Business

“I hear they hired a new payroll clerk—the same job I’ve been doing for five years—and this new person is going to be paid more than I make! I’ve been a loyal employee for years and haven’t had a real raise since I started. Is that fair?”

Cindy couldn’t fault Drew for his feelings, and she knew it was past time the company examined its compensation guidelines.

Once you have an established pay scale, is it really important to reexamine your compensation levels? What is the solution when the going market rate for a position outdistances your set pay scale? Chapter 11 answers these questions and more as it demonstrates the reasons why compensation management is so vital to attracting and retaining your best employees.

SHRM HR CONTENT

See Appendix: SHRM 2016 Curriculum Guidebook for the completelist

B. Employment Law (required)

8. Fair Labor Standards Act of 1938 (FLSA)

E. Job Analysis/Job Design (required)

2. Job evaluation and compensation (grades, pay surveys, and pay setting)

6. Compliance with legal requirements

Equal pay (skill, effort, responsibility, and working conditions) and comparable worth

Overtime eligibility (exempt vs. nonexempt work)

G. Outcomes: Metrics and Measurement of HR (required)

11. Benchmarking

I. Staffing: Recruitment and Selection (required)

16. Employment brand

K. Total Rewards (required)

A. Compensation

1. Development of a base pay system

2. Developing pay levels

3. Determining pay increases

4. Role of job analysis/job design/job descriptions in determining compensation

6. Compensation of special groups (e.g., executives, sales, contingent workers, management)

7. Internal alignment strategies

8. External competitiveness strategies

9. Legal constraints on pay issues

10. Monitoring compensation costs

11. Union role in wage and salary administration

12. Minimum wage/overtime

13. Pay discrimination and dissimilar jobs

14. Prevailing wage

15. Motivation theories: Equity theory, reinforcement theory, agency theory

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COMPENSATION MANAGEMENT

LO 11-1

Identify the components of a compensation system and describe how expectancy and equity theories apply to compensation.

Compensation is the total of an employee’s pay and benefits. Compensation affects both attracting and retaining employees.1 Pay is now the top reason for job satisfaction, overtaking job security as the top driver of satisfaction back in 2013.2 According to recent research by Payscale, “Compensation has officially expanded from ‘just a human resources issue’ to a C-suite issue,”3 with about 57% of individuals in their survey saying that compensation is becoming more important to executives and that it has strategic value to the firm. Pay is the most important priority to North Americans, Latin Americans, and Western Europeans—so HR must pay attention to fair and equitable compensation for company employees.4

HRM in Action Compensation Management

Compensation costs are frequently the largest part of total production costs at today’s firms. Because this is the case, management must continually monitor and manage total organizational compensation. This monitoring function usually falls to the HR department. Compensation costs also continue to rise as companies started to face shortages of skilled talent after the latest recession.5According to the US Bureau of Labor Statistics, average total compensation costs rose from $31.93 to $35.28 per hour from March 2014 to March 2017.6

The Compensation System

A business designs and implements a compensation system to focus worker attention on the specific efforts the organization considers necessary to achieve its desired goals.7 However, if rewards are to be useful in stimulating desired behavior, they must also meet the demands of employees whose behavior they’re intended to influence.8 Thus, poor compensation management practices can have negative effects on performance.9 The compensation system of an organization includes anything that an employee may value and desire and that the employer is willing and able to offer in exchange. This includes the following:

1. Compensation components. All rewards that can be classified as monetary payments and in-kind payments constitute the compensation component.

2. Noncompensation components. All rewards other than monetary and in-kind payments (e.g., company cafeterias, gyms) constitute the noncompensation component.

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TYPES OF COMPENSATION. There are four basic parts of a compensation system:

1. Base pay. This is typically a flat rate, either as an hourly wage or salary. Many employees consider this to be the most important part of the compensation program, and it is therefore a major factor in their decision to accept or decline the job.

2. Wages versus salary. Wages are paid on an hourly basis. Salary is based on time—a week, a month, or a year. A salary is paid regardless of the number of hours worked. Wages are common for blue-collar workers, and salaries are common for white-collar professionals and managers. A salary, however, does not make an employee “exempt”; we will cover this in detail shortly.

2. Wage and salary add-ons. This includes overtime pay, shift differential, premium pay for working weekends and holidays, and other add-ons.

3. Incentive pay. Also called variable pay, incentive pay is pay for performance, and it commonly includes items such as piece work in production and commissioned sales. Pay for performance, especially in the form of short-term incentive pay, continues to increase as a percentage of employee compensation due to the ability of the employer to shift risk from the company to the individual employee.10 The use of pay for performance rather than hours worked11 and giving bonuses12 are the trend today. We will discuss incentives in detail in Chapter 12.

4. Benefits. This is indirect compensation that provides something of value to the employee. You need to include benefits in your system, because they cost thecompany a lot of money even though they aren’t direct compensation to the employee. Benefits are expensive costing employers 25 to 35% of total employee compensation.13 Benefits may include health insurance; payments to employees if they are unable to work because of sickness or accident; retirement pay contributions; and provision of a wide variety of desired goods and services such as cafeteria service, tuition reimbursement, and many other items. We will discuss benefits in detail in Chapter 13.

WORK APPLICATION 11-1

Select a job. Identify the compensation you received there in detail.

Direct versus indirect compensation. The first three compensation components—base pay, any add-ons, and incentive pay—are known as direct compensation. These forms of compensation go directly to the employees as part of their paycheck. Benefits are indirect compensation. The employees don’t directly get any funds from a benefits program. Benefits are usually paid for by the company, and the employees never see those funds.

In for-profit businesses, we want to design the mix of compensation and noncompensation components that provide us with the best productivity return for the money spent. However, to do that, we need to understand something about the motivational value of our compensation system. Let’s take a look at a few theories that help us understand better how compensation systems can motivate our workers to learn and act in the way we need them to act.

11-1 APPLYING THE CONCEPT

Types of Compensation

Review the types of compensation and then write the letter corresponding to each one before the statement(s) describing it.

a. base pay

b. wage and salary add-ons

c. incentive pay

d. benefits

____ 1. I’d like to work for a firm that will help pay for me to get my master’s of business administration (MBA) degree.

____ 2. I get paid only $11 an hour, so I’m looking for a better job.

____ 3. I like getting paid the same each week. It helps me to budget my expenses.

____ 4. I like being paid for every sale I make, but my pay does vary from week to week.

____ 5. I like working nights because it pays more.

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image

Anya Semenoff/The Denver Post via Getty Images

A Honda and MINI dealership in Colorado. Organizations can motivate employees to work harder with incentive systems that pay for high performance.

Motivation and Compensation Planning

When we look at designing compensation programs, we need to remember that we are trying to motivate the employee to do the things that we need them to do, consistently, over a period of time. However, “while 73 percent of employers say they pay their workers fairly, only 36 percent of employees agree.”14 Why does this result exist? Probably the most significant theories that help you to understand compensation planning and employee motivation are expectancy theory and equity theory.15 However, we also need to look at how our employees learn and carry out their jobs in the organization, so we need to remember what we discussed in Chapter 7 about learning theories. But let’s get started with motivation and how it affects the design of our compensation system.

SHRM

K:A15

Motivation Theories: Equity, Reinforcement, Agency

EXPECTANCY THEORY. Expectancy theory is a process theory of motivation. This basically means that we, as human beings, go through a cognitive process to evaluate something; and if we evaluate the process positively, we will likely continue to be motivated to do the same thing. Alternately, if we evaluate the process negatively, we will be disinclined to do the same thing in the future. Expectancy theory proposes that employees are motivated when they believe they can accomplish a task and that the rewards for doing so are worth the effort. Expectancy theory is based on Victor Vroom’s formula: Motivation = Expectancy × Instrumentality × Valence.16

For compensation purposes, we have intentionally simplified the theory to show how it affects a person’s motivation to perform. Expectancy is the person’s perception of their ability to accomplish or probability of accomplishing an objective. Generally, the higher one’s expectancy, the better the chance for motivation. Instrumentality is the perception that a particular level of performance is likely to provide the individual with a desired reward. Valence refers to the value a person places on the outcome or reward, because not all people value the same reward. Again, generally, the higher the valence (meaning the importance to the individual) of the outcome or reward, the better the chance of motivation. One thing that we need to remember here is that the three components of the theory—valence, instrumentality, and expectancy—are multiplicative. This means that ifany one of the three is near zero, the motivating potential is also near zero, and the individual has almost no motivation to perform!17

WORK APPLICATION 11-2

Give an example of how expectancy theory has affected your motivation or that of someone you work with or have worked with. Be sure to specify the expectancy and valence.

How does this theory affect the compensation of our workforce? The simple way to answer is to show expectancy in action (see Exhibit 11-1). An employee will have an expectation to put forth some form of effort at work. This effort is expected to result in some level of performance, and higher effort should result in higher performance levels. (This is expectancy.) The performance level is expected to result in some type of desired reward (this is instrumentality); and if it does, the employee expects to put out more effort. (Obviously, compensation in some form is at least part of the reward expected by the employee.) The reward must be significant to the individual (this is valence); and if it is, the motivation to put forth effort should continue. As long as the process continues unbroken, the employee will continue to put out effort. In other words, as HR managers, if we help employees get what they want, they will give us the work we want to help meet the organizational goals.18

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Exhibit 11-1 EXPECTANCY THEORY AND COMPENSATION

image

We need to realize that expectancy is based on the individual employee’s perception of fairness. So the result of expectancy theory is that our employees will either be motivated by their outcomes, including compensation, or be demotivated by them. A brewing problem here is that new employees are coming into the workforce with unrealistic expectations concerning compensation. In a 2017 survey, college seniors expected to make about $53,500 once they graduated, with more than half expecting at least $50,000; but recruiters said that a new graduate would average a little over $45,000.19 This sets up a very real danger to companies that their new employees will be strongly demotivated if the company cannot get the employee to change their perception of fair pay. Knowing how people internally evaluate their outcomes using the cognitive process of expectancy theory therefore helps us when we are structuring the compensation plan.

Motivating employees with expectancy theory. Here are some keys to using expectancy theory successfully:

1. Clearly define objectives and the performance needed to achieve them. In other words, goal setting is part of expectancy theory.

2. Tie performance to rewards. High performance should be rewarded. Highlight how the reward is a fair return for the performance. When one employee works harder to produce more than other employees and is not rewarded, that employee may slow down.

3. Be sure rewards have value to employees. What motivates one employee may notmotivate other employees, so managers should get to know employees as individuals.20 Letting employees speak (called employee voice) about the rewards they want, and giving those rewards, results in higher levels of motivation and performance.21

4. Make sure employees believe that management will do what it says it will. For example, employees must believe that management will give them a merit raise if they meet their performance goals. And, as noted in Chapter 10, management must do so to earn employees’ trust.

EQUITY THEORY. Equity theory is another concept that affects people in our organizations. Let’s face it, we are not all equal; but we want to be treated fairly,22 with mutually beneficial relationships.23Employees’ perception of being treated fairly affects their attitude and performance.24 So we need to be honest and fair to develop trusting relationship to motivate others.25 When managers are unfair and abusive, they can demotivate employees and hurt performance.26

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We all apply equity theory constantly.27 Equity theory, particularly the version developed by J. Stacy Adams, proposes that people are motivated to seek equity in the rewards they receive (outcomes) in exchange for their performance (input).28 So in general, equity theory proposes that employees are motivated when the ratio of their perceived outcomes to inputs is at least roughly equal to that of other referent individuals. Employees are more motivated to achieve organizational objectives when they believe they are being treated fairly,29 especially regarding pay.30 Here again, there appears to be a problem—almost half of US employees feel they are being paid unfairly,31 and employees in many other countries feel the same.

