Human Resource Management CASE STUDY - COMPENSATION HOMEWORK
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NELSON
Strategic Compensation in Canada, Sixth Edition
by Richard J. Long and Parbudyal Singh
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Library and Archives Canada Cataloguing in Publication
Long, Richard J. (Richard Joseph), author
Strategic compensation in Canada / Richard J. Long, Parbudyal Singh.—Sixth edition.
(Nelson Education series in human resources management) Includes bibliographical references and index. Issued in print and electronic formats.
ISBN 978-0-17-665716-1 (softcover).—ISBN 978-0-17-682554-6 (PDF)
1. Compensation management—Canada—Textbooks. 2. Textbooks. I. Singh, Parbudyal,
author II. Title. III. Series: Nelson Education series in human resource management
HF5549.5.C67L56 2017 658.3'220971
C2017-900419-0
C2017-900420-4
Brief Contents
About the Series About the Authors Preface
Part 1 Strategy, Rewards, and Behaviour
Chapter 1 A Road Map to Effective Compensation
Chapter 2 A Strategic Framework for Compensation
Chapter 3 A Behavioural Framework for Compensation
Part 2 Formulating Reward and
Compensation Strategy
Chapter 4 Components of Compensation Strategy
Chapter 5 Performance Pay Choices
Chapter 6 Formulating the Reward and Compensation Strategy
Part 3 Determining Compensation Values
Chapter 7 Evaluating Jobs: The Job Evaluation Process
Chapter 8 Evaluating Jobs: The Point Method of Job Evaluation
Chapter 9 Evaluating the Market
Chapter 10 Evaluating Individuals
Part 4 Designing Performance Pay and Indirect Pay
Plans
Chapter 11 Designing Performance Pay Plans
Chapter 12 Designing Indirect Pay Plans
Part 5 Implementing, Managing, Evaluating, and
Adapting the Compensation System
Chapter 13 Activating and Maintaining an Effective Compensation System
Appendix
Glossary
Contents
About the Series About the Authors Preface
Part I Strategy, Rewards, and Behaviour
Chapter 1 A Road Map to Effective Compensation
Chapter Learning Objectives
Opening Vignette: A Whopping Salary Increase for Everyone! Does It Work?
Introduction to the Importance of Compensation Systems
Your Compensation System: Asset or Liability? The Premise of This Book
Role and Purpose of the Compensation System
Extrinsic vs. Intrinsic Rewards
Rewards vs. Incentives
Reward vs. Compensation Strategy
Criteria for Success: Goals for the Compensation System A Road Map to Effective Compensation
Step I: Understand Your Organization and Your People
Step II: Formulate Your Reward and Compensation Strategy
Step III: Determine Your Compensation Values
Step IV: Design Your Performance Pay and Indirect Pay Plans
Step V: Implement, Manage, Evaluate, and Adapt the Compensation System
The Context of Compensation Management
Summary
Key Terms Discussion Questions
Using the Internet
Exercises
Case Question
Simulation Cross-Reference
Notes
Chapter 2 A Strategic Framework for Compensation Chapter Learning Objectives
Opening Vignette: A Tale of Two Firms
Introduction to Effective Compensation Systems A Strategic Framework for Compensation
Strategy and the Concept of Fit
Structural Variables
Managerial Strategy
Contextual Variables
Managerial Strategies and Reward Systems
Classical Managerial Strategy
Human Relations Managerial Strategy
High-Involvement Managerial Strategy
Interrelationships Among Structural Variables
Determinants of the Most Appropriate Managerial Strategy
Environment
Corporate Strategy
Technology
Organization Size
The Nature of the Workforce
Tying It All Together
Trends in Managerial and Compensation Strategies
The Evolution of Managerial Strategies
Trends in Compensation Systems
Summary
Key Terms Discussion Questions
Using the Internet
Exercises
Case Questions Simulation Cross-Reference
Notes
Chapter 3 A Behavioural Framework for Compensation Chapter Learning Objectives
Opening Vignette: Fouled-Up Pay Systems Lead to an Economic Meltdown
Introduction to Reward Systems and Behaviour Types of Reward Problems
Failure to Produce Desired Behaviour
Production of Desired Behaviour and Undesirable Consequences
Production of Reward Dissatisfaction
Desired Reward Outcomes
Three Key Employee Behaviours
Three Key Employee Attitudes
Causes and Consequences of Reward Dissatisfaction
Causes of Reward Dissatisfaction
Consequences of Reward Dissatisfaction
Understanding Membership Behaviour
Causes of Membership Behaviour
Rewards, Satisfaction, and Commitment
Is Low Turnover Always Good?
Understanding Task Behaviour
Content Theories of Motivation
Maslow’s Hierarchy of Needs
Process Theories of Motivation
Money as a Motivator
Understanding Organizational Citizenship Behaviour
Causes of Citizenship Behaviour
Creating Citizenship Behaviour
Behavioural Implications for Designing Reward Systems
1. Define the Necessary Employee Behaviour
2. Determine the Necessary Employee Attributes
3. Identify Salient Employee Needs
4. Ensure a Positive Reward Valence
5. Make It Clear That Performance Will Lead to Rewards
6. Provide Conditions for Effort to Lead to Performance
Summary
Key Terms Discussion Questions
Using the Internet
Exercises Case Questions
Simulation Cross-Reference
Notes
Part 2 Formulating Reward and Compensation Strategy
Chapter 4 Components of Compensation Strategy
Chapter Learning Objectives
Opening Vignette: Pay Systems Are Changing
Introduction to Compensation Mix Choices
Fundamental Components of the Compensation Mix
Base Pay
Performance Pay
Indirect Pay
Base Pay Methods: Market Pricing Advantages of Market Pricing
Disadvantages of Market Pricing
Base Pay Methods: Job Evaluation Advantages of Job Evaluation
Disadvantages of Job Evaluation
Base Pay Methods: Pay for Knowledge
Advantages of Skill-based Pay
Disadvantages of Skill-based Pay
Issues in Developing a Skill-based Pay System
Competency-based Pay Systems
Summary
Key Terms
Discussion Questions Using the Internet
Exercises
Case Questions
Simulation Cross-Reference
Notes
Chapter 5 Performance Pay Choices Chapter Learning Objectives
Opening Vignette: Fun and Games at the Exhibition
Introduction to Performance Pay Choices Individual Performance Pay
Piece Rates
Sales Commissions
Merit Pay
Merit Bonuses
Promotions as Rewards
Special-Purpose Incentives
Group Performance Pay
Gain-Sharing Plans
Goal-Sharing Plans
Other Types of Group Performance Pay Plans
Organization Performance Pay Plans Profit Sharing
Employee Stock Plans
Other Organization Performance Pay Plans
Summary Key Terms
Discussion Questions
Using the Internet Exercises
Case Questions
Simulation Cross-Reference
Notes
Chapter 6 Formulating the Reward and Compensation Strategy
Chapter Learning Objectives Opening Vignette: Compensation Strategy at WestJet Airlines
Introduction to Compensation Strategy
Constraints on Compensation Strategy Legislated Constraints
Labour Market Constraints
Product/Service Market Constraints
Financial Constraints of the Organization
Formulating the Compensation Strategy
Define the Required Behaviour
Define the Role of Compensation
Determine the Compensation Mix
Determine the Compensation Level
Evaluate the Proposed Compensation Strategy
Who Develops the Compensation Strategy?
Compensation Strategy for Special Employee Groups
Contingent Workers
Executives
Expatriate and Foreign Employees
Compensation Strategy Formulation: An Example
Your Challenge
Your Company
The Problems
Formulating the New Compensation Strategy at Canada Chemicals
Summary Key Terms
Discussion Questions
Using the Internet Exercises
Case Questions
Simulation Cross-Reference
Notes
Part 3 Determining Compensation Values
Chapter 7 Evaluating Jobs: The Job Evaluation Process
Chapter Learning Objectives Opening Vignette: How Do You Compare Apples and Oranges?
Introduction to Effective Job Evaluation
Job Analysis
Nature of Required Information
Methods of Job Analysis
Identifying Job Families
Pitfalls in Job Analysis
Job Evaluation Methods
Ranking/Paired Comparison
Classification/Grading
Factor Comparison Method
Statistical/Policy Capturing Method
The Point Method
Conducting and Managing the Job Evaluation Process
Who Conducts the Job Evaluations?
Communicating the Job Evaluation Process
Applying Job Evaluation Results
Developing Appeal/Review Mechanisms
Updating Job Evaluations
Conforming to Pay Equity Requirements
Determine What Rules Apply
Identify Female and Male Job Classes
Establish a Body for Conducting the Pay Equity Process
Select a Gender-Neutral Job Comparison System
Collect Job Information
Compare Jobs
Check for Permissible Differences
Adjust Compensation
Communicate the Results
Maintain Pay Equity
Summary
Key Terms Discussion Questions
Using the Internet
Exercises Case Question
Simulation Cross-Reference
Notes
Chapter 8 Evaluating Jobs: The Point Method of Job Evaluation
Chapter Learning Objectives
Opening Vignette: Nurses or Painters: Who Is More Valuable to a Hospital? Using the Point Method to Design a Job Evaluation System
Identifying Compensable Factors
Scaling the Factors
Weighting the Factors
Applying the Job Evaluation System
Testing the Job Evaluation System
Possible Pitfalls of the Point Method of Job Evaluation Inconsistent Construct Formation
Factor Overlaps
Hierarchical Grounding
Gender Bias
Determining the Base Pay Structure
Establishing Pay Grades
Establishing Pay Ranges
Movement Through the Pay Range
Other Possible Elements of Base Pay Structure
Living Wage
Summary
Key Terms Discussion Questions
Using the Internet
Exercises Case Questions
Simulation Cross-Reference
Notes
Chapter 9 Evaluating the Market Chapter Learning Objectives
Opening Vignette: Where Would You Choose to Work?
Introduction to What Is Appropriate Compensation Understanding Labour Markets
Defining the Relevant Labour Market
Sources of Compensation Data
Third-Party Surveys
In-House Surveys
Conducting Compensation Surveys
Identify the Jobs to Be Surveyed
Determine What Information to Collect
Determine Whom to Survey
Determine How to Collect the Data
Analyzing and Interpreting Survey Data Analytical Procedures
Interpreting Survey Data
Limitations of Compensation Surveys
Summary
Key Terms
Discussion Questions Using the Internet
Exercises
Case Question Simulation Cross-Reference
Notes
Chapter 10 Evaluating Individuals
Chapter Learning Objectives Opening Vignette: Microsoft Changes Its Performance Management System to Support
Strategy
Introduction to Performance Appraisal and Performance Management Experience with and Reasons for Performance Appraisal
Experience with Performance Appraisal
Why Do Performance Appraisals?
Pitfalls in Performance Appraisal
Intentional Inaccuracies in Appraisals
Unintentional Inaccuracies in Appraisals
Methods and Instruments for Appraisal
Ranking and Forced Distribution
Graphic Rating Scale
Behaviourally Anchored Rating Scales
Behavioural Observation Scales
Objectives-based and Results-based Systems
Field Review
Combination Approaches
Sources of Appraisals
Appraisal by Superiors
Peer Appraisals
Subordinate Appraisals
Self-Appraisals
Customer Appraisals
Other Appraisers
Multisource Systems/360-Degree Feedback
Performance Management
Linking Pay to Performance Appraisals
Issues in Designing an Effective Merit System Define the Objectives for Merit Pay
Determine the Most Appropriate Performance Measurement System
Determine the Frequency of Appraisals
Determine How to Link Appraisals to Pay
Determine How to Provide Feedback
Determine Mechanisms for Procedural Justice
Determine Procedures for Rater Training and Evaluation
Develop Procedures for Evaluating the Merit System
Evaluating Individuals in Teams
How Can Individuals in Teams Be Evaluated?
Summary
Key Terms Discussion Questions
Using the Internet
Exercises Case Questions
Simulation Cross-Reference
Notes
Part 4 Designing Performance Pay and Indirect Pay Plans
Chapter 11 Designing Performance Pay Plans
Chapter Learning Objectives Opening Vignette: Who Wants to Be a Millionaire?
Introduction to Types of Plans and Design Issues
Gain-Sharing Plans Types of Gain-Sharing Plans
Issues in Designing Gain-Sharing Plans
Goal-Sharing Plans
Types of Goal-Sharing Plans
Issues in Designing Goal-Sharing Plans
Profit-Sharing Plans
Types of Profit-Sharing Plans
Issues in Designing Profit-Sharing Plans
Employee Stock Plans
Employee Stock Bonus Plans
Issues in Designing Stock Plans
Nonmonetary Reward Plans
Types of Nonmonetary Reward Plans
Issues in Designing Nonmonetary Reward Plans
Summary
Key Terms Discussion Questions
Using the Internet
Exercises
Case Questions
Simulation Cross-Reference
Notes
Chapter 12 Designing Indirect Pay Plans
Chapter Learning Objectives Opening Vignette: Benefits Are Extreme Here!
Types of Employee Benefits and Services
Mandatory Benefits
Retirement Income
Health Benefits
Pay for Time Not Worked
Employee Services
Miscellaneous Benefits
Fixed versus Flexible Benefit Systems Fixed Benefit Systems
Semi-Flexible Benefit Systems
Flexible Benefit Systems
Designing the Benefit System
Issue 1: Determine the Role of Indirect Pay in the Compensation Strategy
Issue 2: Choose the Process for Plan Design
Issue 3: Identify the Benefits System and Benefits to Be Included
Issue 4: Determine the Structure of Each Benefit
Issue 5: Develop Procedures for Administering, Communicating, Evaluating, and
Adapting the System
Summary Key Terms
Discussion Questions
Using the Internet
Exercises
Case Questions
Simulation Cross-Reference
Notes
Part 5 Implementing, Managing, Evaluating, and Adapting the
Compensation System
Chapter 13 Activating and Maintaining an Effective Compensation System
Chapter Learning Objectives
Opening Vignette: Thousands of Federal Employees Plagued by Problems with New Compensation System
Introduction to Putting the Systems in Place
Preparing for Implementation
Preparing the Compensation Budget
Planning for Compensation Administration
Planning for Information Technology
Organizing for Compensation Administration
Developing the Implementation Plan
Developing the Plan for Managing Implementation
Developing the Training Plan
Developing the Communications Plan
Developing the Evaluation Plan
Implementing the Compensation System
Step 1: Establish the Implementation Task Forces
Step 2: Put the Infrastructure into Place
Step 3: Test the System
Step 4: Conduct the Training
Step 5: Communicate Information on the System
Step 6: Launch and Adjust the System
Communicating Compensation System Information
Keeping Managers Informed
Keeping Employees Informed
Evaluating the Compensation System
Impact on Compensation Objectives
Impact on Compensation Costs
Impact on Employee Behaviours and Attitudes
Monitoring Changing Circumstances
Changes in External Circumstances
Changes in Internal Circumstances
Adapting the Compensation System
Identifying What to Adapt
Adapting to Financial Crises
Adapting to Labour Shortages
Should Exceptions Be Made for Individual Employees? Summary
Key Terms
Discussion Questions Using the Internet
Exercise
Case Question Simulation Cross-Reference
Notes
Appendix Cases for Analysis
Achtymichuk Machine Works
Alliston Instruments
Eastern Provincial University
The Fit Stop Ltd.
Henderson Printing
Multi-Products Corporation
Plastco Packaging Ltd.
Glossary
Index
About the Series
The management of human resources has become the most important source of innovation,
competitive advantage, and productivity, more so than any other resource. More than ever,
human resources management (HRM) professionals need the knowledge and skills to design
HRM policies and practices that not only meet legal requirements but also are effective in supporting organizational strategy. Increasingly, these professionals turn to published
research and books on best practices for assistance in the development of effective HR
strategies. The books in the Nelson Series in Human Resources Management are the best
source in Canada for reliable, valid, and current knowledge about practices in HRM.
The texts in this series include:
• Managing Performance through Training and Development
• Management of Occupational Health and Safety
• Recruitment and Selection in Canada
• Strategic Compensation in Canada
• Strategic Human Resources Planning
• Industrial Relations in Canada
• Research, Measurement, and Evaluation of Human Resources
• International Human Resources: A Canadian Perspective
The Nelson Series in Human Resources Management represents a significant
development in the field of HRM for many reasons. Each book in the series is the first and now
best-selling text in the functional area. Furthermore, HR professionals in Canada must work with Canadian laws, statistics, policies, and values. This series serves their needs. It is the only
opportunity that students and practitioners have to access a complete set of HRM books,
standardized in presentation, which enables them to access information quickly across many HRM disciplines. Students who are pursuing the CHRP (Certified Human Resource
Professional) designation through their provincial HR associations will find the books in this
series invaluable in preparing for the knowledge exams. This one-stop resource will prove
useful to anyone looking for solutions for the effective management of people.
The publication of this series signals that the HRM field has advanced to the stage where
theory and applied research guide practice. The books in the series present the best and most current research in the functional areas of HRM. Research is supplemented with examples of
the best practices used by Canadian companies that are leaders in HRM. Each text begins with
a general model of the discipline, and then describes the implementation of effective
strategies. Thus, the books serve as an introduction to the functional area for the new student
of HR and as a validation source for the more experienced HRM practitioner. Cases,
exercises,and endnotes provide opportunities for further discussion and analysis.
As you read and consult the books in this series, I hope you share my excitement in being involved and knowledgeable about a profession that has such a significant impact on the
achievement of organizational goals, and on employees’ lives.
Monica Belcourt, Ph.D., CHRP Series Editor October 2016
About The Authors
Richard J. Long
Richard J. Long was Professor of Human Resources and Organizational Behaviour at the
Edwards School of Business at the University of Saskatchewan. He held B.Com. and M.B.A.
degrees from the University of Alberta and a Ph.D. from Cornell University and was a Certified
Human Resources Professional (CHRP).
Dr. Long taught, conducted research, and consulted in human resources management for
more than 35 years and produced over 100 publications based on his research and experience. He was the author of two books, New Office Information Technology: Human and
Managerial Implications, and the textbook Strategic Compensation in Canada. He served
on the editorial boards of International Journal of Human Resource
Management and Relations Industrielles/Industrial Relations. He received the University of
Saskatchewan’s coveted Master Teacher award in 2014.
Parbudyal Singh
Parbudyal Singh is a Professor of Human Resource Management at York University, Toronto.
He completed his Ph.D. from McMaster University. Prior to York, he was the Associate Dean of
the School of Business at the University of New Haven, Connecticut. Dr. Singh has more than
100 refereed publications, many of which are in top-tier journals such as Industrial Relations,
Journal of Business Ethics, The Leadership Quarterly, Human Resource Management,
International Journal of Human Resource Management, and Human Resource
Management Review. He is a co-author of one of the leading human resource management
textbooks in Canada (Managing Human Resources, Eighth Canadian Edition, Nelson Canada). Over his career, Dr. Singh has won numerous scholastic awards, several national
research grants, and teaching and research awards.
Dr. Singh was a member of the committee appointed by the Ontario government in 2015 to
study, consult, and make recommendations on closing the gender wage gap in Ontario. He
has also served as an advisor/consultant for many leading Canadian firms, as well as public sector organizations, on their compensation systems. Prior to being a university professor, Dr.
Singh was a personnel manager at a large manufacturing firm.
Preface
The premise of this book is that an organization’s compensation system can have a major
impact on its success, but that the most effective compensation system may be very different
from one organization to the next and may even differ over time for the same organization.
However, if there is no single compensation system that fits all organizations, this makes life
very complicated for those who manage organizations.
This book provides a systematic framework for identifying and designing the compensation
system that will add the most value to the organization. Chapter 1 lays out a road map for how this book will do that. As you will see, the first half of the book focuses on developing the
compensation strategy, and the second half focuses on how to transform the compensation
strategy into an operating compensation system.
Achieving an effective compensation system requires a diagnostic approach. That is, to
identify the most effective compensation system for a given organization, it is first necessary
to understand that organization, its strategy, and its people. Part One of the book focuses on developing these understandings by first providing a road map to effective compensation
(Chapter 1), a strategic framework for compensation (Chapter 2), and then a behavioural
framework for compensation (Chapter 3).
Part Two provides the ingredients and processes for formulating a compensation strategy. The
three main components of a compensation system are examined, along with the choices to be
made in determining the most appropriate compensation mix for a given firm (Chapter 4). Next, the available choices of performance pay plans is presented (Chapter 5), along with the
key factors in deciding which of these choices are suitable for inclusion in the compensation
mix. After identifying factors that constrain compensation choices, Chapter 6 provides a
process that should result in the formulation of the most appropriate compensation strategy
for a given firm.
However, the formulation of the compensation strategy does not mark the end of the
compensation process. Compensation strategy needs to be translated into an operating compensation system that results in an actual dollar value of compensation for every
employee. Determining a compensation value for a given employee depends on a
combination of the relative value of that employee’s job to his or her employer (as determined through job evaluation), the value the labour market places on that job (as determined by
compensation surveys), and the value of that employee’s performance (as determined by
performance appraisal). Part Three covers the many technical processes necessary to convert
the compensation strategy into a compensation system, including those for evaluating jobs
(Chapters 7 and 8), for evaluating the market (Chapter 9), and for evaluating individual
employees (Chapter 10).
Part Four provides detailed guidance on the key issues in designing performance pay plans
(Chapter 11) and indirect pay plans (Chapter 12). Finally, Part Five provides detailed guidance on the key issues in implementing a new compensation system and its ongoing operation
(Chapter 13).
This book was written for two main purposes: to help those wishing to learn how to create effective compensation systems, and to serve as a useful source of information for
practitioners. In so doing, it fills a gap in the textual resources available in Canada. Other
Canadian books on compensation have lacked an integrated strategic framework and have tended to focus on either the behavioural principles in compensation or the technical details
of compensation. Both of these are important, but what is needed is a balanced,
comprehensive, and integrated presentation of strategic, behavioural, and technical
principles. That is what this book seeks to provide.
The content of this book is based on a foundation of scientific research, informed by relevant
theoretical principles and verified by actual organizational experiences. Although there is still much to learn about the design of effective reward and compensation systems, our knowledge
about compensation has advanced to the point where effective use of the available
knowledge will significantly increase the likelihood of organizational success.
This book can stand alone as the principal resource for a course. Student learning can be further enhanced by accompanying it with Strategic Compensation: A Simulation
Workbook, Sixth Edition, which provides students with the opportunity to design an entire
compensation system, right from formulation of compensation strategy to implementation of the new compensation system, complete with market-based actual dollars attached to the
pay ranges. This simulation has been specifically designed by its authors (Richard J. Long and
Henry Ravichander) to utilize all the steps along the road to effective compensation, as
described in this sixth edition of Strategic Compensation in Canada.
To maximize its value as an effective learning tool, this book incorporates a number of
features. Its content is based on a scientific foundation and is enhanced by a variety of learning devices, but its writing style is informal in order to smooth the road to effective
learning. Another key feature is the overall organizing framework for the book—the “road
map” to effective compensation. Getting to any destination is facilitated by a conceptual map
of how to get there. The entire book is organized around this conceptual road map.
Features retained from the previous edition include chapter learning objectives, opening
vignettes, “Compensation Today” boxes to put issues into real-life context, “Compensation Notebook” features to highlight key points in the chapter, extensive use of Canadian
examples, margin definitions of key concepts, chapter summaries, listings of key terms,
discussion questions, “Using the Internet” exercises, compensation exercises, and questions
for case analysis.
As a part of the process needed to earn a professional HR designation, granted by the HR
provincial associations, applicants must undergo two assessments: one is a knowledge-based
exam, and the second assessment is based on experience. Because the competencies required for the knowledge exams may differ by province, we have not provided lists or links in this
edition. Those interested in obtaining an HR designation should consult the HR association in
their province.
// New to This Edition
One purpose of this revision of Strategic Compensation in Canada is to present current,
relevant content and every new edition of the book brings changes and updates. In addition to
some new discussion questions and exercises in the end-of-chapter material and references on recent publications, the following list highlights some of the new key and updated topics
and examples that have been included in the sixth edition.
Chapter 1: A Road Map to Effective Compensation
• New opening vignette, “A Whopping Salary Increase for Everyone! Does
It Work?”
• Revised introduction to discuss importance of compensation and why
students should study it
• Expanded coverage of extrinsic vs. intrinsic rewards
• New Compensation Today 1.2, Internships: Paid or Unpaid?
Chapter 2: A Strategic Framework for Compensation
• Reorganized strategic framework coverage and new coverage of
horizontal fit, mission values, vertical fit, and vision
• New Compensation Today 2.1, Classical Organizations in the 21st
Century
• Expanded discussion of the role of unions in organizations under “The
Nature of the Workforce”
Chapter 3: A Behavioural Framework for Compensation
• New opening vignette, “Fouled-Up Pay Systems Lead to an Economic
Meltdown”
• Updated coverage in Compensation Today 3.1, Rewards Support
Strategy at Toyota
• Revised Compensation Today 3.3, The Devil Made Me Do It! (Or Was It
Reward Dissatisfaction?) to include coverage of the Global Retail Theft
Barometer study
Chapter 4: Components of Compensation Strategy
• New opening vignette, “Pay Systems Are Changing”
• Example added in “Disadvantages of Performance Pay” section and
updated Imperial Oil example in “Indirect Pay” section
Chapter 5: Performance Pay Choices
• Expanded coverage in the Introduction clarifying the focus in this
chapter and how content links to Chapter 11
• Added coverage of public sector in “Merit Pay” section
• New Compensation Today 5.2, Grade the Teachers? discusses the issue
of merit pay for teachers
Chapter 6: Formulating the Reward and Compensation
Strategy
• New opening vignette, “Compensation Strategy at WestJet Airlines”
• Added coverage of pay decisions influenced by common-law
constraints in “Legislated Constraints” section
• Updated provincial minimum pay rates for select provinces and data in
Table 6.3, Compensation of Canada’s 10 Highest-Paid Executives
• Updated Compensation Today 6.2, Think Your Employer Owes You
Overtime But Won’t Pay? Sue the Boss!
• Added coverage of precarious work in “Contingent Workers” section
and updated statistics
Chapter 7: Evaluating Jobs: The Job Evaluation Process
• More concise coverage of PAQ
• New Compensation Today 7.2, The Gender Pay Gap in Canada—It
Matters Where You Live!
• New Compensation Today 7.3, Negotiating Pay Equity Agreements with
Bargaining Agents
Chapter 8: Evaluating Jobs: The Point Method of Job
Evaluation
• Added new factor—Responsibility for Personnel, Policies, and
Practices—in Table 8.1, Sample Compensable Factors Illustrating
Degrees
• Added Qualcomm Technologies lawsuit example in Compensation
Today 8.1, Alleged Gender Bias Costs Companies
• Updated Compensation Notebook 8.2, Frequently Overlooked Factors
in “Female Jobs”
• New coverage of living wage and new Compensation Today 8.2, The
Debate on a Living Wage
Chapter 9: Evaluating the Market
• Updated statistics in opening vignette
• New Compensation Today 9.3, Traditional and New Salary Survey
compares traditional salary surveys and PayScale
Chapter 10: Evaluating Individuals
• New opening vignette, “Microsoft Changes Its Performance
Management System to Support Strategy”
• Expanded coverage of a recent US study in Compensation Today 10.1,
The Beauty Effect: Does “Hotness” Pay?
• New Compensation Today 10.2: Changing with the Times covers a new
app called “PD@GE” for performance development at GE
Chapter 11: Designing Performance Pay Plans
• Added ArcelorMittal Dofasco example in Compensation Today 11.3,
Profit Sharing at Two Prominent Canadian Companies
• Added coverage of the Sarbanes-Oxley Act in section on Employee
Stock Option Plans
Chapter 12: Designing Indirect Pay Plans
• New Compensation Today 12.2, Go West! covers interesting benefits,
such as paid vacations and flexible personal time–off programs
• New Compensation Today 12.3, Hungry? Go Healthy! discusses
Nature’s Path wellness program
• New Compensation Today 12.4, Taking Pride in Heritage (APTN)
illustrates aspects of work/life balance (and other benefits).
Chapter 13: Activating and Maintaining an Effective
Compensation System
• New opening vignette, “Thousands of Federal Employees Plagued by
Problems with New Compensation System”
// Instructor Resources
The Nelson Education Teaching Advantage (NETA) program delivers research-based instructor resources that promote student engagement and higher-order thinking to enable
the success of Canadian students and educators.
The following instructor resources have been created for Strategic Compensation in
Canada, Sixth Edition.
NETA Test Bank
This resource was written by the author, Parbudyal Singh. It includes over 390 multiple-choice
questions written according to NETA guidelines for effective construction and development of
higher-order questions. Also included are 130 true/false and over 80 short-answer questions.
NETA PowerPoint
Microsoft® PowerPoint® lecture slides for every chapter have been created by Greg Cole of St.
Mary’s University. There is an average of 25 slides per chapter, many featuring key figures,
tables, and photographs from Strategic Compensation in Canada, Sixth Edition. NETA
principles of clear design and engaging content have been incorporated throughout, making it
simple for instructors to customize the deck for their courses.
Image Library
This resource consists of digital copies of figures, short tables, and photographs used in the
book. Instructors may use these jpegs to customize the NETA PowerPoint or create their own
PowerPoint presentations. An Image Library Key describes the images and lists the codes under which the jpegs are saved. Codes normally reflect the Chapter number (e.g., C01
for Chapter 1), the Figure or Photo number (e.g., F15 for Figure 15), and the page in the
textbook. C01-F15-pg26 corresponds to Figure 1-15 on page 26.
NETA Instructor Guide
This resource was written by Edward Marinos of Sheridan College. It is organized according to
the textbook chapters and addresses key educational concerns, such as typical stumbling
blocks students face and how to address them. Other features include notes for End-of- Chapter Discussion Questions, Exercises and Case Questions, and Sources of Lecture
Enrichment.
Contact the Author
The objectives for this book are ambitious, and it is up to readers to judge how effectively they
have been achieved. The second author would welcome any suggestions, comments, or other
feedback from you, the reader. You can use email ([email protected]), telephone (416-736- 2100, ext. 30100), or postal mail (Parbudyal Singh, School of Human Resource Management,
York University, Toronto, M3J 1P3). I look forward to hearing from you!
Parbudyal Singh, Ph.D. School of Human Resource Management York University
Acknowledgments
Many people have contributed to this book in a variety of ways. A project such as this draws on
the knowledge, experience, and insights of a large number of researchers, scholars, and practitioners, each of whom has played a role in developing the body of knowledge reflected
in this book.
I am very grateful for the excellent research assistance provided by Caroline Yang, a graduate
student at York University. Over the years, I have learned with my students at York University
and elsewhere. I thank them for their insights.
I would also like to acknowledge those reviewers who assisted in reviewing earlier editions of
this textbook: Stan Arnold of Humber College, Judy Benevides of Kwantlen Polytechnic
University, Sean MacDonald of the University of Manitoba, and Ted Mock of Seneca College. And for their useful suggestions and thoughtful comments, which helped to fix this edition, I
am grateful to the following reviewers: Bob Barnetson of Athabasca University, Julie Bulmash
of George Brown College, Roger Gunn of NAIT, John Pucic of Humber College, Stephen Risavy of Wilfrid Laurier University, Kristen Rosen at Seneca College, and Carol Ann Samhaber of
Algonquin College.
I would like express my gratitude to the team at Nelson Canada, especially Jackie Wood and Elke Price, for their feedback and guidance. I am also indebted to Monica Belcourt, the series
editor and a colleague, for her confidence in my ability. Finally, I am eternally grateful to my
wife, Nirmala, and three children (Alysha, Amelia, and Aren) for all their encouragement and
support.
My sincere thanks to the many who use our text in both academic and professional settings.
The objectives for this book are ambitious, and it is up to readers to judge how effectively they have been achieved. I would welcome any suggestions, comments, or other feedback from
you, the reader. You can contact me at [email protected] or by telephone (416-736-2100, ext.
30100). I look forward to hearing from you!
Parbudyal Singh, Ph.D. School of Human Resource Management York University
Chapter 1: A Road Map to
Effective Compensation CHAPTER LEARNING OBJECTIVES
After reading this chapter, you should be able to:
• Describe the key purpose of a compensation system.
• Explain why an effective compensation system is so important to most
organizations.
• Distinguish between extrinsic and intrinsic rewards.
• Distinguish between a reward system and a compensation system.
• Describe the key aspects of a compensation strategy.
• Explain why a compensation system must be viewed in the context of
the total reward system, and the broader environment of the
organization.
• Identify and explain the key criteria for evaluating the success of a
compensation system.
• Describe the steps along the road to effective compensation and
explain how this book will facilitate that journey.
A WHOPPING SALARY INCREASE FOR EVERYONE! DOES IT
WORK?
Just imagine working for $40,000 a year in as a compensation analyst in your organization.
Then one day the boss calls a meeting and announces that the minimum pay for everyone would be $70,000! How would you react? How do you think those working above $70,000 will
react? How would the competition react?
Well, this actually happened at Gravity Payments, a Seattle-based credit card processing firm in 2015. It is reported that the CEO of Gravity Payments, Dan Price, was challenged by an
employee about his pay. He was making $35,000 a year, while Dan Price was making over $1
million. Shortly after this encounter, and after reviewing research that suggested employees are not happy until they earn a significant salary, the CEO raised the minimum pay of everyone
in his 120-employee firm to $70,000. To help pay for the increase, he took a pay cut to $70,000.
The news made global headlines. Most of the employees at Gravity Payments reacted with joy;
however, a few did not. In fact, two senior employees left the firm soon thereafter, complaining that those earning above $70,000 were not equitably compensated in the new
pay system and that many of those who were now getting this increase did not deserve it, as
they were just “clocking time” at work.
So, what have been the effects of the pay increase over time? While it is still too early to make
a conclusive evaluation, some of consequences to date are very encouraging from the
organization’s perspective. Applications for jobs with Gravity soared, which allowed the firm to be more selective in its new hires. One Yahoo executive actually took a pay cut to work for
Gravity because she wanted to work in an environment that was “fun and meaningful.” The
media frenzy surrounding the pay increase resulted in free publicity for the firm and demand
for its services grew. This new business has helped to compensate for the pay increase. Profits
doubled in the six months following the pay hike and customer retention rates increased from
91 to 95 percent. Dan Price insists that the move is not intended to generate profits but is the morally right thing to do for his employees. There are reports, however, that some businesses
in the Seattle area are not very happy because of the pressures to match Gravity’s new pay,
and some commentators are calling the move a business gimmick to seek free publicity. One radio personality even called Dan Price a “socialist” and predicted that Gravity will fail. What
do you think?
