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CHAPTER 11

Total Rewards and Compensation

Learning Objectives

Identify the three general components of total rewards and give examples of each

Explain the major laws governing employee compensation

Outline the steps in developing a base pay system

Learning Objectives (continued)

Define variable pay and identify three aspects of effective pay-for-performance plans

Explain three levels of incentives and give one example at each level

Identify four measures used to determine the effectiveness of compensation systems

Nature of Total Rewards and Compensation

Total rewards: Monetary and nonmonetary rewards provided by companies to attract, motivate, and retain employees

Strategic decisions can guide the design of compensation practices

Compliance with all applicable laws and regulations

Cost-effectiveness for the organization

Internal and external equity for employees

Nature of Total Rewards and Compensation (continued)

Performance enhancement for the organization

Performance recognition and talent management for employees

Enhanced recruitment, involvement, and retention of employees

Elements of Total Rewards

Tangible direct rewards

Base pay

Wages and salary

Individual variable pay

Piece rate, bonus, and commission

Team variable pay

Gainsharing and team bonus

Organization variable pay

Profit sharing and equity/stock awards

Elements of Total Rewards (continued 1)

Tangible indirect rewards

Health care benefits

Medical insurance, dental insurance, and health spending account

Paid time off

Vacation, holidays, and medical leaves of absence

Disability benefits

Short-term disability, long-term disability, and long-term care insurance

Elements of Total Rewards (continued 2)

Financial benefits

Education assistance and financial planning

Retirement benefits

Defined benefit plan and defined contribution plan (401k)

Employee development and training

Intangible rewards

Supportive work environment, challenging work, autonomy, and supportive supervisor

Components of Compensation

Tangible rewards: Elements of compensation that can be quantitatively measured and compared between different organizations

Intangible rewards: Elements of compensation that cannot be as easily measured or quantified

Base pay: Basic compensation that an employee receives, often wages or salary

Wages: Payments calculated directly on the basis of time worked by employees

Components of Compensation (continued)

Salary: Consistent payments made each period regardless of the number of hours worked

Variable pay: Compensation linked directly to individual, team, or organizational performance

Benefit: Indirect reward given to an employee or group of employees as part of membership in the organization, regardless of performance

Fair Labor Standards Act (F L S A)

Primary federal law affecting compensation

Enforced by the Wage and Hour Division of the U.S. Department of Labor (D O L)

Provisions focus on the following major areas:

Minimum wage

Limits on the use of child labor

Overtime provisions (exempt and nonexempt status)

Fair Labor Standards Act (F L S A) (continued 1)

Minimum wage

Set by F L S A to be paid to a broad spectrum of covered employees

Congressional action is the only way to change it

Child labor provisions

Set the minimum age for employment with unlimited hours at 16 years

Minimum age for hazardous occupations is 18 years

Individuals who are 14 to 15 years old may work outside school hours with certain limitations

Fair Labor Standards Act (F L S A) (continued 2)

During enactment of F L S A, limited exemptions were included that permitted employers to restrict executives and others from receiving overtime pay

Exempt employees: Employees who hold positions for which they are not paid overtime

Nonexempt employees: Employees who must be paid overtime

Overtime: F L S A established overtime pay requirements at 1.5 times the regular pay rate for all hours worked over 40 in a week

Determining Exempt Status under the F L S A

Categories for exempt status

Executive

Administrative

Professional (learned and creative)

Computer

Outside sales (including pharmaceutical sales)

Determining Exempt Status under the F L S A (continued)

Major criteria for exempt status

Pay level per week—minimum of $455/week

Paid on a salary basis

Job duties and responsibilities

Primary duties of managing

Decision discretion/judgment

Requires advanced knowledge and/or training/education

Pursuit of artistic or creative endeavors

Special Pay/Overtime Issues

Compensatory time off

Incentives for nonexempt employees

Training time

Security inspection time

After-hours e-mail time

Travel time

Donning and doffing time

Pay Equity Laws

Equal Pay Act of 1963

Prohibits companies from using different wage scales for men and women performing substantially the same jobs

