You are on page 1of 39

International Compensation

Dr.Yogananthan

Introduction
Global compensation managers (that is,
everyone involved at any level in payrelated decisions) increasingly deal with
two areas of focus. They must manage
highly complex and turbulent local details
while concurrently building and
maintaining a unified, strategic pattern of
compensation policies, practices and
values.
(cont.)

Introduction (cont.)

For multinationals 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
all within the context of shifting political, economic
and social conditions.

Objectives of international
compensation
When developing international compensation
policies, a firm seeks to satisfy several
objectives. First, the policy should be
consistent with the overall strategy, structure
and business needs of the multinational.
Second, the policy must work to attract and
retain staff in the areas where the multinational
has the greatest needs and opportunities.
Hence the policy must be competitive and
recognize factors such as incentive for foreign
service, tax equalization and reimbursement
for reasonable costs.
(cont.)

Objectives of international
compensation (cont.)
Third, the policy should facilitate the transfer
of international employees in the most costeffective manner for the firm. Fourth, the
policy must give due consideration to equity
and ease of administration.
The international employee will also have a
number of objectives that need to be achieved
from the firms compensation policy. First, the
employee will expect the policy to offer
financial protection in terms of benefits, social
security and living costs in the foreign location.
(cont.)

Objectives of international
compensation (cont.)
Second, the employee will expect a foreign
assignment to offer opportunities for financial
advancement through income and/or savings.
Third, the employee will expect issues such as
housing, education of children and recreation
to be addressed in the policy. (The employee
will also have expectations in terms of career
advancement and repatriation, as discussed in
Chapters 3, 5 and 7.)
(cont.)

Objectives of international
compensation (cont.)
If we contrast the objectives of the
multinational and the employee, we see, of
course, the potential for many complexities
and possible problems, as some of these
objectives cannot be maximized on both sides.
Firms must rethink the traditional view that
local conditions dominate international
compensation strategy.

Key components of an international


compensation program (cont.)

Base salary
In a domestic context, base salary denotes the amount of cash
compensation serving as a benchmark for other compensation
elements (such as bonuses and benefits).
For expatriates, it is the primary component of a package of
allowances, many of which are directly related to base salary
(e.g. foreign service premium, cost-of-living allowance, housing
allowance) and also the basis for in-service benefits and
pension contributions. It may be paid in home or local-country
currency.
The base salary is the foundation block for international
compensation whether the employee is a PCN or TCN. Major
differences can occur in the employees package depending on
whether the base salary is linked to the home country of the
PCN or TCN, or whether an international rate is paid.

Key components of an international


compensation program (cont.)

Foreign service inducement/hardship premium


Parent-country nationals often receive a salary premium as
an inducement to accept a foreign assignment or as
compensation for any hardship caused by the transfer.
The definition of hardship, eligibility for the premium and
amount and timing of payment must be addressed.
In cases in which hardship is determined, US firms often refer
to the US Department of States Hardship Post Differentials
Guidelines to determine an appropriate level of payment.

Making international comparisons of the cost of living is


problematic.
These payments are more commonly paid to PCNs than
TCNs. Foreign service inducements, if used, are usually
made in the form of a percentage of salary, usually 540
per cent of base pay.
Such payments vary, depending upon the assignment, actual
hardship, tax consequences and length of assignment.

Key components of an international


compensation program (cont.)
Allowances
Issues concerning allowances can be very challenging to a
firm establishing an overall compensation policy, partly
because of the various forms of allowances that exist.
The cost-of-living allowance (COLA), which typically
receives the most attention, involves a payment to
compensate for differences in expenditures between the
home country and the foreign country (to account for
inflation differentials, for example).
The COLA may also include payments for housing and
utilities, personal income tax or discretionary items.
The provision of a housing allowance implies that
employees should be entitled to maintain their homecountry living standards (or, in some cases, receive
accommodation that is equivalent to that provided for
similar foreign employees and peers).

Key components of an international


compensation program (cont.)
Allowances (cont.)
Other alternatives include company-provided housing,
either mandatory or optional, a fixed housing allowance or
assessment of a portion of income, out of which actual
housing costs are paid.