Sources: Paul Keegan, “Here’s What Really Happened to That Company That Set a $70,000
Minimum Wage,” Inc., November, 2015, http://www.inc.com/magazine/201511/paul-keegan/does-more-pay-mean-more-
growth.html, accessed June 28, 2016; Karen Weise, “The CEO Paying Everyone $70,000
Salaries Has Something to Hide,” Bloomberg, December 1, 2015, http://www.bloomberg.com/features/2015-gravity-ceo-dan-price, accessed June 28, 2016;
Christine Wang, “$70K CEO: I Wasn’t Ready for the Surge of Attention,” CNBC, April 18, 2016,
http://www.cnbc.com/2016/04/15/70k-ceo-i-wasnt-ready-for-the-surge-of-attention.html, accessed June 28, 2016; Robin Levinson King, “Forget the Minimum Wage. Gravity Payments
CEO Dan Price sets $70K ‘Happiness’ Wage,” Toronto Star, April 17, 2015,
https://www.thestar.com/news/canada/2015/04/17/forget-the-minimum-wage-gravity
-payments-ceo-dan-price-sets-70k-happiness-wage.html, accessed June 28, 2016.
// Introduction To The Importance Of
Compensation Systems
Why is the compensation system important? Why study compensation?
Compensation means different things to different people. As the pay increase at Gravity
Payments shows, it often depends on your perspective. For employers, the compensation
system can be used to help the organization achieve its strategy and objectives; it can help to
attract, retain, and motivate employees. It can also have philosophical and moral
implications. For employees, pay influences their standard of living. For some, it may mean going hungry or not. For shareholders, the financial value of the pay system to the
organization’s bottom line is important. The wider society tends to view compensation from
an equity perspective, and questions on justice are often included in the narratives. Often, the focus is on executive pay and the discussion would tend to revolve around fairness when
compared to employee pay. Regardless of your perspective, the compensation system is
extremely important.
While well-thought out pay systems can have positive implications for organizations,
employees and society, the consequences of poorly designed compensation systems can also
have undesirable consequences, as the two examples below illustrate:
• Green Giant wanted to improve the quality of its canned vegetables, so
it decided to give a bonus to each worker depending on the number of
insect parts each plucked from the processing line. The plan seemed
to be enormously successful—hundreds and hundreds of insect parts
were turned in, and large bonuses were paid. The only problem was
that most of the additional insect parts were coming from the
workers’ backyards, where they were much easier to find, rather than
from the canning line.
• To encourage high productivity among its computer programmers, IBM
rewarded each programmer on the number of lines of computer code
they produced. It took the company years to notice that IBM computer
programs tended to be much longer and more inefficiently written
than those of other companies.
These examples show that reward systems can have powerful effects on behaviour, but that
the behaviour we get is not always the behaviour we want. How can we design reward and compensation systems that produce the behaviour we want, while avoiding the behaviour we
don’t want? How can we predict, before the fact, whether a proposed reward and
compensation system is likely to lead to the behaviour we want? Answering these questions is
what this book is all about.
However, there are no simple answers. First of all, in many fields, the employee behaviour that
companies need has become more complex, and a higher level of performance is required
than in the past. In general, the more complex the behaviour and the higher the level of performance required, the more complex the compensation system needs to be. Second,
there are now more choices of compensation practices available than ever before, and
choosing among these is no simple task.
There is no “one best” compensation system that fits all firms. For every successful
compensation practice described in Compensation Today 1.1, examples can be found where
the same practice was a complete flop. Understanding why the same compensation system
that is successful in one firm fails at another firm is an essential precondition to successful
compensation design.
Why should you study compensation? For many students, this is a required course in a degree,
diploma, and certificate program. It is a key component of the national and provincial
certification examinations. Compensation may also be a key aspect of the jobs that some do; thus, they study it. And a career in compensation is very rewarding. There are several jobs and
career paths within the compensation field, including job evaluation specialists, payroll
administrators, benefits specialists, and executive compensation consultants. The pay varies for these jobs in Canada (and you will learn why this is the case as you progress through this
text); on average, however, compensation professionals tend to be among the highest paid
among human resource practitioners.
COMPENSATION TODAY 1.1
Compensation Supports Strategy: From A to Z
Many organizations regard their compensation system as a cost to be minimized; others, however, believe that compensation can do much to help the company carry out its strategies
and achieve its goals. Here are some examples that span the alphabet (well, not every letter—
that would make the chapter too long!):
• At Adobe Systems Canada, a market-leading software firm, all
employees participate in profit-sharing and employee share purchase
plans; they also receive family-friendly benefits such as flexible
working hours, telecommuting, and maternity leave top-up payments.
The point is to recognize the high degree of commitment that Adobe
employees display.
• At Boeing Canada’s Winnipeg Division, which produces components for
Boeing’s new 787 Dreamliner aircraft, unionized employees
participate in a gain-sharing program, under which they share in any
cost savings they help generate. The company believes that this
program cuts waste and boosts productivity.
• At Canadian Tire, management attributes a great deal of the firm’s
success to its employee profit-sharing plan, which it believes has led
to a more committed and motivated workforce than is usual in the
retail business.
• At Herman Miller, a large manufacturer of office furniture, the
centrepiece of the compensation strategy is a gain-sharing plan under
which employees share in company productivity gains. This plan
supports the company strategy of delegating a high amount of
responsibility to employees.
• At RBC Financial, management is integrating performance pay
elements into compensation packages for all employees in order to
support the firm’s increased focus on customers and performance. In
the past, virtually all employees in the banking industry were paid
fixed salaries.
• At the giant retailer Sears, measures of customer satisfaction are being
factored into all employees’ pay in an attempt to make the
organization more flexible and customer-oriented. Executives are
compensated based on customer and employee satisfaction, as well
as on their financial achievements.
• At Shell Canada’s chemical plant in Sarnia, Ontario, pay is based not on
the specific job an employee does, but on the number of jobs the
worker is qualified to perform. The company believes that this radical
departure from tradition has resulted in a more flexible and efficient
workforce.
• At Starbucks, all employees, including part-time baristas, are given
stock options. This supports the company strategy of committed
service from employees. In most organizations, stock options are
limited to a few top executives.
• At Vanderpol’s Eggs in Surrey, British Columbia, management regards
employee share ownership as vital to its managerial strategy, which is
to create a partnership between owners and employees. Management
believes that employee-owners are more committed and productive.
• At WestJet Airlines, the profit-sharing and stock plans have made
employees “owners.” This pay strategy is aligned with the firm’s
strategy to develop employees’ commitment and increase their
participation and engagement. It has also spawned a culture that
fosters teamwork.
• At Zappos, the huge online retailer of shoes and other consumer
products, the company works hard to create a culture of involvement
and commitment among its 1,500 employees. The extrinsic rewards
are not high (except for health care benefits); instead, the company
relies on intrinsic rewards such as job autonomy and wide latitude for
employees to make job decisions. For example, the amount of time
that employees spend dealing with each customer call is not
monitored, so employees can spend as much time as they see fit with
each customer.
// Your Compensation System: Asset or
Liability?
Canadian firms typically spend 40–70 percent of their operating budgets to compensate their
employees. For many firms, compensation is the single largest operating expenditure.
According to Statistics Canada, employers in Canada are now spending nearly a trillion dollars on wages, salaries, and benefits (imagine a stack of $100 bills 1,112 kilometres high).1 Are they
getting their money’s worth? Is this money being well spent?
In many cases, it is not. Some firms are spending too much. Others are spending too little. But while the amount being spent is important, it is not the key issue. The real question is this:
What is the organization receiving for its investment in wages, salaries, and benefits? Are the
compensation system and the money devoted to it contributing to the achievement of organizational objectives in the fullest possible way? Does the firm have in place the
compensation system that adds the greatest possible value to the company after costs are
taken into account?
A compensation system is one of the most powerful tools available to an employer for shaping employee behaviour and influencing company performance, yet many organizations waste
this potential, viewing compensation as a cost to be minimized. Even worse, some
compensation systems actually promote unproductive or counterproductive behaviour. As we will see in the following chapters, problems of low employee motivation, poor job
performance, high turnover, irresponsible behaviour, and even employee dishonesty often
have their roots in the compensation system. Problems as varied as organizational rigidity,
inability to adapt to change, lack of innovation, conflict between organizational units, and
poor customer service may also stem, at least in part, from the reward system.
What complicates matters further is that without any obvious warning signs, a compensation system that has worked well in the past can become a serious liability when circumstances
change. Failure to adapt reward systems to changing circumstances can cause new strategies
to falter, new organizational structures to collapse, new technologies to malfunction, and entire companies to founder. Ironically, because the reward system often affects behaviour in
very subtle ways, many firms never identify their reward system as a major contributor to
these problems.
// The Premise of This Book
The thesis of this book is that organizations that treat their reward system as a key strategic
variable and use it to support their corporate and managerial strategies receive more value
from their compensation system than those that do not, resulting in superior company
performance and higher achievement of organizational objectives. The purpose of this book is to help you learn to design and implement a reward and compensation strategy that best fits
your particular circumstances—one that will add the greatest possible value to your organiza-
tion. For those of you who are not directly involved in the design of compensation systems, the knowledge gained by learning the material in this text should help you better understand an
organization’s reward systems, as well as your own pay. This chapter starts that process by
clarifying some essential concepts and by presenting a road map of the steps along the path to
effective compensation.
// Role And Purpose Of The Compensation
System
How do you get organization members to do what the organization wants and needs
them to do? This is a central problem that has bedevilled those in charge of organizations
ever since their creation. And it is a problem that is growing more complex, especially for
organizations whose products, services, and technologies are becoming increasingly complicated, whose environments are more dynamic and competitive, who operate in
democratic and relatively affluent societies, and who require complicated behaviours and
high performance levels from their members. Compensation is normally a key part of the solution, although there are many other important parts, all of which must fit together if the
desired results are to be fully achieved.
At its most basic, the purpose of a compensation system is to help create a willingness among qualified persons to join the organization and to perform the tasks the organization needs.
What this generally means is that employees must perceive that accepting a job with a given
employer will help them satisfy some of their own important needs. These include economic needs for the basic necessities of life but may also include needs for security, social
interaction, status, achievement, recognition, and growth and development.
Extrinsic vs. Intrinsic Rewards
In a relatively early theory on motivation, Abraham Maslow contended that humans have a
hierarchy of needs, and that each level of need is satisfied through different behaviours. In
summary, Maslow proposed that humans have five levels of needs, with the most basic being
physiological needs (such as the need for food and shelter), followed by safety and security
(e.g., protection from physical and emotional harm), social needs (e.g., affection,
belongingness), respect and self-esteem (e.g., status and recognition), and self-actualization
(e.g., growth and self-fulfillment). This hierarchy is usually captured diagrammatically with a pyramid, with the physiological needs at the base and self-actualization at the top (Try to draw
it!). The theory posits that humans tend to first satisfy their basic needs (such as physiological
and safety) before the higher-order needs such as self-actualization. Each level in the hierarchy must be fairly well satisfied before the next level motivates human behaviour; that
is, once a lower-order need is satisfied, then the next level takes precedence and dominates
human behaviour. Rewards are linked to this theory.
Anything provided by the organization that satisfies one or more of an employee’s needs can
be considered a reward. The types of rewards available in an organizational setting can be
divided into two main categories: extrinsic and intrinsic. Extrinsic rewards satisfy basic needs
for survival and security, as well as social needs and needs for recognition. They derive from
factors surrounding the job—the job context—such as pay, supervisory behaviour, coworkers,
and general working conditions. Intrinsic rewards satisfy higher level needs for self-esteem, achievement, growth, and development. They derive from factors inherent in the work itself—
the job content—such as the amount of challenge or interest the job provides, the degree of
variety in the job, and the extent to which it provides feedback and allows autonomy, as well
as the meaning or significance of the work.
Rewards vs. Incentives
Although the terms “rewards” and “incentives” are often used interchangeably in common
parlance, it is important to understand that they are not in fact synonymous. Rewards are the positive consequences of performing behaviours desired by the organization, and employees
normally receive these rewards either subsequent to performing the behaviour (in the case of
extrinsic rewards) or during performance of the behaviour (in the case of intrinsic rewards). An incentive is a promise that a specified reward will be provided if the employee performs a
specified behaviour. Incentives are offered to induce employees to perform behaviours that
they might not otherwise perform, or to perform these behaviours at a higher level than they otherwise would. Incentives are intended to induce valued behaviour, while rewards serve
to recognize valued behaviour. However, at a given organization, the two concepts can merge
over time; this is because rewards, when used consistently to recognize a desired behaviour, often come to be seen as an implied promise for performing that behaviour in the future—in
other words, as an incentive.
Reward vs. Compensation Strategy
Both extrinsic and intrinsic rewards are important to people and, if utilized effectively, each
can produce important benefits for the organization. The mix of these rewards provided by an
organization is termed its reward system. The compensation system deals only with the
economic or monetary part of the reward system. But since behaviour is affected by the total spectrum of rewards provided by the organization and not just by compensation, the
compensation system can never be regarded in isolation from the overall reward system. This
practice of looking at the total spectrum of rewards—which include career advancement opportunities, the intrinsic characteristics of the job, work/life balance, employee recognition
programs, and a positive workplace culture, as well as compensation—is known as the total
rewards approach to compensation.2 This approach is becoming increasingly common in
Canada,3 and is the approach adopted in this book.
Under the total rewards approach, before a company starts developing its compensation
system, it needs to establish a reward strategy. The reward strategy is the plan for the mix of rewards, both extrinsic and intrinsic, that the organization intends to provide to its members—
along with the means through which they will be provided—in order to elicit the behaviours
necessary for the organization’s success. The reward strategy is the blueprint for creating the
reward system.
The compensation strategy is one part of the reward strategy—the plan for creating the
compensation system. The compensation system has three main components: (1) base pay, (2) performance pay, and (3) indirect pay. Base pay is the foundation pay component for most
employees and is generally based on some unit of time—an hour, a week, a month, or a
year. Performance pay relates employee monetary rewards to some measure of individual,
group, or organizational performance. Indirect pay, sometimes known as “employee benefits,” consists of noncash items or services that satisfy a variety of specific employee
needs, such as health protection (e.g., extended medical and dental plans) or retirement
security (e.g., pension plans).
There are two key aspects of a compensation strategy. One aspect is the mix across the three
compensation components, and whether and how this mix will vary for different employee
groups. The other is the total amount of compensation to be provided to individuals and groups. In short, “How should compensation be paid?” and “How much compensation
should be paid?” are the two key questions for compensation strategy. While simple to state,
these questions are extremely complex to answer.
The optimal choices for these two aspects of compensation strategy ultimately depend on the organizational context, but the most immediate determinant is the reward strategy. At one
extreme, the reward strategy may include none of the three compensation components
whatsoever; at the other extreme, compensation may be the only appreciable reward
provided by an organization.
Therefore, the first step in formulating a compensation strategy is to determine the role that
compensation will play in the reward system. Assuming that organizations wish to minimize compensation costs whenever possible, we must first identify what other rewards are being
provided by the organization and determine whether these alone are sufficient to elicit the
necessary behaviour from organization members. For example, some voluntary organizations
receive thousands of hours of labour from their members for no pay whatsoever; intrinsic
rewards alone are sufficient to motivate the needed behaviour.
Most work organizations cannot expect to get away with providing no compensation to their
members, even though some may try. See Compensation Today 1.2 for a discussion on interns. The key point is that the amount of pay needed to attract and retain the appropriate
workforce varies with the other rewards that the organization can offer.
Some organizations, such as banks, have traditionally offered high job security. This has enabled them to pay less than other organizations that do not offer job security, while still
attracting the same calibre of employee. However, if job security ceases to be a reward that
banks can provide, they may need to increase pay or other rewards to attract and retain the same calibre of employee. In fact, because bank jobs are no longer as secure as they once
were, and because the needs for bank employee behaviour have changed, most Canadian
banks have radically changed their compensation structures in recent years.
Some organizations provide jobs that have high intrinsic rewards that may allow them to attract employees more easily than those that do not. Similarly, firms that enjoy a high level of
prestige and public esteem often find it less necessary to offer as much pay as firms that do
not enjoy such prestige. Firms that offer opportunities for learning and development may be
able to offer less pay than those that do not.
Firms that do offer many noncompensation rewards may also choose to provide relatively
high levels of compensation in order to attract high calibre employees and elicit high commitment and performance. The key point is that various combinations of intrinsic and
extrinsic rewards need to be considered when developing the optimal reward strategy. It is
only in this context that the most appropriate compensation strategy can be determined.
COMPENSATION TODAY 1.2
Internships: Paid or Unpaid
Unpaid internships have increasing come under fire in Canada in recent years. There are reports that there are about 300,000 interns working in Canada—some of them in leading
organizations—for free. These interns are often expected to be on time for work, perform the
same responsibilities as paid employees, and do their work efficiently.
The use of unpaid interns has led to much debate in Canada and was, in fact, a contested issue
in the last national elections. It was seen a hot issue for youths. While some regard unpaid
internships as a good opportunity for training and “on-the-job” experience, others view it as exploitation. As stipulated by labour and employment standards legislation across Canada,
unpaid internships are legally allowed only under certain conditions: the placement must be
educational (done for credits through a formal program); it must be of benefit to the intern; the internship must not replace a paid position; and the intern must not be promised the job
at the end of the placement. There are, however, many organizations, some well known,
where interns work for no pay but these conditions are not met. This has led to a crackdown
on employers in Canada. One investigation by the government revealed that of 123
workplaces that used interns in Ontario, one-quarter did not meet the requirements under the
employment standards legislation. As a result of the investigation, many interns received pay
owning to them.
Sources: Peter Henderson, “Unpaid Internships Are a Major Concern for Canadian Youth: NDP
and Liberals,” CTV News, October 15, 2015,
http://www.ctvnews.ca/politics/election/unpaid-internships-a-major-concern-for-canadian-
youth-ndp-and-liberals-1.2611206, accessed June 24, 2016; “Unpaid Interns to See Thousands in Pay After Ontario Blitz of Employers,” Huffington Post, April 29, 2016,
http://www.huffingtonpost.ca/2016/04/29/ontario-recovers-thousands-in-wages-for-unpaid-
interns-in-blitz_n_9806010.html, accessed June 23, 2016; CBC News, “Unpaid Internships
Focus of Growing Backlash,” The Canadian Press, http://www.cbc.ca/news/canada/unpaid-
internships-focus-of-growing-backlash-1.2556977, accessed June 27, 2016.
For example, if a firm is experiencing high employee turnover because employees find their
jobs mind-numbingly dull, one solution might be to increase pay to make employees more
reluctant to quit. Another approach might be to try to enrich the jobs to make them more interesting, thereby increasing intrinsic rewards. Of course, it may even be possible to
dispense with these jobs by automating them, which eliminates the reward issue entirely.
The best choice depends on the relative costs and benefits of each approach. It is possible that the most cost-effective approach is to do nothing—that is, if the cost of turnover is less than
the cost of increasing extrinsic or intrinsic rewards or of automating the jobs. However, other
factors come into play in this decision-making process. For example, job enrichment may not only reduce turnover but may also increase work quality. This may tip the scales toward job
enrichment or a combination approach, rather than simply increased pay. The philosophy of
the organization’s leadership is also important.
// Criteria for Success: Goals for the
Compensation System
What should an optimal reward and compensation system achieve? There are eight main
criteria, as shown in Compensation Notebook 1.1. First and foremost, a reward system must
help the organization achieve its goals. Second, it must fit with the organization’s strategy for
achieving its goals and support its structure for implementing that strategy. Third, it must
attract and retain individuals who possess the attributes necessary to perform the required
task behaviours. Fourth, it should promote the entire spectrum of desired task behaviour for every organization member. Fifth, it should be seen as equitable by all organization members.
Sixth, it must comply with all relevant laws within the jurisdictions in which the firm operates.
Seventh, it must achieve all this at a cost that is within the financial means of the organization.
Eighth, it should achieve these objectives in the most cost-effective manner possible.
In general, the optimal reward system will be the one that adds the most value to the
organization, after considering all its costs. However, this does not necessarily mean that the optimal compensation system is the cheapest one. For example, for some firms, a high-wage
compensation strategy may well be the one that maximizes overall company effectiveness.
Resource constraints may prevent a company from adopting what would otherwise be the optimal reward strategy. But in general, an effective reward system maximizes the value
added relative to the resources devoted to the reward system.
COMPENSATION NOTEBOOK 1.1
Goals of the Reward and Compensation System
1. Promote achievement of the organization’s goals.
2. Fit with and support the organization’s strategy and structure.
3. Attract and retain qualified individuals.
4. Promote desired employee behaviour.
5. Be seen as equitable.
6. Comply with the law.
7. Be within the financial means of the organization.
8. Achieve the above goals in the most cost-effective manner.
Overall, the objective of this book is to help readers learn how to create a reward system that
will accomplish all of the criteria outlined in Compensation Notebook 1.1.
But wait a minute! These goals sound very nice in theory, but realistically, is it really necessary
for a firm to achieve all of them? We all probably know of successful organizations that violate several of these criteria. In fact, there are some successful organizations where it would be
difficult to find anyone who believes that their reward system is equitable. So does this mean
that an equitable reward system may be desirable from a social and ethical viewpoint, but not
from the viewpoint of organizational performance?
Not necessarily. As will be seen in Chapter 3, an inequitable reward system creates some
undesirable consequences for an employer, such as increased employee turnover and
reduced work motivation. But the costs of these consequences vary dramatically across employers. For some firms, these costs and consequences may be tolerable, while for others
they may not be. As will be discussed, a variety of factors determine how important an
equitable reward system is to a given employer.
This book argues that in Canada, the circumstances under which an organization can afford an
inequitable reward system are disappearing, and that for most organizations, an equitable
reward system is actually a competitive advantage, if not a business necessity. But overall, organizations vary greatly in terms of how much reward and compensation systems affect
their performance, as Chapter 2 will discuss.
Is it realistic to expect a reward system to achieve all eight of the effectiveness criteria? Probably not. But these criteria still serve as goals and measures of progress. In today’s rapidly
changing work environment, ongoing evaluation of the effectiveness of the reward and
compensation system is crucial for most organizations.
As firms struggle to find the right answers to the compensation puzzle, the field of
compensation is attracting more and more interest in the business and popular media.
Indeed, firms with comprehensive and attractive reward and compensation systems may even
find themselves included among “Canada’s 100 Top Employers”—a significant advantage
when it comes to employee recruitment.4
// A Road Map To Effective Compensation
All of this may sound pretty complicated. So what are the steps along the road to an effective
compensation system? Figure 1.1 provides a road map to follow and links each step along the
road to the section of the book that provides guidance for that step. The six chapters in the first two steps provide the tools you need in order to develop a compensation strategy, while
the seven chapters in the next three steps provide you with the tools and knowledge needed
to transform your compensation strategy into an operating compensation system.
Step I: Understand Your Organization and Your People
The first step in creating an effective compensation system is to understand the organizational
context within which it will operate. The reward system is just one part of the total organizational system, and each part must fit with and support the other parts. There are
three viable patterns into which these parts can be arranged, and each pattern constitutes one
type of managerial strategy.
For success, each managerial strategy relies on a different reward and compensation strategy.
The most appropriate managerial strategy is in turn determined by a number of key
contextual factors, such as the firm’s environment; its corporate strategy; its technology; its
size; and, of course, its people. A key implication of this set of factors is that they are all related—whenever one factor changes, it can create a need for many other organizational
changes, including changes to the reward and compensation system. Chapter 2 (“A Strategic
Framework for Compensation”) will provide a conceptual toolkit for understanding the
organizational context and identifying the compensation system that best fits that context.
Another essential concept to understand is the link between reward systems and human behaviour. Three main behaviours are desirable to an organization—membership behaviour,
task behaviour, and citizenship behaviour—but the importance of each of these can vary
dramatically for different organizations. It is crucial to understand what specific attitudes and behaviours are needed by your organization and the role the reward system can play in
eliciting these behaviours.
Besides understanding how reward systems can promote desired behaviours, it is also important to understand how reward systems can unintentionally
generate undesirable attitudes and behaviours. As Chapter 3 explains, this is a surprisingly
common phenomenon. Chapter 3 (“A Behavioural Framework for Compensation”) provides a conceptual toolkit for understanding the process through which compensation affects
employee behaviour.
Step II: Formulate Your Reward and Compensation Strategy
The next step in creating an effective compensation system is to formulate your reward and
compensation strategy—to determine the mix of compensation components to include in
your system and the total level of compensation to provide, relative to other employers. To
determine the compensation mix, you must understand what compensation options are
available, their advantages and disadvantages, and the consequences each produces.
There are three main compensation components—base pay, performance pay, and indirect
pay. Chapter 4 (“Components of Compensation Strategy”) examines these components, along with the key elements and choices available within each component. Chapter 5 (“Performance
Pay Choices”) examines the key choices available when performance pay is being
incorporated into compensation strategy. Chapter 4 and 5 describe the available choices in sufficient detail to allow you to decide the mix of components and elements to include in a
reward strategy that best fits your organization. To allow you to focus on the strategic aspects
of these choices, most of the technical details for designing and implementing these
components are deferred to later chapters in the book.
Based on the concepts provided in the first five chapters, you can identify the kinds of
behaviour your organization needs and then choose the most appropriate combination of rewards (the reward strategy) to elicit this behaviour. A major purpose of the reward strategy
is to define the role that compensation is expected to play in bringing about the desired
behaviour. From this reward strategy, you will develop specific compensation objectives.
You can then formulate a compensation strategy that defines the mix of compensation components (along with the specific elements of these components) and the compensation
level strategy that best fits your organization. But to do this effectively, you must first
understand the constraints on your organization that define the parameters within which choices can be made. These include legal constraints, labour market constraints,
product/service market constraints, and constraints on the financial resources available to the
organization. Chapter 6 (“Formulating the Reward and Compensation Strategy”) guides you
through this process.
Step III: Determine Your Compensation Values
By this point, you will have developed a compensation strategy, but you don’t yet have a
compensation system. Once you have formulated the compensation strategy, you must next
establish the processes for determining actual dollar values for jobs and for individual employees. The dollar value of compensation to be provided to a specific employee is typically
determined by a combination of three factors:
1. The value of the employee’s assigned job relative to other jobs in the
firm, usually determined by a process called job evaluation.
2. The value of the employee’s job relative to what other firms are paying
for this job, usually determined through a process known as labour
market surveys.
3. The value of the employee’s job performance relative to other
employees performing the same job, usually determined by a process
called performance appraisal.
The first and third of these factors deal with achieving internal pay equity (equity of pay
among employees within the firm), while the second factor deals with achieving external pay
equity (equity with what comparable employees are being paid in other firms). Note that equity is not the same as equality; giving equal pay to employees who make a lesser
contribution to the firm than other employees is in fact very inequitable. When developing a
pay system, pay equity (fairness) is our goal, not pay equality.
In Step II, you decided which of these three processes would play a role in your compensation strategy. For compensation strategies in which job evaluation plays a role, Chapter 7
(“Evaluating Jobs: The Job Evaluation Process”) and Chapter 8 (“Evaluating Jobs: The Point
Method of Job Evaluation”) provide a description of the key steps and procedures in the job evaluation process. For compensation strategies in which compensation is calibrated to the
“going market rates,” Chapter 9 (“Evaluating the Market”) describes how to gather and apply
labour market data to determine these rates. Finally, for those compensation strategies that
include performance appraisals as a basis for determining pay, Chapter 10 (“Evaluating
Individuals”) describes how to design these systems.
Step IV: Design Your Performance Pay and Indirect Pay Plans
Your compensation strategy probably contains some performance pay and some indirect pay.
What you need to do now is actually design your performance pay and indirect pay plans.
Chapter 11 (“Designing Performance Pay Plans”) focuses on design issues for the specific performance pay plans you have chosen, and Chapter 12 (“Designing Indirect Pay Plans”)
focuses on the key issues for designing indirect pay plans that will serve company needs.
Step V: Implement, Manage, Evaluate, and Adapt the
Compensation System
Once developed, the compensation system needs to be implemented and then managed on
an ongoing basis. Key issues here include procedures for implementing the system, communicating information about the system, dealing with compensation problems,
budgeting, and controlling compensation costs.
In addition, after implementation, the compensation system needs to be continually evaluated to determine whether it is accomplishing the company’s objectives and whether it
is doing so in the most cost-effective manner possible.
If not, then some of the technical aspects of the compensation system may need to be
changed, or the compensation and rewards strategy may need to be reworked entirely, as the
feedback loops in Figure 1.1 illustrate.
Furthermore, if the circumstances facing the organization change, or if the technology,
strategy, or structure of the organization changes, these changes may trigger a need for changes to the compensation strategy or system. In addition, the organization must have a
way of detecting unintended negative consequences generated by the compensation system.
The final chapter in this book, Chapter 13 (“Activating and Maintaining an Effective
Compensation System”), provides guidance on how to deal with all of these issues.
// The Context of Compensation
Management
Except for voluntary organizations, all organizations—whether large or small—must deal with
compensation issues.
In small organizations, the responsibility for compensation strategy usually resides with the
owner or chief executive officer, and compensation administration is often contracted out to
firms that specialize in payroll management.
In larger organizations, the compensation function normally resides within the Human
Resources Department, with the head of that department bearing ultimate responsibility for the successful operation of the compensation system. Typically, compensation strategy is
formulated by the head of HR, based on the recommendations of the manager of
compensation, but because it is such a crucial issue for most organizations, the approval of top management (and often the board of directors) is always required for major changes to
compensation strategy.
Within a large firm, there are many specialized roles for compensation specialists. For
example, job analysts develop job descriptions and conduct job evaluations, benefits
specialists oversee benefits plans, compensation analysts evaluate market data, and compensation managers oversee the administration of the compensation system and
recommend, design, and implement compensation policies. Compensation Today 1.3 gives
three examples of HR jobs that require extensive knowledge of compensation, along with their
pay levels.
Responsibility for specialized aspects of compensation (e.g., evaluating the market or
managing benefits plans) is often contracted to compensation consulting firms. Compensation consulting firms have grown in number as a result of the increasing complexity
of compensation systems and have become an important source of employment for
compensation professionals.
In recognition of its importance in the Human Resources field, compensation has been
designated as one of the main categories of professional capabilities required for the Certified
Human Resources Professional (CHRP) designation in Canada. To receive this designation, a candidate must demonstrate expertise in these capabilities through a testing process
conducted by the Human Resources Professionals Association of Ontario and/or the Canadian
Council of Human Resources Associations. As a part of the process needed to earn a professional HR designation, granted by the HR provincial associations, applicants must
undergo two assessments: one is a knowledge-based exam, and the second assessment is
based on experience. Because the competencies required for the knowledge exams may differ
by province, we have not provided lists or links in this edition. Those interested in obtaining an
HR designation should consult the HR association in their province.
COMPENSATION TODAY 1.3
Examples of Jobs That Require Compensation Knowledge
Compensation Analyst
Under the direction of the manager of compensation, helps design and administer company
compensation programs, such as base pay, performance pay, and benefits. May conduct job
analyses and job evaluations. May analyze market data to determine competitive pay levels.
May analyze benefits programs to determine utility and efficiency. May supervise clerks who carry out routine compensation procedures. Requires a university degree with course work in
related areas. A Certified Human Resources Professional (CHRP) designation and appropriate
experience are assets.
Manager of Compensation
Under the direction of the vice president of Human Resources, is responsible for managing the
operations of the compensation system, including staffing, performance review, staff training
and development, and the technical aspects of compensation management. Is responsible for monitoring the effectiveness of compensation policies, making necessary adjustments, and
recommending and implementing new compensation policies. Assists the vice president of
Human Resources in evaluating and formulating compensation strategy. Requires a university degree with course work in related areas and at least five years experience in the field. CHRP
an asset.
Vice President of Human Resources
Under the direction of top management, ensures the acquisition, training, motivation, and
retention of personnel needed to achieve corporate goals. Evaluates human resource
management strategy and organization design and recommends new human resource policies to top management when appropriate. Recommends the most effective recruitment,
selection, training, and compensation strategies and oversees the implementation of
approved policies and programs. Formulates the recommended compensation budget for the upcoming year. Responsible for the selection, appraisal, and coaching of subordinate human
resources managers, achievement of departmental objectives, and meeting of departmental
budget goals. Helps top management and other departments deal effectively with human resource issues and problems and provides support to top management in identifying
strategic issues affecting the company. Requires a university degree in business or commerce,
with specialization in Human Resources, at least ten years of HR management experience, and
a CHRP designation.
What Are These Jobs Worth?
Since this book is a compensation text, your next thought probably is (or should be): What are
these jobs worth in dollars? As subsequent chapters will show, there are many ways to answer this question. However, a quick and easy way is to consult a website that specializes in
providing market values for various jobs. For example, Salary Wizard5 suggests that the
typical range of cash compensation (base pay plus performance pay) for a junior level compensation analyst located in Toronto is $57,331 to $77,137, with a median of $67,012; for a
compensation manager in Toronto, $83,057 to $112,898, with a median of $94,939; and for a
Human Resources Manager in Toronto, $94,579 to $121,024, with a median of $106,152. Note, however, that pay levels vary across Canada and that pay levels in your area may be different
from those in Toronto. Pay also varies by the size of the company and the sector where the job
is located, among other factors (to be discussed in this text).
// SUMMARY
This chapter has explained the purpose of a compensation system, its relationship to the
broader reward system of an organization, and the key elements of a compensation strategy.
It has discussed the goals of an effective reward and compensation strategy, and it has
presented a road map for developing an effective compensation system. The chapter
concluded with a brief discussion of the context of compensation management within a firm and within the field of human resources management. This chapter sets the stage for Chapter
2 , which provides a strategic framework for developing the reward and compensation system
that best fits a given firm, and Chapter 3, which provides a behavioural framework for developing the reward and compensation system most likely to produce employee behaviour
that the firm needs.
Key Terms
• base pay
• compensation strategy
• compensation system
• extrinsic rewards
• incentive
• indirect pay
• intrinsic rewards
• optimal reward system
• performance pay
• purpose of a compensation system
• reward
• reward strategy
• reward system
• total rewards
Discussion Questions
Discussion Question 1.1
Review
Discuss why an effective compensation system is so important to most organizations. Your Answer
No answer submitted
Discussion Question 1.2
Review
Discuss why a compensation system must be viewed in the context of the total reward system.
Your Answer
No answer submitted
Discussion Question 1.3
Review
Discuss the five steps in designing an effective compensation system.
Your Answer
No answer submitted
Using the Internet
Using the Internet Question 1.1
Review
Using Salary Wizard, what conclusions can you draw about variations in pay level in different parts of
Canada? Pick two or three different jobs to make your comparisons across the country?
Your Answer
No answer submitted
Using the Internet Question 1.2
Review
Again using Salary Wizard, check how much the pay ranges for the jobs in Compensation Today 1.3 have changed since 2012, the year in which this book’s salary data were collected.