Lilly Ledbetter Fair Pay Act

Statute of limitations are extended for equal pay claims, and each paycheck is treated as a new act of discrimination

Pay practices resulting in disparate impact are also actionable

Independent Contractor Regulations

Employers do not have to pay Social Security, unemployment, or workers’ compensation costs

Criteria for independent contractor status established by the Internal Revenue Service, or I R S

Firms may control only the result of the work being contracted but not what or how it will be done

The I R S considers the amount of behavioral and financial control a company exercises over the worker and additional relationship factors

Pay for Internships

Many organizations began to pay interns only after the institution of the six-factor test by the D O L

Six-factor test

Issued by the D O L in April 2010

Narrowly permitted for-profit enterprises to utilize unpaid interns

December 2017: The D O L issued new guidance reversing the six-factor criteria and adopting a primary beneficiary test

Additional Laws Affecting Compensation

Prevailing wage: Hourly wage determined by a formula that considers the rate paid for a job by a majority of the employers in the appropriate geographic area

Garnishment: Court order that directs an employer to set aside a portion of an employee’s wages to pay a debt owed to a creditor

Strategic Compensation Decisions

Firms need to manage their compensation philosophy to ensure that employees believe they are being treated fairly

Entitlement philosophy is at one end of the continuum, and performance philosophy is at the other end

Entitlement philosophy: Assumes that individuals who have worked another year with the company are entitled to pay increases with little regard for performance differences

Pay-for-performance philosophy: Assumes that compensation decisions reflect performance differences

Continuum of Compensation Philosophies

Entitlement

Pay and raises based on length of service

Across-the-board raises

Pay scales increased annually

Performance

Pay and raises based on performance

No raises for poor-performing employees

Market-adjusted pay scales

Continuum of Compensation Philosophies (continued)

Entitlement

Industry comparisons of pay only

Holiday bonuses given to all employees

Performance

No raises for length of service or job tenure

Industry comparisons of total rewards

Strategic Compensation Decisions (continued)

Communicating pay philosophy

Helps employees recognize the value of the total rewards package and how their work performance, tenure, and raises can affect their compensation

Administrative responsibilities

H R specialists develop and administer the compensation system and ensure that pay practices comply with all legal requirements

Managers help employees see the connections between their individual performance and the expected rewards

Payroll Administration

Handled in different ways:

H R professionals may or may not do the actual processing of payroll

If they do, payroll staff may report to H R or accounting function

Payroll is outsourced

Accurate payroll processing is important for maintaining a positive workplace and complying with various laws

Managers are responsible for accuracy

Recordkeeping is critical

Motivation Theories and Compensation Philosophies

Expectancy theory

States that an employee’s motivation is based on the probability that his or her efforts will lead to an expected level of performance that is linked to a valued reward

Rewards that are not appreciated by the employee have little power to motivate performance

Managers who understand the key linkages in employee expectations can better monitor employee motivation and adjust reward systems accordingly

Motivation Theories and Compensation Philosophies (continued 1)

Important relationships in expectancy theory within the context of pay

Expectancy can lead to instrumentality, which in turn can lead to valence

Expectancy: Perceived likelihood that if the employee invests time in learning new product features, it will lead to better sales performance

Instrumentality: Perceived likelihood that better sales performance will lead to higher commission pay

Valence: Employee places a high value on receiving high commission pay

Motivation Theories and Compensation Philosophies (continued 2)

Equity theory

States that individuals judge fairness (equity) in compensation by comparing their inputs and outcomes against the inputs and outcomes of referent others

Referent others: Workers whom the individual uses as a reference point to make these comparisons