SHRM

K:A7

Internal Alignment Strategies

According to equity theory, people compare their inputs (effort, loyalty, hard work, commitment, skills, ability, experience, seniority, trust, support of colleagues, and so forth), financial rewards (pay, benefits, and perks), and intangible outcomes (praise, recognition, status, job security, sense of advancement, achievement, etc.) to those of relevant others.32 A relevant other could be a coworker or a group of employees from the same or different organizations.33 Notice that the definition says that employees compare their perceived (not actual) inputs and outcomes.34 Equity may actually exist, but if employees believe that there is inequity, they will change their behavior to create what they consider to be equity. Employees must perceive that they are being treated fairly, relative to others. Managers can also help control employee perceptions of fairness through honest discussion of compensation.35 Perceptions of inequity hurt attitudes, commitment, and cooperation, thereby decreasing individual, team, and organizational performance.36 This perceived inequity is used as a justification for unethical behavior.37

SHRM

K:A8

External Competitiveness Strategies

Unfortunately, at least in some cases, employees tend to inflate their own efforts or performance when comparing themselves to others.38 They also tend to overestimate what others earn. A 2016 Willis Towers Watson report noted that only about 39% of employees understood how their pay compared with others in their own organization, and that number went to 34% compared with employees in other organizations.39 Employees may be very satisfied and motivated until they perceive that a relevant other is earning more for the same job or earning the same for doing less work. When employees perceive inequity, they are motivated to reduce it by decreasing input or increasing outcomes. A comparison with relevant others leads to one of three conclusions: the employee is either underrewarded (will try to get equity, such as ask for a raise or leave for a better job or reduce output), overrewarded (may work harder, or will accept it as equity), or equitably rewarded (not dissatisfied with compensation).40

WORK APPLICATION 11-3

Give an example of how equity theory has affected your motivation or that of someone you work with or have worked with. Be sure to specify if you were underrewarded, overrewarded, or equitably rewarded.

Motivating employees with equity theory. Using equity theory in practice can be difficult, because you don’t know employees’ reference groups and their views of inputs and outcomes. However, the theory does offer some useful general recommendations:

1. Managers should be aware that equity is based on perception, which may not be correct. Possibly, managers can create equity or inequity, so the manager’s role is to be the arbiter of equity.41 If employees believe they are not being treated fairly, there should be procedures in place to resolve the issue or complaint.42 A good performance appraisal system (as discussed in Chapter 8) can help.

2. Rewards should actually be equitable. When employees perceive that they are not treated fairly, morale suffers and performance problems occur. Employees producing at the same level should be given roughly equivalent rewards. It helps to know who the comparison person or group is to know if equity does exit.43

3. High performance should be rewarded, but employees must understand the inputs needed to attain certain outcomes. When using incentive pay, managers should clearly specify the exact requirements to achieve the incentive. As discussed in Chapter 8, a manager should be able to state objectively why one person got a higher merit raise than another did.

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As HR managers, we need to understand that people will be demotivated if they feel (perceive) that they are not fairly compensated.44 As a result, we have to use this information when we begin to structure our compensation plan. We need to “build in” equity to minimize the problems associated with equity theory.

LEARNING THEORIES. We talked about learning at length in Chapter 7, so we want to do just a brief review of those theories here. Remember that learning theories are about changing behaviors of people in the organization. We especially need to remember how reinforcement and social learningwork, because compensation is designed at least partly to reinforce learned behaviors at work.45 If you make something more (or less) attractive, people will do more (or less) of it.46 People respond to consequences and will behave as you want them to if you find the right incentives.47 Managers need to say, “This is what we do and do not do, and here is the behavior that will be rewarded and punished.”48

B. F. Skinner said that if we give employees something that they want in return for doing what we need them to do, they are more likely to continue to do the same work successfully in the future, because their behavior got positive reinforcement. Positive reinforcement generally works better than punishment,49 especially when training employees.50 In the same way, if an employee sees another get positive reinforcement for doing something, Skinner said that the person observing this action is more likely to imitate the rewarded behavior, because of social learning, in order to get a similar reward.

We can also use negative reinforcement because, you will remember, it also causes a person to repeat a desired action. If employees are less motivated because they have to work too much overtime, we can take the overtime away. Because we take away something that the employees don’t want, they are inclined to be more motivated. The whole point of compensation is to motivate employees, so we don’t want to demotivate them because we are working them too hard.

WORK APPLICATION 11-4

Give an example of the types of reinforcement used on a present or past job.

We also set work standards to ensure that employees do a reasonable amount of work for their compensation. (This is called avoidance reinforcement.) If not, we use punishment, such as pay cuts, demotions, and (when necessary) firings.

COMPENSATION STRATEGY

LO 11-2

Identify the seven basic issues that make up the organization’s compensation strategy.

In addition to understanding our compensation options and how they motivate employees, we need to identify what our overall compensation strategy will be. We need to ask ourselves (and get honest answers to) a series of questions concerning the compensation system that we need to design. How much can we afford to pay? What actions are we willing to pay for? How will we structure our compensation system, and why? Will our pay structure be higher or lower than that of our competitors, and why? Let’s discuss some of these major organizational issues that we will need to understand and make decisions about before we can set up our system.

WORK APPLICATION 11-5

Assess the ability to pay of an organization you work or worked for. Explain how you came up with your answer.

Ability to Pay

Probably the first thing we need is an honest assessment of how much we can afford or are willing to afford to pay our employees. This of course means we need to complete an assessment of estimated revenues from our business operations and determine what percentage of revenues can or should realistically go toward compensation costs. There are a number of ways of figuring this out, such as building pro forma financial analyses, but these are beyond the scope of this text.

SHRM

K:A10

Monitoring Compensation Costs

In our analysis, we want to calculate the total amount of annual organizational revenue that we expect to be available for all compensation components—wages, incentive payments, and benefits. One of the worst possible situations a company can find itself in is to have promised a particular level of compensation and then not be able to provide what was agreed upon because the funds are not available. This is especially true in the case of incentive payments. Making incentive promises at the beginning of a year and then reneging on them at the end of the year will almost always cause intense demotivation and high rates of turnover among our workers.51

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What Types of Compensation?

Once we identify how much revenue is available for compensation, the next thing we need to do is determine how to break the compensation structure down. We noted earlier in the chapter that we have four basic components to compensation—base pay, wage add-ons, incentives, and benefits. We will need to determine how to divide the funds available between each of the components.

There are some legal requirements for certain benefits such as Social Security (we will discuss these in Chapter 13), so these legal requirements have to be dealt with “off the top”—they have to be subtracted from the available funds. Once we subtract the amount necessary to provide the benefits that are legally mandated by local, state and federal requirements, we need to determine how much direct compensation will be in the form of base pay and how much will be incentive pay. We will have to ensure that the direct compensation that we provide will allow us to be competitive in the labor markets from which we must draw our employees. Otherwise, we may not be able to get recruits to select jobs with our firm.52

The last type of compensation that we will consider is voluntary benefits. Here again, we need to analyze competition within the labor market and what benefits each of our close competitors provides. We will most likely have to approximately match the benefits that are provided by our main competitors.53 In addition, we may determine that other benefits provide us with leverage that allows us to get better employees to commit to work for our firm, and such benefits may also help us keep the workers who are already part of the organization more satisfied and less likely to quit.54

Pay for Performance or Pay for Longevity?

In breaking down base pay versus incentives, we will need to look at whether our organization is going to have a performance philosophy or a longevity philosophy. What do we mean by performance and longevity? Some companies pay people more for longevity or seniority, meaning accumulating years of service with the firm. If we work for this type of organization, we will likely get promotions and raises over time (assuming that we meet minimal organizational standards) regardless of performance because we have been a loyal member of the organization. Other companies, however, pay more for performance—for completing certain tasks or doing certain things faster or better than average, not just for being there and being loyal to the firm.55

WORK APPLICATION 11-6

Select a job you have or have had. Did the firm pay for performance or longevity? Explain in detail.

Why would anyone pay people just for being in the company for a long time? We may be in an industry where customers have strong relationships with their contact within the firm and where training new employees is costly. In this case, we might need to reward service because it gives us stability and our customers rely on this stability. A common example of an industry where at least part of direct compensation is based on longevity is the insurance industry. Customers create a relationship with their insurance agent, and they may not feel comfortable changing to a new agent every few months. And the company does not want to have to pay to train new insurance agents every few months. In this type of company, base pay may be the largest component of direct compensation.

There certainly may be problems with longevity philosophies. Some of our employees may think, “As long as I am here, regardless of my performance, I will get more compensation over time.” So entitlement-style pay philosophies don’t motivate us much. They may cause us to continue to work, but they probably won’t make us want to perform better over time.

However, if we are in an industry that focuses on performance and where customers want the best possible product or service, then we probably have to lean toward a performance orientation rather than a longevity-based philosophy.56 Such industries include those where competition is intense or where products or services are constantly developing and changing. Here companies might need to base at least a significant portion of their pay on performance. An example might be a company such as Samsung or Apple, which are continuously developing new microcircuit-based electronic products. In these firms, speed to market is a critical component of overall strategy, so major parts of their compensation strategy may be based on worker performance. In companies such as these, incentive pay will likely be a very large component compared to base pay.

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One caution here, though: Pay for performance is on the rise, but there is a potential dark side to individual incentives, as linking pay and performance is difficult in many jobs and employees frequently don’t think the system is fair.57 For example, was one of your professors (or physicians) better or worse than others? Why? And would all professors and students (or doctors and patients) agree and think it is fair to pay such a person differently based on performance? Also, many people believe in the egalitarian approach that we are all in this together, we are all equal, it is not fair to treat people differently, and we deserve the same compensation.58 This is the common mentality of most unions (e.g., teachers’ unions) that fight merit pay. So the challenging part is to design compensation programs that are perceived as fair to everyone.59

Skill-Based or Competency-Based Pay?

The next item that we may consider is whether or not we want to utilize competency-based or skill-based pay. Both fall within the incentive component of compensation. While Chapter 12 is the primary chapter covering incentive pay, we need to consider whether or not we’re going to use this type of incentive pay before we create the company’s pay structure.

image

©iStockphoto.com/Sproetniek

Organizations commonly pay based on the skills and competencies needed to do the job.

If we decide to use skill-based or competency-based pay, we will pay members of the workforce for individual skills or competencies that they bring to work, whether or not those skills are necessary for the individuals to do their current job. Competencies involve the individual’s level of knowledge in a particular area, while skills involve the ability to apply that knowledge set in that field. Examples of competencies include such things as an understanding of negotiation and collaboration, an understanding of the basic principles of physics, or problem-solving and decision-making expertise. Examples of skills related to these competencies would include the ability to actually negotiate contract agreements, apply principles of physics to a new equipment design, or make a high-quality decision based on good analysis of a situation.

Should we use competency-based or skill-based pay? Again, it depends.60 Probably the most important thing that we need to consider is our generic strategy. As we noted in Chapter 2, if our generic strategy is low cost, we probably want to hire and train people for specific jobs and will not generally pay them for knowledge and skills outside of that narrow job description. If, however, our strategy says that we’re going to act as a differentiator, then we may gain significant value from paying individuals extra for bringing to the workplace skills or competencies that can allow them to think, analyze a situation, and come up with good solutions to organizational problems.

However, we are paying our employees for knowledge, skills, and abilities that they may not necessarily ever use in the organization. This obviously drives up our overall costs for compensation. So we have to ask whether it is valuable to have somebody who is well rounded or whether we just need someone who is specifically trained for a job. Thus, skills-based pay is commonly measured based on the number of actual jobs the person can perform. For example, on an assembly line, a person who can work only on one part of production will be paid less than a person who can work on two or three parts. People who can perform multiple jobs are more valuable because they can help out wherever they are needed at any particular time.

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At, Above, or Below the Market?

The next item we must determine is whether we will pay above market, at market, or below market. Are we willing to pay more than necessary to hire individuals? Can we pay less than average and still get people to apply for jobs in our company? What are the advantages and disadvantages of each option?

SHRM

I:16

Employment Brand

Why would we ever want to pay above the market? The simple answer is to attract better workers and enhance our employment brand. We want good employees to have a strong incentive to work for us, and one way to enhance our employment brand is to pay above the market rate.61 We also want better productivity out of our workforce if we pay more for employees.