Your Answer
No answer submitted
Exercises
Exercise Question 1.1
Review
In a small group, describe to one another the compensation system at your most recent job, in terms of
base pay, performance pay, and indirect pay. Then discuss your reactions to this system. Do you believe it
was equitable? What impact did it have on your motivation and commitment to the organization? How could it have been improved? Of the compensation systems described by your group members, which
appeared to be the most effective, and why?
Your Answer
No answer submitted
Exercise Question 1.2
Review
In a small group, discuss your experiences (or those you know) with an internship. Was it for free? Do you believe that the unpaid internship met the legal criteria for identified in Compensation Today 1.2? What
are your thoughts on unpaid internships?
Your Answer
No answer submitted
Case Questions
Case Question 1.1
Review
Read the “Henderson Printing” case in the Appendix. What is your assessment of the compensation system
in place? Do you think it meets the criteria for an effective compensation system as set out in Compensation Notebook 1.1? Which criteria does it meet, and which does it violate?
Your Answer
No answer submitted
Simulation Cross-Reference
If you are using Strategic Compensation: A Simulation in conjunction with this text, you will
find that the concepts in Chapter 1 are helpful in preparing Section A of the simulation.
// Notes
1. Statistics Canada, “Individuals by Total Income Level, by Province and Territory (Canada)”
at http://www.statcan.gc.ca/tables-tableaux/sum-som/l01/cst01/famil105a-eng.htm,
accessed September 20, 2016.
2. Edward E. Lawler, “Creating a New Employment Deal: Total Rewards and the New
Workforce,” Organization Dynamics 40 (2011): 302–9. See also World at Work, The World at
Work Handbook of Compensation, Benefits, and Total Rewards: A Comprehensive
Guide for HR Professionals (Hoboken: Wiley, 2007); Shabnum Durrani and Parbudyal Singh,
“Women, Private Practice, and Billable Hours: Time for a Total Rewards Strategy,” Compensation and Benefits Review 43 (2011): 300–5; Duncan Brown, “The Future
of Reward Management: From Total Reward Strategies to Smart Rewards,” Compensation
and Benefits Review, 46 (2014): 147–51.
3. Todd Humber, “Total Rewards: One Concept, Many Monikers,” Canadian
HR Reporter, February 14, 2005, R3; Gail Evans, “Figuring Out Total Rewards in a Rocky
Economy,” Canadian HR Reporter August 10, 2015, 17.
4. See “Canada’s Top 100 Employers” at http://www.CanadasTop100.com.
5. For Salary Wizard, see http://monsterca.salary.com.
Chapter 2: A Strategic
Framework for
Compensation CHAPTER LEARNING OBJECTIVES
After reading this chapter, you should be able to:
• Understand the concept of “fit” and explain why a compensation
system that is a success in one firm can be a failure in another.
• Explain how the strategic framework for compensation can be used as
a tool for designing effective reward and compensation systems.
• Describe the main elements in the strategic compensation framework,
and explain how they relate to one another.
• Describe the three main managerial strategies that organizations can
adopt, and explain their implications for the most effective
compensation systems.
• Describe the main determinants of managerial strategy, and explain
how they can be used to select the most appropriate managerial
strategy.
• Analyze any organization to determine the most appropriate
managerial strategy for that organization to adopt.
• Discuss how conditions in North America changed during the 20th
century, and explain how this has affected today’s managerial and
compensation strategies.
A TALE OF TWO FIRMS
L-S Electro-Galvanizing (LSE) produces corrosion-resistant sheet steel for the automotive
industry at its plant in Cleveland, Ohio. The firm receives large coils of sheet steel from steel
mills, unrolls and cleans them, and then applies a coating of zinc to precise specifications. Although the process is highly automated, many things can go wrong, and mistakes are very
costly. Rather than hourly pay geared to the specific task that a worker does (such as
packaging or process control), which is the norm in this industry, LSE plant workers are paid
salaries, with their salary level based on the number of different plant jobs that they are qualified to perform (a “pay for knowledge” system). To maintain their skills, workers rotate
through the various plant jobs. This means that someone working at one of the traditionally
lower-paying jobs, such as packaging, may be earning twice the standard industry rate for this same job. On top of this, employees receive an excellent benefits package, as well as gain-
sharing bonuses based on plant productivity and profit-sharing bonuses based on company
performance. Overall, LSE pays its workers far more than its competitors. Are you surprised to
learn that almost no one ever quits?
By contrast, Koch Foods operates a plant in Morton, Mississippi, that converts live chickens
into packages of chicken parts. All work is centred around the “chain” on which the live
chickens are hung, which rattles past line workers at a rate of 90 birds per minute. Workers
posted along the chain perform various operations on the chickens as they pass by, such as
snipping their heads off or reaching in and yanking out their innards. Unlike LSE, Koch Foods hasn’t implemented any pay innovations and simply pays workers an hourly wage not much
above the legal minimum. Employee benefits are minimal. The firm has no fixed pension plan,
other than a savings plan to which the company contributes, but only when the firm is profitable. Are you surprised to learn that employee turnover often exceeds 100 percent a year
in plants like these?
// Introduction To Effective Compensation
Systems
Let’s start this chapter with a little contest. The reward for winning? Strictly intrinsic. As you
noticed, the two firms discussed above have completely different compensation systems.
Here’s your skill-testing question: Which compensation system is more effective? Note that
this question does not ask you to pick the system that you like the most, but the one that best fits our definition of an effective compensation system. As we discussed in Chapter 1, the most
effective compensation system for a given firm is the one that adds the most value to the
organization, after considering all its costs.
So back to the question. Which of these compensation systems do you think is the most
effective? LSE sounds like a workers’ paradise. But how can the company stay competitive
when it pays its workers so much more than its competitors pay theirs? And while Koch Foods certainly can’t be accused of overpaying its workers, wouldn’t that turnover rate cause serious
problems?
Aha, you think, maybe this is a trick question and neither system is effective! But in fact, despite being so different, both compensation systems are effective. How can this be? The
answer is that they each fit the organization and its strategy. If these firms were to trade
compensation systems, they would both soon be as dead as the Koch chickens.
How can a compensation system that is a great success in one organization be a miserable flop in another? And how do you know in advance whether a particular type of compensation
system will succeed for your organization? These are puzzles that must be solved if you want
to successfully design or redesign a compensation system.
// A Strategic Framework For Compensation
Pay is a “red phone.” When it rings, employees want to find out who is on the other end
and what is being said. The goal is to wire the red phone to company strategy.1
Sounds good. So how exactly do you do that? Properly wiring the “red phone” is more
complex than it sounds. Fortunately, this chapter develops a tool to do just that. Be prepared,
though—initially, this tool will seem to only make things more complicated! But once you invest the effort necessary to understand it, you should find it an indispensable part of your
conceptual toolkit for building effective compensation systems.
Strategy and the Concept of Fit
An organization’s mission, vision and/or values provide the basis for its strategies.
The vision of an organization refers to the long-term, optimal desired state; it’s like “what you
want to be when you grow up” or your aspirational goal. Its mission is more immediate; that is,
the present state or purpose of the organization, or “who you are today.” It gives the reason for the organization’s existence. Organizational values refer to its underlying guiding
principles, beliefs, and attitudes that guide behaviour; for instance, “teamwork” and
“integrity” can be organizational values.
Fit is an important concept in strategic management.2 It refers to the alignment of strategies at
various levels in an organization. There are two related concepts: vertical and horizontal fit, or
vertical and horizontal integration.3 Vertical fit refers to the alignment between an organization’s mission, vision and/or values, and the various supportive strategies that
cascade down an organization. A tight fit means that human resource management (HRM)
strategies, for instance, are closely aligned with the strategic thrust of the organization; that is,
the HRM strategies support the organizational strategy. For instance, 3M and Apple are widely known for their innovative organizational strategies. Compensation strategies that support
innovation imply that there is some level of vertical fit. Horizontal fit refers to the alignment
between and among strategies at the same level; for instance, HRM strategies such as
performance management and compensation are aligned or support each other.
The organization’s strategy helps it to achieve its mission, vision, values, and goals.
The business strategy (sometimes known as the “competitive strategy” or “corporate strategy”) is the organization’s plan for how it will achieve its goals. The organization
structure is the vehicle for executing this strategy and has several structural dimensions or
variables. The purpose of the organization structure is to generate the behaviours necessary to
carry out the organization’s strategy.
For the organizational system to be effective, the business strategy and organization structure
must also fit with other key variables, including the type of environment in which the
organization operates, the type of technology it uses, the size of the organization, and the characteristics of the people employed. This is known as the contingency approach to
organization design,4 and it is the foundation for the strategic framework presented in this
chapter.
Ultimately, the success or failure of any reward system depends on how well it fits the
organization’s context and its system as a whole. Therefore, to successfully design, manage,
and modify any reward system, you must understand this context and how it links to the
reward system.
But what are the key aspects of the organizational context, and exactly how do they relate to
reward strategy? This chapter addresses that question by developing a framework that
identifies the key aspects of the organizational context and then illustrates how each affects
the reward system. This framework describes three managerial strategies that an organization
can adopt and shows how each relates to an organization’s structure and its best-fit reward
system. The framework then identifies the determinants of managerial strategy, since these will ultimately determine the most appropriate reward strategy. The chapter ends with a
discussion of trends in managerial strategies and compensation systems.
Figure 2.1 shows the two main sets of variables—contextual and structural—and the link with managerial strategy. As the diagram shows, the reward system is only one of the variables that
make up the organization’s structure. To be effective, the reward system must fit with the
other structural variables, as well as with the managerial strategy, which must in turn fit with the contextual variables. But what do all the double-sided arrows mean? Simply that all of the
structural variables are interrelated and must fit with one another if the organization is to be
effective. The same is true for the contextual variables.
The first step in understanding how to use this framework is to understand each of these
components.
Structural Variables
To generate the behaviours necessary to execute a corporate strategy, an organization
structure needs to do two main things: it first needs to divide the total task into manageable
subtasks (a process sometimes known as “differentiation”), and then it needs to coordinate the completion of these subtasks so that they fit together to accomplish the
organization’s total task (a process sometimes known as “integration”).
An effective organization structure reduces internal and external uncertainty for the organization. It reduces internal uncertainty by structuring and directing employee behaviour;
it reduces external uncertainty by creating specialized units to interpret and deal with key
aspects of the firm’s environment and bring appropriate information to organizational decision makers. For example, a firm may create a marketing department to learn about and
deal with its customers, a purchasing department to learn about and deal with its suppliers,
and an economic forecasting unit to help understand economic trends and how they affect the
organization.
The organization structure has a number of separate variables or dimensions. These variables
are the levers that are used to produce the behaviour the organization desires. Besides the
reward system, there are five other structural variables. Job design describes the manner in which the total amount of work to be done is divided into subtasks that can be handled by
individual workers. Coordination and departmentation mechanisms are the methods used to
ensure that the work of individual employees fits together such that the overall task is
accomplished.
The decision-making and leadership structure comprises the mechanisms through which the
organization’s decisions are made and the type of leadership role played by those in managerial positions. The communication and information structure describes the methods
used to communicate information throughout the organization and the amount and kinds of
information to be transmitted. The control structure is the means used to ensure that
organization members are actually doing what they are supposed to do.
Managerial Strategy
The structural variables described above can be arranged in a virtually limitless number of
ways. However, over time, three main patterns of structural variables, known as “managerial strategies,” have emerged: (1) the classical managerial strategy, (2) the human relations
managerial strategy, and (3) the high-involvement managerial strategy.5 Each of these
managerial strategies represents a particular combination of structural variables that has proved to be successful in the right circumstances. The particular managerial strategy used by
a given firm is the most important single determinant of what will or will not be a successful
reward system for that firm. The specific linkages between managerial strategies and the
structural variables, including reward systems, are discussed in more detail later in the
chapter.
Contextual Variables
So what determines the most appropriate managerial strategy for an organization to adopt?
The five main contextual variables are shown in Figure 2.1: the organization’s environment,
business strategy, technology, size, and workforce. Each of these is discussed in more detail
later in the chapter, along with its relationship to managerial strategy.
But if contextual variables differ between organizations, how are the contextual variables
themselves determined? It all starts with organizational goals. When founders create an organization, they have certain goals for their organization. In a business enterprise, the goals
may include making money and/or providing employment for the owner. In a governmental
organization, the goal may be to satisfy some collective need, such as the need for fire or police protection, or for education. In a not-for-profit enterprise, the goal may be to address
some important need not currently being met. For example, the Canadian Cancer Society was
created to serve the needs of those who have cancer and to find a way to cure or prevent
cancer. UNICEF was created to help serve the needs of children in poverty-stricken areas.
From the interaction between the goals of the founders and the general environment in which
the firm will be situated, the organization’s domain emerges. The domain defines the specific
products or services to be offered by the organization. The domain also defines the task environment, which is the specific slice of the general environment of particular relevance to
the organization. Key elements of the task environment include the customers or clients of the
organization, as well as competitors, suppliers, and regulatory agencies.
Once a firm has established its goals and defined its domain, it needs to formulate a plan for
achieving its goals (its business strategy). Decisions can then be made about the most
appropriate type of technology to produce the product or service, the most appropriate size for the organization, and the nature of the workforce needed. These decisions need to be seen
as interrelated, since changes in one variable affect each of the others. For example, a change
in the firm’s technology may necessitate changes to its business strategy and its workforce, as
well as to the size of the firm.
The key point about contextual variables is that a change in any of them may trigger a need for
a change in the reward system. Thus, a company that changes its business strategy, implements a new technology, grows in size, or experiences a change in its workforce may
need a new reward strategy. A company attempting to introduce work teams or flexible
production almost always needs to change its reward system. A firm striving to change its
managerial strategy usually needs to change its reward system. As discussed earlier, failure to make the right changes to the reward system in the light of these other changes may have dire
consequences. Because organizations are systems, change in one aspect of the organization
almost inevitably has implications for other parts of the organization.
// Managerial Strategies And Reward
Systems
Each of the three main managerial strategies has different implications for how the reward
and compensation systems should be designed. Each of these strategies also reflects different assumptions about employees and how they should be managed. To understand how each
managerial strategy links to rewards and compensation, you first need to understand the
assumptions on which each is based.
Adherents of the classical managerial strategy believe that people are inherently lazy, dislike work, and would prefer to get as much as they possibly can from a work relationship while
giving as little as possible. According to this perspective, the only way to get people to work is
to create circumstances under which satisfaction of their economic needs becomes threatened if they do not behave as the organization wants them to. Essentially, this school of
thought views employees as potentially dishonest shirkers who need to be tightly controlled if
the organization is going to be sure of getting any work out of them.
Adherents of the human relations managerial strategy agree with the classical managers that
people inherently dislike work, but they differ in that they believe people can be motivated by
appealing to their social needs. They have observed that the classical school of thought often creates an adversarial and unpleasant relationship between management and workers and
that peer groups of workers often form within the firm in order to satisfy human needs that are
unmet or threatened by the formal organization.
These peer groups often have more influence than management over the workers and often
work against management. But by treating employees with fairness and consideration and
supporting and encouraging peer groups of workers (rather than trying to break them up, which would be the classical approach), human relations managers believe that positive
employee norms can develop. Employees work loyally and comply with these norms out of
gratitude for the satisfying social environment the firm provides. The human relations view of
employees tends toward paternalism—the organization is like a family, in which employees are like children who need to be treated kindly but firmly by a benevolent employer who
knows what is best for them and the organization.
The high-involvement managerial strategy6 differs from the previous two schools in its belief
that if jobs are structured correctly, people can actually enjoy and be motivated intrinsically
by their work. Adherents believe that people are motivated by needs for interesting work,
challenge, autonomy, personal growth, and professional development, and that employees can exercise self-control if the organization provides these conditions while treating
employees fairly and equitably. (You should be aware that the high-involvement managerial
strategy has several labels. The “mutual gains enterprise,”7 the “high-performance work system,”8“open book management,”9 and “high commitment management”10 are all very
similar to the high-involvement managerial strategy described here.)
Given the disparate assumptions that each of the three managerial strategies holds about
employees, it is not surprising that organizations will be structured very differently, depending
on their managerial strategy. Compensation Notebook 2.1 summarizes how each of the three
managerial strategies compares in terms of the six main dimensions of organization structure.
Classical Managerial Strategy
Under the classical managerial strategy, thinking is completely separated from doing. Jobs are
designed with only a few basic elements so that they can be supervised closely and so that employees can be replaced easily if they quit or are dismissed. The specific duties and work
methods for each job are planned and defined in detail by management, since employees
cannot be trusted to perform effectively without doing so. Jobs are arranged in strict, hierarchical, pyramidal fashion because of the overriding need for accountability.
Coordination is always handled vertically by a common superior. Employees are organized by
function; for example, all engineers are put into one department, all marketers into another
department, and all production staff into another department.
The major role of the supervisor is to control and evaluate subordinates who, according to this
theory’s assumptions, will try to shirk and goof off if given the opportunity. Decisions are made at a relatively high level in the organization, and the main leadership role is autocratic, with a
high emphasis on tasks. Essentially, senior management makes the decisions, middle
management transmits them, and first-line management (supervisors) enforces them.
COMPENSATION NOTE BOOK 2.1
Comparison of the Three Managerial Strategies and Their Structural Implications
Control is exercised through close supervision and the threat of punitive action should the
employee deviate from organizational policies. There is often a large body of formal rules and procedures that are strictly enforced. Control is also frequently embedded in the technology
or the work process itself, as in the case of assembly lines, which do not allow deviation from
the standard procedures.
Communication is quite low, with an emphasis on a downward vertical flow, and tends to be formal. Informal communication (i.e., the “grapevine”) is discouraged, although, ironically, the
grapevine usually flourishes as employees attempt to fill in the information gaps. Generally,
management disseminates as little information as possible, in the belief that information is
power. Communication upward from employees is not generally sought, and when sought is
likely minimal and distorted, due to the adversarial relations.
Since management’s key task is to minimize variations in employee behaviour from the specified behaviour, the reward system is quite simple—an extrinsic (economic) reward.
Wherever feasible, a system that ties pay directly to output—such as piece rates or sales
commissions—is used. Where this is not feasible, pay is tied directly to hours of work. In both cases, pay is no higher than absolutely necessary to attract a sufficient flow of job applicants.
Little indirect pay is used, because it is not tied to individual performance, and management
does not see much value in incurring large benefits costs in order to promote loyalty and reduce turnover. This is because classical organizations are structured to minimize the cost of
turnover: with narrow job categorizations, workers are easy to replace, train, and
supervise. Compensation Today 2.1 illustrates how one firm, Foxconn, utilizes a classical
strategy.
One exception to the general rule about poor compensation in classical organizations arises in
unionized classical firms. Because of the low consideration for workers’ needs in most classical firms and their adversarial worker-management relations, workers in these
organizations often form unions in an attempt to protect their interests. These unions often
win substantially higher compensation packages than management would wish to provide−packages that include extensive benefits. As a result, non-union classical firms often
provide more compensation than they would wish, in order to attract employees and as a
union avoidance tactic. Ironically, these classical firms may end up paying very well indeed,
which is precisely the opposite of their compensation goal.
Human Relations Managerial Strategy
The human relations approach is similar to the classical approach in terms of job design,
although management attempts to arrange jobs to allow social interaction among employees. This approach is also similar to the classical school in the way it coordinates employees. But
the supervisor’s role is much more complicated than it is in the classical school. Leadership is
still autocratic in the sense that senior management makes all the important decisions, but there is a much greater attempt to “sell” the decisions, something the classical manager does
not bother with.
Human relations managers understand that people like to feel they have some control over
their work lives, so they attempt to provide employees with the feeling that they have some
influence over company decisions (although employees typically have little real influence).
Therefore, employees are sometimes asked for their opinions on decisions, or they are
permitted to make a number of minor, inconsequential decisions. Besides attempting to sell decisions, the supervisor has the added task of exhibiting a high concern for people and
fostering a pleasant atmosphere. Overall, the leader plays a controlling but employee-
oriented role.
COMPENSATION TODAY 2.1
Classical Organizations In The 21st Century
If you use an iPhone, or one of many other brand name smart phones, it is very likely to have been made in China by Foxconn. Foxconn is the world’s second largest employer after
Walmart, employing 1.4 million workers in China alone.
For most of the manufacturing workers at Foxconn, a typical work day looks like this: you enter a multi-storey concrete building in the morning, put on the uniform (a plastic jacket, hat,
and booties); for the next 10–12 hours, you may be sitting or standing on a production line
with many others for most of your shift; your tasks may be to grab components from a bin and slot them into circuit boards as they move down a conveyer, or to feed a machine with tapes
that hold tiny microprocessors like candy on paper spools, or to check a component under a
magnifying glass, or to place completed cell phone circuit boards into lead-lined boxes to test each piece for electromagnetic interference. You raise your hand when you need to go to the
washroom and wait for someone to take your spot. You get an hour for lunch and two 10-
minute breaks. You also get to switch roles every few days for cross-training. So far it is
probably the same or similar to factory work anywhere in the world, a 21st-century version of Charlie Chaplin’s Modern Times with some variation. After work, you walk or take a shuttle
back to your company-provided dormitory, where you share a room with up to seven other
employees. While this may seem less than ideal to Westerners, it is much better than many workers in other factories experience; they have to find shelter in dodgy slums or sleep on the
assembly line. After you eat in the company cafeteria, you can watch television in a common
room, or play videogames or check email in one of the on-campus cybercafés. If you are dating, there are a few “couples’ booths” that you can use. The next morning, you clean
yourself up in the communal sinks or showers, then head to the production line to do it all
over again. The hourly pay is $US1–$2, but provides you an opportunity to save and send home money to help your family, often in the rural areas. Fifty-hour workweeks or 10–12 hour
shifts are typical, but up to 100-hour workweeks during peak production can be possible. You
like some overtime work because it gives you the opportunity to make some extra money to send home. Optimizing work design to minimize task variation and leveraging low labour cost
provided by geographical differentials (many workers are from rural areas) is how Foxconn
can deliver flexibility and scale at rock-bottom prices.
While this industrialization process may have benefited many Chinese workers, it was not
without problems. Seventeen worker suicides were reported by 2011. As Foxconn expanded
into the interior of China, strikes and riots were reported. With the increasing public attention
and audits by customers like Apple, Foxconn is making improvements, including increases in wages to keep up, in part, with minimum wages in China, and a commitment to limiting
overtime work to keep within the Chinese legal maximum of 49 hours a week total hours
worked.
At the same time, another new development may not be good news for workers. In 2016,
Foxconn replaced 60,000 factory workers with robots, a continuing trend in the manufacturing
industry as a way to reduce cost.
Sources: Joel Johnson, “1 Million Workers. 90 Million iPhones. 17 Suicides. Who’s to
Blame?” Wired, February 28, 2011, http://www.wired.com/2011/02/ff_joelinchina, accessed
September 20, 2016; Ross Perlin, “Chinese Workers Foxconned,” Dissent, Spring 2013, https://www.dissentmagazine.org/article/chinese-workers-foxconned, accessed September
20, 2016; Jane Wakefield, “Foxconn Replaces ‘60,000 Factory Workers with Robots,’” BBC
News, May 25, 2016, http://www.bbc.com/news/technology-36376966, accessed September 20, 2016; Foxconn website, “Competitive
Advantages,”http://www.foxconn.com/GroupProfile_En/CompetitiveAdvantages.html,
accessed September 20, 2016.
In the human relations school of thought, control is still external but is preferably exercised
through the work group. The human relations organization devotes considerable effort toward developing loyal employees who are dedicated to the norms of the organization. Pressure
from the work group is expected to make individual members conform to the organization’s
expectations. If this fails, the supervisor is then expected to step in. However, punishments are
not used extensively, out of fear that they will disrupt the social harmony.
Communication within informal work groups is encouraged, and management often attempts
to utilize the grapevine for communication. Management also makes considerable effort to facilitate social communication (such as when an employee marries or has a baby). However,
the flow of work-related communication tends to be low, whether up or down the hierarchy.
As in the classical school, management still tries to restrict the flow of what it considers to be
important information. But unlike in the classical school, they often make use of suggestion
systems and newsletters.
The human relations strategy calls for rewards that are mainly extrinsic and that focus on
loyalty to the organization. Salaries (rather than hourly pay) are often used to foster a feeling of permanence. To encourage workforce stability, seniority increases are also likely provided.
In addition, liberal employee benefits may be provided, again to develop employee loyalty. A
number of noneconomic rewards may also be provided, such as five-year pins and employee- of-the-month citations, to show that the organization is interested in its employees.
Management expects employees to find the positive social environment in these firms
rewarding.
One firm that was famous for its human relations strategy was Kodak (see Compensation
Today 2.2), although the firm had been attempting since the 1990s to adopt a more high-
involvement strategy in response to its increasingly dynamic task environment. Unfortunately,
this change did not succeed, and the venerable company slid into bankruptcy in 2012.
High-Involvement Managerial Strategy
Under the high-involvement model, job design is very different from what we saw in the
previous two strategies. Here, a strong effort is made to create jobs that are both interesting
and challenging and to provide workers with considerable autonomy when it comes to
planning and executing the work activity, as well as with job-based feedback on how well they
are performing. Efforts are made to include a meaningful cycle of work activity, with the result that jobs are broader and involve more elements. Joint employee–management planning and
goal setting are often used. In contrast to the classical approach, a conscious effort is made
to combine the thinking and the doing.
Coordination is horizontal as well as vertical. In fact, horizontal coordination, whereby
workers coordinate directly with one another in task completion, is preferred to vertical
coordination. Jobs are often arranged in clusters, with a group of employees responsible for coordinating the completion of a set of tasks. These clusters, or teams, often consist of people
from various specialties mingled together. Departmentation is based on the product,
customer, or project, not on functional groupings.
The role of the supervisor in a high-involvement organization is very different from that in the
other two schools. Rather than being primarily a controller and evaluator, the supervisor is a
facilitator. His or her job is to remove barriers to effective performance and to provide adequate resources and other assistance to enable subordinates to perform effectively. Since
employees are assumed to be able to exercise self-control and self-motivation, the supervisor
does not need to perform a control function. Moreover, because employees are assumed to be self-motivated and competent, decisions can be made at the lowest possible level in the
organization. The leadership style is participative or democratic in nature.
COMPENSATION TODAY 2.2
Did Human Relations Sink Kodak?
Eastman Kodak, the well-known photographic products firm, had been renowned for the
fierce loyalty it generated among its employees. But this didn’t happen by accident. Historically, Kodak’s management practices had included rigid adherence to a “promote from
within” policy, an excellent compensation package with large profit-sharing bonuses, and a
“no layoff” policy to maintain employment security. Its benefits package was truly remarkable, including everything from an excellent pension plan to generous sick leave entitlements and
even free noontime movies. As a result, Kodak attracted top-notch employees.
Although most companies in its industry were unionized, there was never any interest in unionization among Kodak employees, and the company always remained non-union. The
company had many long-term employees who were committed to the traditional “Kodak
way” of doing things, which had proved successful for many years. A classic illustration of
Kodak’s traditional mentality was the case of a supervisor who had recently retired. When he left, it was discovered that he had kept employment records from as far back as the 1930s in
his office drawer “because they had always been there.”
Management style at Kodak could best be described as patient and paternalistic, with an
extensive system of written rules, policies, and procedures. Even minor decisions percolated
to the top. For instance, the head of photographic and information products could be called
on to make a decision on any one of 50,000 products.
Although the company had many years of success with this human relations managerial
strategy, coming to dominate the world market for many photographic products, it started to encounter problems in the 1980s, resulting in financial difficulties by the end of the decade.
Profit-sharing bonuses shrank to nothing, and the company was forced to sell divisions, close
plants, and lay off thousands of employees, the first such layoffs in the company’s history.
What happened?
Several things. New competitors, such as Fuji, had entered the film market, a high-margin
market dominated by Kodak for decades. In addition, technological change in the photographic business had increased dramatically, and Kodak wasn’t able to keep up, despite
spending billions on research and development. For example, Kodak didn’t believe that 35
mm cameras or video cameras would amount to much and delayed entry into these products until they were dominated by others. When Kodak did introduce new products, such as the
disc camera and a CD system for viewing snapshots on a television screen, these new products
flopped.
In late 1993, Kodak brought in a new CEO, George Fisher, who had been head of Motorola (a
highly innovative and effective producer of communications technology) to try to get the
company back on track. Shortly after his arrival, Fisher attempted to move toward a high-
involvement managerial strategy in those areas of the business that depended on innovation.
However, Kodak’s problems continued, resulting in layoffs in 1998 that reduced the
company’s workforce from 100,000 to about 84,000 employees; continuing reductions
decreased total employment to 80,000 by mid-2000. While this did improve the company’s bottom line, it didn’t seem to make the firm any more flexible or innovative. That prompted
some commentators to argue that Kodak should give up on innovation entirely and hive off
the innovative portions of its business—such as digital imaging—into a separate business not
under the control of Kodak management.
Instead, in 2003, Kodak launched a four-year downscoping program to focus on digital
photography products and printers, during which time the firm reduced employment to about 27,000 employees. However, as seems typical for Kodak, it was considered “late in the game”
to get into digital products and services, and the printer market was already saturated. In
2009, Kodak froze employee pay for the year and cut another 4,500 employees. In 2012, the
firm declared bankruptcy.
Sources: Sanford M. Jacoby, Modern Manors: Welfare Capitalism Since the New
Deal(Princeton: Princeton University Press, 1997); Stephen P. Robbins, Organization Theory:
Structure, Design, and Applications(Englewood Cliffs: Prentice-Hall, 1990), 514–15; Mark
Maremont, “Kodak’s New Focus,” Business Week, January 30, 1995: 62–68; Peter Coy, “The
Myth of Corporate Reinvention,” Business Week, October 30, 2000: 80–82; Ben Dobbin,
“Perez to Replace Carp as Kodak CEO,” Business Week Online, May 11, 2005; Franklin Paul,
“Kodak to Cut Up to 4,500 Jobs,” Reuters, January 29, 2009.
Control is internal (within the individual). Employees are expected to exercise self-control, because of their identification with the goals of the organization and the intrinsic rewards
flowing from the work itself, and because they have sufficient training and knowledge to
behave responsibly. Because of this internalized commitment, little supervision is necessary
and formalized rules and regulations can be kept to a minimum.
Full disclosure of information is essential, since decisions are being made at all levels
throughout the organization. Without adequate information, poor decisions would result. The high-involvement firm recognizes this, so communication is a major focus of management
attention. Great effort is made for communication to flow vertically (both up and down the
organization), horizontally, and diagonally.
A high-involvement organization uses a wide variety of both intrinsic and extrinsic rewards.
Employees are expected to receive substantial intrinsic rewards directly from performing their
jobs and participating in decision making. Extrinsic rewards are geared toward fostering good
performance rather than controlling substandard output, and they tend to focus on the work
unit, rather than the individual, since tasks are usually complex and require teamwork.
Base pay tends to be salary, augmented by profit- and gain-sharing plans of various types, as
well as employee share ownership. Pay is often person-based (i.e., pay for knowledge) rather than job-based, in order to promote skills acquisition and flexibility within the organization.
Because of the complex behaviour and high performance levels required in high-involvement
organizations, reward and compensation systems are usually more complex than those in
firms using the other two managerial strategies.
Compensation Today 2.3 illustrates how one high-involvement firm, WestJet, puts all of this
together.
COMPENSATION TODAY 2.3
Involvement Flies High at WestJet
Founded in Calgary in 1996, WestJet Airlines has enjoyed phenomenal growth in an industry characterized by bankruptcies and failures. In 2000, its share of the Canadian market was 7
percent, compared to the 77 percent held by its main rival, Air Canada. By 2011, WestJet’s
market share had quintupled to 36 percent, while Air Canada’s had declined to 56 percent and
most other competitors had disappeared entirely.
Although once a stable industry, the airline industry has been anything but stable in recent
years. Starting with deregulation in the 1980s, the environment for the industry has become turbulent, buffeted by recession and unforeseen events such as the terrorist attacks of
September 11, 2001, increased airport taxes and security costs, the SARS epidemic, and even
the H1N1 flu pandemic, all of which affected travel. So, in this kind of environment, what has
accounted for WestJet’s success?
The founders started with the vision of differentiating WestJet from its competitors by
establishing a workforce of friendly, upbeat employees committed to customer service and by
delivering low ticket prices through operational efficiencies, such as flying only one type of aircraft (the Boeing 737) to reduce maintenance costs. From the beginning, the founders
considered the practice of a high-involvement managerial strategy the cornerstone to the
firm’s success. Jobs are defined broadly, with ticket counter staff doubling as baggage handlers when necessary. (Unlike most airlines, WestJet is not unionized, which provides
more latitude for flexible work assignments.) Within the guidelines that must be followed for
safety and operational reasons, employees are given latitude to do what they can to create an
enjoyable flying experience for “guests”—as passengers are known.
Employees (known as “our people” or “WestJetters”) are aided in developing their trademark
comedic banter by the “WestJesters.” This is one of several committees of WestJet flight
attendants who meet regularly to discuss everything from customer service to language and
culture. This participative approach permeates the entire company. For example, when
confronted with the travel plunge caused by the 2008–09 financial meltdown, the firm included rank-and-file employees in consultations about how to see itself through this
challenging period.
Why can management expect employees to show as much concern about the firm as the owners do? Well, the intrinsic rewards built into the jobs themselves and the highly
participative and satisfying corporate culture certainly help (the firm has been rated as having
the best corporate culture in Canada for several years running), but the most important reason
is that the employees are owners. Instead of a conventional defined benefit pension plan (which the firm was not sure it could afford), WestJet has a share purchase plan under which
employees can invest up to 20 percent of their earnings in company shares, which the
company then matches with free shares. Also, with no employee contributions required,
employees receive shares through an employee profit-sharing plan.
However, as the airline grows, and with pressures to become more mainstream, there are
indications that its culture may be changing. Some employees are becoming disgruntled with their workload and the union threat is becoming real. There are recent reports that employees
are not cracking jokes as before, maybe as a result of increasing job pressures. Competition
from Air Canada and other airlines is also increasing. These are challenges that WestJet will have to effectively manage as it tries to achieve its goal of becoming one of the top five airlines
in the world.
Sources: Jason Kirby, “WestJet’s Plan to Crush Air Canada,” Maclean’s, May 4, 2009, 38–41; Richard W. Yerema, Canada’s Top 100 Employers(Toronto: Mediacorp, 2005); Andrew Wahl,
“Culture Shock: A Survey of Canadian Executives Reveals That Corporate Culture Is in Need of
Improvement,”Canadian Business online, October 10, 2005; Christine Owram, “Losing the WestJet Effect: How the Once Scrappy Upstart is Changing as it Expands Globally,” National
Post, October 2, 2015, http://business.financialpost.com/news/transportation/losing-the-
westjet-effect-how-the-once-scrappy-upstart-carriers -culture-is-changing-as-it-expands-
globally, accessed September 21, 2016; Parbudyal Singh, “WestJet Airlines: Clear Skies or
Turbulence Ahead?” Case Study, Nelson Canada, August 2013.