Employee inputs that are compared with referent other’s inputs

Skills, abilities, knowledge, effort, loyalty, commitment, adaptability, tolerance, determination, enthusiasm, support of colleagues, and personal sacrifice

Motivation Theories and Compensation Philosophies (continued 3)

Employee outcomes that are compared with referent other’s outcomes

Wages, salary, benefits, bonus, recognition, reputation, praise, thanks, responsibility, training, sense of achievement, and advancement opportunities

Compensation Fairness and Equity

External equity

If an employer’s rewards are not viewed as equitable compared with other firms, the employer is likely to experience higher turnover

Internal equity

Employees are compensated fairly within the organization with regard to their K S As

Pay secrecy

Explaining pay grades and pay decision rules can enhance employee perceptions of fair and ethical treatment

Compensation Quartile Strategies

Reflect the overall market position where the organization sets its compensation levels

First quartile

Lag-the-market strategy: Company targets pay ranges so that 75% of other firms pay above and 25% pay below

Used when the employer is experiencing financial difficulties and when an abundance of workers is available

Compensation Quartile Strategies (continued 1)

Second quartile

Match-the-market strategy: Company targets pay ranges so that 50% of other firms pay above and 50% pay below

Attempts to balance employer cost pressures and the need to attract and retain employees

Third quartile

Lead-the-market strategy: Company targets pay ranges so that 25% of other firms pay above and 75% pay below

Compensation Quartile Strategies (continued 2)

Enables a firm to attract and retain sufficient workers with the required capabilities and be more selective when hiring

Deciding which quartile position to target for pay structures is a function of the following considerations:

Available financial resources

Competitiveness pressures

Market availability of employees with different capabilities

Competency-Based Pay

Rewards individuals for the capabilities they demonstrate and acquire

Knowledge-based pay (KBP) or skill-based pay (SBP) systems

Employees start at a base level of pay and receive increases as they learn to do other jobs or gain additional skills and knowledge and thus become more valuable to the employer

Global Compensation Issues

Developing and managing a global compensation system is extremely complex

The growing world economy has led to an increase in employees working internationally

Laws, living costs, tax policies, currency fluctuations, and more must be considered when designing the compensation

Figure 11-7: Compensation Administration Process

Job Evaluation Methods

Job evaluation: Formal, systematic means to determine the relative worth of jobs within an organization

Ranking method: Places jobs in order, from highest to lowest, by their value to the firm

Appropriate in small firms with relatively few jobs

Classification method: Involves writing descriptions of job classes and then putting each job into a grade according to the class it best matches

Used in public-sector organizations

Job Evaluation Methods (continued)

Point factor method: Looks at compensable factors in a group of similar jobs and assigns weights, or points, to them

Compensable factor: Job dimension commonly present throughout a group of jobs within an organization that can be rated for each job

Derived from job analysis

Reflects the nature of different types of work performed in the organization

Most popular approach because it is relatively simple to use and considers the components of a job rather than the total job

Market Pricing

Uses market pay data to identify the relative value of jobs based on what other employers pay for similar jobs

Key to market pricing is identifying relevant market pay data for jobs that are good matches with the employer’s:

Jobs

Geographic considerations

Company strategies and philosophies about desired market competitiveness levels

Market Pricing (continued)

Advantages

Ties organizational pay levels to the external job market, without internal job evaluation distortion

Allows an employer to communicate to employees that the compensation system is truly market linked

Disadvantages

Pay survey data may be limited or may not be gathered in methodologically sound ways

Tying pay levels to market data can lead to wide fluctuations on the basis of market conditions

Pay Surveys

Collection of data on compensation rates for workers performing similar jobs in other organizations

Using benchmark jobs to anchor the survey data is helpful

Benchmark jobs: Jobs that are found in many other organizations that can be used for the purposes of comparison

Internet-based pay information is prevalent

Using Pay Surveys

Involves evaluating many factors to determine if the data are relevant and valid

Is the participant sample realistic?

Is the survey broad based?

