CHAPTER 11: COMPENSATION

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Importance of Compensation
• Impacts employer’s ability to attract, motivate, and 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 and/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 (job evaluation)
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External Equity • Fairness of organizational compensation levels relative to external compensation • Assessed by collecting wage and salary survey 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
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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
• Lag policy
– Lower wages than competitors, compensates employees through other means
• Opportunity for advancement • Incentive plans • Good location • Good working conditions • Employment security Copyright © 2005 South-Western. All rights reserved.

• Market policy
– Wages equal to competitors – Neutralizes pay as factor

• Lead policy
– Higher wages than competitors to ensure organization becomes employer of choice

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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 organizational 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 and mastery of skills – Give employees incentives to learn – Promote flexibility – Easily linked with training programs and 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 and intensify conflict – Need decentralized decision-making system – Need high level of communication with employees – Employees should have voice and provide input into design – Team members need to feel the system is Copyright © 2005 South-Western. All rights reserved. 1–15 fair and equitable

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 (male-female)

• Comparable worth
– Argues that standards of equal pay for equal work should be replaced with doctrine of equal pay for work of 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 (cf. “pay equity” in Canada).

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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 and 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 Copyright © 2005 South-Western. All rights reserved. 1–19 concerns

Key Strategic Issues in Compensation
• Determining compensation relative to market • Balance between fixed and variable compensation • Deciding whether or not to utilize team-based versus individual pay • Creating appropriate mix of financial and nonfinancial compensation • Developing a cost-effective compensation program resulting in high performance

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Reading 11.1 (Pascarella)

Compensating Teams • Reasons for tailoring compensation to individuals
– Motivation comes from within individual, as opposed to group – Development of skills and 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 the team

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Reading 11.1

Compensating Teams
• Look for ways to add on incentives and recognition for team participation • Reward behaviors and 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 decisionmaking process

• Let team decide who gets what from awards basket

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Reading 11.2 (Singh & Agarwal)

Executive Compensation: New Perspectives

• CEOs in larger firms generally earn more • Mixed empirical evidence on relationship between executive compensation and 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 and 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 (Lawler)

New Thinking for New Millennium • Strategic approaches to make compensation systems more effective
– Pay the 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 and attainment of organizational objectives – Individualize pay system to give employees choices in how they are rewarded and what reward they receive Copyright © 2005 South-Western. All rights reserved. 1–27

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