11-1

Chapter 11

Compensation:
Methods and Polices
11-2

Introduction

Secure
Compensation
Compensation Balanced
should
should be…
be…
Cost-effective

Acceptable to employees

Whether pay should be secret

These
These aspects
aspects
of Communication to achieve
of acceptability
acceptability acceptability
will
will be
be
discussed
discussed Employee participation in pay
decision making
11-3

Determination of Individual Pay

Management must answer these questions

How should one employee be paid relative to

another when they both hold the same job?
Should all employees doing the same work,
at the same level, be paid the same?
Most employers pay different rates to employees
performing the same job based on…
Differences in experience, skills, and performance
Belief that seniority, higher performance, or
both deserve higher pay
11-4

Determination of Individual Pay

Reasons to pay different rates for the same job

Employees performing the same job make substantially

different contributions to goals
Changed emphasis on job roles, skills, knowledge
Emphasizes the norms of enterprise
without having employees change jobs
Satisfies the internal equity norms of employees
Recognizes market changes between jobs in the
same grade without overhauling the whole system
11-5

Methods of Payment

 Time worked
 Output produced
 Skills
 Knowledge
 Competencies
 A combination of these factors
11-6

Flat Rates

Unions
Unionsprefer
prefersingle
singleflat
flatrates
rates

Corresponding to some midpoint on a

market survey for a given job

Seniority and experience are ignored

Unions
Unionsdislike
dislikeperformance
performancedifferentials
differentials

Performance measures are inequitable

Could harm jobs that need cooperative effort

11-7

Flat Rates

Paying flat rate versus different rates depends on

the objectives of the compensation analyst

Managers use pay

Recognizing differences differentials to recognize
assumes employees are these differences, and
not interchangeable or to encourage an
equally productive experienced, efficient,
and satisfied workforce
11-8

Payment for Time Worked

Wage… pay calculated at an

Most employees hourly rate
are paid for time
worked Salary… pay calculated at an
annual or monthly rate

Across-the-board

Merit
Pay is adjusted
upward through Cost-of-living adjustment
increases
Seniority
11-9

Variable Pay: Incentive Compensation

Any compensation plan that

emphasizes a shared focus on
organizational success, broadens
opportunities for incentives to
nontraditional groups, and operates
outside the base pay increase system.
11-10

Variable Pay: Incentive Compensation

Employees
Employees receiving
receiving variable
variable pay
pay

Hourly
Hourly Nonexempt
Nonexempt Exempt
Exempt
nonunion
nonunion
11-11

Variable Pay: Incentive Compensation

Successful Clear goals

variable pay
systems are Unambiguous measurements
based on
Visible linkage to employees' efforts

Support by management

Acceptance by employees
Key design
factors Supportive organizational culture

Timing
11-12

Variable Pay: Incentive Compensation

If goals aren't met,

Annual raises are
the pay rate will not rise
not guaranteed
above the base salary

A percent of employees’ paycheck is at risk

Pay returns to base level

The individual earns
the next year; employees
all or part of the bonus
must again compete
by meeting objectives
for the variable reward
11-13

Variable Pay: Incentive Compensation

 Totalcompensation includes
 Base, variable, and indirect pay

 Variable 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

 Paying employees on the basis of output is

usually referred to as an incentive
11-14

Merit Incentives

The most widely used plan for

managing individual performance

A reward based on how well a job was done

Traditionally results in a higher base salary

after an annual performance evaluation
Merit increases usually spread evenly
throughout the subsequent year

80 to 90% of firms offer merit raises, but little research

has examined merit pay or its effects
11-15

Merit Incentives

Advocates 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

This premise has two flawed assumptions

Competence & incompetence are distributed
in evenly within a work group
Every supervisor is a competent evaluator
11-16

Merit Incentives

Employees don’t make the connection

Many merit between pay and performance
pay systems Secrecy of the reward is
fail perceived as inequity
The award is too small
to affect performance

Performance criteria are well

Merit plans
delineated and assessable
can work
There is a compensation where
and career plan
11-17

Merit Incentives

Depends on a reward to produce an effect

A promise of increased salary in exchange
for satisfactory future work

Focus is on the individual

Employees likely to compete with each other,
rather than collaborate or share resources

