Compensation: Methods and Policies

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

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



how individual pay is determined. Define variable pay and discuss the various incentive programs that can be used in such a system. Explain why merit pay may cause employees to compete rather than cooperate. Recognize the significant changes in these innovations and learn to differentiate among them: skill-based, knowledge-based, credential-based, feedback, and competency-based pay. Describe issues such as secrecy, security and compression



compensation system should be: Secure Balanced Cost-effective Acceptable to employees aspects of acceptability will be discussed: Whether pay should be secret Communication to achieve acceptability Employee participation in pay decision making



Determination of Individual Pay

determine individual pay: Management must answer these questions: How should one employee be paid relative to another when they both hold the same job in the organization? Should we pay all employees doing the same work at the same level the same? If not, on what basis should distinctions be made? Seniority, merit, or some other basis?


Determination of Individual Pay

employers pay different rates to employees performing the same job based on: Individual differences in experience, skills, and performance Expectations that seniority, higher performance, or both deserve higher pay


Determination of Individual Pay

to pay different rates for the same job: Employees performing the same job make substantially different contributions to goals A changed emphasis on important job roles, skills, knowledge, and so on Emphasizes the norms of enterprise without having employees change jobs (promotion) Without differentials, the pay system violates the internal equity norms of most employees  Recognizes market changes between jobs in the same grade without overhauling the whole system


Methods of Payment

can be paid for: The time they work The output they produce Skills Knowledge Competencies A combination of these factors


Variable Pay: Incentive Compensation

competition and economic restructuring are requiring businesses to become more productive Reliance on outdated pay systems is holding American businesses back pay systems do not effectively link pay to performance or productivity Managers are increasingly using variable pay plans



Variable Pay: Incentive Compensation
pay is any compensation plan that: Emphasizes a shared focus on organizational success Opens incentives to nontraditional groups Operates outside the base pay increase system in the calculations of variable pay are: Individual incentive awards Individual recognition awards Group and team awards Scheduled lump-sum awards




Variable Pay: Incentive Compensation
implement successful variable pay systems, companies must based their plans on: Clear goals Unambiguous measurements Visible linkage to employees' efforts design factors include: Support by management Acceptance by employees Supportive organizational culture Timing




Variable Pay: Incentive Compensation
variable pay, a percentage of an employee's paycheck is at risk If business goals aren't met, the pay rate will not rise above the base salary Annual raises are not guaranteed The individual earns all or part of the bonus by meeting objectives Pay returns to the base level the next year and the employee must again compete for the variable reward



Variable Pay: Incentive Compensation
compensation includes: Base pay Variable pay Indirect pay



pay helps manage labor costs, but does not guarantee equitable treatment of employees Financial insecurity is built into the system As a result, productivity may actually decline employees on the basis of output is usually referred to as an incentive



Merit Incentives
most widely used plan for managing individual performance is merit pay A reward based on how well a job was done merit pay results in a higher base salary after the annual performance evaluation Merit increases are usually spread evenly throughout the subsequent year to 90 percent of firms offer merit raises, but little research has examined merit pay or its effects





Merit Incentives
claim merit pay is the most valid type of pay increase Awards are directly linked to performance Rewarding the best performers with the largest pay is claimed to be a powerful motivator premise has two flawed assumptions: Competence and incompetence are distributed in roughly the same percentages in a work group Every supervisor is a competent evaluator




Merit Incentives
merit pay systems fail due of three problems: Employees fail to make the connection between pay and performance The secrecy of the reward is perceived as inequity The size of the award has little effect on performance plans can work where: The job is well designed The performance criteria are well delineated and assessable




Merit Incentives
pay systems depend on a reward to produce an effect A promise of increased salary in exchange for a promise to perform satisfactory future work Many existing merit plans are not clearly linked to an individual's performance, so merit increases are not always viewed as meaningful pay focuses on the individual It is more likely to cause employees to compete with each other than to collaborate or share resources




Individual Incentives
oldest form of compensation is the individual incentive plan The employee is paid for units produced incentive plan takes several forms: Piecework Production bonuses Commissions




Individual Incentives
incentive plans are likely to be effective if: The task is liked The task is not boring The supervisor reinforces and supports the system The plan is acceptable to employees and managers The incentive is financially sufficient to induce increased output Quality of work is not especially important Most work delays are under the employees' control



Team Incentives
incentives can be paid to teams of individuals Team incentive plans can reduce administrative costs



to choose a team incentive plan It is difficult to measure individual output Cooperation is needed to complete a task or project Management thinks this is a more appropriate measure on which to base incentives


Team Incentives
Japanese use team incentives to foster group cohesiveness and reduce jealousy In the United States, there may be a clash between societal norms and group incentive systems small-group incentives to be effective, management must: Define its objectives Analyze the situation Select the most appropriate group incentive