Interrelationships Among Structural Variables
It should now be apparent that there are strong relationships among the structural variables.
Some elements are complementary—that is, they must occur together for any of them to be
effective. For example, pushing decision making down to lower-level employees in the
organization is dangerous if they have not been provided with adequate information with which to make informed decisions, a knowledge base to understand this information, and a
reward system that creates a strong sense of identity with the company. But at the same time,
creating knowledgeable, well-informed employees with a financial stake in the firm’s performance and then not allowing them input into decision making creates employee
frustration.
Research has also shown that some structural elements can serve as substitutes for others. For example, a Canadian study has shown that profit-sharing and gain-sharing systems can
serve as substitutes for managerial control.11 This study found that firms that had profit- or
gain-sharing systems (or preferably both) were able to operate with 31 percent fewer
managers and supervisors and significantly fewer rules and regulations than firms without
these systems. These firms, like WestJet, substitute internal (self-)control for external control.
Organizations that consistently adopt a single managerial strategy, no matter what that
managerial strategy is, are usually more effective than those that have an inconsistent mix of structural elements. MacDuffie refers to internally consistent practices as “human resource
bundles”12 and presents evidence that firms that use these “bundles” perform better than
those that do not.
It should be noted that even within a given managerial strategy, there are various possible
combinations of human resource policies. For example, a firm may choose to hire only
experienced workers, or it may hire inexperienced workers and train them. Hiring experienced workers usually costs more in compensation, but hiring inexperienced workers costs more in
training costs and there is the risk of losing them once they are trained.
But different managerial perspectives have different preferences. Because of high turnover, classical organizations would prefer not to incur high training costs. So their tendency is to
hire experienced, trained workers, where jobs require training. (Their preferred course of
action is to fragment tasks into small pieces so that little training is necessary.)
Other human resource policies, such as recruitment, must fit into the managerial strategy.
Because high-involvement organizations need workers who have high potential for growth,
self-control, and motivation by higher order needs, they have the most comprehensive
selection processes. In contrast, because classical organization demands are simple task performance, they have the least sophisticated recruitment and selection procedures. Human
relations organizations fall in between: they want to screen out people who would disrupt the
social environment of the firm.
Before we leave organization structure, there is one other concept that is relevant—
organizational culture. “Organizational culture is the set of values, guiding beliefs,
understandings, and ways of thinking that are shared by members of an organization.”13 Organizational culture—that is, the organization’s informal structure—can
help guide employee behaviour.
A strong culture can play a major role in shaping and directing behaviour within the organization. Culture can supplement the organization’s formal structure or can substitute for
it. For example, because of their need to stay flexible, high-involvement organizations like to
use as little formal structure as possible, so a strong organizational culture is important to them. Classical firms, on the other hand, prefer to depend on the formal structure, so they
focus very little on organizational culture. Human relations firms use both formal structure
and culture to shape behaviour.
A given culture may be beneficial to one organization but detrimental to another, depending
on whether it fits with the managerial strategy. However, some cultures are simply
detrimental. For example, employees in many classical organizations develop a strong anti- management culture, which may include norms such as “never cooperate with management,”
“never go beyond your minimum work requirements,” and “ignore the rules when the
supervisor is gone.” In human relations firms, a culture of avoiding conflict, never criticizing the company or a coworker, valuing tradition, and doing things the way they have always been
done tends to develop. Remember the Kodak employee who kept 50-year-old employment
records in his desk drawer because they “had always been there”? In contrast, key cultural
values in high-involvement organizations such as WestJet include honesty, trustworthiness,
open communication, and acceptance of risk taking.
An organization shapes culture by its actions. For example, a firm that says it values initiative
and risk taking but then punishes every employee initiative that fails teaches employees not to exercise any initiative. The reward system is critical in shaping culture. A firm that says it
values cooperation and teamwork but then promotes an employee who isn’t a team player is
signalling a very different message. If a company’s top management is fond of talking about how “we are all partners in this enterprise” but doesn’t share gains when the firm is successful
and lays off employees at the first sign of trouble, then employees will not feel much like
“partners.”
Human relations and high-involvement organizations typically spend considerable effort
developing their cultures. But culture is most important to high-involvement organizations
because they depend on it as a substitute for the formal structure. Organizational culture, as a
concept, came to prominence with the rise of high-involvement organizations.
// Determinants Of The Most Appropriate
Managerial Strategy
If the most appropriate reward system is determined by the managerial strategy, then it is
important to understand the factors that determine the most appropriate managerial
strategy. The answer lies in the five key contextual variables identified in Figure 2.1: environment, business strategy, technology, organization size, and nature of the workforce. It
important to know how each variable relates to managerial strategy.
This section begins by showing how each of these contextual variables can be categorized into types, and then how each type relates to managerial strategy. At the end of this section (in
Compensation Notebook 2.2), a template is provided as a tool for helping identify the most
appropriate managerial strategy (and hence, reward strategy) for any given organization.
Of course, just because the contextual variables point to a particular managerial strategy
doesn’t necessarily mean that the organization has actually adopted that managerial strategy.
In some cases, firms may be using a managerial strategy that doesn’t match their contextual variables, and in some cases, firms really have no distinct managerial strategy.14 In either case,
company performance will be lower than it should be; indeed, company survival could be
threatened if competitors have adopted the most appropriate managerial strategy.
Finally, an organization may have a mixed set of structural dimensions and thus appear to
have no definite managerial strategy, but it is actually in a planned transition from one
managerial strategy to another. This transition may be very appropriate if the change is being driven by the need to respond to changes in the firm’s contextual variables, although
successful transitions from one managerial strategy to another (such as from classical to high
involvement) are actually very difficult.
Environment
Of the five contextual variables, the most important is the environment that faces a given firm.
The first question to ask is whether the firm’s environment is stable or unstable. An unstable
(dynamic) environment exists where product or service life cycles are short, where product or service demand is volatile, where customer needs change quickly and unpredictably, where
technologies are changing rapidly, where new competitors often enter the field, and where the
regulatory environment is unpredictable. Firms generally have little control over the level of stability in the task environment. Because of their rigidity, classical and human relations firms
have great difficulty operating successfully in dynamic, unstable environments.
The second question to ask is whether the firm’s environment is simple or complex. A firm’s environment is complex if the firm has many distinct product or service domains, if the
product/service provided is complicated, if the technology is complex, and if a multitude of
factors can influence success. While firms do not have much control over the degree of
stability in their environments, they do have some control over the complexity of their task environments. For example, a firm that chooses to operate in a number of unrelated
product/service domains creates a more complex environment for itself than a firm that
operates in only one product/service domain. Thus, the complexity of a firm’s environment depends in part on how broadly it defines its domain(s). But note that some domains (e.g.,
designing microcircuits) are inherently more complex than others (e.g., processing chickens).
However, even if a task environment is complex, as long as it is stable, a classical or human
relations approach can be effective. If the complexity stems from operating in many domains,
either a classical or human relations approach should work. But if the complexity is due to the domain itself, then a human relations approach may work best. This is because complex
domains often require high levels of expertise among employees, and the high turnover that
typifies a classical organization will be very costly in these circumstances.
By contrast, when task environments are dynamic, complexity compounds the uncertainty
facing the organization. Neither classical nor human relations organizations are able to adapt
quickly to environmental change. In general, a high-involvement approach is needed whenever environments are highly unstable or dynamic; this is even more essential when the
environment is also complex.
Corporate Strategy
There are two main ways of classifying an organization’s business strategy, one developed by
Miles and Snow15 and the other developed by Porter.16 Each of these typologies yields useful
insights into how business strategy relates to the most appropriate managerial strategy for an
organization to adopt, so they will be discussed in turn.
Miles and snow typology of corporate strategy
Miles and Snow suggest that business strategies are of three main types—defender,
prospector, and analyzer—with a residual type—reactor—to cover firms that do not practise
any distinct overall strategy.
The defender business strategy entails taking a narrow product or service segment and
excelling in it, based on a combination of product quality and price. A defender firm may not always be the low-cost leader, but it will always try to provide the best possible quality/price
tradeoff so that its products offer the best value to customers. The byword for this strategy
is consistency. The key need is to identify the most efficient process for providing the product or service and then to lock it in. For defenders, the classical or human relations approaches are
most suitable. In general, classical works well for manufacturing, and human relations for
service enterprises, where there is extensive contact with customers.
The prospector business strategy is the complete opposite of the defender strategy. It focuses
on identifying new product and market opportunities and being the first to exploit them.
Prospectors tend to move on to other new products or services as competitors enter the market. These competitors can copy the product and mass produce it at a lower cost than the
prospector can because the competitors do not have to include development costs or costs of
failed products in their pricing structures. The byword for the prospector strategy
is speed. The key needs are for a process to identify new opportunities quickly and for an organization flexible and dynamic enough to get them to market before anybody else. Clearly,
a high-involvement approach is essential.
The analyzer business strategy is the most complex of the three corporate strategies because it attempts to combine the prospector and defender strategies. This strategy entails
identifying and exploiting new product or service opportunities at a relatively early stage—not
long after the prospectors—while also maintaining a firm base of traditional products or
services. The byword for the analyzer strategy is balance. The key need is to be able to balance stability and flexibility. This often requires a hybrid or dual organization structure: one
that promotes speed and flexibility for new product development, and one that promotes
stability and consistency for established products. Typically, analyzer firms are not the first to offer new products or services, but they do enter these markets early, after the prospectors
have identified them. They are generally less efficient in production than defenders, but are
able to get their products on the market long before the defenders in the industry get around
to doing so.
Analyzers likely operate best with something close to a high-involvement approach for new
product development and a classical approach for their traditional products. But since it is
very difficult to practise two such divergent managerial strategies in the same firm, analyzers
often seem to end up practising a compromise human relations strategy across the board.
This can be successful as long as the environment is not too dynamic.
Porter’s typology of business strategy
Porter suggests that business strategies can be categorized along two dimensions, based on
whether the firm is seeking to be the low-cost producer of standard products or whether it is attempting to differentiate itself by having unique products or services, and on whether the
firm is catering to a narrow customer base (a “focus” strategy) or a broad customer base.
These distinctions result in four types of business strategy—the low-cost strategy, the focused
low-cost strategy, the differentiator strategy, and the focused differentiator strategy. Because
they depend on innovation and creativity, the differentiator strategies seem best suited to the
high-involvement managerial strategy; because they emphasize tight cost controls, the low-
cost strategies seem best suited to the classical managerial strategy.
Technology
An organization’s technology is the set of procedures and resources it uses to transform
resources to usable products or services. An organization’s technology can be classified in a variety of ways, such as the type of production processes involved; for instance, the number of
sequential steps a task can be broken down into.17 Classifications can also be made on the
degree to which the technology is routine or non-routine,18 or whether small or large batches
are used.19 The technology used by the organization will have implications for its workforce
capabilities, for example, and this will influence the complexity of the firm’s environment and
the managerial and compensation strategies to be used.
Organization Size
Because of the need to coordinate and control large numbers of people, large organizations
generally use classical or human relations strategies, although these strategies can be found in
organizations of all sizes. In general, it is easier to implement high involvement in a small to medium-sized organization, because the larger the organization, the greater the need for
some formal structure. However, some large organizations have resolved this problem by
segmenting the organization into a series of relatively small units and then practising high
involvement in these units. Hewlett-Packard, the computer products firm, has traditionally
used this approach.
Size affects structure in at least one other way. As organizations get larger, the impact of
technology on their structure lessens. Some large organizations may use a number of different technologies. This diversification may call for different managerial strategies in different parts
of the organization, which can be very difficult to manage since top management tends to
prefer one particular managerial strategy (the one consistent with their assumptions about
people).
The Nature of the Workforce
The nature of the people employed by the organization—their skills, educational
characteristics, and expectations—also has a major impact on the choice of managerial
strategy. Highly skilled, well-educated, or professional employees are generally more suited to
the high-involvement organization. Indeed, a high-involvement strategy requires these
characteristics because of the broad job and decision-making responsibilities that employees
are expected to assume.
Classical organizations are designed specifically to utilize employees with relatively low skill levels. Because of their approach to motivation and control, these organizations are best
suited to workers who badly need the money the job provides. Classical motivational
approaches work best in poor economic circumstances and in areas with high unemployment
and a low standard of living. (This helps explain why many classical firms move their production operations to less prosperous countries, where living conditions make their
managerial strategy effective.) In contrast, human relations organizations can often utilize
relatively low-skilled workers but do not need to depend on poor economic circumstances for
their motivational policies, since they offer both economic and social rewards.
It is also important to note the role of unions in organizations. Unions can have an effect on
employee skills, their tasks and responsibilities, and their expectations. Unions add voice to employees and influence pay in the bargaining unit through collective bargaining. In
unionized environments, employees usually receive higher pay and more benefits. Unions also
have an effect on managerial autonomy; that is, unions may put restrictions on what
management can and cannot do. Overall, unions will have differential effects on managerial
strategies, employees’ attitudes and behaviours, and organizational outcomes depending on
the interaction of all aspects of the organization’s context.
Tying It All Together
In order for an organization to maximize its chances of success, the chosen managerial
strategy must align with the firm’s contextual variables, and those variables must align with
one another. For example, using a long-linked technology or a defender strategy in an unstable environment is courting disaster, because the organization may not be able to
respond quickly to change. Compatible combinations would be those that are consistent with
a given managerial strategy. Thus, a defender strategy, a stable environment, a long-linked technology, a relatively low-skilled workforce, and a large organization would be a good
combination, well suited for the classical managerial strategy.
Compensation Notebook 2.2 illustrates these combinations and provides a template for selecting the most appropriate managerial strategy for a given organization to adopt. (Of
course, where the contextual variables are out of alignment with one another, there can be no
ideal managerial strategy and no ideal reward strategy.) The template also helps solve the mystery of why some firms do quite nicely without adopting pay innovations, and why
compensation systems that work well for some firms are completely inadequate in others.
Let’s use this template to revisit some of the organizations you learned about earlier in the
chapter. Let’s start with Koch chicken processors. But before doing so, you need a little more
background on chicken processing, which Compensation Today 2.4 provides. After reading
Compensation Today 2.4, you will probably know more about chicken processing than you
ever really wanted to know.
Now, let’s compare Koch Foods with the characteristics in the template. Koch Foods has a
stable, simple environment, uses a defender strategy (where low-cost production is crucial)
and a long-linked technology, requires low-skilled employees, and is located in a region (Mississippi) where economic conditions are generally poor. Perfect for a classical structure!
Although employee turnover is high, it doesn’t matter because employees are easy to replace
and train. Employee commitment is not needed because control is easy, with the technology
itself (the “chain”) providing most of the necessary control. Given all this, the sole purpose of
the compensation system is to ensure a sufficient flow of applicants so that the chain is always
staffed at the lowest possible cost.
COMPENSATION NOTEBOOK 2.2
Template for selecting the most appropriate managerial strategy For an organization to
adopt
COMPENSATION TODAY 2.4
Anyone For Chicken Fingers?
If chickens don’t have fingers, then where do chicken fingers come from? One story is that a
marketer was trying to come up with a name for the company’s new chicken product when there was an accident on the processing line. An employee had two fingers lopped off, which
fell into the boxes of chicken parts. As workers shouted, “Get the fingers from the chicken!”
inspiration struck the marketer! Whether or not this story is really true, safety on a chicken-
processing line is no joking matter, and accident rates are high in this line of work.
In a chicken-processing plant, all work is centred around the “chain,” on which the live birds
are first hung by workers dubbed “live hangers.” This is considered the worst of all the jobs in
the plant, as the angry chickens take every opportunity to peck, claw, and defecate all over the
workers, who are expected to clip a desperately struggling bird to the chain every two seconds
or so. Because so few workers can handle this job, it pays a bit more than the minimum wage
most workers receive.
The birds are then stunned electrically, killed, and mechanically plucked. They then continue
along the chain on their way to becoming packages of chicken parts. Many workers play a role in this transformation process as the birds pass by individual workers at up to 90 birds a
minute. Part of the transformation process is performed by workers known as “butthole
cutters,” who open up the bird so that a “gut puller” can reach in and pull out the innards. The process is wet and noisy, with workers in such close quarters that they often cut themselves or
other workers. Since any worker who doesn’t keep up creates more work for those down the
line, the system is basically self-supervising. And all this for minimum wage!
Not surprisingly, turnover is often over 100 percent a year. Since the demand for chicken has
been growing by leaps and bounds in North America, this is one job you won’t find tough to
snag even in a down economy!
Source: Based on Tony Horwitz, “9 to Nowhere,” Wall Street Journal, 1994.
Let’s take a closer look at L-S Electro-Galvanizing, which pays top dollar to its employees.
Because of overcapacity in its industry and stagnant demand for its products, the environment
can be considered quite unstable, although relatively simple, since LSE specializes in a narrow
range of products. The firm uses a defender strategy, with a focus on high-quality products.
Process technology is used. The plant is relatively small, with only about a hundred production workers. But because of the complexity of the production process, the skill levels
required of workers are high. The cost of errors is potentially high, as is the cost of downtime
due to equipment failures and other problems. Economic conditions in Cleveland, where the plant is located, used to be quite good, at least when LSE was first established (as with many
industrial cities in the United States, economic conditions are not great in Cleveland in recent
years).
When you compare these points to the template in Compensation Notebook 2.2, you can see
that the LSE case is not as clear-cut as the chicken plant case: various contextual variables
point toward different managerial strategies. You can find examples of each of the three managerial strategies in the steel industry, although the classical approach predominates. But
LSE has obviously chosen a high-involvement strategy. Worker tasks and responsibilities are
broad. There are few supervisors in the plant, and each shift crew operates as a team to handle whatever needs to be done to maintain production and quality. Each team is delegated
a lot of decision-making power regarding the operation of the plant. To make such decisions,
the employees need to be knowledgeable, informed, and committed to the goals of the organization. They must also be flexible enough to work together to prevent and cope with
production problems. This means they must have broad knowledge of the entire production
process, rather than just a tiny part of it.
Clearly, the pay-for-knowledge system, gain- and profit-sharing systems, and high indirect pay
amount to a compensation strategy that supports the high-involvement managerial strategy.
But how can LSE get a payback from this very expensive compensation strategy? In several ways. First, because of employee flexibility, the plant has eliminated the specialized
maintenance personnel most plants must have on hand in case of a breakdown. Second,
because of delegation of decision making and use of employee self-control, fewer supervisors are needed, which keeps salary costs lower. In addition, LSE operates its plant with fewer
workers than comparable plants using conventional management practices, which reduces
labour costs. Third, turnover is low, which reduces recruiting and training costs. Fourth, and probably most important, the presence of multiskilled personnel reduces plant downtime and
improves product quality. When the system does go down, everybody can play a role in
getting the plant up and running again in a minimum amount of time. In this business, plant downtime is the single biggest driver of cost, followed only by production of an unusable coil
of steel, each of which may be valued at $25,000 or more.
Once all of this is factored in, guess what happens? You guessed it—the LSE plant actually
turns out to be more profitable than its lower-paying competitors.
Remember Foxconn in Compensation Today 2.1? Let’s use the strategic template to classify
this firm. It uses low-skilled labour and a routine technology. The firm deals with things, not people. The environment is simple and relatively stable, because of high demand for its
service.
From this information, we can predict that Foxconn could use a classical managerial strategy
very successfully, which, of course, it does. Given this, the pay system fits with the firm’s
strategy. We may not like Foxconn and we can predict that the employees probably don’t
either. However, whether by accident or design, Foxconn has created an organizational
system, including its pay system, that matches its strategy.
In contrast, Kodak illustrates what can happen when circumstances change and what was
once a highly effective management strategy no longer fits these circumstances. Conditions
used to fit the human relations strategy well. Kodak always had a complex environment, as evidenced by the vast array of products it made, but the firm’s very dominance created a
relatively stable environment. In the 1970s and 1980s, it tended to practise a defender strategy
for some products and an analyzer strategy for others. Technology was routine for most products. Except in the research and development areas, only moderate employee skills and
education were required.
But when competitors entered the field and product innovations occurred, Kodak could not change rapidly enough to adjust to these changes. It was too slow moving, and its overloaded
hierarchical decision-making systems did not have the capacity to judge its environment
accurately. This problem was compounded by the firm’s acquisition of unrelated companies,
such as Sterling Drug in 1988.
Kodak’s organizational culture of stability, which had once been an asset, became a liability
when the firm tried to move toward a prospector strategy. The company undertook several
measures to try to deal with these problems, such as reducing environmental complexity (through the sale of noncore divisions) and moving toward a high-involvement strategy in
areas of the business that depended on innovation. But as Compensation Today 2.2 suggests,
these changes did not bear fruit. Moving from a human relations organization to a high-
involvement organization is a very difficult and long-term process, especially for large
organizations with well entrenched cultures.
Finally, let’s consider WestJet. It is an excellent example of fit. Look at how its high-
involvement managerial style fits the company’s context: unstable, complex environment; differentiator strategy; relatively small size; relatively educated workforce; operating in a
relatively prosperous region. Instead of a formal structure, the organization cultivates a
culture of commitment, egalitarianism, teamwork, and risk taking. And look at how the reward
system fits with and supports the company’s strategy.
// Trends In Managerial And Compensation
Strategies
All three managerial strategies can be effective in the right context. But how are circumstances
changing in North America, and how will these changes affect the choice of managerial
strategy? This is an important question for those designing reward systems, since the most
appropriate reward system for a given firm depends on the managerial strategy that is in place at that firm. To get a handle on this question, you need to understand how business
conditions and managerial strategies have evolved in Canada. As will be discussed at the end
of this section, these changes also help explain some of the current trends in Canadian
compensation practices.
The Evolution of Managerial Strategies
Since the development of classical and human relations managerial strategies in the first half
of the 20th century, many fundamental socioeconomic changes have taken place in Canada, and those changes have created conditions that are more suitable for high-involvement
organizations and less suitable for classical and human relations organizations. Educational
levels have increased, economic security and social security have improved, and social values
have become more democratic and egalitarian.
Information technology has allowed for flatter organization structures and more decentralized
decision making. At the same time, products and services have become more complex, along with the technologies used to produce them. All of this generally calls for greater skill,
initiative, and motivation from employees. Rapid discovery of new knowledge causes older
knowledge to quickly become obsolete, and it is not uncommon for new employees in many firms to understand far more about the firm’s technology than their bosses. All of these
conditions work against classical and human relations organizations.
While there remains a demand for simple products and services, globalization has allowed much of the work of producing these products and services to be outsourced to a variety of
developing countries. Because these developing countries have conditions that better fit
classical organizations (such as large unskilled or semiskilled workforces with relatively poor
economic circumstances) than the conditions in Canada, many classical firms have found developing countries a much better fit for their preferred managerial strategy and have moved
operations there.
While there are still some contexts in which classical and human relations strategies are effective in Canada, notably for organizations producing relatively simple products and
services and operating in protected or less competitive markets, Canadian firms are finding it
increasingly difficult to make these two managerial strategies work for them. For classical firms, besides a problem with poor employee–management relationships, the key problem in
changing times is rigidity. Classical organizations spend huge sums to discover the “one best
way” of doing something, to develop specialized technology and job structures, and then to
lock in employee behaviour. Obviously, employee innovation is discouraged; if a company
already has the “best system,” then by definition, any deviation is inefficient. And despite their
kinder employee relations, human relations organizations tend to be as rigid and inflexible as
classical ones.
To survive, human relations companies have been forced to react to their changing
environment in one of three ways. First, some try to become more classical, eliminating job security, cutting wages and benefits, and cutting staff—in other words, undoing the very
managerial practices that made them successful in the first place. However, while this “lean
and mean” approach may prolong their survival, it does not deal with their fundamental
problem: their inability to cope with change. Paradoxically, there is considerable evidence that such actions actually make the organization more resistant to and/or incapable of change. The
best employees end up feeling betrayed and seek jobs elsewhere, while the remainder try to
keep their heads down. Furthermore, the high stress levels caused by the lean-and-mean approach are antithetical to effective change. Interestingly, there is evidence, based on
samples of Canadian firms, that downsizing generally does not increase future
profitability20 and that it actually decreases worker efficiency.21
A second option is to retain the human relations school of thought but attempt to shift to
markets that are less dynamic. In other words, if your environment no longer fits your
management strategy, find an environment that does. This course of action often requires major surgery, with entire divisions being sold or closed down. However, for those parts of the
organization that remain, there are no major changes to managerial strategy or to the reward
system. Some organizations have used this approach, known as downscoping, and it has
been successful in some but not all cases. As Compensation Today 2.2 described,
downscoping was part of Kodak’s strategy for survival, a strategy that did not succeed.
The final option for human relations firms trying to deal with environmental change is to retain the current domain but attempt to become flexible and innovative—that is, to become a
high-involvement organization. Converting to the high-involvement approach is in many ways
the toughest road, but it is probably the only one that will lead to long-term success if the firm
chooses to stay in a dynamic environment. (Indeed, environments that are not dynamic are becoming increasingly scarce.) This approach has major implications for all aspects of the
organizational system. As Figure 2.1 showed, virtually every structural variable—including the
reward system—must undergo dramatic change to make this conversion.
Classical organizations that find themselves facing a dynamic environment are in an even
worse position than human relations organizations. Since they are already “lean and mean,”
there is not much fat that can be easily trimmed, and tough unions may prevent them from becoming as mean as they would like to be. Seeing unions as a threat to their power, some
firms have attempted to destroy or at least weaken their unions. They then have a freer hand
to cut costs by cutting pay and benefits, reducing staffing levels, and increasing workloads. Other firms have attempted to circumvent the union by contracting out as much work as
possible to non-union or weak-union firms. Another tactic is to shift production to regions or
countries where unions are not strong or economic conditions are poor. Sometimes firms find that simply threatening to do so may be sufficient to get the union to agree to various
concessions.
Classical firms that have chosen to move to a high-involvement management approach have
an even tougher task than human relations organizations, because they are starting off with
very poor and adversarial employee–management relationships, and the key ingredient for
movement to a high-involvement school of thought—trust—is lacking. Furthermore, classical structural characteristics are the exact opposite of what is needed for a high-involvement
organization. It often takes a major crisis, coupled with visionary leadership, to successfully
make the transition.
A key part—perhaps the most crucial part—of making the transition to high involvement is
changing the reward and compensation system. The compensation system can be a powerful
tool for change or a powerful inhibitor of change (see Chapter 3). There is considerable
evidence that business firms attempting to move to high-involvement management find their success short lived if their reward and compensation system does not support the new
managerial strategy.22 Even when employees value high-involvement management for its
intrinsic rewards, failure to spread the extrinsic rewards generated by the new management system to all employees can create a sense of inequity that destroys the foundation of trust
and goodwill necessary for high involvement to be successful.
An exception to the need for extrinsic rewards can arise in not-for-profit organizations. Where the organization generates no financial surpluses that can be shared, employees may be
willing to accept high-involvement management (and even welcome it) on its intrinsic rewards
alone. But even here, it is unlikely that high involvement can survive long unless organization members perceive that whatever extrinsic rewards are available are being distributed
equitably. Overall, reward equity, to the extent that it is within the organization’s control, is a
critical foundation of the high-involvement approach (see Chapter 3).
Trends in Compensation Systems
The strategic framework presented in this chapter helps explain some of the trends that took
place in Canadian compensation systems during the latter part of the 20th century. The
underlying trend has been toward more complicated pay systems. When classical firms dominated, in the first half of the 20th century, pay systems were simple, based on output or
hourly pay. Then, as human relations firms came to the fore in the second half of the 20th
century, indirect pay made extrinsic rewards more complex, as more and more benefits were added to increase employee security and well-being, as illustrated by Kodak. Finally, as some
firms began to practise high-involvement management, with a need for complex employee
behaviour and high employee performance, compensation systems became still more
complex, with group or organizational performance pay added to the mix, as illustrated by
WestJet.
General compensation trends over the past two or three decades have included a major
increase in the adoption of pay-for-performance systems—especially those aimed at organizational performance, such as profit-sharing and employee share plans. There has also
been an increase in group- or team-based incentive systems, and more firms have also
experimented with pay-for-knowledge systems in place of traditional job-based pay systems. Flexible benefit plans have also increased in popularity, and there has been a gradual
movement away from hourly pay toward the use of salary. However, many of these trends
appear to have stalled in the first decade of the 21st century.
Not all trends have been driven by a movement toward high-involvement management. The
1980s and 1990s saw wage freezes and rollbacks, cuts to benefit plans, and the increased use
of two-tier wage structures (under which new employees were hired under a lower pay structure than that for existing employees). These practices fell back out of favour as
economic conditions improved in the late 1990s, then experienced a resurgence as the global
financial crisis and recession of 2008–09 took hold.
Those firms that try to address their financial problems simply by cutting employee
compensation tend to be either classical organizations that are attempting to become even
leaner and meaner or human relations organizations attempting to survive by shifting toward
less benevolent pay policies. Concomitant with this, many firms—not just classical or human
relations firms—are shifting away from defined benefit pension plans (where the employer
guarantees that pension payouts to retirees will be a specified amount) toward defined
contribution pension plans (where the employer makes no such guarantees).
Another change with direct implications for compensation was the increased use of part-time,
temporary, and contract workers (a.k.a. “contingent workers”) during the 1980s and 1990s.
While this trend levelled off in the first decade of the 21st century, it may re-emerge as a result of the difficult economic circumstances at the end of that decade. There were a number of
reasons for this trend (see Chapter 6). That said, a major advantage of contingent workers is
that they are often much cheaper to employ than regular full-time employees because of lower wages and employee benefits. Also, organizations can dismiss contingent workers
without demonstrating cause or providing severance pay; this provides flexibility and fits well
with the classical management philosophy. Another reason classical organizations like these workers is that they are easier to manage because of their economic insecurity. Now that
conditions have become more difficult for classical organizations, many are looking to
contingent workers as one means to survive.
Some high-involvement organizations have increased their use of contingent workers for
different reasons. For example, these workers strengthen employment security for the core
workforce by serving as a buffer against demand fluctuations. In many high-involvement
firms, though, contingent workers are compensated on the same basis as permanent
employees, because the motivation for using them is not to cut costs.
A final trend worth noting here is toward noncash employee recognition programs, whereby
desired employee behaviours are recognized in a variety of ways that do not involve cash
bonuses or pay raises. These programs have developed partly in reaction to the perceived deficiencies of cash-based performance recognition programs, and partly because they are
relatively inexpensive (see Chapter 3). By the early part of the 21st century, more than half of
medium to large Canadian firms reported having noncash employee recognition programs in place.23 However, rather than substituting noncash recognition for cash-based recognition
programs, it appears that most firms are simply supplementing their cash-based performance
pay with noncash employee recognition.
// SUMMARY
This chapter has provided a strategic framework for identifying the reward and compensation
system that will best fit an organization’s strategy and structure. To achieve this, the compensation system must be developed in the context of the total reward system, which in
turn must be developed in the context of the organization’s managerial strategy.
The three managerial strategies identified in this chapter—classical, human relations, and high involvement—each call for a different reward and compensation system. Since the most
appropriate managerial strategy (and therefore the most appropriate reward and
compensation system) for a given organization depends on certain key factors in that organization’s context, it is important that you understand what these factors are and how
they relate to managerial strategy. Compensation Notebook 2.2 provided a template to help
you identify the managerial strategy that best fits the five main contextual factors (environment, business strategy, technology, size, and the nature of the workforce) and
therefore would be the best choice for a firm to utilize.
However, not all firms actually adopt the managerial strategy that best suits their contextual variables, and the way to determine which managerial strategy a firm is actually using is to
examine its structural dimensions.
Overall, conditions in recent years have become much less favourable for the classical and human relations managerial strategies, and the shift to high involvement is changing the
nature of reward systems. Although there are still circumstances in which a classical or human
relations strategy remains viable, these circumstances are likely to become increasingly scarce in Canada. Organizations with a suboptimal managerial strategy can often continue to survive
for a period of time, but only as long as market conditions are favourable or as long as none of
their competitors is managed any better than they are. (Of course, if they have no competitors
at all, as in the case of a monopoly, they may be able to survive for an indefinite time even with
an inappropriate managerial strategy.)
Indeed, not all organizations have a conscious managerial strategy. In fact, in most
organizations, managerial strategy is implicit rather than explicit, although it still governs managerial behaviour in their organizations. The degree of development and refinement of
managerial strategies varies enormously across firms. However, for some firms, there is no
consistent managerial strategy at all. This means there is no ideal reward and compensation
system for these firms. When there is no coherent managerial strategy, you cannot design a
compensation system to support that strategy. In these cases, you cannot start designing an optimal reward and compensation system until you have sorted out the underlying
organizational problems.
But enough about strategy and compensation for now. The next milestone on your journey to effective compensation systems is to add to your conceptual toolkit a framework that will help
you understand how reward systems link to employee behaviour.
Key Terms
• analyzer business strategy
• business strategy
• classical managerial strategy
• communication and information structure
• contextual variables
• contingency approach to organization design
• control structure
• coordination and departmentation
• decision-making and leadership structure
• defender business strategy
• differentiator business strategy
• domain
• focused differentiator business strategy
• focused low-cost business strategy
• high-involvement managerial strategy
• horizontal fit
• human relations managerial strategy
• job design
• low-cost business strategy
• managerial strategy
• mission
• organizational culture
• organization structure
• prospector business strategy
• task environment
• values
• vertical fit
• vision
Discussion Questions
Discussion Question 2.1
Review
“If a compensation system works well for one business, that same compensation system should also work
well for other businesses.” Discuss whether this statement is true, and why or why not.
Your Answer
No answer submitted
Discussion Question 2.2
Review
Using the concept of fit, discuss the types of compensation and rewards that would work best for each of
the three managerial strategies.
Your Answer
No answer submitted
Discussion Question 2.3
Review
Discuss recent trends in compensation practices taking place in North America and explain what may be causing those trends.
Your Answer
No answer submitted
Using the Internet
Using the Internet Question 2.1
Review
Go to the website for the Canadian HR Reporter and click on Payroll. From the stories that have been
published in recent months, what seem to be the key themes and concerns in relation to compensation?
Your Answer
No answer submitted
Exercises
Exercise Question 2.1
Review
Take an organization that you know well, such as a current or former employer, and apply the template in Compensation Notebook 2.2 to determine the most appropriate managerial strategy for that firm. Does
this match the managerial strategy actually in use? If not, why not? Do you agree with what the template
indicates to be the best managerial strategy? Would you consider this firm to be an effective organization?
Does the organization’s reward system match its managerial strategy?
Your Answer
No answer submitted
Steeping some tea...