As a firm internationalizes, formal policies become more


necessary and efficient.
There is also a provision for home leave allowances.
Many employers cover the expense of one or more trips
back to the home country each year.

Firms allowing use of home leave allowances for foreign


travel need to be aware that expatriate employees with
limited international experience who opt for foreign
travel rather than returning home may become more
homesick than other expatriates who return home for a
reality check with fellow employees and friends.

Key components of an international


compensation program (cont.)
Allowances (cont.)
Education allowances for expatriates children are also an
integral part of any international compensation policy.
Allowances for education can cover items such as tuition, language
class tuition, enrolment fees, books and supplies, transportation,
room and board and uniforms.
PCNs and TCNs usually receive the same treatment concerning
educational expenses.

Relocation allowances usually cover moving, shipping and


storage charges, temporary living expenses, subsidies regarding
appliance or car purchases (or sales) and down payments or
lease-related charges.
Allowances regarding perquisites (cars, club memberships,
servants10 and so on) may also need to be considered (usually for
more senior positions, but this varies according to location).
These allowances are often contingent upon tax-equalization policies
and practices in both the home and the host countries.

Key components of an international


compensation program (cont.)
Allowances (cont.)
Spouse assistance to help guard against or offset
income lost by an expatriates spouse as a result of
relocating abroad.
Although some firms may pay an allowance to make up for
a spouses lost income, US firms are beginning to focus on
providing spouses with employment opportunities abroad,
either by offering job-search assistance or employment in
the firms foreign office (subject to a work visa being
available).

Multinationals generally pay allowances in order to


encourage employees to take international assignments
and to keep employees whole relative to home
standards.
In terms of housing, companies usually pay a tax-equalized
housing allowance in order to discourage the purchase of
housing and/or to compensate for higher housing costs.
This allowance is adjusted periodically based on estimates
of both local and foreign housing costs.

Key components of an international


compensation program (cont.)

Benefits
The complexity inherent in international benefits often
brings more difficulties than when dealing with
compensation.
Pension plans are very difficult to deal with country-tocountry, as national practices vary considerably.
Transportability of pension plans, medical coverage and
social security benefits are very difficult to normalize.

Firms need to address many issues when considering


benefits, including:
Whether or not to maintain expatriates in home-country programs,
particularly if the firm does not receive a tax deduction for it.
Whether firms have the option of enrolling expatriates in hostcountry benefit programs and/or making up any difference in
coverage.
Whether expatriates should receive home-country or host-country
social security benefits.

Key components of an international


compensation program (cont.)

Benefits (cont.)
In some countries, expatriates cannot opt out of local
social security programs. In such circumstances, the
firm normally pays for these additional costs.
European PCNs and TCNs enjoy portable social security
benefits within the European Union.

Laws governing private benefit practices differ from


country to country, and firm practices also vary.
Multinationals have generally done a good job of
planning for the retirement needs of their PCN
employees, but this is generally less the case for TCNs.
TCNs may have little or no home-country social security
coverage;
They may have spent many years in countries that do not
permit currency transfers of accrued benefit payments;
Or they may spend their final year or two of employment
in a country where final average salary is in a currency
that relates unfavorably to their home-country currency.

Key components of an
international compensation
program (cont.)

Benefits (cont.)
In addition to the already discussed benefits,
multinationals also provide vacations and special
leave.
Included as part of the employees regular vacation,
annual home leave usually provides airfares for
families to return to their home countries.
Rest and rehabilitation leave, based on the conditions
of the host country, also provides the employees
family with free airfares to a more comfortable
location near the host country.
Emergency provisions are available in case of a death
or illness in the family.
Employees in hardship locations often receive
additional leave expense payments and rest and

Approaches to international
compensation
There are two main options in the area of international
compensation the Going Rate Approach (also referred to
as the Market Rate Approach) and the Balance Sheet
Approach (sometimes known as the Build-up Approach).
The Going Rate Approach

Table 6-1: Going Rate Approach

Approaches to international
compensation (cont.)
The Going Rate Approach (cont.)

With this approach, the base salary for international


transfer is linked to the salary structure in the host
country. The multinational usually obtains information
from local compensation surveys and must decide
whether local nationals (HCNs), expatriates of the same
nationality or expatriates of all nationalities will be the
reference point in terms of benchmarking.