How established is the survey, and how qualified are those who conducted it?

Does it include required elements of compensation to allow comparison of the reward mix?

Does the survey contain job summaries so that appropriate matches to job descriptions can be made?

Timeliness: How current are the data?

Pay Surveys and Legal Issues

Employers use outside sources for pay surveys to avoid charges that they are attempting to “price fix” wages

Companies must safeguard employee privacy and provide only de-identified data so that specific employee pay rates and names are not shared

Care must also be taken to avoid violating the N L R A provisions that apply to disclosing wage and benefit information

Pay Grades

Groupings of individual jobs that have approximately the same value to the organization

Market line: Graph line that shows the relationship between job value as determined by job evaluation points and job value as determined by pay survey rates

Market banding: Grouping jobs into pay grades based on similar market survey amounts

Pay Ranges

Jobs within a point range are classified into job grades using the point factor method

Market data are then used to determine the minimum and maximum pay rates for each job grade, and midpoint is computed by averaging the range of minimum and maximum pay rates

Current pay of employees is compared with the proposed ranges

Broadbanding: Practice of using fewer pay grades with much broader ranges than in traditional compensation systems

Individual Pay

Many organizations use compa-ratio to determine each individual employee’s standing in relationship to the midpoint

Compa-ratio: Pay level divided by the midpoint of the pay range

Red-circled employee: Incumbent who is paid above the range set for a job

Green-circled employee: Incumbent who is paid below the range set for a job

Individual Pay (continued)

Pay compression: Occurs when the pay differences among individuals with different levels of experience and performance become small

Salary inversion: Occurs when the pay given to new hires is higher than the compensation provided to more senior employees

Performance-Based Increases

Targeting high performers

Focuses on providing the top-performing employees with significantly higher pay raises, while providing standard increases to the remaining satisfactory performers

Pay adjustment matrix

Reflects an employee’s eligibility for pay increase

Factors considered:

Employee’s level of performance as rated in an appraisal

Employee’s position in the pay range

Figure 11-10: Pay Adjustment Matrix

Source: Adapted from Payscale’s 2012 Compensation Best Practices Report.

Standardized Pay Adjustments

Methods used

Seniority can be used as the basis for pay increases

Cost-of-living adjustments (C O L A): Every employee’s pay is increased to compensate for inflation and rising prices

Across-the-board increases: Given as a percentage raise based on standard market or financial budgeting determinations

Lump-sum increases (L S I): One-time payment of all or part of a yearly pay increase

Compensation Challenges

Economic recessions

Organizations address shortfalls in revenue by reducing employment-related expenses

Should be used sparingly because such strategies may result in employee job dissatisfaction and turnover

Gender pay gap

Wider in some industries than others

Continued monitoring of organizational pay levels and properly managing women’s career progress are important

Variable Pay

Compensation that is tied to performance

Performance may be evaluated and rewarded at individual, team, or organizational level

Incentives: Tangible rewards that encourage or motivate action

Tying pay to performance can be attractive for both employers and employees

Employers: More output per employee, lower fixed costs, and some risks shifted to employees

Employees: More pay when they do their jobs well

Variable Pay (continued)

Basic assumptions that underlie the philosophical foundation of variable pay:

Some people or groups contribute more to organizational success than do others

Some people perform better and are more productive than are others

Employees or groups who perform better or contribute more should receive greater compensation

A Variety of Possible Incentives

Monetary incentives

Team bonus

Recognition and reward programs

Perks

Piece-rate pay

Opportunities to use personal expertise

Stock options

Autonomy

Bonuses

Professional development

A Variety of Possible Incentives (continued)

Service Awards

Trips

Meaningful work

Gainsharing

Commissions

E S O P’s

Profit sharing

Spot bonus

Praise

Merchandise

Effective Variable Pay

The effectiveness of any variable pay program relies on its consistency with the organization’s culture