Case Questions
Case Question 2.1
Review
Read the “Achtymichuk Machine Works” case in the Appendix, Achtymichuk is having a lot of trouble motivating and retaining its cleaners. To get as many ideas as possible for solving this problem,
management have hired three different consultants. One is an adherent of the classical managerial
strategy, one is an adherent of the human relations managerial strategy, and one is an adherent of the high-involvement managerial strategy. Each consultant works separately and provides a separate set of
recommendations for solving the problem. All of their recommendations include changes to the
compensation system for cleaners, but these changes are all different. Knowing what you do about the three managerial strategies, what do you think the recommendations of each consultant were? Which do
you think would be the most effective solution? Your Answer
No answer submitted
Case Question 2.2
Review
Read “The Fit Stop Ltd.” case in the Appendix. Which managerial strategy would be most effective for this firm? Given what you know about Susan Superfit, which managerial strategy do you think she would prefer to use? Does this match your choice?
Your Answer
No answer submitted
Case Question 2.3
Review
Read the “Multi-Products Corporation” in the Appendix. Which managerial strategy would be most
effective for this firm? What reward and compensation strategy would fit this managerial strategy? What
problems might you encounter in using this managerial strategy?
Your Answer
No answer submitted
Simulation Cross-Reference
If you are using Strategic Compensation: A Simulation in conjunction with this text, you will
find that the concepts in Chapter 2 are helpful in preparing Sections A, B, and C of the
simulation.
// Notes
1. Ted Turnasella, “Aligning Pay with Business Strategies and Cultural Values,” Compensation
and Benefits Review 26, no. 5 (1994): 65.
2. Al-Karim Samnani and Parbudyal Singh, “Stop Chasing Best Practices: Focus on Fit for Your
HR Function,” People and Strategy 34, no. 1 (2011): 34–36.
3. Al-Karim Samnani and Parbudyal Singh, “Exploring the Fit Perspective:
An Ethnographic Approach,” Human Resource Management 52, no. 1 (2013): 123–44.
4. Richard Daft and Ann Armstrong, Organization Theory and Design, First Canadian Edition
(Toronto: Nelson Education, 2009).
5. Raymond E. Miles, Theories of Management: Implications for Organizational Behavior
and Development (New York: McGraw-Hill, 1975).
6. Edward E. Lawler, The Ultimate Advantage: Creating the High
Involvement Organization (San Francisco: Jossey-Bass, 1992); Peter Boxall and Keith Macky,
“Research and Theory on High-Performance Work Systems: Progressing the High Involvement
Stream,” Human Resource Management Journal 19, no. 1 (2009): 3–23.
7. Thomas A. Kochan and Paul Osterman, The Mutual Gains Enterprise (Cambridge, MA:
Harvard Business School, 1994).
8. Gordon Betcherman, Kathryn McMullen, Norm Leckie, and Christina Caron, The Canadian
Workplace in Transition (Kingston: IRC Press, 1994).
9. John Case, Open Book Management: The Coming Business Revolution (New York:
Harper Business, 1995).
10. Stephen Wood, “High Commitment Management and Payment Systems,” Journal of
Management Studies 33, no. 1 (1996): 5–77.
11. Richard J. Long, “Gain Sharing, Hierarchy, and Managers: Are They
Substitutes?” Proceedings of the Annual Conference of the Administrative Sciences of
Canada, Organization Theory Division 15, no. 12 (1994): 5–60.
12. John Paul MacDuffie, “Human Resource Bundles and Manufacturing Performance:
Organizational Logic and Flexible Production Systems in the World Automobile
Industry,” Industrial and Labor Relations Review 48, no. 2 (1995): 197–221.
13. Richard Daft, Organization Theory and Design(Cincinnati: Southwestern, 2001), 314.
14. Randy Hodson, “Disorganized, Unilateral, and Participative Organizations: New Insights
from the Ethnographic Literature,” Industrial Relations 40, no. 2 (2001): 20–30.
15. Raymond E. Miles and Charles Snow, Organizational Strategy, Structure, and
Process (New York: McGraw-Hill, 1978).
16. Michael E. Porter, Competitive Strategy: Techniques for Analyzing Industries and
Competitors (New York: Free Press, 1980).
17. James D. Thompson, Organizations in Action (New York: McGraw-Hill, 1967).
18. Charles Perrow, “A Framework for Comparative Analysis of Organizations,” American
Sociological Review 32 (1967): 194–208.
19. Joan Woodward, Industrial Organization: Theory and Practice (London: Oxford
University Press, 1965).
20. Marc S. Mentzer, “Corporate Downsizing and Profitability in Canada,” Canadian Journal of
Administrative Sciences13, no. 3 (1996): 237–50.
21. Terry H. Wagar, “Exploring the Consequences of Workforce Reduction,” Canadian Journal
of Administrative Sciences15, no. 4 (1997): 300–9.
22. Edward E. Lawler, The Ultimate Advantage: Creating the High Involvement
Organization (San Francisco: Jossey-Bass, 1992).
23. Richard J. Long and John L. Shields, “From Pay to Praise? Non-Cash Employee Recognition in Canadian and Australian Firms,” International Journal of Human Resource
Management 21, no. 8 (2010): 1145–72.
Chapter 3: A Behavioural
Framework for
Compensation CHAPTER LEARNING OBJECTIVES
After reading this chapter, you should be able to:
• Identify the main types of reward problems that can afflict
organizations.
• Define the three key employee behaviours desired by employers.
• Identify three key job attitudes and explain their roles in determining
employee behaviour.
• Describe the causes and consequences of reward dissatisfaction.
• Explain how to generate membership behaviour.
• Outline the process through which task behaviour is motivated.
• Explain how to generate organizational citizenship behaviour.
• Discuss the role that managerial strategy plays in determining the
types
of employee attitudes and behaviour needed by an organization.
• Describe the implications of the behavioural framework for designing
effective reward systems.
FOULED-UP PAY SYSTEMS LEAD TO AN ECONOMIC
MELTDOWN
In regular circumstances, people buying a house go to a bank to apply for a mortgage. The
bank assesses their ability to pay and writes them a cheque for an amount that the bank considers that they can pay back through a monthly installment over the term of the
mortgage. The bank makes money from the interest paid every month.
However, what happened in the years leading to the 2008 recession in the United States did not stop here. The bank sold the mortgages to investment banks for a fee. The investment
banks then packaged the mortgages into more complex investment products, such as
Collateralized Debt Obligation, and sold them to investors. Each time the mortgages changed
hand, someone in the pipeline earned a big fee. Since the housing market was booming, everyone made a lot of money in the process. Things would have been fine if they stopped
with prime mortgages, i.e., those to home owners who had the ability to pay the monthly
installment. But they did not. The banks, through mortgage brokers who were paid an upfront fee, provided subprime mortgages, i.e., those to home owners who did not have the ability to
pay the monthly installment. These mortgages again were sold to investment banks that
packaged them to sell to other investors.
Nearly one-quarter of all mortgages made in the first half of 2005 were interest-only loans.
Each step in the mortgage securitization pipeline depended on the next step to keep demand
going: from the speculators who flipped houses to the mortgage brokers who scouted the loans, to the lenders who issued the mortgages, to the financial firms that created the
mortgage-backed securities. A 1 percent fee on the $1 billion deal would earn Citigroup $10
million. Big bonuses were paid to all the people touching this magic box along the way. More
than 100 people in Merrill’s bond unit alone broke the million-dollar mark in 2006.
While the Financial Crisis Inquiry Report concluded that there were failures in financial
regulation, corporate governance and risk management, and systemic breakdown in accountability and ethics as causes of the recession, the flawed compensation design in the
mortgage pipeline fuelled the crisis. Fees and bonuses were based on the volume of loans
originated rather than the performance and quality of the loans made. Formula-driven
compensation allowed high short-term profits to be translated into generous bonus
payments, without regard to any longer-term risks.
Sources: The National Commission on the Causes of the Financial and Economic Crisis in the
United States, February 25, 2011; The Financial Crisis Inquiry Report, Official Government Edition; Louise Story, “On Wall Street, Bonuses, Not Profits, Were Real,” The New York
Times, December 17, 2008, http://www.nytimes.com/2008/12/18/
business/18pay.html?em&_r=0, accessed September 21, 2016.
// Introduction To Reward Systems And
Behaviour
On the surface, the reward systems for those in the financial sector who dealt with the
mortgage loans in the years leading up to the 2008 recession made sense. The mortgage specialists were encouraged to be aggressive in their deals and they were handsomely
rewarded for their efforts. The financial institutions got what they wanted—high sales.
However, there were adverse consequences and unanticipated problems. The reward systems
drove undesirable behaviours—and almost caused a global recession. Canada was spared many of the economic problems that affected the U.S.—partly because the reward systems for
those in the housing sector are different.
Similar problems occur at the organizational level, as the following examples show.
• To boost book sales in its college division, a major Canadian publisher
introduced a plan that would pay bonuses to its sales reps if annual
sales exceeded a target set by the regional sales manager. Sales reps
played no role in setting the targets, which were set high in order “to
really motivate employees,” according to the vice president of
marketing. The plan seemed to have no effect on sales whatsoever
and was eliminated within a year.
• Sears wanted to increase sales in its service department, so it started
paying a commission to its auto mechanics on the amount of service
work done. This did increase sales dramatically, but many customers
found that much of the work done was unnecessary. When word of
this hit the newspapers, it caused serious damage to the firm’s
reputation.
• A manufacturer of consumer products had the following system for
rewarding its three main units: marketing was evaluated on volume of
sales, production was evaluated on production costs, and research
and development was evaluated on number of patents registered. Not
only did this system cause enormous conflict between the three units,
but also the company also found it almost impossible to bring new
products to the market on a timely basis. Those that did reach the
market either did not achieve customer acceptance or were not
profitable.
• For years, purchasing officers at Canadian National Railways were
evaluated on the basis of how much they had reduced item costs in
comparison to the previous year. For example, one key part of a
boxcar is the axle, a round bar of steel on which the wheels are
mounted. Thousands of axles were being used in a year, which meant
that a purchasing officer who could reduce the cost of each axle by
even 2 or 3 percent was regarded as a hero. It turns out that the axles
would have lasted much longer had they been ordered slightly thicker
and had slightly more been spent on them. Yet under the reward
system, any purchasing officer who bought the longer-lasting axles
would have been penalized.
• A Canadian auto retailer wanted to create a more cooperative “team”
atmosphere among its sales staff by having experienced sales
personnel take more responsibility for training new sales staff.
Compensation for sales staff was straight commission on volume sold.
Management couldn’t understand why, despite their exhortations,
senior sales personnel showed little interest in training new sales staff.
These examples illustrate that reward systems can have a powerful effect on behaviour, but
that the behaviour we get is not always the behaviour we want.
Why do people behave as they do? Why do they often not behave as we want them to? How
can we get them to behave as the organization needs them to behave? And how can reward
systems influence their behaviour? Every manager knows that the answers to these questions
are not obvious. But finding those answers is crucial for designing an effective reward system.
This chapter develops a conceptual framework that can be used to find the answers.
We will start by identifying three main categories of reward problems: (1) failure to produce desired behaviour, (2) production of desired behaviour but with undesirable consequences,
and (3) production of reward dissatisfaction. Then we will look at three types of desired
employee behaviour: (1) membership behaviour, (2) task behaviour, and (3) organizational
citizenship behaviour.
Since reward systems can generate these desired behaviours only through their impact on
employee attitudes, we will focus on the job attitudes that generally lead to these behaviours. From there, we will move on to the issue of reward dissatisfaction, examining the possible
consequences and causes of this potentially devastating phenomenon.
After that, we will examine each of the three desired employee behaviours in depth and consider how the reward system can help generate these behaviours. The culmination of all
this will be a set of specific implications for designing reward systems that will generate the
employee behaviour the organization needs and wants.
// Types of Reward Problems
A multitude of reward problems can arise. To get a better handle on them, we can organize
them into the three basic types mentioned above:
1. failure to produce the desired behaviour,
2. production of the desired behaviour but with undesirable
consequences, and
3. production of reward dissatisfaction.
Failure to Produce Desired Behaviour
Too often, a reward system simply has no impact on behaviour, as in the case of the publisher
described above. (While we don’t know the details, a possible cause was that the sales targets
were set too high, and we know that unrealistic goals do not motivate behaviour.) Obviously, if
the behaviour the organization needs isn’t occurring, or if it is occurring only among certain
employees, this can be a serious problem. And there is an even more harmful variation of this problem: in some cases, the reward system not only fails to produce the desired behaviour,
but also produces undesirable behaviour, or behaviour that has negative consequences. For
example, the Green Giant reward system (see
Chapter 1) did not result in significantly cleaner product, but it did result in higher costs.
Production of Desired Behaviour and Undesirable
Consequences
Another type of problem occurs when the reward system generates the desired behaviour, but
with unanticipated negative consequences. The new reward system for Sears service technicians did cause them to generate increased sales, but Sears hadn’t wanted them to do it
by cheating the customers. CN Rail’s reward system did reduce per-item purchasing costs, but
it also discouraged any search for potentially more valuable approaches to cost savings.
The reward system at the consumer goods company did motivate marketing to increase sales,
production to minimize costs, and research and development (R&D) to develop new products.
However, while the R&D department did secure many patents, most of these products either had no market or were difficult to manufacture. The production department did minimize
costs, but it did so by using poor-quality materials and oversimplifying the product. Marketing
did try to sell these products but found that the only way to do so was by making outlandish
promises or by cutting prices, which put even more pressure on the production department to reduce costs. These behaviours resulted in low cooperation and high conflict among the
departments. Marketing blamed the R&D department for developing “useless” products and
production for producing poor-quality products. R&D blamed production for destroying “good product designs” and blamed marketing for not knowing how to sell. Production accused both
R&D and marketing of incompetence.
In short, the more that each department tried to meet its own reward goals, the less successful the company was. By rewarding mutually incompatible goals in a situation where
interdependence is high and cooperation is essential, the company was guaranteeing failure.
Thus, a reward system that looks reasonable when viewed in a narrow (departmental) context
may in fact be very damaging for the organization as a whole.
A slight variation of this problem occurs when the reward system does generate the desired behaviours with no obvious negative consequences but also suppresses other desirable
behaviours that are not measured or rewarded. The case of the auto retailer illustrates this
problem. If the sales staff are paid only on the basis of their individual sales, why would they want to spend time training possible competitors? When an organization rewards only one
aspect of a job, is it really surprising that the other aspects are neglected?
Why, then, do companies reward only certain aspects of a job? As many studies have shown, companies tend to reward job aspects that are easy to measure—aspects that are highly
visible and for which objective data are available—while hoping that employees will also
perform job tasks that are not measured or rewarded.1 In fact, some conscientious employees may indeed perform all of the desired job aspects, but if they do, it is in spite of the reward
system, not because of it.
Production of Reward Dissatisfaction
A final type of problem is not related specifically to any single aspect of the reward system but
is potentially very serious. When employees believe that the rewards they receive are not
consistent with the contributions they are making to the organization, or when they believe
that the reward system is unfair, they will experience reward dissatisfaction. Reward dissatisfaction can have a variety of negative consequences, such as poor work performance,
high turnover, poor customer service, and even employee dishonesty. Because reward
dissatisfaction can be such a serious problem, its causes and consequences will be examined
in depth later in the chapter.
// Desired Reward Outcomes
Before examining the causes and consequences of reward dissatisfaction, we need to focus
briefly on the other side of the coin—what outcomes should the reward system produce, and
how can we produce them?
Three Key Employee Behaviours
An effective reward system should not only avoid causing undesirable behaviour but also
promote desired behaviour. There are three general sets of behaviours most organizations
find desirable:
1. Membership behaviour occurs when employees decide to join and
remain with a firm.
2. Task behaviour occurs when employees perform the specific tasks that
have been assigned to them.
3. Organizational citizenship behaviour occurs when employees
voluntarily undertake special behaviours beneficial to the
organization that go beyond simple membership and task behaviour,
such as extra effort, high cooperation with others, high initiative, high
innovativeness, extra customer service, and a general willingness to
make sacrifices for the good of the organization. Organizational
citizenship behaviour is sometimes known as “contextual
performance” in contrast with “task performance.”2
Three Key Employee Attitudes
So how do you create a reward system that will generate these behaviours? This question is
complicated by the fact that reward systems do not affect human behaviour directly. They first
affect employee perceptions and attitudes, which then drive behaviour. This brings us to
another question: What are the key employee attitudes that need to be created in order to
generate the employee behaviour we desire? The three key attitudes are:
1. Job satisfaction, which can be defined as the attitude one holds toward
one’s job and workplace, either positive or negative.
2. Work motivation, which can be defined as the attitude one holds
toward good job performance, either positive or negative. Essentially,
it is the strength of an employee’s desire to perform his or her duties
well.
3. Organizational identification, which has three interrelated elements: a
sense of shared goals and values with the organization, a sense of
membership or belongingness, and an intention to remain a member
of the organization. This third aspect of organizational identification is
sometimes known as organizational commitment.
Each of these attitudes can lead to behaviour that is beneficial to the organization in different ways. Job satisfaction leads to membership behaviour, work motivation leads to task
behaviour, and organizational identification leads to citizenship behaviour, although it also
contributes to the other two behaviours. Figure 3.1 illustrates these relationships.
You will notice that Figure 3.1 has arrows leading from organizational identification to both job
satisfaction and motivation. That is because organizational identification can have a positive
impact on each of these elements. For example, a sense of membership and belongingness can help satisfy social needs, which then enhances job satisfaction. A sense of shared goals
and the positive group norms that develop from shared goals can increase employee
motivation.
But wait a minute. Isn’t there an arrow missing? Shouldn’t job satisfaction also increase
motivation and task behaviour? In the past, many people believed that job satisfaction was
virtually synonymous with work motivation. But we now know that this is not true.
Satisfied, happy workers are not necessarily more productive workers, but they are less likely
to quit, to be absent, or to submit grievances, and they are more likely to be pleasant with other employees and customers. Satisfied employees also suffer less work stress, which in
turn reduces errors and accidents and produces fewer health problems, consequently
reducing absenteeism.
Because of low turnover rates, organizations with high job satisfaction have lower recruiting and training costs and more knowledgeable employees, who more often develop cordial
relationships with customers than employees in firms with low job satisfaction. So although
high job satisfaction does not automatically bring high productivity, it certainly can bring a number of real benefits. As with the other two key employee attitudes, the reward system can
have a major impact on job satisfaction.
Figure 3.2 summarizes some of the specific consequences of each job attitude. As just discussed, the consequences of job satisfaction include decreased turnover, absenteeism, and
grievances; reduced stress; and positive group norms. Work motivation leads to job effort,
which should in turn lead to task performance. Organizational identification leads to positive group norms, cooperative behaviour, innovative behaviour, and increased job effort, along
with decreased turnover, absenteeism, and grievances.
Clearly, all three of these attitudes are desirable. But exactly how important they are to a given
firm varies enormously. Consider the example of Koch Foods (Compensation Today 2.4
in Chapter 2). From the point of view of Koch management, employee job satisfaction and organizational identification would probably be nice to have, but they are certainly not
essential. The firm doesn’t need innovative or cooperative behaviour from its employees, nor
does management care if turnover is high, since employee replacement costs are so low. The company doesn’t even need particularly high motivation, since the “chain” dictates
productivity.
What the chicken plant needs is simply enough physical job effort from each employee to keep
up with the chain. No more, no less. In return for this minimal expectation, the firm provides minimal rewards. All that the reward system needs to accomplish is a flow of new employees
sufficient to replace those who quit. Under current conditions, the company’s reward
system—while very simple and exclusively extrinsic—appears to be appropriate. It fits the
firm’s classical managerial strategy, which in turn fits the firm’s contextual variables.
Of course, such minimal employee contributions are utterly inadequate for many firms, whose
reward systems need to be much more sophisticated to promote the full range of desired behaviours. As a general rule, the more complex the desired behaviour—and the higher the
performance level required—the more complex the reward system will have to be, as we have
already seen at L-S Electro-Galvanizing (see Chapter 2).
Compensation Today 3.1 illustrates this point further by describing the multifaceted reward
system at Toyota Motors. For Toyota, all three job attitudes are important. High job
satisfaction is important because the firm wants to develop a stable and loyal workforce with cohesive work teams. Employee motivation is important because Toyota expects very high
employee job performance. Organizational identification is important because the firm
depends on employee initiative for constantly improving the production process and on employee self-control to reduce the need for costly inspection and supervision. Positive group
norms are also important to motivate and direct employee behaviour. As this example shows,
it takes a complex combination of extrinsic and intrinsic rewards to produce the kinds of
attitudes and behaviours Toyota needs for its high-involvement managerial strategy to work.
By now, it should be apparent that the three managerial strategies will require different
behaviours and different attitudes, so let’s summarize here. Classical organizations need only
provide sufficient rewards to create some degree of membership behaviour. They don’t really
need job satisfaction because very little membership behaviour is really needed. Motivation
for task behaviour can be achieved through rewards tied directly to the needed behaviours, or through the use of control systems, with the underlying threat of dismissal providing the basic
motivation. Classical organizations pay a price for not having job and reward satisfaction or
organizational identification, but they are structured to minimize this price.
In contrast, human relations organizations rely on job satisfaction and positive work norms
and must ensure that they have equitable reward systems that generate job satisfaction and a
substantial degree of commitment. They depend on high membership behaviour and
adequate task behaviour. Organizational identification, while desirable, is not essential, since
a high degree of organizational citizenship behaviour is not essential.
Because high-involvement organizations typically require the most complex behaviour from
their employees and the highest level of performance, they generally require the most complex reward systems. They need to generate all three job attitudes and behaviours. The
key job attitude for them is organizational identification, which generates the organizational
citizenship behaviour so important to these firms and plays a major role in generating membership and task behaviour. Work motivation needs to be high. And job satisfaction must
also be high enough to help generate the high membership behaviour that the firm needs.
Clearly, a key element in maintaining these attitudes is employee satisfaction with the reward
system.
COMPENSATION TODAY 3.1
Rewards Support Strategy at Toyota
At its Kentucky assembly plant, Toyota uses a carefully conceived reward system to support its
managerial strategy, which focuses on three central concepts: employee loyalty and
commitment to the firm, teamwork, and high performance. So how do you create the
attitudes necessary to generate these behaviours?
The reward system includes all three compensation components: base pay, indirect pay, and performance pay. Base pay is reasonable, but not high for the industry. But to create a feeling
of cohesion among production workers, all employees receive the same pay once they have
completed 18 months of service. Although Toyota provides an extensive array of benefits to employees, including child care and onsite recreational facilities, they are not out of line for
the auto industry, which is famous for the benefits its unions have won.
What is unusual is that benefits are structured identically for all employees, from assembly workers to the plant manager. There are no executive dining rooms, preferred parking, or
private offices for executives. The company believes that egalitarianism is necessary to avoid
the division between workers and managers that is so common in this highly unionized
industry. (Toyota employees have never voted to unionize.)
When Toyota uses performance pay, it is not based on the individual. For example, annual
bonuses, based on company performance, make up a big chunk of earnings for all employees. Special award money is distributed to groups or teams that have made suggestions that result
in safety, cost, or quality improvements. This money is distributed equally among group
members and usually consists of gift certificates that can be used at local retailers. The purpose of this program is threefold: to make sure that this money simply doesn’t get lost in
the paycheque, to create family involvement, and to make the reward more tangible. For
example, every time the employee looks at her new flat-screen TV, purchased with these
certificates, she will be reminded why she received it. In addition, PT (personal touch) money
is made available to team leaders to support team social activities, such as a summer picnic,
monthly team lunches, or trips to ball games.
As a part of its reward strategy, the company offers numerous rewards beyond compensation, one being job security. According to Terry Besser in a Journal of Management
Studies article, “Of all the rewards an organization can offer, the one which was seen as most
important by nearly all my informants was the job security offered them by Toyota. Every American interviewee mentioned job security in one form or another as either the reason they
took a job with Toyota and/or the reason they would remain, even if offered a better paying
job.”
Another key pillar of the reward system is training and promotion opportunities. The company
has a promote-from-within policy and invests heavily in training for its employees. Toyota
focuses on bringing in top calibre employees with the potential to grow and develop. However, to keep them interested in what is essentially routine and repetitive work is a chal-
lenge. Toyota deals with this challenge by providing job enrichment, team-based decision
making, job rotation, and the possibility of advancement to other jobs.
Finally, there are a number of recognition rewards, such as plaques for a perfect safety record.
These rewards are valued by employees for the symbolic meaning behind them rather than for
any economic value. But they must be seen in the context of the total reward system. As one
observer notes: “Certainly, these tokens alone would be insufficient, perhaps even insulting to employees. However, in conjunction with the other rewards already discussed, they
encourage employees to believe that they will not be ‘fools for busting their butts for the
company.’”
The result of all this? A tightly knit, team-oriented workplace, with very low turnover, high productivity, and high quality. These characteristics have served Toyota well, helping the
company to survive the financial meltdown of 2008–09 without needing to resort to the
taxpayer-funded bailouts that other auto firms needed to survive the economic crisis. In fact, Toyota’s U.S. plants have been so successful that by 2013 all of them—including the Kentucky
plant—had been expanded. By 2015, the Kentucky plant began production of the first U.S.–
assembled Lexus, adding 50,000 vehicles to its current annual capacity of 500,000. In total, approximately ten million vehicles have rolled off the Kentucky plant assembly line. The plant
provided full-time employment to around 7,000 people and has 350 U.S. suppliers with over
100 located in Kentucky.
Adapted from Terry L. Besser, “Rewards Support Strategy at Toyota,” Journal
of Management Studies 34: 1, 1995, pp. 383–399. Copyright © 1995 Blackwell Publishing
Ltd.; The Official Website of Toyota Motor Manufacturing, Kentucky, Inc., accessed on July 20,
2016.
// Causes And Consequences of Reward
Dissatisfaction
Reward dissatisfaction can have many undesirable consequences for organizations. But first,
what causes reward dissatisfaction?
Causes of Reward Dissatisfaction
As Figure 3.3 illustrates, reward dissatisfaction has four main causes:
1. violation of the psychological contract,
2. perceived inequity,
3. relative deprivation, and
4. lack of organizational justice.
Violation Of The Psychological Contract
When people decide to join a firm, they do so based on their expectations about the rewards they will receive and the contributions they will have to make. This is known as
their psychological contract.3 Similarly, an organization hires someone based on the
expectation that the individual will make certain contributions to the organization, in return
for certain rewards. In some cases, these psychological contracts include legally enforceable
contracts that spell out the rewards to be provided and the contributions to be made. In most
cases, they do not.
When an employee accepts an offer and joins a firm, problems with the psychological contract
can arise for two main reasons: (1) there has not been accurate communication about the
rewards that will actually be provided and/or the contributions that are required, and these turn out to be different from what the employee expects; and (2) the employer unilaterally
changes the “contract” in a way that the employee perceives as detrimental.
Researchers have labelled these two possibilities “incongruence” of expectations and “reneging,” and argue that either can lead to a perceived violation of the psychological
contract.4 They cite evidence that perceived violations can cause employees to have less trust
in their employer, decreased job satisfaction, reduced citizenship behaviour, and decreased
work performance, and can lead to increased turnover, theft, or even sabotage.
Psychological contracts are related to reward dissatisfaction in at least two other ways. First,
employee perceptions of the fairness of the “contract” may change. That is, employees may
come to see the original contract as unfair (even though it is being honoured) in the light of new information they receive. Second, employees may feel compelled to accept a contract
even though they believe it to be unfair right from the outset. In each of these cases, reward
dissatisfaction will likely occur.
Spurred by the economic recession that began in 2008, many firms reduced aspects of their
reward structures (including indirect pay), in violation of longstanding psychological
contracts. Not surprisingly, research has shown that their doing so had a negative impact on the psychological contract.5 However, the impact of these violations depended on the nature
of the firm. For human relations firms, the costs of contract violations can be especially high,
since employee satisfaction and trust in management are the glue that holds these organiza- tions together. These problems will be particularly severe if the cuts appear to be
unnecessary—if, for example, cuts are made even in the face of acceptable company
profitability.
Compensation Today 3.2 illustrates what can happen when an organization promises a
fundamentally new type of psychological contract but then is perceived to be violating these
promises.
Perceived Inequity
Individuals use at least two perceptual screens when deciding whether the rewards/
contributions balance is fair. The first is an internal calculus, based on their own valuations of the rewards received and contributions made. The second is a comparison with the
rewards/contributions ratio of relevant others, a process explained by equity theory.6
COMPENSATION TODAY 3.2
Violating the Psychological Contract at CAMI
Perceived violation of the psychological contract helped derail an attempt to create a
collaborative union– management relationship at CAMI Inc., a joint GM–Suzuki venture that was established in 1988 to manufacture small cars in Ingersoll, Ontario. Before the new plant
opened, CAMI agreed to a voluntary recognition of the union (the Canadian Auto Workers:
CAW). The union agreed to accept somewhat lower wages and benefits than were offered by the “big three” North American automakers (GM, Ford, Chrysler) in return for a nonclassical
approach from management, in which workers would be treated with respect and dignity and
their ideas and inputs would be valued.
To reinforce this image of equality, time clocks, executive parking spaces, and executive
cafeterias were eliminated, and production was organized into teams. Hourly employees were
known as production associates, team leaders, and maintenance associates. However, despite the titles, relatively few changes were made to the nature of the work itself. Perhaps most
significantly, no changes were made to the usual reward system for hourly employees, and no
rewards were provided for productivity or performance. Part of the reason may have been that
the CAW is philosophically opposed to performance pay, although it is not clear whether the
company actually pushed for group or organizational performance rewards.
Consequently, despite all the symbolic changes, workers soon came to believe that the
promise of a fundamentally different relationship was an empty one, and that all the changes
were merely superficial ones oriented toward manipulating workers to produce more. Workers
pointed to extremely lean staffing levels, which put great pressure on them to produce.
As a result of this perceived violation of the psychological contract and the nonappearance of
the intrinsic rewards the employees were expecting, union– management relations became bitter, culminating in 1992 in the first and only strike at any Japanese “transplant” in North
America. Prominent among the strike issues were the demand that workloads be reduced and
that the wage/ benefit gap between CAMI and other “big three” plants be narrowed. The
company made both concessions.
It appears that after the strike, a psychological contract emerged that was more in line with
the North American auto industry; workers now believed that the firm was “just another car factory” and did not really expect treatment different from the industry norm. Since then,
there have been no major strikes, and in 1998, CAMI was selected as lead plant for the produc-
tion of two new sport utility vehicles. However, this decision was likely prompted more by the plant’s relatively new production technology than by any special union–management
relationship. As an example of the continuing tense relationship at the plant, on May 30, 1999,
workers refused to report to work in protest over the firing of a union steward involved in an altercation with a supervisor. The company responded by replacing the termination with a
suspension, and work resumed.
Since that time, the company and its employees appear to have come to a mutual
understanding regarding the nature of the psychological contract, and operations are now
running smoothly at the plant. Indeed, in 2005, GM announced a $500 million investment in
the CAMI plant so that it could retool and expand. In 2009, CAMI was reported to be one of the
most efficient auto plants in North America, and enjoyed an employee absenteeism rate of less than 1 percent. By 2012, demand for its products was so high that employees were working
mandatory overtime just to keep up.
Sources: James Rinehart, Christopher Huxley, and David Robertson, Just Another Car
Factory? (Ithaca: ILR Press, 1997); Norman De Bono, “Ingersoll Plant Ranks Fifth in a CAW
Report on Productivity,” London Free Press Online, January 28, 2009; Norman De Bono,
“CAMI Ups Wow Factor with High-End Denali,” London Free Press Online, March 20, 2012.
Equity theory helps explain a number of mysteries—for example, why a person making over $5
million a year doing a job he has coveted all his life may bitterly declare that he is underrewarded and even threaten to quit, while another person earning $50,000 a year at a
job she never particularly wanted is quite satisfied with her rewards. Sound far-fetched? Not if
the first person is the highest scoring hockey player in the National Hockey League and the second is an accounting clerk with a high school education, employed by a firm that provides
high job security. The accounting clerk may look around and see that most people with
performance, education, and job security similar to hers are earning less than she is; the
hockey player may look around and see six players who scored fewer goals but have a higher
paycheque than he does.
Equity theory also helps explain why, for two employees working side by side at the same job, each making $50,000 per year, one may believe this arrangement to be equitable, while the
other regards it as highly unfair. Why? The dissatisfied employee believes that his or her
contribution is much greater than the contribution of the other employee, yet both are
receiving the same rewards.
Thus, the essence of equity theory is simple: people compare their own contribution/ rewards
ratio to the ratios of relevant others, mostly coworkers. When making this comparison, they are often more concerned about fairness than about the actual amount of rewards received.
Research has found that employee satisfaction is determined more strongly by relative pay
than by the absolute amount of pay7 (much to the astonishment of economists!).
An important aspect of equity theory is the selection of the comparison “other.” For example,
the managers of a veterinary hospital at a Canadian university were astonished when they
discovered that their veterinary hospital technicians considered themselves underpaid, even though their pay and working conditions were considerably better than those of technicians
employed by private veterinary hospitals. It turns out that instead of comparing themselves
with their private sector colleagues, they were comparing their pay and working conditions
with those of the professors and research scientists with whom they were working.
As another example, the gap between the earnings of rank-and-file employees and top
executives has been widening dramatically in recent years. Between 1980 and 1995, executive
pay in the United States increased from 42 times the average worker’s pay to 141 times.8 By the first decade of the 21st century, the average compensation of CEOs in publicly traded U.S.
corporations was 521 times the average pay of a factory worker.9 Although workers may
recognize that the job of a top executive is not similar to theirs, they may still believe it is inequitable for their CEO to be receiving 521 times as much as they do. This is particularly true
when workers are being asked to make sacrifices in their rewards, while executives are
receiving increases, as was the case toward the end of the first decade of the 21st century.
Relative Deprivation
Crosby10 suggests that employees experience dissatisfaction with their pay level under six
conditions:
1. There is a discrepancy between the outcome they want and what they
actually receive.
2. They see that a comparison “other” receives more than they do.
3. Past experience has led them to expect more than they now receive.
4. Expectations for achieving better outcomes are low.
5. They feel they are entitled to more.
6. They absolve themselves of personal responsibility for the lack of
better outcomes.
To assess the validity of this theory, a research team examined four samples of American
employees.11 They found strong support for Crosby’s theory. While actual pay level did predict pay satisfaction (the higher the pay, the greater the satisfaction), in every sample, Crosby’s six
conditions were at least three times as important as the pay level in predicting pay
satisfaction. Three conditions were of particular importance: social comparisons (condition 2, which is the basis of equity theory), the discrepancy between desired and actual pay
(condition 1), and sense of entitlement (condition 5).