The oldest form of compensation

Employee is paid for units produced

Piecework, production bonuses, commissions

11-18

Individual Incentives: Straight Piecework

The most common individual incentive plan

Pay based on units of production per time period

Work standards set through work measurement

studies, modified by collective bargaining
Easy for employees to understand,
but setting work standards is hard
Standard-hour plan bases wages on completion
of a job or task in an expected period of time
Ideal for long cycle operations and highly skilled,
non-repetitive jobs
11-19

Individual Incentives: Differential Piece Rate

One rate for Another rate

those producing Differential for those
below or up to piece rate producing
standard above standard

 Designed to reward highly efficient workers and

penalize the less efficient
 Also known as the Taylor plan
11-20

Individual Incentives: Production Bonus

Pays an hourly rate plus a bonus when the

standard is exceeded

Japanese
Bonus usually
Not widely used workers get
equals 50
in the United semi-annual
percent of labor
States production
savings
bonuses
11-21

Individual Incentives: Commissions

Based
Basedon
onaapercentage
percentageof
ofsales
salesin
inunits
unitsor
ordollars
dollars

Straight commission Variation pays

equals straight piecework salesperson a small salary
Typically a percentage of plus commission or bonus
the price of the item when sales goal exceeded

Only
Onlyworks
worksififperformance
performanceisisspecified
specifiedin
interms
termsof
ofoutput
output

Employees must work independently of each other

for individual incentives to be applied equitably
11-22

Individual Incentives

 Firms with piece rate systems often find that

problems result from the compensation plans
 If an employer tries to change work standards or
pay rates, workers often oppose the changes
 Individualincentives increase output, but other
performance criteria may suffer
 Some jobs paid at piece rate should not be
11-23

Individual Incentives

Likely to be effective if…

The supervisor The plan is

The task is liked reinforces and acceptable to
and not boring supports the employees and
system managers

Work delays are

The incentive is Quality of work
under the
large enough to is not especially
employees'
increase output important
control
11-24

Team Incentives

Reasons to choose a team incentive plan

1. It’s hard to measure individual output

2. Cooperation is needed to complete a task or
project
3. Management thinks this is a more appropriate
measure on which to base incentives
4. Need/desire to reduce administrative costs
11-25

Team Incentives

 The Japanese use team incentives to foster

group cohesiveness and reduce jealousy
 In the U.S., there may be a clash between
societal norms and group incentive systems
 Forsmall-group incentives to be effective,
management must
 Define objectives
 Analyze the situation
 Select an appropriate group incentive
11-26

Team Incentives

In individual and group incentive systems,

competition can result in
Withholding information or resources

Political gamesmanship

Not helping others

Sabotaging the work of others

To minimize these problems, some organizations are

using organizationwide incentive plans
11-27

Organizationwide Incentives

Sharing profits generated by the

Payments
Payments efforts of all
based
based on
on two
two
concepts
concepts Sharing money saved as a result of
employees' cost-cutting efforts

Suggestion systems

Company group incentive plans

Approaches
Approaches (gainsharing)

Profit sharing
11-28

Suggestion Systems

A formal method of obtaining employee advice

about organizational effectiveness
 Includes some reward based on successful
application of the idea
 The key to success is employee involvement
 Very cost-effective

 Suggestion systems can

 Improve employee relations
 Foster high-quality products
 Reduce costs
 Increase revenue
11-29

Suggestion Systems

Immediate
Management
response to
commitment
suggestions
A successful
suggestion
Clear goals system includes Regular publicity

Designated Structured
administrator award system
11-30

Gainsharing Incentive Plans

Distribute organizationwide gains

Uses
Uses aa
financial
financial Unite diverse organizational elements
formula
formula toto in the common pursuit of improved
organizational effectiveness

Through
Through cash
cash Improved productivity
bonuses,
bonuses, these
these
systems Reduced costs
systems share
share the
the
benefits
benefits of
of
Improved quality
11-31

Gainsharing Incentive Plans

 Exceptionally good at enhancing teamwork in

 Manufacturing organizations
 Service organizations

 Gainsharing plans
 Lincoln Electric
 Scanlon
 Rucker
 ImproShare
11-32

Profit-Sharing Plans

 Distribute a fixed percentage of total profit

to employees in cash or deferred bonuses
 Profit sharing is not dominant in other
industrialized countries
 Typically found in three combinations
 Cash or current distribution plans
 Deferred plans
 A combination of both
11-33

