CHAPTER 11:

COMPENSATION

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 Importance of Compensation

• Impacts employer’s ability to attract & retain

employees
• Ensure optimal levels of employee performance in
meeting organization’s strategic objectives
• Compensation’s components
– Direct compensation in wages or salary
• Base pay (hourly, weekly, monthly)
• Incentives (sales bonuses &/or commissions)
– Indirect compensation in form of benefits
• Legally required benefits (e.g., Social Security)
• Optional (e.g., group health benefits)

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 Exhibit 11-1
Compensation System

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 Internal Equity

• Fairness of pay differentials

between different jobs in
organization
• Established by job ranking, job
classification, point systems or
factor comparisons

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 External Equity

• Fairness of organizational
compensation levels relative to
external compensation
• Assessed by collecting wage & salary
information to guide in setting
organization’s pay strategy to lead,
meet or lag labor market wages

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 Individual Equity
• Fairness about pay differentials among individuals
in same job
• Established by using
– Seniority-based pay systems: Reward longevity
– Merit-based pay systems: Reward employee performance
– Incentive plans: Employees receive part of compensation
based on performance
– Skills-based pay systems: Compensation based on
employees possessing skills that firm values
– Team-based pay plans: Encourage cooperation & flexibility

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 Exhibit 11-2
Equity Theory

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 Exhibit 11-3
Equity & Work-Related Outcomes

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 Exhibit 11-4
Classification System –
Federal Government

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 Exhibit 11-4
Point System
Method

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 Exhibit 11-7
Comparison of Job Evaluation Methods

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 External Equity

• Collect wage & salary information to

determine market wage rates
• Also consider other forms of compensation
• Determine pay strategy relative to market

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 External Equity

• Market
Lag policy
policy
– Lower
Wageswages
equal to
than
competitors
competitors, compensates employees
– through other
Neutralizes paymeans
as factor
• Opportunity for advancement
• Lead• policy
Incentive plans
– Higher
• Goodwages than competitors to ensure organization
location
becomes employer
• Good working of choice
conditions
• Employment security

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 Individual Equity

• Basing pay on seniority

• Merit pay systems
• Incentive pay
– Returns financial rewards to employees responsible for
creating them
– Allows organizations to adjust compensation expenses
based on organization performance
– Variety of forms
– Tied to employee’s, work unit’s, or organization’s results

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 Individual Equity

• Skill-based pay systems

– Base compensation on acquisition & mastery of
skills
– Give employees incentives to learn
– Promote flexibility
– Easily linked with training programs & strategic
needs

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 Individual Equity

• Team-based pay plans

– Can be less time-consuming than administering individual
reward systems
– May impact group dynamics
– Can adversely impact & intensify conflict
– Need decentralized decision-making system
– Need high level of communication with employees
– Employees should have voice & provide input into design
– Team members need to feel system is fair & equitable

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 Legal Issues in Compensation

• Title VII of Civil Rights Act of 1964

– Protects workers rights to fair treatment
• Equal Pay Act of 1963
– Requires equal pay for equal work
• Comparable worth
– Argues that standards of equal pay for equal work should be
replaced with doctrine of equal pay for equal value
– Objective, measurable data to support assessment of value
of different jobs is lacking
– No basis in current law for arguments of comparable worth

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 Legal Issues in Compensation

• Fair Labor Standards Act of 1938

–Regulates minimum wage
–Sets overtime policy
–Establishes exempt classes for managers &
other professional employees

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 Executive Compensation

• No real average or standard

• Typical annual compensation for senior
executives
– 20% salary
– 30% annual incentives
– 50% long-term incentives

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 Executive Compensation

• Stock Grants
– Require organization meet specific financial goals
• Stock Options
– Provide opportunity to purchase shares at some future date,
at price determined when options are awarded
– Focus employee attention on creating shareholder value
– Do not have to be reported as expenses
– Can create culture obsessed with improving stock
performance at expense of other concerns
– Can prompt executives to engage in creative accounting
practices

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 Key Strategic Issues in Compensation

• Determining compensation relative to market

• Balance between fixed & variable compensation
• Deciding whether or not to utilize team-based
versus individual pay
• Creating appropriate mix of financial & non-
financial compensation
• Developing cost-effective compensation program
resulting in high performance

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 Reading 11.1
Compensating Teams
• Reasons for tailoring compensation to
individuals
– Motivation comes from within individual as opposed
to group
– Development of skills & behaviors is individual
undertaking
– Fairness in dealing with teams does not mean equal
pay for all
– Team compensation is not payoff but means of
nurturing behavior that benefits team
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 Reading 11.1
Compensating Teams
• Look for ways to add on incentives & recognition
for team participation
• Reward behaviors & activities rather than results
• Other ways of saying “thank you” constitute best
incentive over long run
– Nonmonetary recognition
– Gifts of appreciation after fact
• Be careful about anything that may be viewed as
“buying”

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 Reading 11.1
Compensating Teams
• Management often overlooks powerful
intrinsic rewards that come from
– Team participation
– Being part of corporate decision-making process
• Let team decide who gets what from
awards basket

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 Reading 11.2
Executive Compensation: New Perspectives

• CEOs in larger firms generally earn

more
• Mixed empirical evidence on
relationship between executive
compensation & firm performance

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 Reading 11.2
Executive Compensation: New Perspectives

• Classifications of firm strategy:

– Prospector firms emphasize long-term incentives
– Defender firms are more likely to emphasize fixed pay
– Analyzer
– Reactor
• Significant relationship between organizational
strategy & executive compensation
• Firm size continues to be major determinant of
executive compensation

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 Reading 11.2
Executive Compensation: New Perspectives

• Earnings per share is significant predictor

of short-term executive compensation
earned as annual bonuses
• Predictors of long-term executive
compensation earned through stock option
exercise
– Share price growth
– Return on stocks
– Market measures of firm performance

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 Reading 11.3:
New Thinking for New Millennium
• Strategic approaches to make compensation
systems more effective
– Pay person for individual worth (knowledge, skills and
competencies) rather than for value of job they perform
– Reward excellence through pay for performance
compensation that establishes clear relationship between
significant amount of pay & attainment of organizational
objectives
– Individualize pay system to give employees choices in how
they are rewarded & what reward they receive

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