plans that encourage cooperation and
flexibility in employees.

Types of Base Pay Systems

Job-based
Pay the job (not the person)
Market-based (external equity focus)
Point factor-based (internal equity focus)

Skills / knowledge-based
Pay the person (not the job)
62% of F1000 firms used some type of skill based
pay in 1999

Job Based Pay

Attraction

Depends on market pricing

Motivation

No performance impact

Skill Development

Learn job-related and upward mobility

skills

Culture

Bureaucratic, hierarchical

Structure

Hierarchical, individual jobs and

differentiation

Cost

Good control of individual pay

Individual Skill/Knowledge Based Pay

Attraction

Attracts learning-oriented individuals,

high skills individuals

Motivation

Little performance impact

Skill Development

Motivates needed skill development

Culture

Learning, self-managing

Structure

Flat or team-based

Cost

Higher individual pay

When to Use a Job-based Pay Policy

A job-based pay work best in situations where:

Job duties are stable.

Skills are generic.
Employees move up through the ranks over time.
Jobs are fairly standardized within the industry.

Drawbacks of a job-based pay system

Discounts individual ability.

Discourages lateral movement.
Tends to be bureaucratic, mechanistic, and inflexible.
Employees perceptions of equity are more important than market
or point data.

Individual-based Compensation
Individual-based compensation works when:

The firm has a relatively educated workforce.

Employees often do different jobs
Technology changes frequently.
Employee participation and teamwork are encouraged.
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.

Pricing Jobs
First conduct job analysis
Qualifications
KSAs

Non-quantitative methods
Job Ranking (create hierarchy of jobs)
Job Classification (create groups of similar jobs)

Quantitative Methods
Point factor systems
Compare compensable factors

Market pricing

Compensable Factors
Characteristics in the job that the organizational
values and that help achieve its objectives.
Hay Factors
Know-how
Problem solving
Accountability

National Position Evaluation

Plan (MAA)

Skill
Effort
Responsibility
Job Conditions

Pricing Jobs

Variable Pay Incentives

Linking performance to pay

Individual Bonuses, piece-rates, stock options

Team Bonuses and awards
Plant / Unit / Business Gainsharing, profit sharing
Corporation ESOPs

Line of sight is the perceived link between individual

behavior and the reward.

Individual Merit
Attraction

Good for high performers

Motivation

Good line of sight

Skill Development

Learn skills that lead to rewarded

performance

Culture

Performance oriented, job focused

Structure

Individual and independent jobs

Cost

Depends on the size of the awards

Team Incentives
Attraction

Good if team performs well

Motivation

Moderate line of sight

Skill Development

Encourages team skills

Culture

Team focused

Structure

Team-based and integrated

Cost

High if significant awards given

Organizational Plans
Attraction

Good if organization performs well

Motivation

Weak line of sight

Skill Development

Encourages broad understanding of

business

Culture

Business involvement

Structure

Organization wide integration

Cost

Possible self-funding if based on

performance improvement

Pay for Performance Requires

1. Definition of performance
How are we going to measure and compare people?
2. Distribution of performance
Can we distinguish high and low performers?
3. Decide the increase for each level of performance.
How large a difference between high and low
performers?

Key Strategic Issues in Compensation

Determining compensation relative to the market.
Striking a balance between fixed and variable
compensation.
Deciding whether or not to utilize team-based versus
individual pay.
Creating the appropriate mix of financial and nonfinancial compensation.
Developing a cost-effective compensation program
that results in high performance.

New Thinking for the New Millennium

Strategic approaches to may compensation (pay)
systems more responsive:
Pay the person for individual worth (knowledge, skills and
competencies) rather than for the value of a job they
perform.
Reward excellence through a pay for performance
compensation that establishes a clear relationship between
a significant amount of pay and attainment of organizational
objectives.
Individualize the pay system to give employees choices in
how they are rewarded and what reward they receive.