Compensation Strategies and Practices

Lecture 8 :
Compensation Strategies
and Practices
Variable Pay and Executive

Compensation
Lecture 8 - Compensation Strategies and

Practices, Variable Pay and Executive
N600 Compensation 1
N600 Compensation 2
Video - Henry Ford and Wage Efficiency
Theory

N600 Compensation 3
Nature of Compensation
 Types of Rewards
◦ Intrinsic
 Intangible, psychological and social effects of compensation
◦ Extrinsic
 Tangible, monetary and nonmonetary effects of compensation
 Types of Compensation
◦ Direct compensation
 The employer exchanges monetary rewards for work done.
◦ Indirect compensation
 Employer-provided benefits—like health insurance—that are
provide employees for being a member of the organization.

N600 Compensation 4
Components of a Compensation System

N600 Compensation 5
Direct Compensation
The basic monetary compensation that an employee
Base Pay
receives, usually as a wage or salary.
Wages Payments calculated on the amount of time worked.
Consistent payments made each period regardless

Salary
of the number of hours worked in the period.
Variable Compensation linked to individual, team, or

(Merit) Pay organizational performance.

N600 Compensation 6
Strategic Compensation
 Objectives of a Strategically Supportive Compensation
System:
 Legal compliance with all appropriate laws and
regulations
 Cost effectiveness for the organization
 Internal, external, and individual equity for employees
 Performance enhancement for the organization

N600 Compensation 7
Continuum of Compensation Philosophies

N600 Compensation 8
Jack Welch (Winning)
 “I’ll never forget the time I was at a meeting about how GE should reward the
winner of the Steinmetz Award given annually to the company’s best scientist. I
was a group VP at the time, and so my ears really perked up when one of the
vice-chairmen, a guy with a lot of stature and a lot of money, registered his
opinion. ‘These people don’t want money’ he said ’they want recognition’. He
must have forgotten where he came from. Of course people want to be
recognized for great performance. Plaques and public fanfare have their place.
But without money, they lose a lot of their impact. Even the Nobel prizes come
with cash awards. If your company is managing people well, it tightly aligns
good performance with rewards. The better you do, the more you get—and you
get in both the humanity and the wallet.”

N600 Compensation 9
Total Rewards
 Three Components:
 Compensation
 Base and Merit/Variable Pay
 Benefits
 Typical plus extras (e.g., education, work-life balance)
 Performance/Talent Management
 Performance feedback
 Recognition
 Training
 Career Development
 Balances costs of employer and needs of employees

N600 Compensation 10
Compensation Approaches

Compensation Systems Effects
 Performance Pay
 Turnover- higher performers have more incentives and
are less likely to turnover.
 Overall, this enhances functional turnover
 Competency Based Pay
 Compensation for what people know and CAN do
 Must invest in training
Vide0 1- Using Statistical Research to Change
Compensation Strategy at Google_ Part 1
Video 2- Using Statistical Research to Drive
Compensation Stategy at Google part 2
Typical Components of Expatriate Compensation
Global Market Compensation
Pay more?
Pay same- “balance

sheet”
Pay less?

Market Competitiveness and
Compensation
Meet the Attempting to balance employer costs and the need
Market to attract and retain employees.
Paying all that the firm can afford. Taking advantage

Lag the
of the abundant supply of potential employees in a
Market loose labor market.
Lead the
Paying for higher qualified, more productive workers.
Market

Perceptions of Pay Fairness
The perceived fairness between what a person
Equity does (inputs) and what the person receives
(outcomes).
Employee compensation viewed as equitable in relation

External
to the compensation of employees performing similar
Equity jobs in other organizations.
Employees receive compensation in relation to the

Internal
knowledge, skills, and abilities they use in their jobs as
Equity well as their responsibilities and accomplishments.
Perceived fairness of the process and procedures

Procedural Justice used to make decisions about employees.
Distributive Justice Perceived fairness in the distribution of outcomes.
Pay Openness/ The degree of openness or secrecy that an

Secrecy organization allows regarding its pay system.
Sri Lanka Department of Labour
Labour Compensation
1) Workmen's Compensation Ordinance
2) Payment of Gratuity
3) Labour Standards and Employment

Relations Manual – BOI
4) Wages board Ordinance

Employees and Independent Contractors

Valuing Jobs Using Market Pricing
 Market Pricing
 Use of pay survey data to identify the relative value of
jobs based on what other employers pay for similar jobs.
 Advantages of Market Pricing
 Ties organizational pay levels to what is actually
occurring in the market, without being distorted by
“internal” job evaluation.
 Communicates to employees that the compensation
system is “market linked,” rather than distorted by
internal issues.
Market-Banded Pay Grades for Community Bank

Valuing Jobs Using Market Pricing
(cont’d)
 Disadvantages of Market Pricing
 It relies on market survey data that is limited or may
have been gathered in methodologically sound ways.
 The responsibilities of a specific job in a company may
be somewhat different from those of the “matching” job
identified in the survey.
 The market data’s scope (range of sources) is another
concern.
 Tying pay levels to market data can lead to wide
fluctuations based on market conditions.
Compensation
Administration
Process

Determining Pay Increases
 Seniority
◦ Time spent in an organization or on a particular job that is used to
determine eligibility for organizational rewards and benefits.
 Cost-of-Living Adjustments (COLA)
◦ A percentage increase in wages to maintain real wages in a period of
economic inflation.
◦ Adjustments are tied to changes in an economic measure (e.g., the
Consumer Price Index).
 Lump-Sum Increases (LSI)
◦ A one-time payment of all or part of a yearly pay increase that does
not increase base wages.
CEO Pay
 Made in America—My Story
 Sam Walton and John Huey (1993)
 “A lot of what goes on these days with high-flying
companies and these overpaid CEO’s who’re really
looting from the top and aren’t watching out for
anyone but themselves, really upsets me.”
 Video - CEO Pay
 Video - CEO Pay Scam