For example, a Japanese bank operating in New York


would need to decide whether its reference point would
be local US salaries, other Japanese competitors in New
York or all foreign banks operating in New York.

With the Going Rate Approach, if the location is in a


low-pay county, the multinational usually supplements
base pay with additional benefits and payments.

Approaches to international
compensation (cont.)
The Going Rate Approach (cont.)

Advantages and disadvantages of the Going Rate


Approach

Table 6-2: Advantages and disadvantages of the


Going Rate Approach

Approaches to international
compensation (cont.)
The Balance Sheet Approach

Table 6-3: The Balance Sheet Approach

The basic objective is to keep the exp


atriate whole (that is, maintaining relativity to PCN
colleagues and compensating for the costs of an
international assignment) through maintenance of homecountry living standard plus a financial inducement to
make the package attractive.

IBUS 618 Dr. Yang

Approaches to international
compensation (cont.)
The Balance Sheet Approach (cont.)

The approach links the base salary for PCNs and TCNs
to the salary structure of the relevant home country.

For example, a US executive taking up an international


position would have his or her compensation package
built upon the US base-salary level rather than that
applicable to the host country.

The key assumption of this approach is that foreign


assignees should not suffer a material loss due to
their transfer, and this is accomplished through the
utilization of what is generally referred to as the
Balance-sheet Approach.
IBUS 618 Dr. Yang

Approaches to international
compensation (cont.)
The Balance Sheet Approach (cont.)

There are four major categories of outlays incurred by


expatriates that are incorporated in the Balance Sheet
Approach:

Goods and services home-country outlays for items such


as food, personal care, clothing, household furnishings,
recreation, transportation, and medical care.
Housing the major costs associated with housing in the
host country.
Income taxes parent-country and host-country income
taxes.
Reserve contributions to savings, payments for benefits,
pension contributions, investments, education expenses,
social security taxes, etc.
IBUS 618 Dr. Yang

Approaches to international
compensation (cont.)
The Balance Sheet Approach (cont.)

Where costs associated with the host-country


assignment exceed equivalent costs in the parent
country, these costs are met by both the firm and the
expatriate to ensure that parent-country equivalent
purchasing power is achieved.

IBUS 618 Dr. Yang

Approaches to international
compensation (cont.)

Table 6-4: Expatriate compensation worksheet


IBUS 618 Dr. Yang

Approaches to international
compensation (cont.)
The Balance Sheet Approach (cont.)

There are advantages and disadvantages of the Balance


Sheet Approach

Table 6-5: Advantages and disadvantages of the


Balance Sheet Approach
IBUS 618 Dr. Yang

Approaches to international
compensation (cont.)
Taxation

This aspect of international compensation is probably the


one that causes the most concern to HR practitioners and
expatriates (both PCNs and TCNs), as taxation generally
evokes emotional responses. No one enjoys paying taxes,
and this issue can be very time consuming for both the
firm and the expatriate.
An assignment abroad can mean that a US expatriate is
taxed both in the country of assignment and in the USA.
This dual tax cost, combined with all of the other
expatriate costs, makes some US multinationals think
twice about making use of expatriates.

Approaches to international
compensation (cont.)
Taxation (cont.)
Whether benefits should be maintained on a homecountry or host-country basis, who is responsible for
the cost, whether other benefits should be used to
offset any shortfall in coverage and whether homecountry benefit programs should be exported to local
nationals in foreign countries.

Differences in national sovereignty are also at work


in the area of mandated public and private pension
schemes, what many nations refer to as social
security programs.

IBUS 618 Dr. Yang

Approaches to international
compensation (cont.)

Table 6-7: Social security contributions by employers and employees


IBUS 618 Dr. Yang

Approaches to international
compensation (cont.)
International living costs data

Obtaining up-to-date information on international living


costs is a constant issue for multinationals.
The level of local knowledge required in many areas of
international HRM requires specialist advice.
Many multinationals retain the services of consulting
firms that may offer a broad range of services or
provide highly specialized services relevant to HRM in
a multinational context.
With regard to international living costs, a number of
consulting firms offer regular surveys calculating a
cost-of-living index that can be updated in terms of
currency exchange rates.
IBUS 618 Dr. Yang

Approaches to international
compensation (cont.)
Differentiating between PCNs and TCNs

One of the outcomes of the Balance Sheet Approach is


to produce differentiation between expatriate
employees of different nationalities because of the use
of nationality to determine the relevant home-country
base salary.
This is a differentiation between PCNs and TCNs.