Do better workers generally have higher levels of productivity? In fact, there is some evidence that says that this is the case. Efficiency wage theory says that if a company pays higher wages, it can generally hire better people who will in turn be more productive.62 Walmart began an experiment using efficiency wage theory in 2015, at least partially due to a continuing slip in customer satisfaction surveys. As of late 2016, they were paying 13.7% above the average employee wage at “general merchandise stores” in an attempt to improve the candidate pool and ultimately the total skill set of their 1.2 million employees in the United States.63 There is some evidence that their attempt is working, as customer satisfaction has been rising steadily, although profit has not risen in step with customer ratings yet. Efficiency wage theory says that because we have higher-quality employees, we get a productivity increase that more than offsets the higher cost of employing them; but it does not conclude that increased profitability will necessarily follow increased productivity.64

Based on efficiency wage theory, would we necessarily get lower productivity from our workforce if we paid below the market? In general, yes, but not always. Low-paying firms may save money on pay, but the savings can be lost to the high cost of turnover as employees leave for better jobs; but just good pay will not retain good employees.65 If our firm is in an industry where unemployment is high, it is easy to find replacement workers; and if most positions require a low-level skill set, we may be able to get away with paying less than average. But is this a good idea? What will likely happen if the labor market gets tighter and there are fewer unemployed workers with the skills that we require? It will become easier for an employee with such skills to quit our company and go to work for another, and we will likely start to lose at least some of our more skilled employees because of job dissatisfaction and a lack of organizational commitment.66 So if you pay too little and the skill set you need is in high demand, it will be hard to find people.

WORK APPLICATION 11-7

Select a job you have or have had. Did the firm provide above-average, average, or below-average compensation? Explain how you came up with your answer, using comparisons to competitors.

So we have to think about our overall pay levels. Are they going to be at the market average, above it, or below it? We can’t pay higher than average if we can’t afford to, but HRM professionals consistently conduct research to find out what the average compensation is so they know where they stand. In the end, most of them select the average option.

Wage Compression

Wage compression is another concern in setting up a pay structure. Wage compression occurs when new employees require higher starting pay than the historical norm, causing narrowing of the pay gap between experienced and new employees.67 It generally occurs over a significant period of time. We bring workers into the organization in both good economic times and bad. When the economy is doing poorly and overall wages are depressed, people will generally accept jobs for less than they would if the economy were doing well and higher-wage jobs were available. Since raises are frequently based on an employee’s initial salary or pay rate, those who start at lower pay than others may stay that way over time, and pay inequality for the same work may increase over time as well.

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Because we have to pay more to attract new employees when the overall economy is doing well or when their skills are in high demand, we may create a situation where workers with less time on the job might be paid nearly as much as, or more than, employees who have worked for us for many years but who came into the organization under other circumstances. For example, the supply of accounting professors with PhDs and CPA certifications is far lower than the demand. So some universities end up hiring such professors who don’t have any full-time academic experience and pay them more than some tenured full professors in other areas, such as organizational behavior.

This wage compression can weaken the desired link between pay and performance (expectancy theory), creating significant dissatisfaction on the part of long-term employees because of the pay differential.68 Employers are usually unaware that pay compression exists until problems surface. Most companies and organizations don’t set out to do this—they just fall into it.69 If we understand wage compression when creating a pay structure for the organization, we can avoid at least some of the dissatisfaction associated with the pay differentials between short-term and long-term employees.

Pay Secrecy

If we are savvy managers, we know that based on equity theory, our employees will review both internal and external equity, meaning they will compare themselves to other people both inside the firm and in other companies. Because our employees do this, we also have to pay attention to both types of pay equity. Sometimes we actually do a worse job with internal equity than we do with external equity. We have some knowledge of what a job is worth in other companies or on the open market through the use of pay survey data. However, we can have people working next to each other who have significant differences in salary, possibly because of wage compression or possibly from other factors such as personal productivity. When workers talk to each other and find out that they are getting significantly different pay, they might get upset.

Many managers think that one of the solutions to deal with this issue is pay secrecy, which means requiring employees to not disclose their pay to anyone else. But the NLRB has consistently ruled over the past several years that companies may not discipline workers who reveal information about their pay and other work conditions as long as the workers are participating in “protected, concerted activity,” and the NLRB views this activity very broadly. As a result of these rulings, any company that continues to function with pay secrecy rules and that uses those rules to discipline employees in any way may be charged by the NLRB with violating the NLRA. In addition, President Obama signed an Executive Order in 2014 (EO 13665) prohibiting pay secrecy policies in federal government contractors, with potential loss of government contracts as punishment for failure to comply. So, enforcing pay secrecy clauses is becoming more dangerous to companies.

However, there may be legitimate concerns about pay secrecy within companies. We may want to keep employees from discussing their pay because if we have two people working next to each other and doing the same basic job, and if there are big pay differences between them, then there could be a problem—even if the two individuals have significantly different performance histories. We think we may be able to avoid the problem by not letting them talk about it, but can we really avoid the problem? As a general rule, we can’t.

If you’re an employee who is required to sign a contract with a pay secrecy clause, what is one of the first things that pops into your head? You immediately begin to believe that we must be paying somebody else more than you. So, one of the issues here is that we almost immediately create a motivation and job satisfaction problem because of your perception of inequity (remember, perception is the key to equity).70

So there is a perception problem associated with pay secrecy, even if pay secrecy is deemed to be legal in some cases. Employees may assume the employer is unfair and biased against them, whether it is the truth or not. Therefore, they may try to balance the equation in a different way. There are also potential legal questions that the employer may be trying to avoid—potential age, race, and gender discrimination or other issues. For example, companies might have pay secrecy rules because they have older employees making less than younger employees. This may be because of the wage compression that we discussed in the last section, or it may be because the older workers have fewer current skills than someone who is just out of school. When you get out of college, you should have fairly up-to-date skills, but older employees may not even want to learn those new skill sets. In that kind of situation, the younger person may be worth more to the company, but the older person doesn’t feel like that’s true. So there is some potential for discrimination lawsuits.

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But will all of this really keep everyone from talking about their pay? Of course not—at least some people will talk. So one thing that we create by putting a pay secrecy clause into employment contracts is a whole bunch of rule breakers. This is never a good idea. Well, will it cause people to be more satisfied with their pay, since they don’t know that anyone else is getting paid more than they are? We have already dispelled that assumption, because of perception. All right, won’t we have to answer a lot of questions about why someone is getting paid more than someone else in a similar job? Yes, we might, but isn’t this something that you should do proactively if you are doing your job and you know that the differential exists because of performance, knowledge, or skills? If we can explain the reason for inequity successfully, we change the equity theory equation. So, there usually are no defensible reasons for pay secrecy.

Open companies, where large amounts of corporate information are available to everyone in the organization, are becoming more common. Namaste Solar in Colorado has decided to practice complete salary transparency.71 And salaries at SumAll are continually adjusted, both up and down. SumAll’s CEO says that peers will be your measure. “When they feel you’re doing well, they argue for you to make more money, and when they feel you’re doing poorly, they pull you down.”72

Recent research supports opening the books as well, with evidence that pay secrecy has an adverse effect on performance and voluntary turnover.73 According to Ed Lawler of the University of Southern California, companies may not have a choice to remain secretive because of the nature of work in the new economy. However, this will put more pressure on management to be able to explain differences in pay when questioned.74

LEGAL AND FAIRNESS ISSUES IN COMPENSATION

LO 11-3

Discuss the three major provisions of the FLSA and the penalties for misclassification of employees.

In Chapter 3, we discussed the Equal Pay Act and how it specifically deals with paying women and men equally when all other factors are the same. We also just mentioned EO 13665, which requires pay openness and gender equity for federal contractors. We have to provide equal pay for equal work unless there is a difference in productivity, seniority, merit, or other factors “other than sex.” There are also a number of federal and state laws that directly or indirectly affect pay and compensation systems. Virtually every equal employment opportunity (EEO) law identifies compensation as one of the employment actions where discrimination is prohibited if it is based on a protected characteristic. So we have to keep these laws in mind as we set up our pay system. See Exhibit 11-2 for a list of some of the major EEO laws and legal concepts that cover compensation.

WORK APPLICATION 11-8

Select a job you have or have had. Did people know how much other employees made, or was there pay secrecy?

Fair Labor Standards Act of 1938 (Amended)

Besides the Equal Pay Act and the other EEO laws, there are some laws that deal with specific compensation issues. The grandfather of these laws is the Fair Labor Standards Act (FLSA). We must really understand the FLSA well in order to create a pay system. The law’s major provisions cover minimum wage, overtime issues, and child labor rules for most US-based businesses.75 Let’s complete a quick review of the major provisions of the FLSA.

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Exhibit 11-2 SAMPLE OF JOB SATISFACTION SURVEY (JSS) QUESTIONS

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SHRM

B:8

Fair Labor Standards Act of 1938 (FLSA)

THE MINIMUM WAGE. The first major provision of the FLSA concerns the federal minimum wage. The minimum wage is the lowest hourly rate of pay generally permissible by federal law. The current federal minimum wage for most employees in the United States as of 2017 is $7.25 per hour.76 This is adjusted periodically by Congress, but the FLSA applies the minimum wage provision. It doesn’t matter how the employer pays employees—the net value paid per hour can’t generally fall below the minimum wage. In other words, we can compensate employees based on a “piece-rate” payment; on commission; or by use of a straight hourly wage, salary, or other common form—but the amount has to equal $7.25 per hour or more for the hours worked.77 Some states and even cities have set the minimum wage higher than the federal rate. You may have seen in the news that Seattle, Washington, is increasing the city’s minimum wage to $15 per hour! However, there is some recent research that posits that this increase in the minimum wages has actually harmed low-wage workers because their hours have been cut and others laid off. As wages increase, businesses will use more technology to replace workers. Have you seen an ordering and paying kiosk at McDonald’s or other places? Other research disputes this, so we are not sure at this point whether or not a higher minimum wage helps the lowest paid workers in a particular labor market.78 In addition, a rule to raise the minimum wage for federal contract workers to $10.10 per hour was in place as of July 2017.79

SHRM

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Minimum Wage/Overtime

Does everyone get paid at least the minimum wage for their area? Not exactly. There are some exemptions to the rules.80 If someone is exempt, by the definitions in the FLSA, they are exempt from the minimum wage requirement, overtime provisions, or child labor rules or possibly all three. People not meeting any of the requirements for an exemption are called nonexempt and must be paid minimum wage, overtime, and so forth.

WORK APPLICATION 11-9

Select a job you have or have had. What is the minimum wage in your state? Does the firm pay its lowest-level employees below, at, or above the state minimum wage?

As an example, workers who most people know are commonly exempt include restaurant servers. The current minimum wage for servers is $2.13 per hour.81 Why should servers be paid less than $7.25? The obvious answer is that they are in a “tipped” position. Servers would normally expect to get a large portion of their wages in tips. The FLSA says that we can pay servers a minimum of $2.13 per hour as long as their tips make up the difference. If somebody in a restaurant works 20 hours in 1 week and does not make an average of $5.12 an hour in tips, it is illegal to pay that person $2.13. So just because there is an exemption, it does not mean that we can pay our servers $2.13 per hour, no matter the circumstances. This is why workers at the local McDonald’s or Taco Bell are not paid $2.13 an hour: Most workers at fast-food restaurants don’t get tipped. For food service workers, average tips must make up the difference between the wage paid and the minimum wage; and in these businesses, tips will not do so.82 There are also other exemptions for individuals who are live-in child care providers, newspaper carriers, seasonal workers, and so on. In fact, there are hundreds of exemptions (see Exhibit 11-3 for examples).

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WORK APPLICATION 11-10

Give examples of jobs that are exempt and nonexempt. Be sure to state why they are classified as such.