Variable Pay: Incentives for
Performance
 Variable Pay
 Compensation linked to individual, group/team, and/or
organizational performance.
 Basic assumptions:
 Some jobs contribute more to organizational success than
others.
 Some people perform better and are more productive than
others.
 Employees who perform better should receive more
compensation.
 Some of employees’ total compensation should be tied
directly to performance.
Effective Incentive Plans
Boeing, Nordstrom, Wal-Mart, Safeway

Successes and Failures of
Variable Pay Plans
 Successful incentive plans require:
 The development of clear, understandable plans that are
continually communicated.
 The use of realistic performance measures.
 Strong links among performance results and payouts
that truly recognize performance differences.
 Clear identification of variable pay incentives separately
from base pay.

Types of Variable Pay Plans
Deferred compensation is an arrangement

in which a portion of an employee's income is
paid out at a date after which that income is
actually earned. Examples of deferred
compensation include pensions, retirement
plans, and stock options.
Piece-Rate Systems
 Straight Piece-Rate Systems
 Wages are determined by multiplying
the number of pieces produced by
the piece rate for one unit.
 Differential Piece-Rate Systems
 Employees are paid one piece-rate for
units produced up to a standard
output and a higher piece-rate wage
for units produced over the standard.

Individual Incentives: Bonuses
 Bonus
 A one-time payment that does not become part of
the employee’s base pay.
 Spot Bonus
 A special type of bonus used is a “spot” bonus, so
called because it can be awarded at any time.

Special Incentive Programs
 Performance Awards
 Cash or merchandise used as an incentive reward.
 Recognition Awards
 Recognition of individuals for their performance or service to
customers in areas targeted by the firm.
 Service Awards
 Rewards to employees for
lengthy service with an organization.

Types of Sales Compensation Plans
 Salary-Only
 All compensation is paid as a base wage with no
incentives.
 Commission
 Straight Commission
 Compensation is computed as a percentage of sales in units or
Rupees / dollars.
 The draw system make advance payments against future
commissions to salesperson.
 Salary-Plus-Commission or Bonuses
 Compensation is part salary for income stability and part
commission for incentive.
Determining Sales Effectiveness

Group/Team Incentives (cont’d)
 Distributing Rewards
 Same-size reward for each member
 Different-size reward for each member
 Problems with Group/Team Incentives
 Rewards in equal amounts may be perceived as “unfair” by
employees who work harder, have more capabilities, or
perform more difficult jobs.
 Group/team members may be unwilling to handle incentive
decisions for co-workers.
 Many employees still expect to be paid according to
individual performance.
 Social Loafing
 The foolishness of rewarding A and hoping for B
Conditions for Successful Group/Team Incentives

Organizational Incentives
 Profit Sharing
 A system to distribute a portion of the profits of the
organization to employees.
 Primary objectives:
 Increase productivity and organizational performance
 Attract or retain employees
 Improve product/service quality
 Enhance employee morale
 Drawbacks
 Disclosure of financial information
 Variability of profits from year to year
 Profit results not strongly tied to employee efforts

Framework Choices for a Profit-Sharing Plan

Employee Stock Plans
 Stock Option Plan
 A plan that gives employees the right to purchase a fixed
number of shares of company stock at a specified price
for a limited period of time.
 If market price of the stock is above the specified option price,
employees can purchase the stock and sell it for a profit.
 If the market price of the stock is below the specified option
price, the stock option is “underwater” and is worthless to
employees.

Employee Stock Plans
 Employee Stock Ownership Plan (ESOP)
 A plan whereby employees gain significant stock
ownership in the organization for which they work.
 Advantages
 Favorable tax treatment for ESOP earnings
 Employees motivated by their ownership stake in the firm
 Disadvantages
 Retirement benefit is tied to the firm’s future performance
 Management tool to discourage hostile takeover attempts.
Deferred compensation
 Deferred compensation
Portion of an employee's income is paid out at a date after
which that income is actually earned.
Examples of deferred compensation include pensions,
retirement plans, and stock options. The primary benefit of
most deferred compensation is the deferral of tax to the
date(s) at which the employee actually receives the income.

Components of Executive
Compensation Packages

Executive Compensation
 “Reasonableness” of Executive Compensation
 Would another company hire this person as an executive?
 How does the executive’s compensation compare with
that for executives in similar companies in the industry
 Is the executive’s pay consistent with pay for other
employees within the company?
 What would an investor pay for the level of
performance of the executive?
 Investors are owners
 We as managers are overseers (agency theory)
Common Executive Compensation Issues

Questions ?


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Lecture 8 :

Variable Pay and Executive

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

Wages Payments calculated on the amount of time worked.

Consistent payments made each period regardless

Variable Compensation linked to individual, team, or

Lecture 8 - Compensation Strategies and

 Internal, external, and individual equity for employees

 Performance enhancement for the organization

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

 Balances costs of employer and needs of employees

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

Pay same- “balance

Lecture 8 - Compensation Strategies and

Paying all that the firm can afford. Taking advantage

Lecture 8 - Compensation Strategies and

Employee compensation viewed as equitable in relation

Employees receive compensation in relation to the

Perceived fairness of the process and procedures

Distributive Justice Perceived fairness in the distribution of outcomes.

Pay Openness/ The degree of openness or secrecy that an

1) Workmen's Compensation Ordinance

3) Labour Standards and Employment

4) Wages board Ordinance

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

Boeing, Nordstrom, Wal-Mart, Safeway

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

Deferred compensation is an arrangement

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

Lecture 8 - Compensation Strategies and

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