Profit-Sharing Plans

 Incentive value of profit-sharing declines as

 The time between performance and payoff
increases
 The size of the payoff declines

 Profit-sharing plans have distinct advantages

 They do not need elaborate cost-accounting
systems to calculate rewards
 Companies of any size can implement them
11-34

Ownership

Employee
EmployeeOwnership
OwnershipPlan
Plan (ESOP)
(ESOP)

Similar to profit sharing, goal is to increase

worker commitment and performance

A qualified, defined contribution benefit plan

that invests primarily in company stock

Employer makes yearly contributions that

accumulate to produce a benefit
11-35

People-Based Pay

Variants of
people-based Competency
Skill based
pay based

Knowledge
Feedback
based
Credential
based
11-36

Skill-Based Pay

 Skill-based
pay sets pay levels on the basis of
 How many skills employees have, or
 How many jobs they can do

 Expected positive outcomes

 Increased quality
 Higher productivity
 More flexible workforce
 Improved morale
 Decreased absenteeism and turnover
11-37

Skill-Based Pay

 Methods for defining individual

skills:
 Direct observation
 Testing
 Measurable results
11-38

Knowledge-based Pay

Rewards Applies to current and new jobs

employees for
acquiring Stretches the skill-based model to
knowledge professionals, managers, and some
technical personnel

One used job-centered pay; the other a

A study of two knowledge-based design
manufacturing
plants After 10 months, the pay-for-knowledge
plant had higher quality, lower
absenteeism, fewer accidents

The traditional plant had

higher productivity
11-39

Competency Pay

A combination of skill-, knowledge-,

and credential-based pay
Term often applied to skill-based pay designs
used with highly educated "knowledge workers"

Difficult to assign dollar value with this model

Includes personal characteristics in addition

to skills, knowledge, credentials
Competencies are independent of the job and
can be taken from job to job by the individual
11-40

Executive Pay

 The Enron scandal brought

attention to CEO compensation
and stock option programs
 Some question whether any
CEO is worth pay packages
that exceed $100 million/year
 The new mantra is “pay for
performance”
11-41

Executive Pay

 The popularity of stock options is waning

 Fewer CEOs are receiving stock options
 More boards of directors are reviewing the
long-term incentives awarded to senior
executives
 Executive compensation has grown
dramatically compared to non-executive pay
 From 140 times what the average worker
earns to over 400 times
11-42

Executive Pay

Excessive for a number of reasons…

Passive boards that do not question pay

No arms’ length bargaining

Pay is less sensitive to performance

Compensation portion is often a less
significant amount of the total pay
No incentives to align manager and
shareholder interests
11-43

Stock Options

The right to purchase a specific number of shares of a

firm’s stock…

At a predetermined price

During a specified time period

Allows employees to share in the growing value of a

company without risking money

Gain can be greater than annual compensation

Not taxed until exercised and/or the stock is sold

11-44

Issues in Compensation Administration

Managers
Managersmustmust make
makepolicy
policydecisions
decisions
that
that involve
involvethe
theextent
extent to
towhich
which

Compensation
Compensation
will
will be
be secret
secret
Compensation
Compensation Pay
Pay isis
will
will be
be secure
secure compressed
compressed
11-45

Pay Secrecy or Openness

Pay ranges/individual pay open to public & fellow

Open
Open employees
system
system
Public sector, universities, union members

Secret Pay known only to employee, superior, HRM

Secret
system
system Employees can’t discuss pay matters or own pay

What do employees want to know about pay?

Deciding
Deciding Will the information harm or help the firm?
Weigh performance, interdependence, and
causal relationships
11-46

Pay Security

Current compensation can motivate performance

So can belief in future compensation security

Plans for providing this security

A guaranteed annual wage (GAW)
Supplementary unemployment benefits (SUB)
Cost of living allowances (COLAs)
Severance pay
Seniority rules
Employment contracts
11-47

Pay Compression

Occurs when employees perceive too narrow a

difference between their pay and that of colleagues

There is a narrowing gap between senior and junior

employees & 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
11-48

Pay Compression

Solutions
Solutionsfor
forPay
PayCompression
Compression

Reexamine how Emphasize

many entry-level Reassess performance
people are recruitment instead of salary-
needed grade assignment

Let first-line
Limit the number
managers
Base all salaries of new hires with
recommend
on longevity excessive
equity
salaries
adjustments