However, there is a set of quick guidelines concerning exempt and nonexempt persons at work. If you make under $23,660 per year, you are pretty much guaranteed to be nonexempt under the current provisions of the FLSA.83 “Highly compensated employees” paid $100,000 or more per year (and at least $455 per week) are pretty much automatically exempt from the minimum wage and overtime rules if they regularly perform at least one of the duties of an exempt executive, administrative employee, or professional employee identified in the standard tests for exemption.84 If an individual is paid more than $23,660 but less than $100,000, then the employee usually must meet a set of specific “duties tests” in order to fall within an exemption category (see Exhibit 11-4).

You may have heard that in the United States the minimum weekly salary test was going to increase significantly. The Department of Labor (DOL) did implement a rule that would have nearly doubled the weekly salary requirements for anyone in one of the general exemption categories to $913 per week,85 but the rule had not taken effect before the new president was inaugurated. Once this change occurred, the DOL withdrew the new rule, although it is still possible that we will see an increase in the salary test, but at a lower level than originally proposed. If you are about to graduate and are going to work in the HRM field, you will want to pay close attention to this issue so that you can take action once you are employed.

Exhibit 11-3 COMMON EXEMPTIONS

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11-2 APPLYING THE CONCEPT

Employee Exemptions

Identify each job as generally being considered exempt or not from minimum wage or overtime pay (write a or b before each job type).

a. exempt

b. nonexempt

____ 6. Auto mechanic

____ 7. Fruit picker

____ 8. Worker on a foreign-flag cruise ship

____ 9. Librarian

____ 10. Taxi driver

____ 11. Real estate agent

____ 12. Bellperson at a hotel

____ 13. Computer programmer (paid more than $27.63 per hour)

____ 14. Hairdresser

____ 15. Bank teller

Exhibit 11-4 DUTIES TESTS FOR GENERAL EMPLOYEE EXEMPTIONS

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Source: US Department of Labor, http://www.dol.gov/whd/regs/compliance/fairpay/fs17g_salary.htm, retrieved July 15, 2017.

OVERTIME. Overtime is a higher than minimum, federally mandated wage, required for nonexempt employees if they work more than a certain number of hours in a week. Overtime is currently set by the FLSA as “time-and-a-half,” or 150% of the individual’s normal wages. If somebody is not an exempt employee and works more than 40 hours a week, do we have to pay that employee overtime? Yes, in almost all cases. But what if the person works more than 8 hours a day? No, there is no limit to the number of hours per day for calculation of overtime. With very few exceptions, if a nonexempt employee works more than 40 hours in a week, that employee is eligible for overtime.

SHRM

K:A6

Compensation of Special Groups

In a few cases, the organization may be allowed to average an employee’s work hours over 2 weeks in order to determine whether the individual is eligible for overtime—but this is an exception, not the rule! One type of work for which this may be allowed is shift work for firefighters, police officers, or medical personnel who may work 12- or 24-hour shifts. This is because they may work 48 hours one week and 24the next, so we can calculate their overtime based on a 2-week average rather than a 1-week total. Remember, though, that these situations are fairly rare and are explicitly identified in the FLSA.

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Compliance With Legal Requirements

Overtime Eligibility

What about double time? If an employee works more than 60 hours in a week, do we have to pay that person double time? In fact, we don’t. The FLSA has no requirement for paying anything more than time-and-a-half for any overtime work.87 Employers are also not required to provide paid holidays, vacation, or extra pay for working on weekends or on holidays. Many do this, though, because of the issue of job satisfaction and organizational commitment.

CHILD LABOR. The FLSA also has rules on the use of child labor, meaning any workers under 18 years old. If individuals are 18 or older, we can use them in any normal employment situation. However, we can employ 16- and 17-year-olds only in nonhazardous jobs, although their work hours are unrestricted. Finally, there are significantly different rules for 14- and 15-year-olds.

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WORK APPLICATION 11-11

Select a job you have or have had. Who gets paid overtime, why, and how much?

Minors age 14 and 15 may work outside school hours for no more than “three hours on a school day, 18 hours in a school week, eight hours on a non-school day, and 40 hours in a non-school week.”88 They can’t start work before 7:00 a.m. or work after 7:00 p.m., except from June 1 through Labor Day, when they can work until 9:00 p.m. Jobs they can work are limited to retail, food service, and gasoline service at establishments specifically listed in the FLSA regulations. Employees 14 and 15 years old may not work overtime. While there are some exceptions to these rules for businesses such as family businesses or family farms, these are the general guidelines for child labor.

WORK APPLICATION 11-12

Select a job you have or have had. Does the organization hire child labor? If so, why, and what do the child laborers do?

EMPLOYEE MISCLASSIFICATION UNDER THE FLSA.Misclassification of employees as exempt from minimum wage or overtime is one area where companies can get into serious trouble. In a news release in June of 2017, the Department of Labor noted the recovery of $3.4 million in unpaid overtime from Zenefits, a human resources benefits company.89 The DOL charged that the 743 account executives and sales representatives identified in their investigation were non-exempt. You would think that an HR company would know—and follow—the rules on minimum wage and overtime, but this shows how complicated it can sometimes be to identify who is exempt under federal rules. Another interesting point here is that the investigation was most likely initiated by the complaint of one or a few workers. So how would more than 700 people end up getting back wage settlements when perhaps only one made a complaint?

Once a complaint is filed, the Department of Labor’s Wage and Hour Division (see the website at http://dol.gov/whd/), the enforcement arm for wage complaints, will investigate the situation. If it finds evidence of minimum wage or overtime violations with the complainant, it will typically investigate every employee record at the company (at least in that employee class). In the case of Zenefits, the Department of Labor investigated all of individuals in the sales and account executive jobs who had been labeled as exempt by the company. They determined that these individuals did not meet the duties tests that we discussed earlier, and as a result, Zenefits agreed to pay back wages for the misclassification.

Why does misclassification occur? Obviously, companies want to save money. Many employers think that if they put you on salary, they don’t have to pay overtime—so they put you on a salary and work you 70 hours per week. Another company might say, “All my people are professionals, so they are all exempt.” But this is rarely possible in reality, if you look at the FLSA rules for exemption.

So what happens if we exempt someone who is not legitimately in an exempt category? We could end up being investigated by the Wage and Hour Division of the DOL. And what are the penalties for misclassifying employees? The employer can personally be criminally prosecuted and fined up to $10,000 per infraction. That can add up real fast—think of the 743 Zenefits employees; that would have been more than $7.4 million if the DOL had decided that the misclassification was willful on top of the $3.4 million paid to the employees! Also, there is no limit to the fines in this law—a fact that most managers don’t realize. A second conviction could result in imprisonment, and in addition, employers who willfully or repeatedly violate the exemption rules may be assessed civil penalties of more than $1,100 per violation. It’s also worse for child labor violations. Here, the civil penalty can be more than $11,000 per worker for each violation. And this can go to as much as $50,000 or even $100,000 if the violation causes the death or serious injury of an employee younger than 18 years of age.90

So what do we need to do as HR managers? We must try to impress on company leadership that misclassifying employees as exempt to save a few dollars is not the smart thing to do. Would you rather pay a few extra dollars a week or have a multimillion-dollar liability because of multiple fines?

Finally, states can’t allow a lower minimum wage than the federal guidelines of $7.25, but they can require a higher wage. Therefore, we need to remember that many states have a state minimum wage that is higher than the federal minimum wage.91 Currently, over half of US states have their own minimums that are higher than the federal minimum wage. So we need to make sure that we know our state’s laws concerning minimum wage and overtime. Note that this can be complicated for firms with employees in several states, and even more so with international business operations.

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PAY EQUITY, COMPARABLE WORTH, AND OTHER LEGAL ISSUES

LO 11-4

Briefly describe the concept of comparable worth and highlight the other legal issues in compensation.

Although the FLSA is the major compensation law, there are a number of other federal laws, as well as state and local statutes that affect organizational compensation decisions. Companies have to be aware of all of the laws—and even local sentiment concerning fair pay—in order to be able to set up a compensation system. Let’s look at some of the other issues here.

Comparable Worth

One of the more controversial issues in compensation is comparable worth. Comparable worth is the principle that when jobs are distinctly different but entail similar levels of ability, responsibility, skills, and working conditions, they are of equal value and should have the same pay scale. Comparable worth legislation has been proposed as a solution to the problem of persistent gender inequity in pay. According to the US Senate, women earn an average of 79 cents for every dollar that men earn.92This is one of the major reasons that comparable worth continues to be an issue in both business and government. While equal pay for equal work is the law (EPA of 1963), comparable worth is not currently federal law except in some very limited cases. However, a number of states—with California in the lead—have passed fair pay laws that are designed to require comparable pay in at least most work environments, and shift to the employer the burden of showing that any pay differences are due to valid, legal reasons.93

SHRM

K:A13

Pay Discrimination and Dissimilar Jobs

What does “comparable worth” mean? It is simply “similar pay for similar work.” While this sounds almost like the equal pay for equal work stipulated by the Equal Pay Act, the doctrine of comparable worth says that if we can compare your job with that of another person, and if the two jobs are similar but not the same, then we should pay you a similar wage but not necessarily exactly the same wage. So this concept is much broader than equal pay.

SHRM

E:6

Compliance With Legal Requirements

Equal Pay and Comparable Worth

If comparable worth were federal law, companies would be required to pay people who are in similar jobs similarly, which leads to a whole bunch of questions: What is similar work? Who determines what work is comparable? How do we take market supply and demand for labor into account? And what is comparable pay?

Let’s look at an example to see what comparable worth is all about. Say that Amanda and Kenny—an engineer and a nurse, respectively—both work for Baptist Medical Center. Amanda has a graduate degree in mechanical engineering. She started working at Baptist about 5 years ago as the head of heating/ventilation/air-conditioning services. Amanda is paid $85,000 a year. Her primary job is maintaining the HVAC system and reengineering it as necessary when the hospital changes its facilities in any way. Kenny, on the other hand, is a registered nurse (RN), and he also has a master’s degree (in nursing). He has been at Baptist for about 5 years, too. Kenny’s primary job is to work as an RN in one of the intensive care units (ICUs). He is responsible for maintaining the health of the patients in the ICU, and his job frequently involves life-and-death situations. However, Kenny gets paid only $65,000 a year. He may feel like Amanda’s job doesn’t involve life and death as his job does, although it might in some ways if she were to do a poor job of engineering something at the hospital and thus caused an accident. How might Kenny feel about the pay differential if he knew about it? He might feel like he is not getting paid enough, right? Kenny would therefore be using the equity equation that we talked about earlier in the chapter to determine that he is underpaid, and that is exactly what comparable worth legislation would do.

OK, so how much should Kenny be paid relative to Amanda?

There is no simple answer to this question, and it would be very difficult to apply comparable worth to determine a dollar value for Kenny’s job. Why? It is too hard to classify these jobs and determine what is comparable, because there are too many variables. These jobs are certainly comparable in such things as education (both have graduate degrees), tenure on the job (both about 5 years), and classification (both are considered professional occupations). But are there other factors? Of course there are, including thousands of details within each job plus the supply and demand for nurses and mechanical engineers. So who should get paid more if there are too many nurses and not enough engineers? It would be very difficult to deal with the market value factor of a job within a federal law. This is probably the main reason why Congress has not been able to pass a comparable worth law, at least not one that covers most businesses. Almost every year since the mid-1990s, at least some members of Congress have tried to bring up and pass a comparable worth law. Attempts to pass such laws have so far failed, mainly because of the issue of market forces and the difficulty of enforcing the laws.

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WORK APPLICATION 11-13

Select an organization you work at or have worked at. Could comparable worth work at that organization? Why or why not?

As we noted, though, there are a few cases where comparable worth is now law, even though business argues that the laws are vague. Some states have passed comparable worth legislation that applies to state, county, and city agencies; and some have now even passed “fair pay” acts that apply to all employers in the state. California’s law requires all employers to provide comparable pay for “substantially similar work,”94 but who makes the decision concerning what work is substantially similar? It will be interesting to see what effect these laws have on pay equity and comparable worth, and how such laws will be enforced.