Many companies find that variable pay plans make performance results a higher priority for employees

Variable pay systems should be tied to desired performance

Line of sight: Idea that employees can clearly see how their actions and decisions lead to desired outcomes

Factors for Effective Variable Pay Plans

Variable pay effectiveness

Current updated plans

Results in desired behaviors

Clearly separate from base pay

Clearly communicated

Performance results are clearly linked to payout

Clear differentiation based on performance level

Factors for Effective Variable Pay Plans (continued)

Sufficient financial resources

Consistent with organizational culture

Measurable performance

Plan is clear and understandable

Linked to organization objectives

Effective Variable Pay (continued)

Establishment involves determining appropriate performance measures to evaluate performance and the resulting rewards

Most firms have a number of important targets to track results related to critical success factors

Critical success factors: Variables that have a strong influence on the results of the organization

Key performance indicators (K P I’s): Scorecard measures that tell managers how well the organization is performing relative to critical success factors

Levels of Variable Pay

Variable pay plans can be classified into three levels or categories:

Individual

Team

Organizational

Individual Incentive Systems

Tie personal effort to additional rewards for the individual employee

Necessary conditions to be considered when using individual incentive plans

Individual performance must be identifiable

Individual competitiveness must be desirable

Individualism must be stressed in the organizational culture

Individuals must be in control of the pace of production

Individual Incentive Systems (continued)

Piece-rate system

Pay system in which wages are determined by multiplying the number of units produced by the piece rate for one unit

Results in inequality in pay, which can lead to dysfunction within a work group

Training managers in the program specifics is helpful

Individual Incentives

Bonus: One-time payment that does not become part of the employee’s base pay

Factors leading to success in utilizing bonuses include:

Establishing clear, metric-based reviews

Ensuring that employees who have not met performance criteria do not receive a payout

Educating managers and employees about the incentive plan details

Other types of bonuses: spot, referral, hiring, retention, and project completion

Individual Incentives (continued)

Nonmonetary Incentives

Performance awards

Incentive rewards for performance

Recognition awards

Recognizes individual employees for their work

Service awards

Recognizes and rewards longevity with the company

Team Incentives

When employees participate in team-level incentives, they share more information among the team members

Concerns are how and when to distribute the incentives and who will determine the incentive amounts

Primary ways for distributing those rewards are as follows:

Same size reward for each member

Different size reward for each member

Team Incentives (continued)

Challenges with team incentives

Rewards distributed in equal amounts to all members may be perceived as unfair by some employees

Some individuals who are performing poorly may prevent the team from meeting the goals needed to trigger the incentive payment

Free rider: Member of the group who contributes little

Gainsharing: Sharing with employees greater than expected gains in profits and/or productivity

Organizational Incentives

Profit sharing: System to distribute a portion of an organization’s profits to employees

Stock option plan: Gives employees the right to purchase a fixed number of shares of company stock at a specified price for a limited period of time

Employee stock ownership plan (E S O P): Gives employees significant stock ownership in their organizations

Types of Sales Compensation Plans

Salary only

Useful when an organization emphasizes serving and retaining existing accounts over generating new sales and accounts

Commission plans

Commission: Percentage of the revenue generated by sales that is given to an agent or salesperson

Straight commission: Compensation is computed as a percentage of the value of the sales generated

Salary plus commission: Combines the stability of a salary with the performance aspect of commission

Executive Compensation

Handled differently from employee pay in various types of organizations

Determined by the board of directors

Subject to shareholder approval via a say-on-pay provision in the Dodd-Frank Act

Contracts with executives include a clawback provision

Clawback provision: Permits the organization to require an employee to return rewards obtained through unethical or negligent actions

Figure 11-13: H R Metrics for Compensation

H U M A N R E S O U R C E

MANAGEMENT

VA L E N T I N E M E G L I C H M AT H I S J A C K S O N

SIXTEENTH EDIT ION