Lack of Organizational Justice
The concept of organizational justice12 is also useful for understanding how people judge the
fairness of their rewards. Organizational justice has two main components. Distributive
justice is the perception that overall reward outcomes are fair, which is what equity theory is all about. Procedural justice is the perception that the process through which rewards are
determined is fair. Unless people believe that both of these are fair, they will not feel that the
reward system is fair.13
For example, suppose an individual has no faith in the process for determining rewards,
regarding it as arbitrary or even capricious. Even if the actual outcome turns out be fair in a
given instance (distributive justice), the employee may still feel dissatisfied with the reward system, because he or she has little confidence that the outcome will be fair next time. On the
other hand, if the employee believes that the process is fair (procedural justice), even if the
reward outcome is less than the employee believes to be warranted, the employee will be less
dissatisfied with that outcome.
As an example, suppose a firm is facing extreme financial pressure and that the total salary bill
must be cut by 10 percent. At the moment, company employees are fairly compensated
relative to industry standards. If the employees view the process by which it is determined that a 10 percent cut is necessary as reasonable, and if the cut is distributed fairly, then they will be
much less likely to feel reward dissatisfaction.
Research shows that distributive justice and procedural justice both have an impact on employee pay satisfaction but that distributive justice has a much stronger effect.14 However,
these findings are reversed when employee satisfaction with the supervisor is examined:
apparently, employees strongly blame their supervisors for unfair pay procedures but only mildly blame them for perceived lack of fairness in the total amount of pay they receive
(distributive justice).15 For job satisfaction, both distributive justice and procedural justice also
have an effect, but the latter has a stronger effect.16 And when organizational commitment— the degree of attachment to the firm expressed by employees—is examined, only procedural
justice has an impact.
In practical terms, procedural justice can be achieved if the pay system meets the following
conditions.17 The pay system must be:
• consistent—procedures are applied uniformly to different jobs and time
periods,
• free of bias—personal interests do not enter into application of the
procedures,
• flexible—there must be procedures for employees to appeal pay system
decisions,
• accurate—the application of procedures must be based on factual
information,
• ethical—accepted moral principles must guide the application of the
procedures, and
• representative—all affected employees must have an opportunity to
express their concerns, which the organization must consider
seriously.
In general, when an organization has no choice but to change the psychological contract in
ways that may be unfavourable to employees, it can reduce the negative impact by practising
principles of both distributive and procedural justice.
Consequences of Reward Dissatisfaction
What happens when employees experience reward dissatisfaction—when they perceive that
the balance between rewards and contributions is unfair? Figure 3.4 provides an illustration
of some of the possible consequences. As can be seen, employees have two main options to
redress the imbalance: increase the rewards they receive, or reduce the contributions they
make.
Attempt to Increase Rewards
Employees who choose to try to increase their rewards have a number of options. One is to quit the organization and take a more rewarding job. Of course, this is an option only if a more
rewarding job is available to the employee.
Another alternative is to simply demand higher extrinsic rewards, either individually (i.e., by
asking for a raise) or collectively through a union (i.e., by demanding wage increases during the next round of collective bargaining). If no union exists, employees may attempt to form
one if enough of them perceive an unfair rewards/contributions balance. If more rewards are
forthcoming, then reward dissatisfaction is reduced, as Figure 3.4 illustrates. But if more rewards are not forthcoming, employees may simply quit, or they may attempt to even the
balance in another way.
COMPENSATION TODAY 3.3
The Devil Made Me Do It! (Or Was it Reward Dissatisfaction?)
“The devil made me do it!” This was a trademark line used by an old-time comedian to explain
any malfeasance he committed. But it is not a very scientific explanation. The Global Retail
Theft Barometer Study surveyed retailers in 24 countries and reported that retail theft cost the industry $128 billion in 2014 and $42 billion in the U.S., representing 1.48 percent of U.S. sales.
Among the loss, employee theft accounted for 42.9 percent, followed by shoplifting at 37.4
percent. U.S. retailers also spent 0.42 percent of their sales in loss prevention programs and
equipment.
Rather than the devil, a sense of reward dissatisfaction or inequity can account for this
situation. The relationship between reward dissatisfaction and employee theft is supported in
the academic literature. In an early study by Gerald Greenberg (1990) in manufacturing plants,
employee theft was measured before, during, and after a temporary ten-week pay cut caused
by a decrease in orders. Greenberg found that theft increased dramatically during the rollback but returned to normal levels once the normal pay level had been restored. Interestingly, the
increase in theft was less pronounced in a plant where management explained the need for
pay cuts in a candid way, and where they expressed concern for the well-being of employees.
More recently, Clara Xiaoling Chen and Tatiana Sandino (2012) studied a sample of retail
chains to examine whether high levels of employee compensation can deter employee theft.
Their study found that employee theft decreased when employees were paid higher relative to those in competing stores after controlling for employee characteristics, the monitoring
environment, and the socioeconomic environment. They also found that coworkers are less
likely to collude to steal inventory when they were paid relatively higher than competitors,
and more likely to collude to steal inventory when paid lower relative to competitors.
Sources: Jerald Greenberg, “Employee Theft as a Reaction to Underpayment Inequity: The
Hidden Cost of Pay Cuts,” Journal of Applied Psychology 75 (1990): 561–68; Laura Klepacki, “The High Cost of Retail Theft,” hainstoreage.com, January 2015; Anne Fisher, “U.S. Retail
Workers Are No.1 … in Employee Theft,” Fortune, January 26, 2015,
http://fortune.com/2015/01/26/us-retail-worker-theft, accessed September 21, 2016; C.X. Chen and T. Sandino, “Can Wages Buy Honesty? The Relationship Between Relative Wages and
Employee Theft,” Journal of Accounting Research 50, no. 4 (2012): 967–1000.
Some employees may resort to illicit means to increase their rewards, such as padding their expense accounts or stealing the firm’s property or money. Employees may rationalize this
behaviour by telling themselves that since the company is shortchanging them, they are
perfectly justified in “evening the score.” In some sectors where rewards are low and many illicit reward opportunities exist (such as in retailing), employee theft can be a serious
problem, as Compensation Today 3.3 shows. In other cases, it may be the customer—not the
employer—who is the victim, as Compensation Today 3.4 illustrates.
In some instances, employees may actually increase their work performance in response to
reward dissatisfaction, but only if they are quite certain this will lead to significantly increased
rewards. For example, if a promotion would provide a job in which rewards and contributions
are balanced, and if increased performance has a high probability of leading to this promotion, then the employee may attempt to improve performance, even though, in the
short run, this worsens the rewards/contributions imbalance. But this is not the most likely
response to reward dissatisfaction.
COMPENSATION TODAY 3.4
Bad Tippers Beware!
Stories of what can happen when restaurant customers displease restaurant staff are
legendary. While the most common response is tampering with the food (see the movie “Road
Trip” for one particularly harrowing example!), one enterprising server at a Florida restaurant found a way of both punishing unreasonable diners and evening out her rewards-
contributions balance. This server apparently “used a hand-sized electronic skimming device
to scan customers’ credit cards without their knowledge or consent.” She then passed on this information to associates, who used it to make purchases (most of them relatively small) at
nearby retailers.
However, the server was selective in who she scammed. She apparently scammed only those
customers she considered to be overly demanding or who tipped too poorly, leaving most
customers alone. Although the server must have known that her actions were illegal, in her own mind she probably saw herself as “only being fair,” since she scammed only those cus-
tomers she believed had short-changed her!
Source: Geffner, Marcie, “Waitress Scams Bad Tippers,” Credit Card Blog: Bankrate.com,
August 9, 2011.
Finally, some employees may seek to even the balance by increasing their intrinsic rewards. For example, they may seek improvements to their job duties such that their work becomes
more intrinsically satisfying. Their reasoning may go like this: “I may not be getting the pay I
deserve, but at least I will now have a job I enjoy doing.”
Attempt to Reduce Contributions
If rewards cannot be increased in some way that is significant to the employee, the employee
may remain with the firm but redress the imbalance by reducing his or her contributions. This may be done formally or informally. For example, employees may formally request that their
job duties be reduced. They may ask to be relieved of duties that require them to spend
weekends away from home or that cause them to put in unpaid overtime.
This reduced contribution may also take the form of reduced effort or longer coffee breaks. It
may also involve reducing the quality of customer service or eliminating any voluntary work
activities. Organizational citizenship behaviour is one of the first things to go when employees
seek to reduce their contributions. This is a major reason that reward dissatisfaction can be
particularly damaging to high-involvement organizations.
Reduced contributions can also take the form of increased absenteeism or negative employee
behaviour, such as sabotage, as a means of evening the balance. Of course, such behaviours
can result in dismissal, but this may not be seen as much of a loss by the employee.
If the perceived imbalance cannot be evened out, then an employee may seek a less
demanding job in a different firm, even if it pays no more than the current job. If able to find such a job, the employee will quit. And even if there are no other employment opportunities
available, some employees may still quit, preferring unemployment to an intolerable
imbalance and the stress it causes.
Predicting Employee Reactions
But exactly how will a given employee respond to reward dissatisfaction? Individual reactions
to reward dissatisfaction are difficult to predict because they depend on the personal characteristics and circumstances of the employee and on the specific characteristics of the
situation. Are alternative jobs readily available? Can the employee afford to be unemployed?
Does the employee have strong values about honesty or a strong work ethic that would
prevent that person from using illicit rewards or reducing work performance?
In some instances, certain options are simply not available to employees, because organizations deliberately structure themselves to prevent them. For example, how could you
reduce work performance at the chicken-processing plant? About the only way would be by
not showing up for work. But if you don’t show up, you simply don’t get paid, so absenteeism
doesn’t get you very far.
So at these classical firms, there isn’t much employees can do to increase rewards or decrease
contributions, other than to threaten to quit. But that probably would not be effective either, because these firms pay little price for high turnover. Clearly, classical organizations are much
more able to tolerate reward dissatisfaction than are human relations or high-involvement
firms.
The employer’s response to the concerns the employee raises has a strong influence on what
further actions the employee takes. Employee reactions also depend on their tolerance for
stress and perceived inequity. For example, some employees have a high level of a personality trait known as equity sensitivity. Such people focus on maximizing their personal rewards and
are predisposed to perceiving inequity, be it imagined or real.18 They are also more likely to
resort to drastic action to reduce their perceived reward imbalance.
The specific factor causing the reward dissatisfaction may help predict an employee’s
response to it. For example, the addition of new job duties may trigger demands for more pay
in recognition of increased employee contribution. A wage cut may lead to increased illicit
rewards, reduced job performance, or withdrawal from the organization, depending on the personal values of the employee. Reduction in job security may cause employees to seek
employment where greater job security exists, or to seek higher pay to compensate for their
increased risk of job loss.
// Understanding Membership Behaviour
Why would anyone choose to pull chicken guts for a living? In fact, why would a person choose
to engage in paid employment at all? Not everyone does. Of the potential Canadian labour
force (defined as persons aged 15 or older), just under 62 percent are currently engaged in
paid employment or self-employment, according to Statistics Canada. At this writing, around 7
percent of the potential labour force are not employed but are seeking employment.
That leaves about 31 percent of the potential labour force who are choosing not to seek paid
employment at this time. Most of these people are retirees, students, stay-at-home spouses,
or single parents. Overall, the proportion of adults not choosing employment has been declining steadily over the past 50 years, primarily due to women entering the labour force
during the 1960s and 1970s. The proportion of adults not choosing employment may decrease
even further now that mandatory retirement has been abolished. Clearly, more people are
choosing to engage in paid employment than in the past.
So back to our question: Why do people work? Basically, people accept employment (1) if they
have unsatisfied needs, (2) if they perceive employment as the best means to satisfy those
needs, and (3) if they are able and willing to do the things the employment requires. Put another way, people accept a job if the inducements or rewards associated with it exceed the
costs of the contributions they must make to secure and retain it. If several jobs are available
that fit the above criteria, people tend to choose the one in which the value of the rewards
exceeds the cost of the contributions to the greatest extent.
That part is simple. The complicated part is that people can value the same rewards, costs,
and contributions differently, depending on their personal characteristics and circumstances. Thus, when three people are each presented with the same two job offers, one person may
choose the first offer, another may choose the second, and a third person may reject both.
(The model of behaviour presented later in this chapter sheds more light on how people make
these decisions.)
Causes of Membership Behaviour
Let’s assume that an individual has selected an employer. What factors determine whether
she stays with that employer? Many factors can play a role, but two job attitudes—job satisfaction and organizational identification—are pivotal, as was discussed earlier in the
chapter.
In general, job satisfaction develops when the job satisfies one’s important needs. One well- known model suggests that job satisfaction has five main facets: pay, promotion, supervisors,
coworkers, and the job itself.19 Although the weighting of each of these facets varies from
person to person, each likely plays some role in overall job satisfaction.
Satisfaction with pay means that economic rewards meet employee needs and are
considered fair. Satisfaction with promotion regards the extent to which advancement
opportunities are available. Satisfaction with supervisors regards whether supervisors are seen as supportive, helpful, and fair in their treatment of employees. Satisfaction with
coworkers regards the extent to which coworkers are viewed as friendly, sociable, helpful,
cooperative, and supportive. Satisfaction with the job itself is defined as the extent to which
the job provides various intrinsic rewards.
But there are other important components besides these, such as job security. Researchers
have found that for most employees, the degree of job or employment security provided by the organization plays a major role in their level of job satisfaction.20 Other important
employee needs have to do with work motivation, which is discussed later in this chapter.
Job satisfaction is a positive contributor to ongoing membership behaviour but is not the only
important factor. The strength of an individual’s attachment to an organization is known as his or her level of organizational commitment. There are two main types of commitment: affective
commitment and continuance commitment.
With affective commitment, individuals remain with the organization out of a sense of belongingness and loyalty and because they identify with the organization’s goals.
With continuance commitment, individuals stay with an organization because they would lose
too much by quitting: they cannot find another job that would be comparable in terms of the
ratio of rewards to contributions. Continuance commitment implies nothing about an employee’s emotional attachment to the employer or that employee’s job satisfaction. It is
simply a hardheaded calculation that “I have no better alternatives available to me.” It’s
possible for an individual to have high continuance commitment but extremely low levels of
job satisfaction and affective commitment.
Research shows no relationship between continuance commitment and affective
commitment21 or between continuance commitment and job satisfaction.22 However, affective commitment and job satisfaction are related: an analysis of 155 studies found that affective
commitment and job satisfaction have equal influence on reducing employee
turnover.23 Research has also shown that continuance commitment has an additional,
separate effect on reducing employee turnover.24
Rewards, Satisfaction, and Commitment
So the key question now is this: What role can the reward system play in generating job
satisfaction and organizational commitment? Since a reward is anything provided by the organization that satisfies a person’s needs, rewards clearly have a direct impact on job
satisfaction. Of the five facets of job satisfaction discussed earlier, four are extrinsic and one
(the job itself) is intrinsic. Also, two of the facets are compensation-related: pay satisfaction
and promotion satisfaction.
With regard to generating organizational commitment, the key issue is not so much what
individuals receive from their jobs, but the relationship between employees and the organization as a whole. Psychological contracts, trust, and organizational justice— especially
procedural justice— play a major role in organizational commitment. For example, research
has found a strong relationship between procedural justice and affective commitment.25 Another study found that organizations perceived to be concerned about their
employees’ welfare had higher affective commitment than other organizations.26 Employee
benefits can help create this perception, and rewards geared to organizational performance, such as profit-sharing and employee share plans, help create a feeling of belongingness and
shared goals, leading to organizational identification and affective commitment.
Job security has also been found to relate to both job satisfaction and affective commitment.
However, the impact of job security varies with its source. For example, some unionized
employees have a high level of job security built into their contracts. This should enhance job
satisfaction, but it may not enhance affective commitment if the employer is seen to be
granting the job security grudgingly. For job security to have a positive impact on affective commitment, it needs to be seen as something granted willingly by the employer. Employees
need to feel that “I am a valued and loyal employee and the firm is recognizing this by giving
me job security,” not “They’d love to fire me, but they can’t.”
To generate continuance commitment, several types of compensation policies can be used.
Seniority-based rewards are a cornerstone; these include seniority increases in pay as well as
benefit packages that increase with continued employment (especially if they are not entirely
portable). Of course, simply paying better than competitor firms reduces employee turnover
by increasing the costs of quitting (thus increasing continuance commitment).27
But if a high pay level is the only strategy a firm adopts to decrease turnover, it may be a very costly one. One study found that higher pay levels did decrease quit rates somewhat, but it
concluded that “raising wages to reduce turnover would be profitable only if turnover costs
were enormous.”28 This finding is not surprising, since we have seen that pay level is only one of many factors affecting turnover. Indeed, researchers examining the impact of pay level
satisfaction (distributive justice) and pay system satisfaction (procedural justice) on affective
commitment found that satisfaction with pay level had absolutely no impact on affective commitment, while satisfaction with the pay system was strongly related to affective
commitment.29
Is Low Turnover Always Good?
You have no doubt noticed that most of the earlier discussion assumes that employee
turnover is a bad thing. Turnover can be very costly, but is a very low turnover rate always a
good thing? Low turnover may not be a sign of organizational health if it is due only to
continuance commitment. If a firm focuses on continuance commitment (by, say, providing high wages) but neglects job satisfaction and affective commitment, it risks ending up with a
workforce of dissatisfied, disgruntled employees who will never quit.
So, turnover rate does not always tell the whole story. Two firms may have identical turnover rates, but this does not mean they have equally good reward and compensation systems. The
key question is: Who is quitting? Are they employees who are not really a good fit with the
organization, or are they valuable employees the firm truly needs?
Excessively low turnover can also cause stagnation in an organization, especially when the
organization is not expanding. Some firms have launched early-retirement programs
specifically to provide opportunities to younger employees. And at the opposite end of the employee spectrum, Compensation Today 3.5 describes a firm that actually offers financial
incentives for their newly trained recruits to quit! Their logic is that any new employee who
can be enticed to quit because of a financial incentive is not an employee who shows the
affective commitment the organization wants.
COMPENSATION TODAY 3.5
At Zappos, Finish Your Training and Then We’ll Pay You to Quit!
Las Vegas-based Zappos has always been an unconventional firm, turning the unlikely
concept of selling shoes over the Internet into a billion-dollar business. A crucial part of its
business model is to employ friendly and helpful call centre employees, something that any
Internet retailer would like to do. But how can you be sure that every one of your 1,600 call
centre employees has the right stuff, before unleashing them on your customers?
It’s simple: test the commitment of newly trained employees by offering them cash to quit! After prospective call centre employees finish one week of paid training, every one of them is
presented with “The Offer”—quit today and receive a $2,000 bonus! (“The Offer” continues in
effect throughout training and a few weeks after completion.) “The Offer” was conceived by CEO Tony Hsieh, who implemented it at Zappos in 2006. His logic was that any employee
willing to quit in return for a financial inducement was not likely the kind of employee who
would show the type of affective commitment that the firm wanted and needed. Employees are given a lot of latitude in handling calls, and unlike most call centres, the firm does not keep
track of the time that employees spend with each customer, so it is important that employees
“buy into” company values. CEO Tony Hsieh continues to introduce unconventional
management practice. Holacracy, a self-management operating structure, was launched in
2013 as a way of ensuring sustainable growth and productivity. By 2015, he offered generous
severance packages to employees who could not commit to embracing Holacracy with the
same logic: employees must align their behaviours to the company’s culture.
Sources: Jennifer Reingold, “The Zappos Experiment,” Fortune, March 15, 2016; Richard
Feloni, “Inside Zappos CEO Tony Hsieh’s Radical Management Experiment That Prompted 14% of Employees to Quit,” Business Insider, May 16, 2015,
http://www.businessinsider.com/tony-hsieh-zappos-holacracy
-management-experiment-2015-5, accessed September 21, 2016; Tony Hsieh, 2011. “How
Zappos Creates Happy Customers and Employees” (2009), Great Place to Work Institute,
online; Rachel Mendleson, “Why Zappos Pays New Hires to Quit,” Maclean’s, June 9, 2008: 52.
// Understanding Task Behaviour
Have you ever watched somebody do something and then wondered, “Now, why did that
person do that?” To understand a person’s behaviour, you need to understand the
person’s motivation. Over the past few decades, two useful sets of motivation theories have emerged—content theories and process theories—that can help us better understand
motivation.
Content theories of motivation focus on identifying and understanding underlying needs, based on the common-sense notion that people behave in ways they think will help them
satisfy their key needs. For example, a basic human need is the need for survival—for food and
shelter. In modern society, this translates into a need for money. But content theories cannot
predict the precise behaviours that different people will perform to satisfy their need for money. For example, some people will seek paid employment. Some will buy lottery tickets or
go to the racetrack. Some will seek a rich spouse. Some will rob banks.
If we all have the same basic needs, but can pursue different avenues in attempting to satisfy
those needs, what determines how each person will go about satisfying them? Process
theories of motivation help us understand the process through which different people choose
different courses of action in pursuit of the same needs.
Content Theories of Motivation
What are the important needs that human beings seek to satisfy? Using a variety of
classification systems, psychologists have identified dozens of specific needs that drive
behaviour. However, for our purposes, it is useful to group these needs.
Maslow’s Hierarchy of Needs
We briefly described Maslow’s hierarchy of needs in Chapter 1; we will now discuss it in more
detail. Maslow suggested that people have five sets of needs, which are arranged in a
hierarchy,30 as shown in Figure 3.5. There are two key points to his theory. First, lower order
needs must be satisfied before higher order needs come into play. Second, a satisfied need no
longer motivates behaviour.
Thus, once a person’s immediate physiological (survival) needs—for food and shelter—are satisfied, that person will become concerned about the next level—safety and security needs:
that is, how to satisfy his or her survival needs tomorrow and the next day and the day after
that. People like the security of knowing that their basic needs will be satisfied in the future.
Once safety and security needs are met, people then become concerned about satisfying their
needs for companionship and positive social regard by others, a need to be with and be
accepted by other humans. Once these social or belonging-ness needs are met, people then
become concerned with ego or esteem needs—for accomplishment, achievement, and mastery or competence. Finally, if these needs are satisfied, the final set of needs is
activated—for self-actualization. This is the need to maximize one’s human potential, the need
for continued learning, growth, and development. Maslow argues that self-actualization is the
ultimate motivator, because, unlike the other needs, it can never be satisfied.
But is Maslow correct? Does human motivation really work the way he suggests? So far,
research has not been able to confirm the theory precisely as outlined by Maslow. Some
researchers have collapsed Maslow’s five categories into three: existence (corresponding to Maslow’s lower two need levels), relatedness (corresponding to Maslow’s middle or social
need level), and growth (corresponding to Maslow’s upper two levels).31 Research has shown
that lower order needs do not have to be completely satisfied before the other needs come
into play, and that people can be motivated by more than one level of needs simultaneously.
To illustrate the possible variation in needs, consider the most basic need—the need for
survival. Most people would view the need for survival as the most important need. But even here there are dramatic variations. If the basic need for survival dominates all else, then why
did the electrical crew of the Titanic—faced with certain death from drowning if they did not
leave—stay at their stations deep in the bowels of the ship to keep the vital electrical system operating even as the ship slid beneath the waves? Of course, it is possible that they believed
that the ship really was unsinkable, and that this is why they stayed at their stations. But what
about secret service agents who willingly accept the duty to shield their heads of state from an assassin’s bullet with their own bodies? And what about those cases where people
intentionally take their own lives?
The reality is that people differ greatly in the strength of their various needs. And the same
individual may vary over time in the strength of her or his different needs. For example, a
single person may have relatively low economic needs but relatively high social needs.
Therefore, that person will turn down opportunities to earn overtime in order to socialize with
friends. But suppose that person gets married, buys a house, and has children. Economic needs may increase, reducing the importance of social needs. That person will then be more
likely to be motivated to work overtime.
But even though Maslow’s theory is unable to predict an individual’s motive pattern, it is still useful because it does appear to describe group or aggregate behaviour very accurately. For
example, as the income of a group or society increases, there tends to be a greater concern for
satisfying higher-order needs. Thus, in a relatively wealthy society, such as Sweden, where the social welfare system ensures that lower-order needs are met, it is difficult to entice people to
work at jobs that do not satisfy their higher-order needs.
The Two-Factor Theory of Motivation
In an attempt to determine the most important factors causing job satisfaction or
dissatisfaction, Frederick Herzberg asked a sample of employees to list factors that made
them feel good about their jobs and then to list those that made them feel bad about their jobs. He was surprised to find that the factors mentioned in the two lists were completely
different. He had expected many of the same items to appear on both lists, except reversed.
For example, he expected high pay to make people feel good about their jobs and low pay to
make people feel unhappy about their jobs.32
Instead, he found that while low pay did indeed make people dissatisfied, high pay did not
make them enthusiastic about their work. Factors that made them feel good about their work
had more to do with job content—mastering a difficult task, learning a new skill, or completing a major job accomplishment. Factors that made them dissatisfied were low pay, a
poor relationship with their supervisor or coworkers, and poor working conditions—factors
dealing with the job context.
Subsequently, Herzberg realized that he was really dealing with two different concepts—job
satisfaction and work motivation.33 The factors that caused job dissatisfaction he labelled
“hygienes,” and the factors that made people feel good about their work he labelled “motivators.” He concluded that job satisfaction was caused by extrinsic (hygiene) factors and
motivation by intrinsic (motivator) factors. He suggested that to have both satisfied and
motivated employees, an organization had to provide both extrinsic and intrinsic rewards (i.e.,
both hygienes and motivators). Hertzberg’s theory fits well with Maslow’s, since the hygienes
correspond to the lower-order needs and the motivators to the higher-order needs.
Job Characteristics Theory of Motivation
Richard Hackman and Greg Oldham extended Herzberg’s work by attempting to identify the
specific job characteristics that cause intrinsic motivation and by developing a method for
calculating the amount of intrinsic motivation in a particular job.34 They identified what they called five core job dimensions—(1) task identity, (2) task significance, (3) skill variety, (4) job
autonomy, and (5) job feedback—and suggested that jobs high in these dimensions are intrin-
sically motivating: people enjoy them for the satisfaction they derive from performing them
rather than for the extrinsic rewards they receive from them.
Task identity is defined as the extent to which a worker is able to perform a complete cycle of
activities, from start to finish, rather than only one small part of the job cycle. Task
significance is the perceived importance of the job in the general scheme of things. For example, the job of heart surgeon would carry more task significance than that of hot dog
vendor. Skill variety is the extent to which a substantial number of skills are required for task
completion. Job autonomy is the extent to which workers are able to decide for themselves how to perform their jobs. Job feedback refers to the level of feedback on work quantity and
quality that an individual receives from the job itself. For example, a typist using a spell-check
program gets feedback on the quality of work from the job itself. Bomb disposal experts do
not need outside feedback to know whether they have been successful in their jobs!
Organizations that redesign their jobs to include higher amounts of the five core dimensions
are said to be engaging in job enrichment. Many organizations, especially high-involvement firms, have job enrichment programs. As long as employees do not perceive the enrichment as
simply an attempt to load more work onto them, most respond favourably to job enrichment.
However, some organizations forget that if employees are expected to perform at a higher level, the compensation system should recognize this; otherwise, perceived inequity and
reward dissatisfaction will result, undoing the otherwise favourable effects of job enrichment.
Although job characteristics theory is a separate theory, it fits well with the other content
theories of motivation. As Figure 3.6 illustrates, the intrinsic job characteristics identified by Hackman and Oldham correspond to the motivators identified by Herzberg and address the
higher order needs delineated by Maslow. The same figure shows how these content theories
relate to the three managerial strategies.
Salience of Needs
Before leaving our discussion of human needs, we need to consider need salience. The
salience of a particular need determines the extent to which an individual is compelled to satisfy that need. For a reward to be motivating, it must address a salient need. Clearly,
different needs are salient for different people. As Figure 3.7 shows, two sets of factors—
personal circumstances and personal characteristics—interact with basic human needs to
determine need salience.
How does this process work? Two key factors determine the salience of a need for a given
person at a given time: the amount of need deprivation and the importance of the
need. Need deprivation is the difference between how much a person currently has and how
much he or she requires to satisfy a particular need. It is strongly influenced by personal
circumstances. For example, if a person needs several close friendships to satisfy social needs
but currently lives in an isolated area and has no friends at all (personal circumstances), there is high need deprivation. As another example, if a family requires about $50,000 a year to
maintain what they consider a suitable standard of living, but actual family income is $25,000,
then there is considerable need deprivation. Clearly, personal circumstances, such as dependants, financial obligations, and current financial conditions (e.g., lack of savings), affect
the degree of need deprivation for money.
However, need salience is also determined by the importance the individual places on the
need. For example, someone may have a high deprivation of a certain need, but if that person
does not consider it an important need, it may be less salient than a more important need for
which there is less deprivation. Personal characteristics tend to determine the relative importance of a given need. For example, some individuals value self-actualization more than
any other need and pursue this need regardless of whether their other needs are satisfied. The
classic example is the “starving artist.” On the other hand, some people are high in “money ethic” and have a much higher tendency to change jobs if they perceive that doing so will
increase their financial rewards.35
So high deprivation and high importance add up to high need salience. The higher the need salience, the higher the value placed on things that satisfy that need. Compensation Today
3.6 illustrates the role that personal circumstances play in this process.
COMPENSATION TODAY 3.6
Need Salience In The Klondike
The Klondike Gold Rush (1896–1898) was the greatest gold rush in Canada’s history. Almost
overnight, Dawson City went from an unpopulated, mosquito-infested mud flat in the middle
of the Yukon Territory to the largest city west of Winnipeg and north of Seattle. But those who
struck gold found themselves in an odd position: there was nothing to buy, not even labour. At
this time in the rest of North America, the top wage for a working man was $1.50 a day. In
Dawson, it was difficult to find someone who would work for ten times that much.
But as economic needs became less salient, other needs became more salient. Because of the
isolation, aspects of life that would have had little or no value elsewhere commanded exorbitant prices. For example, “when one man drifted in with an ancient newspaper soaked
in bacon grease, he was able to sell it for fifteen dollars”—equivalent to about $1,000 today.
With their economic needs satisfied, the needs of the grizzled miners changed dramatically.
Because of their isolation, a need that became highly salient was for news of the outside
world.
Source: Pierre Berton, Klondike: The Last Great Gold Rush 1896–1899 (Toronto: Penguin
Books, 1972), 373.
Process Theories of Motivation
Even when a multitude of people have the same need, different individuals will choose
different paths or behaviours to satisfy that need. Process theories of motivation attempt to
explain how individuals choose to pursue one path over another when attempting to satisfy a
need.
Reinforcement Theory of Motivation
The simplest process theory is reinforcement theory,36 sometimes called behaviourism, operant conditioning, or behaviour modification. This theory’s premise is that an individual
will repeat behaviours that have led to need satisfaction in the past and will discontinue
behaviours that do not contribute to need satisfaction. This theory is based on learning
theory. All young children experiment with a variety of behaviours. They learn to repeat
behaviours that have positive consequences and to discontinue behaviours that have negative
ones.
For reinforcement theory to work, the individual must perceive a link between the behaviour and the consequence. For example, children who grow up in a household where rewards and
punishments are provided in a capricious or arbitrary manner learn that there is little
connection between behaviour and consequences. They also tend to develop a personality trait known as an “external locus of control”—as adults, they will tend to believe they have
very little control over outcomes. In the work setting, these individuals tend to believe that the
degree of job effort they exert has very little influence on the degree of performance they
achieve or on the rewards they receive.
According to reinforcement theory, the key to predicting a person’s future behaviour is to
understand how that person and others around them were reinforced for various types of behaviour in the past. As an example, if someone grows up in an environment where most
people are unemployed, and where those who are employed never earn more than minimum
wage, that person may come to regard employment as a very unlikely way to satisfy the need for money. If the same person sees local drug dealers driving around in big cars and wearing
fancy clothes, that person may perceive drug dealing as a much more viable way to satisfy the
need for money.
Reinforcers can be of two types: positive and negative. With positive reinforcement, a reward follows a valued behaviour; with negative reinforcement, an undesirable consequence results
whenever the valued behaviour does not occur. This undesirable consequence can be either
the removal of something valued (such as docking a day’s pay for an unauthorized absence) or
the imposition of something not wanted (such as assigning an employee to the least desirable
job in the plant on the day following an absence).
For those who are designing a reward system, the guidelines offered by reinforcement theory
are quite clear. Desired behaviours for each employee need to be clearly specified. Then each time that behaviour occurs, it needs to be followed by a reward of significant value to the
recipient. The closer in time the reward is to the behaviour, the better.
Clearly, reinforcement approaches can change behaviour, even when other methods have failed. For example, one problem afflicting many Canadians is obesity, and many diet plans
have been developed to address this problem. Unfortunately, despite the large sums spent on
these plans, Canadians are heavier than ever. Could we apply reinforcement theory to this
problem? Compensation Today 3.7 describes what happened when researchers did so.
COMPENSATION TODAY 3.7
Want to Help People Lose Weight? Pay Them to Take Pounds Off!
Although earnings growth for most Canadians has stagnated, one area of growth for many
Canadians is in their waistlines. Many remedies for this problem have been suggested, but
most of these seem to be of little real help to those wishing to lose weight. Extra pounds may
not only reduce quality of life but also pose a serious threat to our health.
Since existing methods are failing to solve the problem, doctors at the University of
Pennsylvania decided to try a different approach. Knowing that financial incentives are effective for changing many types of human behaviour, they decided to conduct an
experiment to see if they could be used to help people lose weight.
They selected 57 volunteers who wanted to lose weight. All participants were given the same overall goal—to lose 16 pounds (approximately 7 kilograms) in 16 weeks—and each was given
one hour of counselling about the importance of diet and exercise in achieving this goal. The
participants were then randomly assigned to one of three different experimental groups.
The first group was put under a lottery-based system, whereby they would receive money if
they met monthly weight loss goals. The second group was put under a system where they put
their own money into an account, which was matched by the researchers. If they met their monthly weight loss goals, they would receive the money for that month, but if they did not,
they would lose the money. The third group received no financial incentives; they were just
required to report in for monthly weigh-ins, like all the other participants.
What do you think happened? With your knowledge of compensation theory, are you ready to
make a prediction? Remember that the only difference between the three groups was the
financial incentive; all participants were equally interested in losing weight prior to being
assigned to one of the three groups.
So, all participants had intrinsic motivation to lose weight, while participants in Groups 1 and
2 also had extrinsic motivation, in the form of the cash incentive. In fact, participants in Groups 1 or 2 were far more likely to meet the weight loss goal than those in Group 3. Some 52 percent
of the lottery group met the 16-pound weight loss target, as did 47 percent of the deposit
group, compared to just 10 percent of the group relying on intrinsic motivation alone. On average, participants in Groups 1 and 2 lost 13–14 pounds (some 6–6.5 kilograms) after 16
weeks, while those in Group 3 lost an average of just 4 pounds (about 2 kilograms) over the 16
weeks. Participants in the lottery group earned an average of $273 over the 16-week period,
and those in the deposit group earned $378, while those in the third group ended up with no
cash (none was offered to them) and very little weight loss.