SHRM

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Legal Constraints on Pay Issues

Other Legal Issues

A number of other federal laws place controls on pay and benefits. Recall from Chapter 10 that the National Labor Relations Act (NLRA) allows collective bargaining on the part of workers who join a union. Since the NLRA allows employees to bargain collectively with their employers for wages, benefits, and working conditions, in limited cases, the workers can agree to a workweek that is longer than 40 hours. The wages paid must be significantly higher than the minimum wage, and other conditions apply; but it is possible for the collective bargaining unit to agree to more than a 40-hour workweek.95

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Union Role in Wage and Salary Administration

Mandatory employee pension and benefits legislationalso includes the following:

• Social Security

• Workers’ compensation

• Unemployment insurance

• Family and Medical Leave Act (FMLA)

• Patient Protection and Affordable Care Act (PPACA)

• Employee Retirement Income Security Act (ERISA—mandatory for employers who offer pension plans)

• Health Insurance Portability and Accountability Act (HIPAA—mandatory for employers who offer health insurance)

We will discuss each of these laws further in Chapter 13.

JOB EVALUATION

LO 11-5

Identify the three types of job evaluation and discuss whether they are more objective or subjective in form.

Deciding how much to pay each employee in a company is difficult. There are two approaches to this—internal and external—though they may be used together. An external approach involves finding out what other organizations pay for the same or similar jobs through available pay surveys, and it sets pay levels based on market pricing. The vast majority of firms use this external approach to identifying pay levels. In a recent survey, about 95% of companies said that they use at least one source of pay survey data or other external information to determine market pricing for their jobs.96 On the other hand, an internal approach uses job evaluation. Job evaluation is the process of determining the worth of each position relative to the other positions within the organization. The most common form of internal job evaluation, the point-factor method, was used in only about one sixth of the companies surveyed.97 Organizations commonly group jobs into pay levels or grades, and the higher the grade of the job, the higher the pay. A common example of this type of grouping is the federal government’s GS ratings.

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SHRM

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Job Evaluation and Compensation (Grades, Pay Surveys, and Pay Setting)

How do we accomplish a job evaluation? There are several ways, but the methods usually involve assigning points to activities that occur within a job and totaling the points for the job. Once this is done, we can place the job in a hierarchy and create our pay grades. Let’s discuss some of the more popular job evaluation methods.

SHRM

K:A4

Role of Job Analysis/Job Design/Job Descriptions in Determining Compensation

Job-Ranking Method

Job ranking is simply the process of putting jobs in order from lowest to highest or vice versa, in terms of value to the company. This is the easiest and fastest method of job evaluation, but it has limited usefulness because it is subjective.

image

Luke Sharrett/Bloomberg via Getty Images

Generally, the higher a person is in the organization, the more compensation that employee is given.

When doing job ranking, we utilize the job descriptions that we discussed in Chapter 4 to identify the factors in each job and then rank those jobs based on their content and complexity. We usually do job ranking without assigning points to different jobs. So we might start at the top of the organization with the CEO as the highest-ranking person and then work all the way down to the lowest-skilled housekeeping job.

But if you look at this method for a second, you will see that somebody has to decide the value of each job and do so without any quantitative factors. Therefore, this determination requires judgment and is highly subjective. This means it is difficult to defend if we have to do so.

Point-Factor Method

A second type of job evaluation is the point-factor method. The Hay Guide is probably the most well-known point-factor method, but there are many others.98 Point-factor methods attempt to be completely objective in form. They break a job down into components like particular skills or abilities, and then they assign a number of points to each component based on its difficulty. These components are usually referred to as compensable factors.

Essential functions, as defined in the ADA, would certainly be compensable factors to which points would be assigned when evaluating a job. Many of the compensable factors will be common among a number of different jobs, so once we have identified the number of points the factor is worth, we can then transfer that same value to all other jobs where the factor is present. The value of the point-factor job evaluation method is that we can differentiate jobs based on the difficulty or intensity of each factor, so it becomes easier to determine the total value of the job in a quantitative form.

WORK APPLICATION 11-14

Select an organization. Identify and describe which of the four job evaluation methods are used in that organization to determine pay.

Factor Comparison Method

The factor comparison method combines the job-ranking and point-factor methods to provide a more thorough form of job evaluation.99 This model is somewhat similar to the point-factor method in that it assigns points to compensable factors. However, the factor comparison method first identifies a group of benchmark jobs—positions that are identified and evaluated in a large number of organizations and that can generally be found in most pay surveys. Examples of benchmark jobs include “Training Specialist I,” “Accountant II,” “Lending Officer I,” or “Hotel Registration Clerk.” These benchmark jobs are then analyzed in some detail based on their compensable factors. We then rank the benchmark jobs in order, and we finally compare all other jobs in the organization to the benchmark jobs to determine where each one fits in the rankings. Here again, the primary method of determining the monetary value of a job is through the analysis of the compensable factors.

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11-3 APPLYING THE CONCEPT

Job Evaluation

Review the list of job evaluation methods and then write the letter corresponding to each method before each statement below.

a. external

b. job-ranking

c. point-factor

d. factor comparison

____ 16. I use two methods together to determine how much to pay each position because I’m an HR professional.

____ 17. I look at the job and determine the specific skills needed to do the job, and then I add up the total point value of the skills to set the pay.

____ 18. To figure out how much to pay the data entry person, I’m checking the SHRM data.

____ 19. I placed all the jobs in rank order, from the one that was worth the most to the one that was worth the least, in order to determine how much to pay for each position.

____ 20. All of the companies in our industry pay essentially the same hourly wage.

A custom factor comparison method is more complex and time-consuming than the ranking or point-factor methods, mainly because it is customized to the individual organization and to the jobs within the organization.100 Because the factor comparison method uses both point factors and ranking, it has both objective and subjective components.

DEVELOPING A PAY SYSTEM

LO 11-6

Briefly describe the concepts of job structure, pay levels, product market competition, and labor market competition.

Well, we have finally gotten to the point where we can start to develop our new pay structure. Remember, though, all of the things that we had to review and decide on first. We had to review motivational theories that show us how compensation motivates our workers, and why. We also looked at how much revenue we expect to be available for compensation purposes. Then we reviewed each of our pay policies to make sure they were fresh in our minds so that we could maintain consistency in our compensation system.

	Licensed Video Boosting Wages
	Licensed Video Employee Wages

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Development of a Base Pay System

We also reviewed each of the major federal lawsconcerning compensation and equity, and we went through the process of ensuring that our job analysisfiles were up-to-date. From these, we were able to complete job evaluations of each of the jobs in the organization. We also most likely researched external equity using one or more industry-specific pay surveys.

Take a look now at Exhibit 11-5 to see how each of these items comes together to allow us to create a pay structure and individual pay rates for each job.

Job Structure and Pay Levels

A pay structure is a hierarchy of jobs and their rates of pay within the organization.101 It allows us to identify what the pay range is for each job. Once we have completed the process of creating a pay structure, we will have the pay range for every job in the hierarchy. From that, managers can determine individual compensation levels based on the employee’s performance, seniority, skills, and any other significant contingency factors.

A pay structure is composed of both a job structure and pay levels. The job structure is what gives us our job hierarchy. As we noted in the job evaluation section of this chapter, the job structure is the stacking up of the jobs in the organization, from the lowest to the highest level. Each of the jobs within the job structure will end up at a particular pay level. On the other hand, a pay level (frequently called a pay grade) is made up of many different jobs, and each pay level has a maximum pay rate and a minimum pay rate.

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Exhibit 11-5 CREATION OF A PAY STRUCTURE AND INDIVIDUAL PAY RATES

image

CREATION OF PAY LEVELS. To establish pay levels and determine the maximum and minimum pay rates for particular jobs, we have to look at some market factors. We must look at market pricing because if we don’t pay attention to external equity or fairness, we are going to have trouble filling many of our jobs.

PRODUCT MARKET COMPETITION AND LABOR MARKET COMPETITION. To set the minimum value for a particular pay level, we have to look at the applicable labor market competition, meaning labor supply versus demand for labor. If we graph compensation for a given type of work versus the number of workers in the labor market who can do that type of work, the place where the two lines cross is the average pay for that work. Per Exhibit 11-6, when the supply of labor equals the demand for that labor in the workforce, we have equilibrium. The market will pay about what the workers demand to be paid, or workers who have the necessary skills won’t be willing to fill the job.

What happens in bad economic times when there are more workers available than jobs? The market can get some of them to work for less than the normal rate (where the lines cross) because those workers need to work and earn a living. So the average compensation will most likely go down because we will have an oversupply situation. Conversely, what if we have more jobs available than we have workers with the requisite skills? In this case, we will usually have to pay more to attract the limited number of workers with the skills set that we require. We noted earlier in the chapter that as of 2016, Walmart was paying about 13.7% more than the average wage to entice workers to apply to work in their stores. The company realized that the labor market was tightening, and that they would have to pay more in order to get applicants with good skill sets. In either case, though, labor market competition will set the minimum pay that a worker will require in order to come to work for us. Also recall that we have to pay at least minimum wage to nonexempt employees. For example, if we need to hire an arc welder for one of our shops and the average pay for a welder is $16 per hour, what happens if we advertise that we will pay minimum wage ($7.25 per hour)? Will we be able to hire a qualified welder for that wage? It is really unlikely, unless there are way too many welders who are out of work. If that’s the case, though, we might be able to hire a welder for minimum wage, but we had better understand that as soon as the market for welders recovers, the new employee will likely quit.

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Exhibit 11-6 SUPPLY AND DEMAND CURVE

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What happens if, instead of there being too many welders available, there are too few? If the average pay for a welder is $16 per hour and we advertise that we will pay $16 per hour for a welder, will we be able to hire one? We will probably have to raise the minimum amount that we are willing to pay in order to get someone to take the job. If our pay rate is too low in either situation, we won’t get anybody. That’s why we have a base wage—the bottom of our pay level. We have to compete for people who are willing to do the job, and labor market competition sets the minimum amount for any pay level—but it can be a moving target that we have to track.

On the other hand, how do we determine the top of the pay level? We have to look at something called product market competition. This is basically a function of the value of the product or service that we sell to the customer.102 Again, an example will help make it clear.

Let’s say we manufacture utility trailers (see Exhibit 11-7). The public will pay about $500 for our 5- by 8-foot utility trailers. To make the problem simple, we will pretend that we have only a couple of components that go into making that trailer: labor (our welder can also assemble other parts of the trailer) and materials (all of the pieces that go into the making of the trailer). Let’s assume that all of the materials are going to cost $250 (we might need bolts, axles, angle iron for the basic frame, welding rods, etc.).

What do we have left for labor? Do we have $250? No! We also have some other indirect costs, don’t we? And we would like to make a profit, right? So if we estimate all of our other costs at $50, we now have $200 left. We can pay labor $200 if we only want to break even. However, if we want to make any money, we have to pay less than $200 for labor. Assume again that our welder makes $20 per hour (because this employee is a good welder and has worked for us for a long time) and it takes the welder 8 hours to build a trailer—$160 for the 8 hours of labor costs. So we have a $40 profit left, or about 8% profit.

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Exhibit 11-7 PRODUCT MARKET COMPETITION LIMITS

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Now, our welder comes to you and says, “Boss, I need more money—I need a raise.” What do you just about have to tell the employee? “We can’t pay you more.” The trailer can sell only for a certain amount of money. If our trailer is $800 and a competitor’s trailer is $500, almost everyone will buy the competitor’s trailer. We can’t charge much more than the normal rate for a product or service. The labor is worth only so much money, because the sale price of the good or service has to cover the cost of the labor.

