International Compensation

Module 6 Ref: Peter J Dowling IHRM Book

M6-International Compensation

Syllabus
Forms of compensation and factors that

influence compensation policy Key components of international compensation Approaches to international compensation Compensation practices across the countries Social security systems across the countries Global compensation: emerging issues.

M6-International Compensation

Introduction
Compensation is not just about paying the employee For MNCs successfully to manage compensation

and benefits requires knowledge of employment and taxation law, customs, environment and employment practices of many foreign countries, familiarity with currency fluctuations and the effect of inflation on compensation and an understanding of why and when special allowances must be supplied and which allowances are necessary in what countries [awareness about political, economic and social conditions] Fixing and managing compensation for an expat is M6-International Compensation always complex because they are high cost

Objectives of International compensation

Compensation policy should be consistent with

the overall strategy of MNC

Policy must work to attract and retain competent

staff in the locations where MNC has greatest needs and opportunities
Policy should facilitate the transfer of international

employees in the most cost effective manner for the firm

Policy must give due consideration to equity and

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easy administration [should be fair and easy to

Forms of Compensation
1. Intrinsic & Extrinsic Compensation Intrinsic : non financial related nature of work, interest in work and career aspects, related to job satisfaction of the employee Extrinsic: financial nature 2. Direct & Indirect Compensation Direct: an employees fixed and variable annual income Indirect: consists of all deferred income, pension, insurance, benefits like company car, expense allowance Sum of direct and indirect compensation makes M6-International Compensation up organizations total compensation program

Factors influencing compensation policy

1. Internal business factors

Margin for wage costs, depends on profit

generated by company Labour shortage or surplus influences pay rates. Labour Shortage-- rise in pay rates, labour surplus--- fall in wage Organizational cost strategy Performance based culture encourage good or high pay rates for better performance, means organizations culture influences compensation structure M6-International Compensation

Factors influencing.. Contd.

2. Purchasing power and prosperity Level of economy Economy prosperity and cost of living 3. Social factors Wage bargaining power [national and industry level] Labour unions Cultural/ social factors/ characteristics like Japan- collectivism culture-group appraisal Germany- high uncertainty avoidance-performance related Compensation pay will not be much encouraged, they M6-International focus on fixed salary

Key components of an international compensation

Base Salary

Foreign

service inducement/hardship premium Allowances Benefits Vacations and special leaves Bonuses
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1. Base salary
In

domestic context base salary denotes the amount of cash compensation serving as a benchmark for other compensation elements [like bonuses, benefits, HRA etc] For expats it is the primary component of a package of allowances, many of which are directly related to base salary [ cost of living allowance COLA, foreign service premium, housing allowance] It will be the basis for in service benefits and pension contributions It may be paid in home or local country currency Differences may occur in compensation package depending on whether base salary is linked to the M6-International Compensation of PCN or TCN, or whether an home country

2. Foreign Service Inducement / Hardship Premium

PCNs often receive salary premium as

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an inducement to accept foreign assignment or as compensation for any hardship caused by transfer More commonly paid to PCNs than TCNs Usually 5 to 40% of base pay will be paid as Foreign Service Inducement Payment may vary depending upon M6-International Compensation assignment, actual hardship, tax

3. Allowances
MNCs generally pay allowances to motivate

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employees to accept international assignments A. Cost of living allowance[COLA] Payment made to compensate the differences in cost of living between home and foreign country Difficult to determine, so most of the MNCs prefer to take help of agencies or consultancies who can provide updates and information to them M6-International Compensation It may also include payments for utilities,

3. Allowances contd..
B. Housing Allowance Objective is to help expat manager to maintain his/her standard of living in the foreign country Sometimes accommodations are provided by MNC, it can be optional or mandatory Are often paid on either an assessed or an actual basis This can be a fixed allowance or some portion of income out of which actual housing costs are paid C. Home leave allowances Many employers cover the expense of one or more trips back to the home country each year Expats will get opportunity to meet family, friends and M6-International Compensation relatives, and can build up their morale level

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3. Allowances contd..
D. Education Allowances Allowances for expats children education includes tuition fees, enrolment fees, books, transportation, room, board and uniforms etc E. Relocation Allowances Covers moving, shipping and storage charges, car expenses etc F. Spouse Assistance This will be given to offset income lost by an expats spouse as a result of relocating abroad Alternative to this compensation, MNC can also provide employment opportunities abroad by offeringCompensation job research assistance or in their foreign M6-International subsidiary office

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4. Benefits
Ex: pension plans It is very difficult to determine It comprise approximately 1/3rd

of compensation

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package Issues when considering benefits 1. Whether or not to maintain expatriates in homecountry programs, particularly if the firm does not receive a tax deduction for it. 2. Whether firms have the option of enrolling expatriates in host-country benefit programs and/or making up any difference in coverage. 3. Whether expatriates should receive home-country or host-country social security benefits. M6-International Compensation Most US PCN remain under their home country