Of course, many diets do result in weight loss; the trick is keeping the weight off, and most dieters regain most or all of the lost weight after the diet ends. Participants who had been paid
to lose weight did regain some of those pounds in the months following termination of the
experiment, and it is not clear how much of the weight loss will be permanent. But this experiment certainly confirms the effectiveness of financial incentives in causing at least
short-term behaviour change. An intriguing sidelight to this experiment is that simply wanting
to change wasn’t sufficient to actually bring about change for most participants; it seems that
many people need extrinsic motivation to help them do something they already want to do!
Source: Kevin G. Volpp, Leslie K. John, Andrea B. Troxel, Laurie Norton, Jennifer Fassbender,
and George Loewenstein, “Financial Incentive-based Approaches for Weight Loss: A
Randomized Trial,” Journal of the American Medical Association 300 (2008): 2631–37.
Behaviour modification theory also states that unrewarded behaviours eventually disappear,
so this can be a way of dealing with undesirable behaviours. It is very important that undesirable behaviours not be inadvertently rewarded, as was the case in the opening
vignette and other examples in the introduction of this chapter.
However, reinforcement theory can be difficult to apply. One problem is that it assumes that all desired behaviours are measurable and that it is practical to identify and respond to every
instance of the behaviour. As we have seen, rewarding only some of the behaviours desired
from an employee can cause serious problems.
A second problem is that reinforcement theory considers only those rewards that the
organization can control. For example, an autoworker who welds pop bottles inside car rocker
panels is not receiving any kind of company-based reward for doing so, but may be receiving psychological rewards for “outsmarting” the company. In other words, behaviourism is an
extrinsically based theory: it does not recognize differences in how individuals value rewards
or how they evaluate the costs of alternative behaviours. It also does not recognize intrinsic
rewards or the possibility of altruism.
Third, there is the issue of what happens when rewards stop—does the desired behaviour cease? Reinforcement theory predicts that it eventually does, so behaviour needs to be
continually rewarded under this system.
Some critics argue that behaviourism takes away employee responsibility for their actions, making them incapable of self-control,37 and removes intrinsic motivation.38 It can also make
many employees feel manipulated, like powerless pawns; and it can cause resentment toward
the punisher—even the rewarder in some cases. However, there is no doubt that reinforcement principles can change human behaviour.39 Reinforcement theory appears to
work best for simple behaviours and for short-term behavioural change.
Expectancy Theory of Motivation
Although reinforcement theory is important, it does not help us understand the thought
process that takes place when individuals choose to perform a particular behaviour from the
virtually infinite possibilities. The main theory for explaining this process is known as the expectancy theory of motivation.40 Expectancy theory suggests that the likelihood of
performing one behaviour or another depends on three things: (1) the net value (valence) of
the consequences of that behaviour, (2) the perceived likelihood that the behaviour will actually lead to those consequences (instrumentality), and (3) the perceived likelihood of
actually being able to accomplish those behaviours (expectancy). As Figure 3.8 indicates,
valence, instrumentality, and expectancy must all be positive before a person exerts effort to
perform a given behaviour. When there are various competing behaviours from which an individual must choose, she or he will pursue the behaviour with the highest net valence from
among those with satisfactory instrumentality and expectancy.
In essence, individuals ask themselves three questions before acting:
1. Is the task worth doing—do the rewards exceed the costs (Is net
valence positive)?
2. Will I actually receive the rewards if I accomplish the task (Is the
instrumentality clear)?
3. Will I actually be able to accomplish the task if I exert the effort (Is my
expectancy strong)?
Only when the answers to all three questions are positive will the person attempt the
task. Compensation Today 3.8 illustrates this process.
The implications of this theory for reward systems are quite clear. First, make sure that the net
valence for performing a behaviour is positive in the eyes of the person expected to perform
the behaviour. This involves maximizing the person’s rewards while minimizing the costs of performing the behaviour. To accomplish this, you need to understand the needs and
personal values of the people you are attempting to motivate. But motivating a group
becomes much more complicated if the group members all vary in their needs and values. For this reason, many firms have an implicit preference for a homogeneous workforce and tend to
hire “clones”—employees who are very similar to those they have now.
COMPENSATION TODAY 3.8
The $50,000 Hamburger
Picture this. It is a beautiful summer day. You are sitting on a park bench, eating your lunch.
Suddenly, your reverie is interrupted by an elderly stranger sitting next to you, who offers you
$10 if you will run to the hamburger stand two kilometres away and bring him back a “Big
Mike” sandwich. But there’s a catch. He will pay you the $10 only if you can bring it back within
10 minutes, because he has to leave then. Would you do it? Let’s use expectancy theory to
predict your reaction.
First, you would likely consider whether the net value (valence) of the outcome is positive,
once the costs are subtracted from the rewards. For example, getting the hamburger will make
you late for work, and your boss has warned you that one more late appearance could cost
you your job. You are pretty sure that you would not be fired for getting back a few minutes
late, but you are not positive about that. The boss would certainly be angry, and who needs
that? Given the small size of the reward, the net valence of the outcome is probably negative, and you will probably not go any further in considering whether to perform the desired
behaviour.
But suppose that the stranger bumps the reward up to $50,000. You might then conclude that the size of that reward outweighs the risk of job loss, and the valence is now positive. So would
you now get the hamburger? Probably not. Why not? You are likely not convinced that the
behaviour (getting the hamburger) would actually lead to the reward (would the stranger
really give you $50,000?). In other words, you perceive a low instrumentality.
But let’s suppose that the stranger reveals himself to be an eccentric billionaire well known for
such bizarre acts as paying $50,000 for a hamburger. He also shows you that he has more than
$50,000 in his billfold. You now believe that it is very probable you would receive the $50,000 if you brought back the hamburger (instrumentality is high). Now would you go get the ham-
burger? Of course! You’d be crazy not to!
Well, that depends on your expectancy that you could actually perform the behaviour—that is, bring the hamburger back within 10 minutes. You are at the centre of the park, the sidewalks
are crowded, and you would probably have to stand in line for at least five minutes. In high
school, your best time for running 1000 metres was three minutes, and that was quite a few doughnuts ago! If you believe that there is no chance of bringing back the hamburger within
the 10 minutes (zero expectancy), you will not be motivated to attempt to perform the
behaviour.
How could the stranger attempt to motivate you at this point? What if he made the reward $1
million? This would have no impact on your behaviour. When either instrumentality or
expectancy is zero, the size of the reward is irrelevant. So the only thing he could do would be to somehow change the expectancy—for example, by lending you a bicycle or increasing the
time allowed for task completion.
Second, make sure that instrumentality is strong. Employees must understand clearly that
performance of the desired behaviours leads to the specified rewards. Trust and credibility
may be an important issue here. Have you promised rewards in the past that failed to
materialize?
And third, make sure that expectancy is strong—that employees have confidence in their
ability to accomplish the desired behaviours. This may involve providing the physical and
mental tools necessary to get the job done and creating a context that facilitates performance
of the desired behaviours.
Attribution Theory of Motivation
Expectancy theory does not distinguish between extrinsic and intrinsic rewards in determining
the valence for a particular behaviour. It assumes that rewards simply add up: thus, people are
more motivated to perform a behaviour that has both intrinsic and extrinsic rewards, all other
factors being equal. This certainly is consistent with the findings of the weight loss experiment
described in Compensation Today 3.7.
However, there is one theory that argues that extrinsic rewards may cancel out or actually
destroy intrinsic rewards. This is known as attribution theory.41 The premise of attribution theory (sometimes known as “cognitive evaluation theory”) is that human beings are active
creatures, continually engaging in a variety of activities without necessarily having a conscious
understanding of their motives before performing them. But after performing an activity, people often feel compelled to try to understand why they did—“Now why did I do that?” In
other words, people seek to attribute some motive to that activity. If there is an “obvious”
reason for so doing, they will attribute their activity to that motive. The following story may
help illustrate this concept:
An elderly man who lived next to a vacant lot had enjoyed his peace and quiet until the
neighbourhood children selected the site for various noisy games every day after school. After vainly trying a number of approaches, such as admonishing them to be quiet or trying to convince them to play elsewhere, he tried a new approach. He gathered the children around him one day and announced that he had come to enjoy the sound of their play so much that he wanted to reward them. He told them that he would give each of them a dollar for each day they would come and play at the vacant lot.
The children thought this was great, and the noise actually increased! However, after
several days, the old man regretfully announced that since he was not a wealthy man, he would have to reduce their payment to 50 cents a day. Although the children grumbled, they accepted this. He subsequently lowered their pay to 25 cents and then to 10 cents, at which point the children announced that they would not be coming back to play anymore. It was simply not worth it for a dime a day!
This story illustrates how the elderly man replaced intrinsic motivation with extrinsic
motivation, which he then extinguished by removing the extrinsic rewards. Research studies in
laboratory settings—usually with children as subjects—involving intrinsically interesting
activities such as doing a puzzle have confirmed this result.42 Some subjects are paid to make puzzles, while others are simply asked to make puzzles. Researchers find that once the pay
ends, the paid group stops making puzzles, while the unpaid subjects elect to continue
making puzzles. This is taken as evidence that the extrinsic reward has destroyed the intrinsic
motivation for the paid group.
But what about situations where the extrinsic rewards are not removed, which is a more
realistic scenario in actual workplaces? An analysis of 20 studies found that in work behaviour simulations in which extrinsic rewards are not removed, extrinsic rewards add to intrinsic
rewards to create greater task behaviour.43 A recent study of actual companies also found that
individual performance pay seemed to increase intrinsic motivation.44
What, then, are the implications of attribution theory for reward systems? E.L. Deci argues that
pay should not be related to output and that intrinsic rewards should be used to motivate
performance. Of course, this approach assumes that there is intrinsic motivation in the first place. If there is not, either intrinsic motivation must be generated by enriching jobs, or
extrinsic means must be used.
So does this mean that you should never provide extrinsic rewards for good individual performance if it is already intrinsically motivated? Not necessarily. Some researchers argue
that providing extrinsic rewards as recognition for accomplishment can actually increase
feelings of equity and satisfaction without damaging intrinsic motivation, but only if rewards
are not seen as driving, controlling, or evaluating behaviour.45
Consider the case of volunteers who work at a UNICEF gift shop. Suppose UNICEF decides it
would like to recognize their services by providing $1 an hour for their work as a token of
appreciation. Volunteers would fill in time cards, which would be verified by a supervisor.
Would this increase motivation? Likely not. We can predict that the volunteers will be insulted
by the implication that they are involved with the organization to serve their own self-interest, that their time is worth just $1 an hour, and that they cannot be trusted. On the other hand, if
dedicated service is recognized by paying a volunteer’s expenses to a valued national
convention, this will not likely decrease intrinsic motivation and may enhance overall
commitment.
To explain this type of situation, some “rogue economists” have come up with the idea of
“moral incentives” versus “economic incentives,” analogous to our concepts of “intrinsic” versus “extrinsic” motivation.46 In a variety of interesting experiments (such as the one
described in Compensation Today 3.9), they found that adding economic incentives to moral
incentives often seemed to destroy the power of the moral incentives, so that organizations
actually ended up with less of the behaviour that they wanted. However, in almost all of their
experiments, the economic incentives were actually quite small. Larger economic incentives
would no doubt have produced different results.
Economic Theory of Motivation
Although economic theory can be a useful predictor of some employees’ behaviour, it reflects
a much narrower view of human motivation than other theories. Economic theory assumes
that people are motivated only by extrinsic (i.e., economic) rewards and that they always seek
to maximize those rewards while minimizing their contributions to the organization. This
theory sees all work as inherently distasteful and assumes that people do as little of it as
possible. You will recognize this as the theory on which classical organizations are based.
COMPENSATION TODAY 3.9
Fining Latecomers Increases Lateness!
A behaviour that many types of organizations would like to avoid is tardy arrivals, which can
disrupt work flow. One organization that had this problem was not concerned about tardy
employees, but tardy customers. Put yourself in the manager’s shoes.
You are the manager of a day care facility for children. Parents are supposed to arrive at 4 p.m.
sharp to pick up their children, but are often late, which upsets the children and requires a staff member to stay late until all the children are gone. You consult a friend, who happens to
be a traditional economist, and the friend suggests fining all parents who are more than ten
minutes late. You set the fine at $3 per late appearance and wait for behaviour to change.
Well, behaviour does change all right—it gets worse! After the fine is instituted, the incidence of lateness more than doubles, much to the surprise of your economist friend! What
happened?
Part of the explanation seems obvious. People didn’t consider $3 to be enough of an incentive to reduce their lateness. But how does this explain the increase in lateness that took place?
Rogue economist Steven Levitt (he is considered a “rogue” economist because he believes,
unlike “traditional” economists, that economic factors are not the only factors that affect human behaviour) has come up with a theory that explains this result (which actually occurred
at a real day care facility). His thesis is that in addition to economic incentives, people can also
be motivated by moral and social incentives. “Moral incentives” centre around the desire of people to behave in ways that are consistent with (or at least not inconsistent with) personal
values they hold dear. “Social incentives” centre around the desire of people to behave in
ways that are consistent with (or at least not inconsistent with) the norms of their reference
group or broader society.
Levitt explains what happened in this way. What the day care had done was to substitute an
economic incentive for a moral incentive (the guilt parents were supposed to feel when they arrived late). For just a few dollars each time they were late, parents could “buy off” their guilt
and end up with what amounted to cheap baby-sitting. Moreover, if the day care placed such a
low value ($3) on lateness, then lateness must not be such a big problem, so why should I, as a
parent, be overly concerned about it?
But this is still not the end of the story. After three months, the day care discontinued the fines.
However, lateness didn’t decline to its original level—it stayed at the new, higher level.
Dropping the late fines apparently signalled that lateness was not a problem, and parents
were now able to come late, feel no guilt, and pay no fine!
Source: Stephen D. Levitt and Stephen J. Dubner, Freakonomics: A Rogue Economist
Explores the Hidden Side of Everything (New York: William Morrow, 2005).
One of the most prominent economic theories is agency theory.47 This theory makes a key
distinction between principals (those who own the enterprise) and agents (those who work for them within the organization). Agency theory assumes that the interests of principals diverge
from those of agents and that faced with a choice between advancing the principals’ interests
or advancing their own, agents will always seek to further their own. It follows that principals need procedures to monitor agent behaviour in order to minimize agent pursuit of their own
interests at the expense of the principals. However, this monitoring is expensive, and
principals seek to reduce these costs whenever possible. Therefore, principals tend to favour reward systems that closely tie individual rewards to specific behaviours desired by the
principals, especially individual performance pay.
Economic theory represents a simplified view of employee behaviour. It assumes that all people are fixated at the lowest level of Maslow’s needs hierarchy, that personal values such
as honesty and a strong work ethic do not exist, and that intrinsic rewards have little or no
relevance to behaviour. In general, economic theory is useful only if the employees of the
organization actually match these assumptions. When they do, it can be a useful model of behaviour for designing reward systems. But when they do not, it can result in the
development of reward systems that are suboptimal, ineffective, and counterproductive.
Money as a Motivator
So, how do we sum up the role of money as a motivator of performance? For Herzberg, money
is not a true motivator; for Deci, it is actually a demotivator, one that extinguishes intrinsic
motivation.
In answering this question, we first note that although human behaviour is driven by needs,
money itself is not technically a need, but rather a generalized resource that can be exchanged
for things that will satisfy needs. Thus, for those persons whose underlying needs are satisfied, money may not be much of a motivator, at least in its instrumental role as a vehicle for
satisfying underlying needs.
In its role as a generalized resource, money gives recipients control over how their needs will
be satisfied. For example, a hungry person might be given a sum of money sufficient to purchase an inexpensive meal, or be given a voucher for a bowl of soup, redeemable only at a
specified outlet. Both alternatives may satisfy the need for sustenance, but the money
certainly gives the person more control over how to satisfy that need than does the voucher.
This sense of control is in fact an important intrinsic human need.
Besides providing a sense of control, money also has a symbolic value: to many people, it
represents status and accomplishment. In organizations, the amount one is paid and how one
is paid send important signals about how one is regarded by the employer. For example, a worker who receives a slightly smaller raise than a coworker, even if the raise itself is
generous, may infer that the coworker is more highly regarded and has the inside track on the
next promotion.
Money can also be a basis of social comparison; and here, again, it is the relative amount, not
the absolute amount, that is important to people. For example, a study conducted at Harvard
University found that when asked about whether they would prefer to earn $100,000 per year while all other employees earned $200,000, or to earn $50,000 when everyone else earned
$25,000, the majority of participants (56 percent) chose the second option!48
The multifaceted nature of money as a motivator adds complexity to the compensation process, as does the fact that people vary in their “money ethic”—that is, the inherent value
they place on money.49 But what about the argument that providing pay for performance does
more harm than good, by destroying intrinsic motivation?50
First, while there is evidence that pay based on individual performance can extinguish intrinsic
motivation, this is only an issue where intrinsic motivation exists in the first place. Second, in
most cases, motivation declines only when the extrinsic reward is subsequently removed. This emphasizes the importance of using economic rewards only in circumstances where they are
likely to be sustained. Third, although money is a motivator for most people, there is no
reason not to supplement it with nonmonetary rewards, including those that produce intrinsic
motivation. Fourth, many of the concerns posited for individual performance pay plans do not
apply to plans based on the performance of the group or the organization as a whole.
As a result of concerns about the possible drawbacks to monetary rewards, many firms have
implemented noncash employee recognition programs.51
These programs provide nonmonetary rewards that “honour outstanding performance after
the fact and are designed for awareness, role modelling, and retention of recipients.”52 The
rewards may include social reinforcers, such as a mention in the company newsletter; plaques or letters of commendation; learning and development opportunities; merchandise or travel
prizes; or extra time off. Overall, “recognition represents a reward experienced primarily at the
symbolic level,”53 although some of the rewards may embody practical or economic value
(such as a restaurant voucher).
Research shows that many Canadian firms are adopting noncash recognition programs;
interestingly, however, they are not substituting them for cash-based recognition,54 as critics of cash-based programs suggest. Instead, they are using noncash programs to supplement
their cash recognition programs. Because these programs are relatively new, there is little
evidence about their effectiveness.
There is no question that money can be a highly effective motivator when the right
performance pay plan is applied in the right context. That said, such programs face a number
of pitfalls, and they are complex both to design and to apply effectively (see later chapters).
Pay based on individual performance is most problematic, and in many circumstances,
development of intrinsic motivation (where feasible) may be preferable to individual
performance pay.
// Understanding Organizational Citizenship
Behaviour
Organizational citizenship behaviour is a relatively new concept. Basically, it describes
voluntary or discretionary behaviours that go beyond task and membership behaviour. At a
broad level, it is a “willingness to cooperate” in the pursuit of organizational goals. It is no
coincidence that this concept has emerged simultaneously with the rise of high-involvement
organizations. Because of the nature of their managerial strategy and the conditions of high
uncertainty and dynamism in which they operate, high-involvement firms greatly value organizational citizenship behaviour, in contrast to human relations firms and especially
classical firms.
Although the concept of citizenship behaviour continues to evolve from its original formulation,55 one important conceptualization suggests that it has five main
dimensions.56 Altruism is the willingness to offer help to a coworker, supervisor, or client
without any expectation of personal reward for so doing, and without any repercussions if the help had been withheld. General compliance is the extent to which conscientiousness—in
terms of attendance, use of work time, and adherence to policies— goes beyond the necessary
minimum. Courtesy is the practice of “touching base” with people before taking actions that could affect their work. Sportsmanship is the ability to tolerate, with good grace, the minor
nuisances and impositions that are a normal part of work life. Civic virtue is the extent to
which individuals take an interest and participate in the broader governance and operation of
the organization.
Causes of Citizenship Behaviour
The principal source of citizenship behaviour is organizational identification. Two causes of
organizational identification are (1) shared organizational goals and (2) feelings of
membership (or belonging).
Shared organizational goals. There are two ways in which shared goals may affect
organizational identification. In the first way, known as “organizational integration,”57 the interests of the individual and the organization are congruent: “If the organization is
successful, I will share in the rewards.” An example would be a firm in which employees are
also significant shareholders. The second way in which shared goals affect identification arises when the organization’s goals match important values of the individual employee. Some
researchers refer to this as “moral” or “normative” commitment. For example, people might
join UNICEF because they want to help fight child poverty, or a person might choose to work in
a hospital because of a desire to help heal the sick.
Feelings of membership. People who feel that they are valued and respected members of
their organization are much more likely to engage in citizenship behaviour. Their citizenship
behaviour is also connected to perceptions of justice, fair treatment, and reciprocity: “The organization does whatever it can to look after my interests, and I will therefore do the same
for the organization.”
Employees with high organizational identification seek to further organizational goals in any way possible, ranging from increasing job effort to making innovative suggestions. Employees
also promote a spirit of cooperation within the organization, since this also furthers
organizational goals. Other results of organizational identification are decreased turnover,
absenteeism, grievances, and other negative behaviours.
A key value of organizational identification is that it acts as a counterweight to narrow self-
interest. In the Green Giant case discussed in Chapter 1, employees pursued their own self- interest at the expense of the company’s interests by “cheating” on the payment system. Had
organizational identification been high, this result would have been much less likely.
Creating Citizenship Behaviour
So how can organizational identification be created, and what role can the reward system play
in this process? Several preconditions are necessary for the development of citizenship
behaviour. One of these is employment security. Employers cannot reasonably expect
employees to be loyal to an organization that shows no loyalty to them. Trust is another key precondition—if employees do not trust management, little citizenship behaviour will take
place.
Research also indicates that an organization that shows genuine concern for the needs of its employees—for example, through benefits that help employees successfully mesh their work
and family lives—offers more fertile ground for organizational citizenship. 58 Another
precondition is a sense of distributive and procedural justice within the organization, and the sense that the organization is attempting—within the means available—to provide as fair a
psychological contract and reward structure as possible. Both procedural justice59 and
supervisory fairness60 have been shown to be key determinants of organizational citizenship.
One way of creating identification is by developing reward systems in which both the
organization and its employees benefit when organizational goals are met. These may include
employee stock plans as well as gain sharing, goal sharing, or profit sharing. Another way the reward system can foster shared goals and values is by attracting and retaining employees
who already possess compatible values. The employer identifies the needs of people who
already share organizational goals and values and then gears the reward system to those
needs.
Participation in decision making, especially in goal setting, has also been shown to foster
organizational identification. People with a role in setting organizational goals are much more
likely to be committed to those goals. In addition, employee participation in developing the company reward system will likely produce reward systems that are consistent with employee
needs and result in more trust in the system itself. But all types of participation in decision
making have been shown to create greater commitment to the decisions that are made,
besides providing a sense that employees are true “citizens” in the organization and that their
views are valued and respected.
A good example of using employee participation to create organizational identification
involves Byers Transport, a trucking company in western Canada that was purchased from its
corporate owner by its employees.61 With the change in ownership, management style became more open, with information sharing and participative management. In short, the firm moved
from a classical to a high-involvement managerial style. After the employee purchase, many
employee attitudes and behaviours changed almost overnight. Group norms, which had been
somewhat poor under corporate ownership, improved dramatically.
Losses resulting from “shrinkage” (i.e., employee theft) declined dramatically, as did customer
damage claims and employee turnover. Grievances disappeared. A new attitude of commitment and cooperation permeated the company. Truck drivers made great efforts to
satisfy customers, and everyone, whatever their position, was always on the lookout for
potential new customers. The result? A dramatic increase in profitability, which had been
absent in the years prior to the employee purchase.
But that is not the end of the story. Because of the success of the firm under employee
ownership coupled with high-involvement management, a corporate buyer extended a very lucrative buyout offer that the employee-owners found too good to refuse. After the buyout,
though, management became more traditional, and many of the earlier improvements
disappeared.
// Behavioural Implications for Designing
Reward Systems
So far in this chapter, we’ve discussed a lot of concepts and theories about how to generate
the types of employee behaviour that an organization needs. Now it is time to draw out the
specific implications of all of this for crafting reward systems that will produce the employee behaviours necessary for organizational success. As shown in Compensation Notebook 3.1,
there are six main behavioural implications when designing effective reward systems.
COMPENSATION NOTEBOOK 3.1
Behavioural Implications for Designing Effective Reward Systems
1. Define the employee behaviour that is really needed.
2. Determine the employee attributes and qualifications necessary to
perform the needed behaviour.
3. Identify the needs that individuals possessing these qualifications are
likely to find salient.
4. Ensure a positive valence for needed behaviour by providing rewards
that address salient needs and by reducing the costs to the employee
of performing the behaviour.
5. Make it clear that performance of the behaviour will lead to the
promised rewards.
6. Provide conditions that make it likely that employee effort will actually
lead to the desired behaviour.
1. Define the Necessary Employee Behaviour
As discussed earlier in this chapter, the first step in designing a reward system that produces
the desired employee behaviour is to define clearly the behaviours the firm really needs.
Classical firms require task behaviour, human relations firms require task and membership behaviour, and high-involvement firms require task, membership, and organizational
citizenship behaviour. But within these general types of behaviour, more specific behaviours
can also be identified. For example, do we need our employees to be creative and innovative in coming up with ways to perform their job duties, or do we need them to be careful and
consistent to ensure they are performing their job procedures in the specified manner?
2. Determine the Necessary Employee Attributes
Once we understand the behaviour we expect from our employees, we can identify the
necessary attributes and characteristics of the employees who would best be able to perform
the required behaviour. Do we need highly educated employees with university degrees? Do we need technical school graduates? Do we need creative employees who will be innovative
on the job? Do we need employees with advanced interpersonal and team skills? Do we need
employees who are able to perform routine processes in a dependable and consistent manner
without succumbing to boredom?
To identify the types of employees who will suit the needs of our firm, we need to examine
their personal characteristics in relation to the behavioural expectations we have of them.
Personal characteristics include the competencies, values, and personality of a given individual; thus, we need to identify the specific personal competencies, personal values,
and personality characteristics that will fit best with the needs of our organization.
3. Identify Salient Employee Needs
Once we have identified the employee attributes that are desirable, we can identify the needs
our employees will find most important. As we discussed earlier, personal circumstances and
personal characteristics influence the needs our employees will find salient.
Of particular importance are personal values and demographic characteristics. For example,
employees who highly value learning may find opportunities for learning and growth most salient. For younger employees, needs for recreation and time off for travel may be more
salient than for other employees. For older employees, needs for income security and
supplementary health plans may be most salient. For employees with dependent children,
financial needs may be the most salient—or, for those with younger children, child care needs.
One way of identifying the salient needs of our workforce is to analyze the personal
values, demographic characteristics, and personal circumstances of our employees. Conducting surveys of our employees to identify their most salient needs can be a useful part
of this process.
4. Ensure a Positive Reward Valence
According to the expectancy theory of motivation, the first question people ask when deciding
whether to attempt any behaviour is, “Do the rewards flowing from performing this behaviour
outweigh the costs of performing this behaviour?” In other words, is the net valence of this
behaviour positive?
Reward systems that produce the highest net valence are more likely to lead employees to
attempt to perform the desired behaviour. Knowing the salient needs of our employees allows
us to develop rewards with a more positive valence.
However, besides increasing the positive valence of our rewards, we can also increase net
valence by reducing the costs of performing the desired behaviour. There are four main types
of “costs” for a person in performing any behaviour—(1) tangible costs, (2) physical costs, (3) psychological costs, and (4) opportunity costs—and the more the employer can reduce these
costs, the higher the net valence and the greater the likelihood of employees performing the
desired behaviour.
Let’s take a specific behaviour—accepting a job rather than continuing to remain unemployed.
There are tangible costs, such as transportation costs and the costs of work clothing
and physical costs, such as fatigue and possible health risks. Psychological costs may
include stress and frustration, or the requirement to violate one’s personal values in order to perform the job, as when a person strongly opposed to smoking is offered a job in a tobacco
factory, or when an environmentalist is offered a job in a polluting industry. Finally, there are
the opportunity costs of taking this job, in the sense that doing so will reduce the opportunity
to do other things, such as spend time with the family or engage in leisure or social activities.
How might an employer reduce these costs? Transportation costs might be reduced by hiring
employees who live nearby or by allowing work from home. Physical costs might be reduced
by providing ergonomically designed equipment that minimizes the physical strain of the work. Psychological costs incurred by employees at the tobacco firm might be reduced by
hiring only employees who are not opposed to smoking. Opportunity costs for employees with
families might be reduced by having flexible work schedules or by developing work/life
balance programs.
5. Make it Clear that Performance Will Lead to Rewards
If the balance of perceived benefits and costs nets out to a positive valence, the second
question individuals will ask is, “What is the likelihood that the promised rewards will actually
materialize?” If a person performs the desired behaviour (i.e., to accept and perform a
particular job), will that person really receive the promised rewards? If workers perceive the
likelihood—the instrumentality—of this to be low, then motivation will be low.
For example, a firm may promise starting pay of $18 an hour, with a raise to $25 after six
months and to $32 after a year. It may also promise lucrative opportunities for overtime pay,
as well as annual profit-sharing bonuses. This may all sound pretty good, but to be motivated by these promised rewards, an employee must believe that the employer will in fact follow
through on its promises.
Thus a key issue is employer credibility: Can this employer be trusted to carry through with
the rewards that have been promised? A person’s perception of the likelihood of promised
rewards materializing is conditioned by her or his past experience with employers in general
and with this employer in particular. Does this employer have a history of promising rewards
that never actually materialize for one reason or another?
For employers, the bottom line on this issue is that if they promise certain rewards in return for
certain employee behaviours, then they need to do everything possible to actually provide those rewards when the behaviours are performed. Otherwise, future promises will hold no
credibility and no power to motivate. And once an employer’s credibility has been damaged, it
can take a very long period of consistently honouring promises before credibility and employee trust is restored. Thus it is important for the employer to make only those reward
promises that it is confident it will be able to keep.
6. Provide Conditions for Effort to Lead to Performance
If employees do believe that the promised rewards will materialize, the final question they will
ask themselves is: “What is the likelihood that I will actually be able to achieve the desired
behaviour or result if I exert my best efforts?” In other words, do employees expect that
effort will lead to successful performance of the desired behaviour? For example, if the desired behavioural outcome is to double the sales in their sales territory, sales employees may
believe that no amount of effort will achieve that result. If the expectancy of being able to
perform a particular behaviour is low, then promising rewards for doing so will not motivate
any extra employee effort.
So, how does an employer create a positive expectancy among employees for attempting to
perform a particular behaviour? First, make sure that the desired behavioural outcome is
realistic. Second, provide an organizational context that supports achievement of the desired behavioural outcome. Before making the effort, employees must perceive there is enough
organizational support to make successful performance of the behaviour likely. Organizational
support consists of the resources, training, and tools the organization needs in order for successful job performance to occur. Third, before they exert effort, employees must believe
they possess the necessary personal competencies and abilities to achieve the desired
performance—that their effort will lead to performance. It is an important part of the training
process to create this expectancy, besides creating the actual skills and competencies.
// SUMMARY
This chapter has shown you how reward systems can affect behaviour in organizations. You
have learned how reward systems may not only fail to produce the desired employee
behaviour but actually create undesirable consequences, some of which could threaten the
survival of the organization. You now know the potentially high costs of reward dissatisfaction—from low motivation and low employee satisfaction to high turnover and even
employee theft. You also know some of the causes of reward dissatisfaction, including
violation of the psychological contract, perceived reward inequity, discrepancy between
desired and actual reward levels, and a perceived lack of distributive and procedural justice.
You have learned that there are three main sets of desired employee behaviours—
membership behaviour, task behaviour, and citizenship behaviour—and that these behaviours are valued more by some firms than others. Task behaviour is the only one of the three valued
by classical firms, while human relations firms value task and membership behaviour, and
high-involvement firms value all three. You have also learned that these behaviours can be induced only by generating three key job attitudes—job satisfaction, work motivation, and
organizational identification—and you now recognize the role that reward systems can play in
fostering these attitudes.
You now understand how the managerial strategy of your firm affects the way you will tailor
the reward system. Classical organizations need to provide only enough rewards to create a
tolerable psychological contract that results in the minimal degree of membership behaviour
they require. They can achieve work motivation through rewards tied directly to the needed
behaviours or through the use of control systems, with the underlying threat of dismissal pro-
viding the basic motivation. Classical firms pay a price for lacking job and reward satisfaction
and organizational identification, but they are designed to minimize this price.
In contrast, human relations organizations rely on job satisfaction and positive group work
norms. In a human relations firm, you must ensure that the reward systems are equitable and
that they generate job satisfaction and a substantial degree of commitment. Organizational
identification, while desirable, is not essential.
Because they typically require the most complex and high-level behaviour from their
employees, high-involvement organizations generally require the most complex reward
systems. These reward systems need to be seen as equitable and as adhering to principles of organizational justice. Of the three managerial strategies, reward dissatisfaction is most
damaging to high-involvement firms, because this dissatisfaction undermines the foundation
of trust needed for successful utilization of this strategy.
You should also take from this chapter an understanding of several other considerations that
can affect reward system success. For example, be cautious when using extrinsic rewards
(especially individual rewards) to motivate specific behaviours, since unrewarded behaviours will likely be neglected, and your reward system may generate negative consequences (such
as lack of concern for the performance of other employees or of the organization as a whole).
Use individual extrinsic incentives only in limited circumstances, as will be discussed in the
following chapters. Whenever possible, choose intrinsic rewards over extrinsic ones. But note
that extrinsic rewards tied to group and organizational performance are beneficial for many
organizations.
This chapter concluded by abstracting six key behavioural implications for developing an
effective reward system—(1) define the employee behaviour that is really needed, (2)
determine the necessary employee attributes, (3) identify the salient needs of these employees, (4) ensure a positive valence for desired behaviour, (5) make it clear that promised
rewards will be provided, and (6) provide conditions so that employee effort is likely to lead to
the desired behaviour.
Having developed an understanding of how rewards link to behaviour (in this chapter) and
how strategy links to rewards (in the previous chapter), you have now finished the first step
along your road to creating an effective compensation system. The next step is to understand
the menu of compensation options and choices that are available so that you can select the
optimal combination for your organization’s compensation strategy.