Many TCNs have a great deal of international experience


because they often move from country to country in the
employ of one multinational (or several) headquartered in
a country other than their own (for example, an Indian
banker may work in the Singapore branch of a US bank).

Approaches to international
compensation (cont.)
Differentiating between PCNs and TCNs (cont.)

As Reynolds has observed, there is no doubt that paying


TCNs according to their home-country base salary can
be less expensive than paying all expatriates on a PCN
scale (particularly if the multinational is headquartered
in a country such as the USA or Germany, which have
both high managerial salaries and a strong currency),
but justifying these differences can be very difficult.
Nonetheless, it is common practice for multinationals to
use a home-country Balance Sheet Approach for TCNs.
The reduction in expenses outweighs the difficulty of
justifying any pay differentials. However, as firms
expand internationally, it is likely that TCN employees
will become more valuable and firms may need to
rethink their approach to compensating TCNs.

Approaches to international
compensation (cont.)
Differentiating between PCNs and TCNs (cont.)

Starting point, multinational firms need to match their


compensation policies with their staffing policies and
general HR philosophy.

If, for example, a firm has an ethnocentric staffing policy, its


compensation policy should be one of keeping the
expatriate whole (that is, maintaining relativity to PCN
colleagues plus compensating for the costs of international
service).
If, however, the staffing policy follows a geocentric
approach (that is, staffing a position with the best person,
regardless of nationality), there may be no clear home for
the TCN, and the firm will need to consider establishing a
system of international base pay for key managers paid in a
major reserve currency such as the US dollar or the Euro.
This system allows firms to deal with considerable
variations in base salaries for managers.

Some tentative conclusions:


patterns in complexity
It may be that international compensation

administration is more complex than its domestic


counterpart, but not radically different in pattern or
form. Recent developments in the study of global pay
issues may be seen to operate at three distinct levels:
The basic level of cultural values and assumptions;
The level of pay strategy, practices and systems
design; and
The level of pay administration and form.

Some tentative conclusions:


patterns in complexity (cont.)

Figure 6-1: Patterns for international pay

Some tentative conclusions:


patterns in complexity (cont.)
At the level of cultural values, a debate is

ongoing between advocates of pay systems


that value competitive individualism and
result in hierarchical pay systems with large
pay differentials for executives, marketsensitive professions and other critical
employee groups and the advocates of pay
systems that value cooperative collectivism
and result in more egalitarian pay systems
with smaller pay differentials and more
shared group or firm-wide reward practices.

Some tentative conclusions:


patterns in complexity (cont.)
Multinational firms that violate corporate or

local norms in one location in order to


respond to local norms in a second location
do so at their own risk.
This debate is enlivened by a global
reaction to hierarchical pay systems as an
exported best practice from the USA in
the light of recent CEO pay scandals as
reported in the global media.
These US-based pay scandals have set off
a global reaction often reinforcing local
norms and values.

Some tentative conclusions:


patterns in complexity (cont.)
At the level of pay strategy and attendant

practices and systems design, increased


complexity may be understood using a
horizontal and a vertical axis. Horizontally,
universal pay systems may be preferred by
corporate pay planners rather than dealing
with myriad local systems.
Ease of administration and the
standardization of practices are attractive
and can contribute to simplicity in global
assignments, resolving disputes related to
perceived inequities or policy
inconsistencies, etc.

Some tentative conclusions:


patterns in complexity (cont.)
Increasingly, we may combine pay packages

across these vertical levels of analysis and pay


for a combination of personal, job, group,
national or corporate purposes.
These composite pay systems are more
complex, but they are also more flexible and
responsive to diverse employee demands
and changing global business conditions.

Reference
IBUS 618 Dr. Yang, web article
Semere Haile, Grambling State
University, Challenges in
International Benefits and
Compensation Systems of
Multinational Corporation