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5. Apart from all these, MNCs also give vacations and special leaves to expatriates 6. Bonuses There are three approaches to provide bonuses; A percentage is added to base pay ranging from 10% to 30% of base pay Lump sum payment at the beginning or end of foreign assignment or combination of first two M6-International Compensation

Approaches to International compensation

There are two main options in the area of

international compensation
Going Rate Approach [also known as Market

rate Approach] The Balance Sheet Approach [also known as Build up Approach]

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M6-International Compensation

Going Rate Approach[Market Rate Approach]

Based on local market rates Relies on survey comparisons among:

- Local nationals (HCNs) - Expatriates of same nationality - Expatriates of all nationalities Compensation based on the selected survey comparison MNC obtains information from local compensation surveys Base pay and benefits may be supplemented by additional payments for low-pay countries M6-International Compensation 17

Contd..
For ex:

Japanese bank operating in New York would need to decide whether its reference point would be Local US salaries or Other Japanese competitors in New York or All foreign banks operating in New York
If location is in a low pay country, MNC usually adds additional benefits and payments with base pay.
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Merits & Demerits of Going Rate Approach

Advantages Equality with local nationals Simplicity Identification with host country Equity amongst different nationalities
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Disadvantages Variation between assignments for same employee Variation between expatriates of same nationality in different countries Potential re-entry problems

Balance Sheet or Build Up Approach

Objective is to keep the expatriate whole

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[maintaining home country living standard plus financial inducement to make package attractive] Home country pay and benefits are foundations of this pay Adjustments to home package to balance additional expenditure in host country Financial incentives are added Most common system in usage by MNC firms Expats will not suffer from material loss

M6-International Compensation

Four Balance Sheet Approach categories

1. Goods and services home-country outlays for items such as food, personal care, clothing, household furnishings, recreation, transportation and medical care. 2. Housing the major costs associated with housing in the host country. 3. Income taxes parent-country and hostcountry income taxes. 4. Reserve contributions to savings, payments for benefits, pension contributions, investments, education expenses, social security taxes, etc. M6-International Compensation

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Merits & Demerits of balance Sheet Approach

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Expatriate Compensation Worksheet sample

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International taxation
There are two approaches for international taxation 1. Tax protection In this approach, the company reimburses the expatriate for the difference, if the actual home tax plus the host country tax is greater than the hypothetical tax calculation.

If the two are less than the hypothetical tax calculation, the expatriate gets to keep the difference. M6-International Compensation 24

International Taxation contd..

2. Tax equalization In this approach the company pays both the home and host country taxes for the expatriate. The company calculates the hypothetical tax and makes the deductions from the person's paycheck on that basis. If the actual tax is less, the company reimburses the expatriate for the over-deduction. If the actual tax is more than has been deducted, then the expatriate reimburses the company for the difference. M6-International Compensation 25

International living costs data

MNCs

using the balance sheet approach must constantly update compensation packages with new data on living costs, which is an ongoing administrative requirement There is also much debate about what should be in the basket of goods which consulting firms use as the basis for calculating living costs around the world For example the Swiss Bank UBS uses the Big Mac Index to measure the living costs around the world According to the Index, it takes more than 3 hours for the average worker in Nairobi to earn enough for a Big Mac. In Los Angeles, Tokyo, the global burger can be bought for a mere 10 minutes effort.
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Range of working times required to buy one Big Mac

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Compensation practices across the countries

INDIA Basic wage corresponds with Fair Wages Committee [1948] and 15th labour conference [1957] recommendations Criteria for determining basic wage are: skills, experience needed for job, difficulty of work [both mental and physical], training needed, responsibilities involved and hazardous nature of job DA is linked with AICPA [All India Consumer Price Index Government has set up Wage Boards, Pay M6-International Compensation Commissions for fixing & revising wages,

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US
Basic compensation package comprises of a base

salary, a variable performance linked bonus, long term cash incentives, compulsory benefit contributions and voluntary benefit contributions During the fiscal year salary adjustments are warranted, these are known as interim increases & generally classified into 3 ways 1. Administrative oversight: an adjustment to an individuals pay, frequently occurring shortly after the effective date of annual merit increase 2. Alignment: is used to adjust pay of individuals whose salary is low in comparison to pay of similarly performing employees within the peer group 3. Retention: is used to reward employees who are M6-International 29 critical to Compensation the success of an organizations mission or a

Russia
Having a good fixed salary is important in

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compensation package The optimal compensation package combines bonus and non monetary benefits In most cases bonus varies 20% to 40% of total salary The most common type of bonus is the payment of thirteen month of salary, if certain objectives have been achieved by the company Apart from above, Russians have been used to receive non-monetary benefits such as good lunches, medical insurance, life insurance and so M6-International Compensation on

Japan
Japan has seniority based wage system, which

has 2 features The amount of pay goes up according to the length of service and age Wages are not set separately for individual jobs Bonuses are paid in summer and winter Allowances are paid when worker leaves the company Basic salary is determined according to job related qualifications and competence, ranks within a job category Pay hikes on base salary are given every year in M6-International Compensation 31 April

