Compensation

The Importance of Compensation

• Impacts an employer’s ability to attract and retain
employees.
• Ensure optimal levels of employee performance in
meeting the organization’s strategic objectives.
• Compensation’s 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
– KSA’s
• 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.
National Position Evaluation
Hay Factors Plan (MAA)
– Know-how – Skill
– Problem solving – Effort
– Accountability – 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 – ESOP’s

• “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 non-
financial 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.