Problems with Incentives
individual and group incentive systems, competition can result in: Withholding information or resources Political gamesmanship Not helping others Sabotaging the work of others minimize these problems, some organizations are using organization-wide incentive plans




Organization-wide Incentives


incentives are more common than individual or group incentives Payments are usually based on one of two performance concepts: Sharing profits generated by the efforts of all employees altogether Sharing money saved as a result of employees' efforts to reduce costs


Organizationwide Incentives
approaches to incentive plans are used at the organizationwide level: Suggestion systems Company group incentive plans (gain-sharing) Profit sharing



Suggestion Systems
formal method of obtaining employee advice about organizational effectiveness It includes some kind of reward based on the successful application of the idea The key to success is employee involvement These programs are quite cost-effective systems can: Improve employee relations Foster high-quality products Reduce costs Increase revenue



Suggestion systems are often administered by the HR department


Suggestion Systems
successful suggestion system includes: Management commitment Clear goals Designated administrator Structured award system Regular publicity Immediate response to each suggestion



Gainsharing Incentive Plans
plans are company-wide group incentive plans that use a financial formula to: Distribute organization-wide gains, and Unite diverse organizational elements in the common pursuit of improved organizational effectiveness cash bonuses, these systems share the benefits of: Improved productivity Reduced costs Improved quality




Gain-sharing Incentive Plans
incentive systems are exceptionally effective in enhancing teamwork in: Manufacturing organizations Service organizations used gain-sharing plans: Lincoln Electric Scanlon Rucker ImproShare




Profit-Sharing Plans
plans distribute a fixed percentage of total profit to employees in cash or deferred bonuses Profit sharing is not dominant in other industrialized countries plans are typically found in three combinations: Cash or current distribution plans Deferred plans A combination of both
80% of the companies using profit sharing use the deferred option




People-Based Pay
bureaucratic job-based method of determining pay will not be used in the future The new designs will be people-based of people-based pay: Skill-based Knowledge-based Credential-based Feedback Competency-based




Skill-Based Pay
pay sets pay levels on the basis of: How many skills employees have, or How many jobs they can do positive outcomes include: Increased quality Higher productivity A more flexible workforce Improved morale Decreased absenteeism and turnover
When a new skill is added to an existing job, the employee earns a pay increase by mastering it




Skill-Based Pay


for defining individual skills: Direct observation Testing Measurable results


Knowledge-based Pay
pay rewards employees for acquiring additional knowledge Applies to both the current and new job Stretches the skill-based model to professionals, managers, and some technical personnel study compared two manufacturing plants One used the job-centered pay design; the other a knowledge-based design After 10 months, the pay-for-knowledge facility had higher quality, lower absenteeism, fewer accidents The traditional plant had higher productivity




Credential-based Pay
pay rests on the fact that an individual must have: A diploma or license, or Pass one or more examinations from a third-party professional or regulatory agency pay is more cut-and-dried than skill-based or knowledge-based pay




Feedback Pay
pay is based on: Aligning pay with strategic business objectives Establishing a direct connection between the jobholder and his/her part in accomplishing goals design must conform to four principles: Flows directly from strategic business goals Directly links employees' actions to these goals Provides sufficient opportunity for rewards to hold employees' attention Is timely




Issues in Compensation Administration
must make policy decisions that involve the extent to which: Compensation will be secret Compensation will be secure Pay is compressed



Pay Secrecy or Openness
are degrees of pay secretiveness and openness In many organizations, pay ranges and individual pay are open to the public and fellow employees (open system)



the secret system, pay is known only to the employee, her/his superior, and HRM/payroll In some organizations, employees cannot discuss pay matters and, specifically, their own pay


Pay Secrecy or Openness
up a system has costs and benefits To reduce the manipulative aura surrounding pay, a company must share pay information with employees As firms post job openings, information on pay becomes a critical decision deciding on secrecy or openness: Determine what employees want to know about pay Decide if the information will harm or help the firm Weigh performance, interdependence, and causal relationships




Pay Security
compensation can motivate performance So can the belief that there will be future compensation security for providing this security include:



guaranteed annual wage Supplementary unemployment benefits Cost of living allowances (COLAs) Severance pay Seniority rules Employment contracts


Pay Compression
when employees perceive too narrow a difference between their pay and that of colleagues There is a narrowing gap between senior and junior employees and between supervisors and subordinates Differentials of 10 percent or less are not unusual Junior employees are sometimes brought in at salaries greater than those of their superiors The resulting low morale can lead to decreasing productivity, higher absenteeism, and turnover To identify pay compression, compare salaries and incumbents' years of experience with the company



Pay Compression
for pay compression include: Reexamining how many entry-level people are needed Reassessing recruitment Emphasizing performance instead of salary-grade assignment Basing all salaries on longevity Giving first-line supervisors and other managers the authority to recommend equity adjustments Limiting the number of new hires with excessive salaries


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