Something you always need to keep in mind in HR and as a manager is how much you can pay for labor, meaning what the job is worth. We do not price the value of a person when we create a pay scale—we price the value of a job. You need to understand that you can’t pay more than the value added to the product or service by the labor. The biggest reason that you need to understand this is so that you can explain it to your employees. The decision of whether or not to pay someone more for a particular job is not a function of liking or disliking the employee; it is a function of being able to pay only a certain amount because of the product’s market value. So, product market competition sets the top of the pay level for most types of jobs in the company.

SHRM

K:A2

Developing Pay Levels

Exhibit 11-8 shows that we have a maximum and a minimum level of pay for a particular class of jobs. So labor market competition sets the bottom of the range, and product market competition sets the top of the range. Remember, though, that this is a simplified example—there may be other factors involved as well.

BENCHMARKING PAY SURVEY DATA. Next, we look at benchmarks from the pay survey data that we reviewed earlier and put those benchmark jobs into the pay level where they belong (the blue dots in Exhibit 11-8). Once we place some benchmark jobs in a plot of our pay levels, we can get a market pay line (sometimes called a pay curve)—a line that shows the average pay at different levels in a particular industry (see Exhibit 11-9). We use the benchmarks to see whether or not what we are doing is OK. If the range is correct, we have successfully created a pay level; if not, we have to figure out what is wrong with our range.

Exhibit 11-8 PAY LEVELS

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Exhibit 11-9 PAY STRUCTURE

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SHRM

G:11

Benchmarking

After going through this process for a particular pay level, we end up with a rate range, which provides the maximum, minimum, and midpoint of pay for a certain group of jobs. Once the range is created, we can go in and add to the range any other jobs that are at approximately the same level based on our earlier job evaluations.

SHRM

K:A14

Prevailing Wage

PAY STRUCTURE

LO 11-7

Briefly describe the concept of a pay structure, including broadbanding and delayering.

So we have figured out our first pay level. So what do we do now? Job structure and paylevel design are the last pieces that we need in order to put together a complete pay structure for our organization. How are we going to accomplish this? Let’s review theprocess.

Stacking Pay Levels and Evaluating

We start to lay pay levels out next to each other, creating a pay dispersion.103 Again, look at Exhibit 11-9. We take our first pay level and put it down: bottom, midpoint, and top. The bottom of the range for the first level will probably be near minimum wage in most cases. Then our second tier will start, and beyond that will be the third and the fourth, and so on.

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Notice that the ranges overlap each other in Exhibit 11-9. Why do they overlap? What would happen if each pay level started with its minimum pay rate at the maximum rate of the previous level? Would we have any room to pay people differentially in a particular level? Take a look at the market pay line. It would have to go exactly through the corners of each pay level if the levels didn’t overlap. That doesn’t give us much wiggle room on which to base people’s pay rates, does it? So the major reason for the overlap is to give the company some flexibility in each person’s pay within a particular pay level.

SHRM

K:A3

Determining Pay Increases

Once we set up our pay levels, we can actually plot the real pay levels for people in the organization. These are indicated in Exhibit 11-9 as black dots. We identify where people fall within the pay structure, and we will sometimes see that we have someone plotted outside our pay-level ranges—either too high or too low. Individual pay rates that fall outside our pay range on the high side are called red-circle rates (red dots in Exhibit 11-9), and those that are lower than the bottom of the pay range are green-circle rates (green dots in Exhibit 11-9). If we find a green-circle rate for an individual, the correct thing to do is to raise the individual’s pay to at least the minimum for that pay level, because we are not paying them fairly for their skill set.104

WORK APPLICATION 11-15

Select an organization. Identify the rate range for a category of jobs.

But what should we do about a red-circle rate? We probably won’t cut someone’s pay, but we will not be able to pay them any more unless they move up to a higher skill level, and therefore a higher pay level. For instance, if our welder is making $24 per hour, the maximum for his pay level is $20, but he wants a pay raise and hasn’t had a one in several years, we may have to tell him no. However, we can also tell him that if he is willing to become a supervisor over other welders, he can get the chance to raise his pay rate because the skill level for a supervisor is higher than that of a welder.

Understanding pay levels and our pay structure allows us to provide good answers to our employees about why their pay is set at a certain level. If a worker decides to become a supervisor, that employee is worth more and we can pay more. So we are able to tell the employee, “The job isn’t worth any more than what you are being paid,” instead of saying, “You are not worth any more than that.” It also gives us leverage to get good workers to consider becoming supervisors or managers if we tell them, “If you want a pay raise, become a supervisor.”

Delayering and Broadbanding

A trend over many years now has been to lower the number of pay levels using one of two options—either delayering or broadbanding. Delayering is the process of changing the company structure to get rid of some of the vertical hierarchy (reporting levels) in an organization. On the other hand, broadbanding is accomplished by combining multiple pay levels into one.105 What is the benefit of combining levels either vertically or horizontally in this way? Is it that we can make bigger groups, and bigger is always better? Well, bigger isn’t always better, but in this case it may be. When we lower the number of pay levels that we have to deal with, we make the process simpler. It takes a long time to create, maintain, and evaluate 20 pay levels, when instead we can have just 5 broadbands. It also allows us more capacity to reward outstanding performers. Because we have taller and wider levels, we can move them up way more while staying within the boundaries of the pay level.

Take a look at what happens to our pay structure in Exhibit 11-10 when we convert it into a broadband pay structure. The new broadband pay structure combines the first two pay levels, the third and fourth level, and finally the fifth and sixth, making three levels instead of six. This causes our red- and green-circle rates to disappear. It also gives us greater ability to adjust the pay of people based on their performance and ability. Finally, it lowers the administrative burden of maintaining the compensation system. For these reasons, companies may have broadened the pay levels that they use. It is fairly easy to see why it would be easier to work with just 5 pay levels rather than 20. It just takes much more management time to administer the larger number of levels. However, recent research showed that only about 3% of companies worldwide are actually using some form of broadbanding.106

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Exhibit 11-10 BROADBANDING OF MULTIPLE PAY LEVELS

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So when we are done with our pay structure, we will have created that hierarchy of jobs that we mentioned earlier—from lowest to highest. And as you have probably already guessed, much of this work is now done using computers. Once the HRIS have the necessary data, we can create most of our pay structure using existing company information. The computer models will identify the outliers for us. In many cases, the HRIS can identify the market pay line and provide other compensation information, too. We can see very quickly if we have a whole bunch of employees in level 3 and also see that they are all getting almost the highest possible pay for that level. From this information, we can analyze why this may be happening and figure out whether the pay scale needs to be changed in some manner. HRIS are very valuable tools for job structure analysis.

TRENDS AND ISSUES IN HRM

LO 11-8

Briefly discuss the issues of independent contractors versus employees and the problem of the gender–wage gap.

What compensation trends and issues do we see in organizations? One continuing trend is toward classifying individuals as independent contractors instead of as employees. And gender equity in pay continues to elude most organizations, even though awareness is at an all-time high. Let’s look at these issues in a little more depth here.

Designation of Independent Contractors Continues to Be an Issue

Earlier, we discussed the trend toward more on-demand workers, and companies continue to create more independent contractor relationships and fewer employer-employee relationships as part of this trend. While some of these contract relationships are absolutely legitimate, many have been set up to intentionally avoid an employee relationship and all of the associated record-keeping and legal issues.

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11-1 SELF ASSESSMENT

Compensation Management Satisfaction

This exercise is also a good review of the chapter, as it uses most of the important concepts. Select an organization that you work or have worked for and select your level of satisfaction with each of the following parts of the compensation management system, on a scale of 1 to 5.

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_____ 1. Base pay

_____ 2. Wage and salary add-ons

_____ 3. Incentive pay

_____ 4. Benefits

_____ 5. Meeting expectancy theory

_____ 6. Meeting equity theory

_____ 7. What the firm actually pays based on its ability to pay

_____ 8. Pay for performance versus longevity

_____ 9. What the firm pays based on being below, at, or above market-level pay

____ 10. Wage compression

____ 11. Pay secrecy

____ 12. Meeting the Fair Labor Standards Act

____ 13. Pay equity and comparable worth

____ 14. The system used for job evaluation

____ 15. Job structure

____ 16. Pay levels

____ 17. Benchmarking

____ 18. Pay structure

____ 19. Pay raises

____ 20. Benefit increases

_____ Total the points and place the score on the continuum below.

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The higher the score, the greater your level of satisfaction with the compensation management system of the organization. However, to most employees, what really matters most is answers to questions regarding their own pay and benefits (compensation), and we all are more satisfied when these increase.

Think about the people you worked with as a group. You can select the group’s level of satisfaction with each question. Would their answers vary from yours? Would the satisfaction level vary by the level in the organization—among executives versus nonmanagers, by department, or among other groupings?

Why are companies so intent on moving toward independent contractor relationships? One reason for the shift is to maximize organizational flexibility. In many cases, the relationship with independent contractors can be severed much more easily than those with employees. If there is no long-term contract, the company can release the contractor immediately on completion of whatever job is currently being done. Another reason for maintaining this type of arms-length relationship is that it can save the company from significant costs. Compensation of an independent contractor is much simpler than compensation of employees. In the contract relationship, the company pays the agreed-upon amount on the contract, and there is no need to calculate hours, minimum wage, overtime, benefits costs, health care insurance eligibility, or any other compensation factors. They also do not have to pay federal (social security and other) taxes or state mandated (unemployment, workers’ compensation, etc.) taxes on employees and other potential costs. All of those requirements fall to the contractor to manage.

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Employers may think that it is easy to make an employee into a contractor, but independent contractors must be truly independent of the company’s control. According to the IRS website, “The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done” (emphasis added).107 The US Supreme Court identified an “economic realities” test to help determine whether or not a case is dealing with an employer-employee relationship:108

1. The extent to which the work performed is an integral part of the employer’s business.

2. Whether the worker’s managerial skills affect his or her opportunity for profit and loss.

3. The relative investments in facilities and equipment by the worker and the employer.

4. The worker’s skill and initiative.

5. The permanency of the worker’s relationship with the employer.

6. The nature and degree of control by the employer.

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Mike Coppola/Getty Images for Lyft

Lyft uses contractors as drivers. Drivers’ compensation depends on how often they choose to work; however, the company does not provide benefits to drivers.

Most everyone has by now heard of the ongoing dispute between the ride-sharing service Uberand the federal government concerning whether or not Uber drivers are independent contractors. At last count, there were more than a dozen lawsuits on this single issue. In one case, a federal judge rejected a proposed settlement for $100 million because the deal “undervalued” potential claims.109 The government wants to show an employee relationship because, if they can, they receive more in the form of taxes on those employees’ wages. And drivers suing Uber want to be employees because of the worker protections involved under the FLSA and other federal and state laws. Of course, Uber wants to maintain the independent relationship so that the company doesn’t have the internal costs associated with collecting and delivering those tax costs to the federal (and state) government. HR managers will need to follow these cases as they progress through the courts as the decisions will significantly affect the ability to identify independent contractors in the future.

Even though the DOL has recently pulled back on previously issued guidance concerning the employee versus independent contractor designations, employers need to be aware of, and concerned with their use of such identifications. Intentionally misclassifying of employees as contractors is similar to calling an individual exempt under the FLSA when that worker is nonexempt by current laws. It is unethical and illegal to intentionally misclassify individuals to avoid paying them what would reasonably and ordinarily be due them in their relationship with the company, and it carries the same penalties as other FLSA violations should the employer get caught.

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The Stubborn Gender–Wage Gap: Can It Be Fixed?

According to Fortune magazine, “Gender parity in wages still has a long way to go.”110 Research backs this up. Sex differences in total rewards in the workplace were 14 times larger than sex differences in performance evaluations,111 according to one study. Even though the pay gap is likely the smallest it has been since about 1960, evidence still shows that women make about 79% of what men do on average across all industries in the United States.112 Why is this wage gap so stubborn?