Saudi Arabia
In addition to base monthly salaries, companies

provide benefits and allowances to their Saudi and expatriate employees Includes housing, food, auto allowances, vacation tickets to home country, school fees etc Some benefits are mandated by Saudi Labour Law and others are granted by discretion of company Apart from this, bonuses will be provided

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China
A nationally unified wage system was structured in

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1956 for both blue and white collar employees Under this system, there were 8 grades for workers, 15 grades for technical person and 25 grades for managers and administrative personnel Reform of compensation system began at enterprise level Enterprise Law was issued in 1988 and related regulations during 1990s provided separation of an enterprise from its controlling authority so that enterprise had autonomy and incentives A state regulated wage systems have now replaced by diversified wage packages with more focus on enterprise profitability and individual performance M6-International Compensation

Social Security Schemes

According to International Labour Organization [ILO], social security is security furnished by the society through appropriate organization against certain risks to which its members are exposed. The risks are sickness, maternity, old age and death
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Contd..
Scope of social security programs differs from country to

country and they have 4 common features in common: 1. They are statutorily established by the government 2. They provide some form of payment to individuals to compensate part of the lost income due to contingencies such as unemployment, maternity, injury at work etc. 3. Tripartite financing [(government)treasury, financial institution and bank] has been accepted by many countries as a mechanism for financing the social security insurance system 4. Benefits of services are provided in 2 ways; Social insurance to contributors during old age, sickness, disablement etc Social assistance, non-contributory benefits towards the M6-International Compensation 35 maintenance of children, women, aged, disabled etc

Social Security Schemes in different countries

Germany Wage earners come under compulsory insurance through Wage Earners Sickness Insurance Act, 1883, the Accident Insurance Act 1884, and Invalidity and Old age Protection 1889. The statutory sickness insurance scheme provides benefit in the form of early detection of diseases, sickness benefits, hospital treatment, etc Under the Occupational Safety Act 1974, employers are required to appoint industrial medical officers and occupational safety specialists
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Great Britain: social security schemes

The Workmens Compensation Act of 1987 made

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earnings related compensation, payable to those who were injured at workplace. The Old Age Pensions Act of 1908 made provision of means-tested pension, to people aged over 70 The 1934 Unemployment Act introduced to provide benefits for those unemployed but not covered by national insurance Social Security and Housing Benefits Act of 1982, provides contributory benefits like retirement pensions, unemployment benefits, widows benefit, sickness benefit and non contributory benefits like guardians allowance, child benefit etc M6-International Compensation Social security expenditure is 10% of gross national

US: Social security schemes

Social security system was introduced in 1935 as a

program of insurance protection for the workers and his family against complete loss of income through old age or death In 1950 it was extended to cover farm and household employees and other persons The following social security programs provide financial security to workers and their families; The Old Age and Survivors Insurance (OASI) program The Disability Insurance (DI) program The Hospital Insurance (HI) program The Supplementary Medical Insurance (SMI) There are union negotiated welfare plans which are M6-International Compensation 38 financed by the employers

Japan: Social Security Schemes

Being the first country to establish a social

insurance system, Japan adopted Health Insurance Scheme for employees of large companies in 1992, followed by national, health insurance in 1938, seamans insurance in 1939 and employees pension program in 1941 The contributory employees pension program covers regular employees. The national pension program has a contributory as well as a non contributory segment. Contributory segment has a compulsory and voluntary part. A number of pension programs also exist for special groups M6-International Compensation 39 such as civil servants, seaman, and private school

Contd..
Japan has 2 main health insurance programs: one

is Compulsory Employees Health Insurance Plan for workers employed in manufacturing, mining and retail establishments with 5 or more employees . The second one is National Health Insurance Plan, which covers residents not insured as a result of their employment. It is designed to cover the oldest, poorest and most sick segments of Japanese society Since 1947, Japan has had unemployment insurance, the law was amended in 1975 to make the coverage compulsory for all industrial and M6-International Compensation 40 commercial firms with more than 5 employees.

India: social security schemes

The social security legislation in India regarding the

industrial field consists of following enactments Workmens Compensation Act 1923 Minimum Wages Act 1948 Payment of Wages Act 1936 Industrial Disputes Act 1947 Employees Provident Fund and Miscellaneous Provisions Act 1952 Payment of Bonus Act 1965 Maternity Benefit Act 1961 The Payment of Gratuity Act, 1972
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Global Compensation: Emerging Issues

Skill based pay: as technology progress newer skills are

required. Skill based pay can help organizations pay its people based on skills that are currently in need. It forms a part of base pay, some use it as a contingent pay. Broad banding: it can be defined as delayering of pay structure. It involves consolidation of the existing pay grades into a small number of wide bands. This consolidation results in broad minimum to maximum spread attached to it. Such pay structures are better suited to the needs of todays flexible, flatter and performance oriented organizations Variable pay: it is a financially measurable reward paid to an individual based on his or her overall performance. Team rewards: team rewards provide an opportunity for each team member to receive a bonus based on the output of the team as a whole. Team incentives are most appropriate when jobs are highly interrelated.
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