Some of the gender–wage gap can be explained away based on a number of factors other than discrimination. For instance, it is true that women leave the workforce more often than men and that women tend to be absent more when employed than their male counterparts. There are logical reasons for these facts, including the fact that women still tend to be the primary care giver to children in a family; but they are still facts. However, at least some of the difference appears to still be an inherent bias in companies toward paying men more than their female counterparts. Some states have begun to pass laws that limit the ability for companies to exhibit such biases. For instance, Oregon recently passed a pay equity law that provides for “two years of back pay at the employee’s regular rate of pay, compensatory and punitive damages, and attorney fees”113 to an employee who wins a fair pay claim against their employer; and California passed a law that required comparable pay for “substantially similar” work—which significantly expands the ability of an employee to claim unfair wage discrimination.114

Companies are taking notice. According to HR Magazine, “Pay equity has become a top-of-mind concern for employers nationally as a result of California’s new gender pay equity law and similar legislation in New York and elsewhere.”115 Pay equity is not just a US issue either. Countries as varied as Iceland, New Zealand, Canada, and Singapore are discussing the issue and passing gender equity laws.116 But not enough seems to be getting done.

So what can be done to mitigate the problem? Government rulemaking can go only so far. In some cases, it appears that there has been some overreach on the part of federal—and maybe state—agencies, which will probably not help the situation very much. Google recently pushed back when the DOL demanded information that the company claimed would cost more than $1 million to gather on a contract that paid them only $600,000.117 That argument is still being litigated as this is written. But good companies, including Google, say that they want to do something to minimize the gap. The monitoring of the problem and enforcement of solutions will almost always fall to the HR department for implementation in such situations. HR leaders can maintain records of initial salary negotiations and ultimately of offers, manage and evaluate any compensation increases over time, and complete pay audits on a periodic basis. If unexplainable disparities are found during the various analysis efforts, HR needs to make recommendations to senior management to correct any problems by adjusting compensation components as needed. Pay disparity is a fact. Consistent vigilance is the only way to combat this historically stubborn issue.

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DIGITAL RESOURCES

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Compensation Management*

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Employee Performance and Compensation Management

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Is There a Research-Practice Gap in Compensation Management?

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Boosting Wages*

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Total Compensation Statement

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Integrated Pay for Performance

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Employee Wages*

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Compensation and “Total Rewards”

* premium video only available in the interactive eBook

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CHAPTER SUMMARY

11-1. Identify the components of a compensation system and describe how expectancy and equity theories apply to compensation.

Components of compensation include the following four items:

1. Base pay, either an hourly wage or salary. Base pay is frequently a major decision factor for most employees in deciding to accept the job.

2. Wage and salary add-ons. These include overtime pay, shift differential, premium pay for working weekends and holidays, and other add-ons.

3. Incentive pay for performance. Incentives give workers strong reasons to perform above the standard.

4. Benefits. This is indirect compensation that provides something of value to the employee. Benefits cost the company money even though they aren’t direct compensation.

Expectancy theory (Motivation = Expectancy x Instrumentality x Valence) says that employees expect to put forth some form of effort at work and believe they can accomplish the task or objective (expectancy). This effort is expected to result in some level of performance resulting in some type of reward (instrumentality). The reward has to be significant (valence) to the individual; and as long as it is, the employee will continue to put out effort to get the reward.

According to equity theory, people compare their inputs (the things they do in the organization) and outcomes (the things that they receive from the organization) to those of relevant others. But it’s their and others’ perceived inputs and outcomes that employees compare, not necessarily actual inputs and outcomes. If employees believe that there is inequity, they will change their work behavior to create equity. Employees must perceive that they are being treated fairly, relative to others. Compensation is obviously a large part of the perceived outcomes.

11-2. Identify the seven basic issues that make up the organization’s compensation strategy.

1. Ability to pay. This is an honest assessment of how much we can afford, or are willing to afford, in order to compensate our employees.

2. Types of compensation. This refers to the mix of the four basic components of compensation—base pay, wage add-ons, incentives, and benefits—that we employ. We must divide available funds among the components.

3. Pay for performance or longevity. Will we pay people based on organizational loyalty/tenure, or will we pay based on performance in their jobs?

4. Skill- or competency-based pay.

5. At, above, or below the market. What will our general pay structure look like, and why?

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6. Wage compression. This lowers the pay differential between long-term and newly hired employees.

7. Pay secrecy. Will we utilize pay secrecy clauses in employment contracts? Pay secrecy may allow us to hide actual wage inequities from employees, but it has the potential to create dissatisfaction and demotivation.

11-3. Discuss the three major provisions of the FLSA and the penalties for misclassification of employees.

1. Minimum wage rates identify the lowest hourly rate of pay generally allowed under the FLSA. There are many exemptions; but if a person is nonexempt, minimum wage willapply.

2. Overtime rates are also required for persons who are nonexempt. However, there are different exemptions for overtime than there are for minimum wage, so HR managers must check the law to determine who will have to be paid overtime.

3. Child labor requirements within the FLSA identify the jobs and allowable working hours for individuals between 14 and 18 years old. Sixteen- and 17-year-olds can be employed only in nonhazardous jobs, but their work hours are unrestricted. However, 14- and 15-year-olds can work only outside school hours, and the jobs that they are allowed to do are limited to retail and other service positions. They may not work overtime.

The employer can personally be criminally prosecuted and fined up to $10,000 per misclassification infraction. There is no maximum limit to the allowable fines, so fines in the millions of dollars have been assessed in the past. A second conviction can result in imprisonment. Employers who willfully or repeatedly violate the exemption rules may be assessed civil penalties of up to $1,100 per violation. For child labor violations, the civil penalty can be up to $11,000 per worker for each violation and can go to as much as $50,000 or even $100,000 if the violation causes the serious injury or death of an employee younger than 18 years old.

11-4. Briefly describe the concept of comparable worth and highlight the other legal issues in compensation.

Comparable worth is similar pay for similar work, which is different from equal pay for equal work. The concept of comparable worth holds that if we can compare your job with that of another person and they are similar, we should pay you a similar wage, which makes this concept much broader than equal pay. The biggest problem with comparable worth from a legal standpoint is how to legislate the value of a job while taking supply and demand into account.

Other legal issues besides the FLSA and comparable worth include:

• The NLRA

• Social Security

• Workers’ compensation

• Unemployment insurance

• Family and Medical Leave Act (FMLA)

• Patient Protection and Affordable Care Act (PPACA)

• Employee Retirement Income Security Act (ERISA—mandatory for employers who offer pension plans)

• Health Insurance Portability and Accountability Act (HIPAA—mandatory for employers who offer health insurance)

11-5. Identify the three types of job evaluation and discuss whether they are more objective or subjective in form.

1. The job-ranking method is simply the process of putting jobs in order from lowest to highest or vice versa, in terms of value to the company. However, it has limited usefulness because it is subjective.

2. Point-factor methods, on the other hand, attempt to be completely objective in form. They break a job down into component skills or abilities, known as factors, and then apply points to each factor based on its difficulty.

3. The factor comparison method combines the job-ranking and point-factor methods to provide a more thorough form of job evaluation. It identifies benchmark jobs, and then analyzes and rank-orders them. We then compare all other jobs in the organization to the benchmark jobs to determine where each one fits in the rankings.

11-6. Briefly describe the concepts of job structure, pay levels, product market competition, and labor market competition.

• The job structure is what gives us a job hierarchy. The job hierarchy is the stacking of the jobs in the organization from the lowest (simplest) to the highest (most complex) levels.

• A pay level (frequently called a pay grade) will be made up of several different jobs. Pay levels provide a framework for the minimum and maximum pay for a particular group of jobs in the organization. Pay levels are then laid out one next to another in order to create the entire pay structure for the company.

• Product market competition sets the top of a pay level. We can pay someone only as much as we can recover from a customer when we sell our goods or services. We can’t pay more than the value added to the product or service by the labor. Together, product market and labor market competition identify the maximum and minimum rates of pay for a particular group of jobs in a pay level.

• Labor market competition sets the bottom of a pay level. We have to compete with other companies to attract labor; and if we don’t pay enough, we will be unable to attract the workers we need. So we compete in the labor market for available workers.

11-7. Briefly describe the concept of a pay structure, including broadbanding and delayering.

A pay structure is created by laying out our pay levels, one next to the other. The entire group of pay levels creates the pay structure. Benchmark jobs can be plotted on the pay structure to get a market pay line—a line that shows the average pay at different levels in a particular industry. Once pay levels are set, we can actually plot employee rates of pay on the pay structure to see if any are plotted outside our pay-level ranges, either high or low. Individuals who fall outside our pay range to the high side are paid red-circle rates, and those who fall outside low are paid green-circle rates. Each of these rates should be reviewed and corrected if necessary.

Broadbanding lowers the number of pay levels that a company administers by combining multiple pay levels into one. Lowering the number of pay levels makes the process simpler. It takes a long time to create, maintain, and evaluate many pay levels; but instead, we can have just a few broadbands. Because pay bands are wider and taller under broadbanding, the company also has more flexibility in pay rates for individuals who are overperforming or underperforming. Broadbanding may also cause most red- and green-circle rates to disappear. Delayering also lowers the number of pay levels, but it does so by getting rid of layers of vertical hierarchy in the organizational structure.

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11-8. Briefly discuss the issues of independent contractors versus employees and the problem of thegender–wage gap.

Companies are using more independent contractors to maintain maximum organizational flexibility, and in some cases at least, to lower costs associated with maintaining employees. Costs include the need to calculate hours, minimum wage, overtime, benefits costs, health care insurance eligibility, or any other compensation factors. They also do not have to pay federal (social security and other) taxes or state mandated (unemployment, workers’ compensation, etc.) taxes on employees and other potential costs. The gender–wage gap continues to stymie governments and companies. Evidence still shows that women make about 79% of what men do on average across all industries in the United States. Some of the gap can be explained based on legitimate factors, but some can’t. Individual states and local governments are starting to pass wage equity laws, which makes it more difficult for companies to manage widespread operations, so pay equity has become an executive concern. HR leaders need to maintain records of initial salary negotiations and ultimately of offers, manage and evaluate any compensation increases over time, and complete pay audits on a periodic basis. If unexplainable disparities are found during the various analysis efforts, HR needs to make recommendations to senior management to correct the problem.

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KEY TERMS

broadbanding 412

compensation 388

compensation system 388

delayering 412

equity theory 392

expectancy theory 390

job evaluation 405

minimum wage 399

overtime 402

pay structure 407

rate range 411

wage compression 396

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KEY TERMS REVIEW

Complete each of the following statements using one of this chapter’s key terms.

1. ________ is the total of an employee’s pay and benefits.

2. ________ includes anything that an employee may value and desire and that the employer is willing and able to offer in exchange.

3. ________ proposes that employees are motivated when they believe they can accomplish a task and that the rewards for doing so are worth the effort.

4. ________ proposes that employees are motivated when the ratio of their perceived outcomes to inputs is at least roughly equal to that of other referent individuals.

5. ________ occurs when new employees require higher starting pay than the historical norm, causing narrowing of the pay gap between experienced and new employees.

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6. ________ is the lowest hourly rate of pay generally permissible by federal law.

7. ________ is a higher than minimum, federally mandated wage, required for nonexempt employees if they work more than a certain number of hours in a week.

8. ________ is the process of determining the worth of each position relative to the other positions within the organization.

9. ________ is a hierarchy of jobs and their rates of pay within the organization.

10. ________ provides the maximum, minimum, and midpoint of pay for a certain group of jobs.

11. ________ is the process of changing the company structure to get rid of some of the vertical hierarchy (reporting levels) in an organization.

12. ________ is accomplished by combining multiple pay levels into one.

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COMMUNICATION SKILLS

The following critical-thinking questions can be used for class discussion and/or for written assignments to develop communication skills. Be sure to give complete explanations for all answers.

1. Do you believe it is always necessary to provide incentives as part of a pay structure? Why or why not?

2. As the HR manager, would you pay more attention to expectancy theory or equity theory in designing your compensation system? Why?

3. If your company had promised an incentive program right before the recession of 2007–2008, and if the recession made it impossible for the company to pay employees what they had been promised, then how would you explain this to your workforce to keep them motivated?

4. Would you rather have higher pay or better benefits? Why?

5. Would you ever consider paying below the market rate for employees if you had control of wages? Why or why not?

6. Do you believe that pay secrecy can ever really work in a business? Why or why not?

7. How would you approach a CEO or company president who insisted on classifying nonexempt workers as exempt? What would you say to get the CEO to stop this practice?

8. Do you think that comparable worth should be made federal law? Why or why not?

9. If you were the lead HR manager in your company, would you ever consider setting pay levels by just using external pay surveys and no internal analysis? What are the advantages and disadvantages of this?

10. As the head of HR, would you rather change narrow pay levels into broadbands? Can you think of any disadvantages to doing so?

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CASE 11-1 DISCOUNTING EVERYTHING BUT COMPENSATION AT COSTCO

Costco has gone head to head with the likes BJ’s, Target, and SAM’s Club and has come out the winner. Offering over 3,700 discounted household products to over 71 million people across Asia, Spain, Puerto Rico, Mexico, Canada, and 44 states in the United States, and like their competitors, they also offer additional services including mortgage, car, and home insurance, as well as travel packages.(1)

Costco has proven though that there is more to warehouse stores than just low prices. So how can Costco beat other retailers like Walmart, BJ’s, and Target, who sell similar products and services? By having “great jobs, great pay, great benefits and a great place to work,”(2) Costco has attracted employees who are ardent and arduous workers, who thrive on working in a dynamic and hypercompetitive industry, who are high achievers and excel in a team environment. So how does one then attract such superstars to one’s business?

Costco has learned that the secret to hiring the best and the brightest is not through salary alone but by offering a superior work environment including a comprehensive benefits package. They pay a higher insurance premium percent than their competitors toward employees’ and include in the plan the employees’ entire family (spouse, domestic partner, and dependents). Employees pay their portion of the premiums with pre-tax dollars, therefore reducing their taxable income. Employees also qualify very quickly for benefits relative to industry standards. Salaried employees receive benefits after the first month of service while full-time/part-time hourly employees are eligible after 90/180 days of service or 450/600 hours.

Costco’s generous benefits package includes the following:

• Health care

• Dental care

• Pharmacy program

• Vision program

• 401(k) plan

• Dependent care assistance plan

• Care network

• Voluntary short-term disability

• Long-term disability

• Life insurance

• Employee stock purchase plan

• Health care reimbursement account

• Long-term care insurance

Does Costco’s strategy about superior benefits work? If one asks their employees, the resounding answer is yes. Glassdoor.com ranks the best companies to work for based upon benefits and compensation and obtains this information directly from the firms’ employees. Ninety-two percent of Costco’s personnel thought CEO Craig Jelinek was doing a good job, while 82% would want a friend to work there as well. Interestingly their benefits package received an 88% rating, while employee satisfaction slipped to 76%. Nonetheless the scores where high enough to rank Costco 2nd overall, just behind the megastar Google.(3)One Costco employee on glassdoor.com’s website summed it up quite well:

The best incentive at Costco is the benefits, whether you are working full time or part time. I paid 20 bucks a month for a $500 deductible with no co-pay. The hourly compensation is more than fair, and I got the sense very quickly that management was eyeing the most competent workers for advancement. . . . Great wages, benefits . . . and working for a great company that really truly cares about their members and employees.(4)

Questions

1. What organizational processes does compensation affect and what is Costco’s rationale for having an exceptional compensation plan?

2. What are the parts of a compensation system, and what component(s) does Costco’s compensation system focus on?

3. What are the four basic types of compensation, and which are evident at Costco?

4. What is expectancy theory, and how does or does not Costco employ this theory within their compensations system?

5. What are the differing types of basic wage classifications, and how does Costco categorize their workforce by basic wage?

6. What is Costco’s philosophy about employee compensation?

7. Costco lists numerous benefits that the firm provides employees above their basic salary. What pay rate and benefits must Costco provide their employees as required by Federal Labor Laws?

References

(1) Gledhill. M. (n.d.). Costco Wholesale Corporation. Hoovers. Retrieved May 3, 2017, from http://0-subscriber.hoovers.com.liucat.lib.liu.edu/H/company360/fulldescription.html?companyId=17060000000000

(2) Costco Wholesale. (n.d.). Costco careers. Retrieved May 3, 2017, from https://www.costco.com/jobs.html

(3) Costco Wholesale. (n.d.). Costco has great benefits. Retrieved May 3, 2017, from https://www.costco.com/benefits.html

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(4) Denman, T. (n.d.). Costco employees rave about compensation and benefits. Retail Information Systems. Retrieved May 3, 2017, from https://risnews.com/costco-employees-rave-about-compensation-and-benefits

Case created by Herbert Sherman and Theodore Vallas, Department of Management Sciences, School of Business Brooklyn Campus, Long Island University

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CASE 11-2 EMPLOYEE RED-LINING AT CVS: THE HAVE AND THE HAVE NOT

CVS Caremark is the second-largest drugstore chain in the United States (just behind Walmart). It employs 286,000 people in 45 states under the CVS logo, and it operates more than 7,600 drugstores. In 2013, CVS’s sales exceeded $126 billion, but its net income was only around $4.6 billion, for about a 3.6% profit—about the median profit for the industry.(1)

As would any other public corporation, CVS wanted to increase its profitability for stockholders and regain its position as the industry leader. One method of increasing profits is cutting operational costs, and CVS decided to do just that. It adjusted employee annual pay raises by placing an earnings ceiling on salaries, and any employees earning the highest hourly wage in their job classification became ineligible for a raise.

Besides the obvious cost savings, why put a “red line” on wages? The main goal was to adjust the highest-paid employees’ compensation to the job market average and, with these savings, provide raises to the employees who were paid below that average. The philosophy was that as a CVS employee, one should expect lower raises (or none at all) if one is earning much more than one’s colleagues. So once an employee reached the red line, that person received no additional compensation.

CVS executives knew that the new compensation policy would negatively impact some of their most loyal employees, yet the executives felt that they needed to draw a line on salaries in order to make the most of limited compensation dollars. What they did not figure was that the policy mostly hurt the employees who had been working there the longest. Worse, these same employees feared retaliation if they publicly criticized the new policy. How would it look to the other lower-paid employees (and worse, the public at large) if the highest-paid employees complained about their lack of raises?

Nationwide, the minimum wage is set at $7.25 per hour, but the wage management guidelines of CVS are different in most regions depending on the minimum wage in each state. Lowest-ranked employees with exceptional skills would receive a 4.75% raise on an annual basis if they were making minimum wage. However, if an employee with exceptional skills in the same position was already earning $12.50 an hour, that person would not receive a raise, having already crossed the red line.(2) With employment-at-will, the possibility of being laid off, and a tough job market, where would these employees get such high-paying jobs in the retail and service industries? It was better for them to keep quiet about their pay and stay in a company that they were comfortable with.(3)

Wage rates depend on employees’ rank, and it is no secret that the CEO is going to be paid much more than the company’s average worker. This is because the CEO job requires a more demanding set of skills compared to the average store job, and the workload of a CEO is much more demanding. But if the range of compensation is so great, it may discourage employees who are paid less.(4)

Some ethical and legal concerns arose when these same red-lined employees found out that this new compensation policy did not seem to apply to the top-level executives. The CEO of CVS was paid a total of $23 million in 2013, including bonuses and additional perks. He earned a 26% raise from the previous year, and that was almost 800 times more than the median income of a CVS employee. The red-lined employees saw an inequitable pay situation, with the rich getting richer because they were allowed a raise while the in-store employees had a cap on their income. The CEO’s salary package was tied to the company’s performance, and according to CVS spokesperson Carolyn Castel, “Last year, CVS Caremark had an outstanding year and continued to deliver strong financial results and enhanced returns to shareholders in a challenging economic environment, performing favorably against our peer group in several key areas.”(5)

Questions

1. Describe the pay structure and compensation system for a CVS store employee. How might this pay structure be different from that of the CEO of the firm?

2. Define the rate range of CVS employees. How would you change the pay structure to encourage performance, especially for red-lined employees?

3. In terms of expectancy and equity theories, describe how the red-line policy will affect the motivation of employees.

4. In light of the red-line policy, what was CVS’s philosophy toward employee performance, compensation, and longevity?

5. If you were CVS’s CEO, knowing that you have to reduce costs and balance employee wages, what other measures would you take besides freezing raises for the highest-paid employees?

6. Why would the firm implement an HR policy that it knew would negatively affect its highest-paid employees? Did it perhaps have a hidden agenda?

References

(1) Hoover’s Inc. (2014). CVS Caremark Corporation [Hoover’s Company Records: In-Depth Records]. Retrieved July 12, 2014, from Long Island University Academic Database.

(2) Lazarus, D. (2014, June 26). At CVS, only the very rich get much richer. Los Angeles Times. http://www.latimes.com/business/la-fi-lazarus-20140627-column.html

(3) Ibid.

(4) Ibid.

(5) Kell, J. (2013, March 29). CVS Caremark CEO’s pay jumps 44%. Wall Street Journal. http://online.wsj.com/news/articles/SB10001424127887323501004578390383929384430

Case created by Herbert Sherman and Theodore Vallas, Department of Management Sciences, School of Business Brooklyn Campus, Long Island University

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SKILL BUILDER 11-1 JOB EVALUATION

Objective

To develop a better understanding of the job evaluation process

Skills

The primary skills developed through this exercise are as follows:

1. HR management skills—Technical, conceptual and design, and business skills

2. SHRM 2016 Curriculum Guidebook—K: Total Rewards

Assignment

Step 1. You decided to open a restaurant and pub, and you have five job categories:

• Owner/manager: You are the owner, performing all the management functions and also greeting and seating people as you oversee all activities.

• Wait staff: They take food orders and bring food to customers.

• Cooks: They prepare the food.

• Helpers: They bus tables, wash dishes, help in food preparation, and bring food to some customers.

• Bartenders: They make the drinks for both the dining and bar areas.

Step 2. Using the table below, rank each job for each of the five factors commonly used in job evaluations. Rank the jobs from 1to5, with 5 being the highest-ranking job and 1 being the lowest.

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Step 3. The five factors are commonly weighted since some are more important than others.

(A) In the above table in the bottom row—Factor Rank—now rank the five factors from 1 to 5, with 5 being the most important and 1 being the least important.

(B) The five factors can also be weighted as percentages. For example, based on a total of 100%, the highest-rated factor could be weighted at 40%, then the next-highest could be rated at 30%, followed by 20%, and the other two at 5% each. So also include your percentage-based weights for each factor, like in the example.

People generally will not agree on all the rankings, and that is a major reason why there is virtually always a committee that conducts job evaluations.

Step 4 (optional due to difficulty). Assign pay values to each of the five factors and weight them to determine pay levels for each job.

Apply It

What did I learn from this experience? How will I use this knowledge in the future?

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SKILL BUILDER 11-2 PRODUCT MARKET COMPETITION LIMITS

Objective

To develop a better understanding of product market competition limits

Skills

The primary skills developed through this exercise are as follows:

1. HR management skills—Technical and business skills

2. SHRM 2016 Curriculum Guidebook—K: Total Rewards

Assignment

Complete the math problems below:

_____ 1. Your product sells for $1,000. Materials cost $300, labor costs $300, and overhead costs $200. What is your profit in dollars and as a percentage?

_____ 2. Your product sells for $750. Materials cost $250, labor costs $300, and overhead costs $150. What is the profit in dollars and as a percentage?

_____ 3. Your product sells for $1,000. Materials cost $300 and overhead costs $200. What is the maximum amount you can pay labor to make a $100 profit with a 10% return?

_____ 4. Your product sells for $750. Materials cost $250 andoverhead costs $150. What is the maximum amount youcan pay labor to make a 10% profit return on the sales price?

_____ 5. Your product sells for $800. Materials cost $300 andoverhead costs $200. What is the maximum amount youcan pay labor to make a 15% profit return on the sales price?