Key Terms
• affective commitment
• agency theory
• attribution theory
• content theories of motivation
• continuance commitment
• demographic characteristics
• distributive justice
• equity sensitivity
• equity theory
• expectancy theory
• job autonomy
• job enrichment
• job feedback
• job satisfaction
• Maslow’s hierarchy of needs
• membership behaviour
• need salience
• noncash employee recognition program
• organizational citizenship behaviour
• organizational commitment
• organizational identification
• personal competencies
• personality characteristics
• personal values
• procedural justice
• process theories of motivation
• psychological contract
• reinforcement theory
• skill variety
• task behaviour
• task identity
• task significance
• two-factor theory of motivation
• work motivation
Discussion Questions
Discussion Question 3.1
Review
Discuss the main types of reward problems. Have you ever encountered any of these problems?
Your Answer
No answer submitted
Discussion Question 3.2
Review
Discuss how employee job attitudes serve as the link between reward systems and employee job behaviour.
Your Answer
No answer submitted
Discussion Question 3.3
Review
Discuss how reward systems can be used to generate task behaviour, membership behaviour, and
citizenship behaviour.
Your Answer
No answer submitted
Discussion Question 3.4
Review
Discuss the key aspects of expectancy theory. What are the practical implications of this theory for managers?
Your Answer
No answer submitted
Using the Internet
Using the Internet Question 3.1
Review
Go to Queendom and browse through the free personality and values tests. Identify at least one test that would be relevant to employee motivation, and take that test. Discuss what it tells you about your own
motivation pattern, and how it might relate to the reward strategy that would best motivate you.
Your Answer
No answer submitted
Exercises
Exercise Question 3.1
Review
In a group of four to six people, discuss situations in which employees experienced reward dissatisfaction.
What caused that dissatisfaction? How did people react to it? What were the consequences for the organization? Were they serious consequences? Why or why not?
Your Answer
No answer submitted
Exercise Question 3.2
Review
This chapter contained two examples of auto companies—Toyota (Compensation Today 3.1) and CAMI
(Compensation Today 3.2)—that apparently wanted to adopt a high-involvement managerial strategy. Adopting high involvement was not successful at CAMI but was very successful at Toyota. Are there any
concepts from this chapter or previous chapters that could help explain this result? Assuming that
management at CAMI really wanted to move away from the classical school, what should have been done differently?
Your Answer
No answer submitted
Exercise Question 3.3
Show Correct Answer
Using a diagram, show the linkages (with arrows) between an organization’s strategy, reward systems,
employee attitudes and behaviours, and employee productivity. Acceptable file types: PDF and Image
(PNG, JPEG, or JPG).
Students can browse their computer or drag and drop file
Max file size:50MBAccepted file types:PDF, JPG, JPEG, PNG
Case Questions
Case Question 3.1
Review
Analyze the “Henderson Printing” case in the Appendix. Why do you think there is a high turnover of new
employees? What concepts may help explain employee reactions to the compensation system? Do you think the compensation system is fair? Is it effective? What principles for effective reward systems does it
violate? What changes should be made? Your Answer
No answer submitted
Case Question 3.2
Review
Read the “Plastco Packaging” case in the Appendix. The Plastco machine operators appear to be suffering from low job satisfaction and motivation. Develop a plan for solving these problems by redesigning these
jobs to add more intrinsic rewards. Besides these changes to job design, can you recommend any other changes to the various dimensions of organization structure (including the reward structure)?
Your Answer
No answer submitted
Simulation Cross-Reference
If you are using Strategic Compensation: A Simulation in conjunction with this text, you will
find that the concepts in Chapter 3 are helpful in preparing Sections A, B, and C of the
simulation.
// Notes
1. Steven Kerr, “On the Folly of Rewarding A, While Hoping for B,” Academy of Management
Executive 9, no. 1 (1995): 7–14. See also “More on the Folly,” Academy of Management
Executive 9, no. 1 (1995): 15–16.
2. James R. van Scotter, Stephan J. Motowidlo, and Thomas C. Cross, “Effects of Task
Performance and Contextual Performance on Systemic Rewards,” Journal of Applied
Psychology 85, no. 4 (2000): 526–535. See also Ian R. Gellatly and P. Gregory Irving, “Personality, Autonomy, and Contextual Performance of Managers,” Human Performance 14,
no. 3 (2001): 229–43.
3. Denise M. Rousseau, Psychological Contracts in Organizations: Understanding Written
and Unwritten Agreements (Thousand Oaks: Sage, 1995). See also Denise M. Rousseau and
Violet T. Ho, “Psychological Contract Issues in Compensation,” in Compensation in
Organizations: Current Research and Practice, ed. Sara L. Rynes and Barry Gerhart (San
Francisco: Jossey Bass, 2000).
4. Elizabeth W. Morrison and Sandra L. Robinson, “When Employees Feel Betrayed: A Model of
How Psychological Contract Violation Occurs,” Academy of Management Review 22, no. 1
(1997): 228–56.
5. Margaret A. Lucero and Robert E. Allen, “Employee Benefits: A Growing Source of
Psychological Contract Violations,” Human Resource Management 33, no. 3 (1994): 425–46.
6. J. Stacy Adams, “Inequity in Social Exchange,” in Advances in Experimental Social
Psychology, vol. 2, ed. L. Berkovitz (New York: Academic Press, 1965).
7. Andrew E. Clark and Andrew J. Oswald, “Satisfaction and Comparison Income,” Journal of
Public Economics 61 (1996): 359–81.
8. Nancy C. Pratt, “CEOs Reap Unprecedented Riches While Employees’ Pay
Stagnates,” Compensation and Benefits Review 28, no. 5 (1996): 20–24.
9. Franz Christian Ebert, Raymond Torres, and Konstantinos Papadakis, Executive
Compensation: Trends and Policy Issues (Geneva: International Institute for Labour
Studies, 2008).
10. F. Crosby, “A Model of Egoistical Relative Deprivation,” Psychological Review 83 (1976): 95–
113.
11. Paul D. Sweeney, Dean B. McFarlin, and Edward J. Inderrieden, “Using Relative Deprivation
Theory to Explain Satisfaction with Income and Pay Level: A Multistudy Examination,”
Academy of Management Journal 33, no. 2 (1990): 423–36.
12. Jerald Greenberg, “Organizational Justice: Yesterday, Today, and Tomorrow,” Journal of
Management 16, no. 2 (1990): 399–432.
13. Michel Tremblay, Bruno Sire, and David Balkin, “The Role of Organizational Justice in Pay
and Employee Benefit Satisfaction and Its Effects on Work Attitudes,” Group and Organization
Management 25, no. 3 (2000): 269–90.
14. Robert Folger and Mary A. Konovsky, “Effects of Procedural and Distributive Justice on
Reactions to Pay Raise Decisions,” Academy of Management Journal 32, no. 1 (1989): 115–30.
15. Vida Scarpello and Foard F. Jones, “Why Justice Matters in Compensation Decision
Making,” Journal of Organizational Behavior 17 (1996): 285–99.
16. Michel Tremblay and Patrice Roussel, “Modelling the Role of Organizational Justice: Effects
on Satisfaction and Unionization Propensity of Canadian Managers,” International Journal of
Human Resource Management 12, no. 5 (2001): 717–37.
17. Roland Theriault, Mercer Compensation Manual (Boucherville: G. Morin, 1992).
18. R.C. Huseman, J.D. Hatfield, and E.W. Miles, “Test for Individual Perceptions of Job Equity:
Some Preliminary Findings,” Perceptual and Motor Skills 61 (1985): 1055–64.
19. P.C. Smith, L. Kendall, and C. Hulin, The Measurement of Satisfaction in Work and
Retirement (Chicago: Rand McNally, 1969).
20. Susan J. Ashford, Cynthia Lee, and Philip Bobko, “Content, Causes, and Consequences of
Job Insecurity: A Theory-based Measure and Substantive Test,” Academy of Management
Journal 32, no. 4 (1989): 803–29.
21. Ian R. Gellatly, “Individual and Group Determinants of Employee Absenteeism: Test of a
Causal Model,” Journal of Organizational Behavior 16 (1995): 469–85.
22. Duncan Cramer, “Job Satisfaction and Organizational Continuance Commitment: A Two-
Wave Panel Study,” Journal of Organizational Behaviour 17 (1996): 389–400.
23. Robert P. Tett and John P. Meyer, “Job Satisfaction, Organizational Commitment, Turnover
Intention, and Turnover: Path Analyses Based on Meta-Analytic Findings,” Personnel
Psychology 46, no. 2 (1993): 259–93.
24. Stephen J. Jaros, John M. Jermier, Jerry W. Koehler, and Terry Sincich, “Effects of
Continuance, Affective, and Moral Commitment on the Withdrawal Process: An Evaluation of
Eight Structural Equation Models,” Academy of Management Journal 36, no. 5 (1993): 951–
95.
25. Suzanne S. Masterson, Kyle Lewis, Barry M. Goldman, and M. Susan Taylor, “Integrating
Justice and Social Exchange: The Differing Effects of Fair Procedures and Treatment on Work
Relationships,” Academy of Management Journal 43, no. 4 (2000): 738–39.
26. Joan E. Finegan, “The Impact of Personal and Organizational Values on Organizational
Commitment,” Journal of Occupational and Organizational Psychology 73 (2000): 149–69.
27. John E. Delery, N. Gupta, Jason D. Shaw, G. Douglas Jenkins, and Margot L. Ganster,
“Unionization, Compensation, and Voice Effects on Quits and Retention,” Industrial
Relations 39, no. 4 (2000): 625–45.
28. Irene Powell, Mark Montgomery, and James Cosgrove, “Compensation Structure and
Establishment Quit and Fire Rates,” Industrial Relations 33, no. 2 (1994): 229–48.
29. Marcia P. Miceli and Paul W. Mulvey, “Consequences of Satisfaction with Pay Systems: Two
Field Studies,” Industrial Relations 39, no. 1 (2000): 62–87.
30. A.H. Maslow, Motivation and Personality (New York: Harper and Row, 1954).
31. C. Alderfer, Existence, Relatedness, and Growth (New York: The Free Press, 1972).
32. Frederick Herzberg, B. Mausner, and B.B. Snyderman, The Motivation to Work (New York:
John Wiley, 1959).
33. Frederick Herzberg, Work and the Nature of Man (Cleveland: World, 1996).
34. J. Richard Hackman and Greg Oldham, Work Redesign (Reading: Addison-Wesley, 1980).
35. Thomas L. Tang, Jwa K. Kim, and David S. Tang, “Does Attitude Toward Money Moderate
the Relationship Between Intrinsic Job Satisfaction and Voluntary Turnover?” Human
Relations 53, no. 2 (2000): 213–45.
36. Skinner, Science and Human Behavior.
37. Kohn, Punished by Rewards.
38. See Deci, Intrinsic Motivation; and Deci and Ryan, Intrinsic Motivation.
39. K. O’Hara, C.M. Johnson, and T.A. Beehr, “Organizational Behavior Management in the
Private Sector: A Review of Empirical Research and Recommendations for Further
Investigation,” Academy of Management Review 10 (1985): 848–64.
40. See Victor V. Vroom, Work and Motivation (New York: Wiley, 1964). Or see Edward E.
Lawler, Motivation in Work Organizations (Monterey: Brooks/ Cole, 1973).
41. See Deci, Intrinsic Motivation; see also Deci and Ryan, Intrinsic Motivation.
42. Ibid.
43. Uco J. Wiersma, “The Effects of Extrinsic Rewards in Intrinsic Motivation: A Meta-
Analysis,” Journal of Occupational and Organizational Psychology 65 (1992): 101–14.
44. Meiyu Fang and Barry Gerhart, “Does Pay for Performance Diminish Intrinsic
Interest?” International Journal of Human Resource Management 23, no. 6 (2012): 1176–96.
45. J.M. Harackiewicz and J.R. Larson, “Managing Motivation: The Impact of Supervisor
Feedback on Subordinate Task Interest,” Journal of Personality and Social Psychology 51
(1986): 547–56.
46. Stephen D. Levitt and Stephen J. Dubner, Freakonomics: A Rogue Economist Explores
the Hidden Side of Everything (New York: William Morrow, 2005).
47. See also M. Jensen and W. Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure,” Journal of Financial Economics 3 (1976): 305–60. See also
Kathleen Eisenhardt, “Agency Theory: An Assessment and Review,” Academy of
Management Review 14, no. 1 (1989): 57–74.
48. Arthur C. Brooks, Gross National Happiness(New York: Basic Books, 2008).
49. Thomas L. Tang, Jwa K. Kim, and David S. Tang, “Does Attitude Toward Money Moderate
the Relationship Between Intrinsic Job Satisfaction and Voluntary Turnover?” Human
Relations 53, no. 2 (2000): 213–45.
50. Kohn, Punished by Rewards.
51. Richard J. Long and John L. Shields, “From Pay to Praise? Non-Cash Employee Recognition in Canadian and Australian Firms,” International Journal of Human Resource
Management 21, no. 8 (2010): 1145–72.
52. J.L. McAdams, “Nonmonetary Rewards: Cash Equivalents and Tangible Awards,” in The
Compensation Handbook: A State of the Art Guide to Compensation Strategy and
Design, ed. L.A. Berger and D.R. Berger (New York: McGraw-Hill, 1999), 242.
53. J.-P. Brun and N. Dugas, “An Analysis of Employee Recognition: Perspectives on Human
Resource Practices,” International Journal of Human Resource Management 19, no. 4
(2008): 716–30.
54. Long and Shields, “From Pay to Praise?”
55. T.S. Bateman and D.W. Organ, “Job Satisfaction and the Good Soldier: The Relationship
Between Affect and Employee Citizenship,” Academy of Management Journal 26 (1983):
587–95.
56. Dennis W. Organ, “The Motivational Basis of Organizational Citizenship
Behavior,” Research in Organizational Behavior 12 (1990): 43–72.
57. Chris Argyris, Integrating the Individual and the Organization (New York: Wiley, 1964).
58. Susan J. Lambert, “Added Benefits: The Link Between Work–Life Benefits and
Organizational Citizenship Behaviour,” Academy of Management Journal 43, no. 5 (2000):
801–15.
59. Robert H. Moorman, “Relationship Between Organizational Justice and Organizational
Citizenship Behaviors: Do Fairness Perceptions Influence Employee Citizenship?” Journal of
Applied Psychology 76, no. 6 (1991): 845–55.
60. Mary A. Konovsky and Dennis W. Organ, “Dispositional and Contextual Determinants of
Organizational Citizenship Behaviour,” Journal of Organizational Behavior 17 (1996): 253–66.
61. Richard J. Long, “Employee Buyouts: The Canadian Experience,” Canadian Business
Economics 3, no. 4 (1995): 28–41.
Chapter 4: Components of
Compensation Strategy CHAPTER LEARNING OBJECTIVES
After reading this chapter, you should be able to:
• Define base pay and discuss its advantages, disadvantages, and
applicability.
• Define performance pay and discuss its advantages, disadvantages,
and applicability.
• Define indirect pay and discuss its advantages, disadvantages, and
applicability.
• Identify and differentiate between the three main methods for
establishing base pay.
• Define market pricing and discuss its advantages, disadvantages, and
applicability.
• Define job evaluation and discuss its advantages, disadvantages, and
applicability.
• Define the pay-for-knowledge system and discuss its advantages,
disadvantages, and applicability.
PAY SYSTEMS ARE CHANGING
Pay systems have been evolving in the United States, Canada, and globally over the past three
decades. Here are a few key changes to employee pay systems over this period:
1. There is an increasing utilization of market data, especially in the
United States. A WorldatWork study of 941 organizations found that, in
2012, 88 percent organizations used market pricing to some degree. In
Canada, organizations also depend heavily on market data; however,
job evaluations continue to be extensively used because of pay equity
requirements and concerns about internal equity.
2. Strategic rewards designs have ebbed and flowed, at times overcoming
the inertia of the field’s perpetual instinct simply to copy the practices
of others, most notably in the 1990s. Businesses are challenging
compensation professionals to align pay systems with business
strategy to create a unique competitive advantage.
3. Base pay increases have stagnated, with annual increases dropping to
1–3 percent today; employee wages have barely kept up with inflation
in the past 35 years.
4. While base pay has stagnated, benefits costs have increased steadily,
especially in the United States where benefits now represent
approximately 30 percent of total rewards. In Canada, the figure is
lower (about 20 percent) largely because of health care benefits
provided by the government. Defined contribution pension plans are
increasing in both countries. Work/life benefits are popular
currently.
5. While skills, knowledge and competencies are being rewarded by many
organizations, typically relatively few people are paid using formal
skill-, knowledge-, or competency-based pay systems.
6. Incentive pay has surged in a variety of forms but is still used far more
heavily with executives and managers than with other employees.
There are many forms of incentive plans rewarding individual
performance (e.g., individual bonus, spot awards), group or unit
performance (e.g., gain sharing, project or team bonus), or corporate
performance (e.g., profit sharing, stock options, employee share
ownership plan).
Sources: Gerald E. Ledford Jr., “The Changing Landscape of Employee Rewards: Observations
and Prescriptions,” Organizational Dynamics 43 (2014): 168–79; Gerald E. Ledford Jr.,
“Overview of the Commentaries on the Changing Landscape of Employee Rewards:
Observations and Prescriptions,” Compensation and Benefits Review 46, no. 5–6 (2014):
254–61; Canadian Inflation Rate Trends,
http://www.tradingeconomics .com/canada/inflation-cpi, accessed September 22, 2016;
Mercer Press Release, “Salary Budgets Indicative of a ‘New Normal’ as Employers Remain Cautious of Slow Moving Economy,” September 9, 2016,
http://www.mercer.ca/en/newsroom/mercer-salary-budgets-indicative -of-a-new-
normal-as-canadian-employers-remain-cautious-of-slow -moving-economy.htm, accessed
July 28, 2016.
// Introduction to Compensation Mix Choices
Why does the person who works as a secretary at your college or university get paid per hour,
while the person who cuts your hair get paid per head? In fact, why use time-based pay at all?
Some compensation systems do not. For example, realtors get paid only when they sell a
house, auto salespeople are paid only when they sell a car, and stockbrokers are paid only
when they make a trade. Carpet installers are paid for each square metre of carpet laid, long- haul truck drivers are paid per kilometre driven, and dentists are paid for each tooth drilled.
Why not pay everybody this way?
That’s a good question—and one that will be addressed in this chapter. This chapter is the first of three (chapters 4–6) that together constitute what you need to know to be able to formulate
reward and compensation strategy. This book has been designed so that its first half focuses
on providing the tools you need to formulate reward and compensation strategy, while the second (chapters 7–13) provides the more technical knowledge that you will need to have in
order to transform your compensation strategy into a functioning compensation system.
In designing any compensation strategy, we must address two key questions:
• What role (if any) should each of the three compensation components
(base pay, performance pay, indirect pay) play in the compensation
mix, and how should each component be structured?
• What total level of compensation should be provided?
We will defer the second question until Chapter 6. The purpose of this chapter and of Chapter
5 is to provide a foundation for answering the first question by examining the choices that need to be made regarding each of the three compensation components. This is illustrated
in Figure 4.1, which represents the “menu” of choices for a firm’s compensation mix. In this
chapter, we start the discussion on performance pay in general and then discuss specific performance pay choices in Chapter 6. In this way, you are not overwhelmed with the material
(you see, we care!).
As Figure 4.1 shows, the first strategic decision is about the relative proportions of base pay,
performance pay, and indirect pay to include in the compensation mix. Within this, there are
three key decision aspects—what method(s) should be used for establishing base pay, what
type(s) of performance pay (if any) should be provided, and which elements of indirect pay
should be included. This chapter provides the foundation for making decisions about the
proportions of base pay, performance pay, and indirect pay to include in your compensation
strategy, and for deciding which of the three methods for determining base pay will be used.
Chapter 5 provides the foundation for choosing among the various options for performance
pay, while Chapter 6 will provide a specific process for formulating compensation strategy. In
order to keep a sharp focus on the strategic choices that need to be made in establishing a compensation system, we have deferred most of the technical aspects of designing base pay,
performance pay, and indirect pay until the second half of the book (chapters 7–13).
// Fundamental Components of the
Compensation Mix
In designing a compensation system, firms must choose which of the three fundamental
components to include in the compensation mix, and how much of total compensation each
of these components will account for. A compensation system can include one, two, or all three of these fundamental components of the compensation mix. To complicate things
further, it usually makes sense for different choices to be made for different employee groups
within the firm.
Base Pay
Base pay is the portion of an individual’s compensation that is based on time worked, not on
output produced or results achieved. For a majority of employees in Canada, base pay serves as the largest component of their compensation package. According to research conducted by
one of the authors, base pay accounts for about 75–80 percent of the compensation for a
typical employee, performance pay for 5–10 percent, and indirect pay for about 15 percent of
total compensation.
However, these proportions vary across firms (and across occupational groups), with some
firms providing virtually 100 percent of their compensation in the form of base pay (as in the
case of firms that rely mainly on hourly paid part-time workers), while others provide virtually 100 percent in the form of performance pay (as in the case of salespeople working on straight
commission). Until recently, there had been trends toward increased performance pay
(especially that geared to group or organizational performance) and increased indirect pay (particularly health benefits), but these trends appear to have levelled off in recent years,
perhaps due to the difficult economic circumstances that have characterized a large part of
the first decade of the 21st century.
Base pay is “guaranteed” by the employer: if a person works for a certain amount of time, he
or she is paid a prespecified amount of money. In some cases, this amount is calculated on an
hourly basis (e.g., $15 per hour); in others, daily (e.g., $300 per day); in others, weekly (e.g., $1,500 per week), monthly (e.g., $6,000 per month), or annually (e.g., $72,000 per year). When
calculated on an hourly basis, base pay is known as a wage; when calculated on a weekly,
monthly, or annual basis, it is known as a salary.
Why Use Base Pay?
Wouldn’t it be more efficient just to use output-related pay? Why not eliminate base pay, as
some employers have done? The answer is that output-related pay cannot always be used,
which forces the use of base pay. In addition, base pay is sometimes preferable to output-
related pay, even where output-related pay is feasible.
For some organizations, output-related pay is impractical. Substitution of output-related pay
for time-based pay is feasible only for jobs in which the output is:
• a. easy to measure,
• b. easy to price in terms of its value to the employer,
• c. easy to attribute to individual employees,
• d. controllable by the individual employee, and
• e. relatively stable.
Obviously, most jobs do not meet all these criteria, and attempts to use output-related pay in
such jobs can cause serious problems.
In some organizations, output-related pay is possible but not desirable because of the
unintended consequences. For example, some mines do not use output-related compensation
because of a concern that this might lead to a strong push for production at the expense of safety. In the retail sector, salespeople may become too aggressive or may resort to unethical
sales practices in order to maximize their commission income. Jobs that combine some
measurable outputs with immeasurable outputs are also not good candidates for a pay system based only on output, since employees tend to focus on the measured behaviours and
neglect other behaviours.
In some organizations, output-related pay may be practical and desirable from the employer’s
point of view, but not from the employee’s. In general, people prefer certainty in their rewards and thus prefer a large component of base pay in their compensation mix. Trade unions have
worked for many years to make wages more certain and have generally pushed for more base
pay and less performance pay. (Note, however, that unions may have lost the will or ability to oppose performance pay; recent research suggests that unionized employers in Canada no
longer differ from non-union employers in their proportions of base and performance pay.1)
Indeed, because of the general preference among employees for base pay, it may be necessary to offer higher total pay in order to induce employees to accept jobs in which all pay is
performance-contingent. This may actually result in higher total compensation costs as
employees demand a premium for the additional risk.2 If the performance-contingent pay plan does not boost output sufficiently to cover the additional pay costs, then a firm is better off
with a time-based pay system.
So far, base pay has been portrayed as something to be used because no other alternative is
viable, and this is indeed the principal motivation for using it. But base pay can also be used
for more positive reasons:
1. Flexibility. With time-based pay, the employer is essentially buying time
from the employee. Within certain limits, this time may be directed in
many ways and redirected as need arises. Base pay doesn’t confine
employees’ attention to only one or two behaviours, as output-based
pay tends to do.
2. Base pay allows the employer to recognize and encourage important
job behaviours that don’t directly produce output, such as skill
development.
3. Base pay can signal the relative importance of jobs within the
organization. Generally, jobs of greater importance to the
organization carry higher pay rates.
4. Base pay demonstrates a commitment on the part of the employer to
the employee, creating a greater likelihood of employee commitment
to the employer.
5. Depending on the method used to establish it, base pay can support a
particular managerial strategy. For example, a pay-for-knowledge
base pay strategy supports a high-involvement managerial strategy.
6. Finally, one very important reason for the use of base pay is simplicity—
it is usually much simpler to implement and administer than an
output-related system.
Disadvantages of Base Pay
Base pay also carries some disadvantages:
1. Base pay represents more of a fixed employer commitment than
performance pay, especially if salaries are used. It is not linked to
variability in an employer’s ability to pay in the way that performance
pay can be.
2. While base pay does contribute to membership behaviour, it does not
directly motivate task behaviour, nor does it signal key task
behaviours.
3. Since base pay does not relate organizational success directly to
individual success, it does not directly contribute to citizenship
behaviour.
4. Base pay is not self-correcting. In an output-related system, employees
who do not perform up to standard tend to voluntarily remove
themselves from the organization because they are unable to earn
enough money. Time-based pay provides no such mechanism.
Time-based pay and output/performance-related pay are not mutually exclusive and can be
combined. Managers can then capture the advantages of both while minimizing the
disadvantages. In recent years, there has been a trend away from compensation systems that
rely solely on either base pay or performance pay. Many firms that have traditionally relied
only on base pay are starting to add performance-contingent elements to their pay systems; others that have traditionally relied only on performance pay (such as stock brokerage firms)
are starting to add base pay to their compensation systems.
Performance Pay
Performance pay can be defined as any type of financial reward provided only when certain
specified performance results occur. It is sometimes known as “performance-contingent pay,”
“variable pay,” or “at-risk pay.” Pay-for-performance plans can be classified into three main categories, depending on whether the performance relates to the individual employee, the
group or work team, or the entire organization. Individual performance pay plans include
piece rates, commissions, merit pay, and targeted incentives. Group performance pay
plans include productivity gain-sharing plans, goal-sharing plans, and other types of team-
based pay. Organizational performance pay plans include employee profit-sharing plans,
employee stock plans, and other organizational pay plans.
Why Use Performance Pay?
Paying employees only when the desired performance takes place sounds like a wonderful
idea—if you are an employer. The latter part of the 20th century did see a dramatic growth in performance pay, particularly group and organizational performance pay. Yet many
employers still choose not to use performance pay at all, and among those that do, it usually
constitutes a relatively small proportion of total compensation. So, why should organizations
consider utilizing performance pay?
Performance pay plans have several advantages:
1. Properly designed, they can signal key employee behaviours and
motivate employees to achieve them.
2. They can reduce the need for other types of mechanisms for controlling
employee behaviour. When employees know that their pay is
dependent on performing particular behaviours, they won’t need a
supervisor watching them to make sure they are working.
3. Such plans can raise employee interest in performance and provide
employees with information about their current performance levels.
4. Different types of performance pay can be used to support specific
managerial strategies. For example, individual performance pay can
support a classical managerial strategy. Group- or organization-based
performance pay can support a high-involvement managerial
strategy.
5. Finally, performance pay plans make pay more variable and thus can
help link compensation levels to the firm’s ability to pay. This linkage
helps stabilize an organization’s employment levels,3 lessening the
need to lay off employees in difficult times only to rehire them when
business improves. This employment stability has advantages for both
employers and employees, since employers risk losing employees
whenever they are forced to lay them off, and employees often prefer
reduced-pay employment to layoffs.
Disadvantages of Performance Pay
It is difficult to generalize about the disadvantages of performance pay plans because the types of performance pay plans differ radically and each has its own specific advantages,
disadvantages, and limitations. (The specific advantages and drawbacks for each type of
performance pay plan will be covered in Chapter 5.) That said, one general drawback is that employees generally prefer predictable and certain rewards to unpredictable and uncertain
rewards. Of course, employees usually do not object to performance pay if it is clearly an add-
on, to top off base pay and indirect pay. But employees will generally resist substitution of
performance pay for base pay or indirect pay.
To induce employees to accept this substitution, it may be necessary to offer higher total
compensation than would otherwise be necessary. Some organizations that rely heavily on performance pay appear to pay a very steep price for so doing. For example, The Globe and
Mail reported that some stock traders received as much as $800,000 in gross pay several years
ago. Is it really necessary to pay this much? Is it really efficient to pay this much? Research in the United States indicates that workers on incentive systems average about 20 percent more
earnings than comparable workers on time-based pay systems.4
Sometimes the higher total compensation may not even retain the high-priced employees. At Canaccord Genuity Group Inc., Canada’s largest independent brokerage, between 30 and 40
senior investment bankers, traders and analysts at the director and managing director level
received compensation exceeding $500,000 a year. After losing some of its biggest producers,
Canaccord started to request its senior employees to commit to staying with the company for
the next year in order to receive their fiscal year-end bonuses.5
In addition, as discussed in previous chapters, performance pay may cause employees to
focus only on aspects of behaviour that are being measured, ignoring other unmeasured but still important behaviours. If poorly designed, performance pay can have unanticipated
negative consequences.6 Getting performance pay to work right is usually no easy matter;
base pay is often much simpler and more flexible. Overall, research undertaken by one of the authors shows that performance pay plans have a substantial failure rate, as judged by the
relatively high discontinuation rate of these plans.
Indirect Pay
At Alberta-based Imperial Oil, employees have company matching saving plans, extended
health and dental plans, short and long-term disability benefits, and company-paid and optional life insurance plans. The company also offers flexible company-paid pension plan
options, scheduled and floating earned days off, statutory and floating holidays, competitive
vacation entitlement, company-paid educational assistance, discounts on Esso gasoline
and home heating oil, and relocation assistance and support.7
These features cost Imperial a lot of money. So why provide them? Many companies don’t.
Why not keep things simple and just use direct pay?
In Canada, indirect pay is a major expenditure for many firms. In the past, indirect pay was
known as “fringe benefits,” but as the extent and costs of these benefits increased, they became known simply as “benefits.” In this book, “indirect pay” is preferred, because this
term acknowledges that benefits are in fact integral to total compensation for many firms and
should be considered a component of employee pay just like base pay and performance pay.
Often, employees and even employers underestimate the impact of indirect pay on the total pay package. This needs to change, given the cost of benefits and the strategic role they can
play in the compensation system.
Research conducted by one of the authors found that indirect pay in Canada averaged 15
percent of total compensation in medium to large private-sector firms; this ranged from 17
percent in the manufacturing sector down to 10 percent in the accommodation/food industry,
where many employers don’t provide any benefits beyond the statutory minimum. Other
research puts this cost between 10 and 20 percent of total compensation, depending on the
type of employers surveyed.8 Besides including larger employers, which pay more benefits, this sample included public sector organizations, which traditionally have provided more
benefits, on average, than private sector firms.
So, what do employers hope to gain from these expenditures? Why do some employers invest heavily in indirect pay, while others provide only the minimum required by law? Why bother to
provide indirect pay at all? Is indirect pay a costly frill, or can it play a significant role in
furthering key compensation objectives? This section of the chapter provides the foundation
for addressing these questions.
Indirect pay can be anything that costs the employer money, addresses some type of
employee need (thus conferring some type of “benefit” on the employee), and is not included as part of base or performance pay. There are six main types or categories of indirect pay, as
shown in Compensation Notebook 4.1.
These pay systems vary in other ways. One key variation is choice—that is, whether employees
can choose what benefits they receive (a flexible benefits system) or whether they cannot (a fixed benefits system). Another variation is responsibility for the costs—whether the employer
covers all costs, or whether employees are required to share in the costs. Yet another
important difference is whether coverage varies for different employee groups. All of these
issues will be discussed in more detail in Chapter 12.
COMPENSATION NOTEBOOK 4.1
Major Categories of Indirect Pay
1. Benefits mandated by law, including employer contributions to the
Canada/Quebec Pension Plan, Employment Insurance, and Workers’
Compensation benefits.
2. Deferred income plans, more commonly known as retirement or
pension plans.
3. Life insurance; extended medical, dental, and disability insurance; and
other types of health benefits.
4. Pay for time not worked, such as paid holidays and leaves.
5. Employee services, ranging from psychological counselling to food
services.
6. Miscellaneous benefits, which may range from provision of company
cars to purchase discounts on company products or services.
Why Use Indirect Pay?
Why do firms provide indirect pay? There are eight main motives:
1. Competitive pressure. If competitors are offering benefits that are
important to the people the firm wants to hire, then an employer may
need to offer similar benefits to attract those employees. For example,
some employees would never dream of working for an employer that
did not provide an adequate pension plan.
2. To satisfy the security needs of their members, unions have always
bargained strongly for comprehensive employee benefits, and
unionized firms have had to respond to these pressures. To remove
one possible incentive for unionization, non-union firms may match
the packages won by unions at other firms (although they do not
always do so). On average, employees in unionized firms receive
about 45 percent higher benefits than comparable non-union
Canadian employees.9
3. Certain types of indirect pay receive more favourable income tax
treatment than direct pay (see Chapter 12). In these cases, a firm may
use indirect pay to provide a higher total amount of after-tax
compensation to employees than it would if the firm had paid out the
same number of dollars in the form of direct pay.
4. Many benefits items, such as extended medical or dental coverage, can
be purchased more cheaply by the employer than by the employee,
due to group discounts from economies of scale in purchasing these
items. (Indeed, some employees, such as those with serious health
problems, might not even be able to acquire such insurance on their
own.) Again, this provides a higher level of reward to employees for
the same amount of company money.
5. Benefits can protect the financial security and peace of mind of
employees, thereby helping maintain good employee performance.
Employees who have concerns about their ability to deal with health
expenses, or what would happen should they become disabled, or
who have personal problems, may have difficulty focusing on their
work.
6. Many employers feel a genuine sense of responsibility for the welfare of
their employees and want to help protect them from adversity. Others
may not have the same concern but still do not want to appear
hardhearted when employees encounter financial or health problems.
The benefits system provides a systematic way for dealing with these
types of problems.
7. Benefits can reinforce a particular managerial strategy. For example,
the human relations strategy relies on a stable workforce. Since
benefits for employees usually increase as their tenure increases,
benefits can encourage membership behaviour. They can also create a
sense of gratitude and obligation on the part of employees toward
their employer—a key feature of the human relations strategy. It is no
coincidence that the boom in benefits plans started during the 1950s
and 1960s, when human relations firms were becoming preeminent.
But indirect pay can be used to reinforce other managerial strategies
as well. For example, because high-involvement companies focus on
employee learning and development, they generally provide generous
tuition reimbursement and educational leave plans. These two
benefits can help provide the intrinsic rewards on which these
organizations rely for employee retention and motivation.
8. Specific benefits can be used to promote consequences that benefit
the organization. For example, subsidizing fitness classes or providing
supplemental medical coverage may result in healthier employees
who miss less work due to sickness. In addition, employee assistance
programs may help employees resolve personal problems that could
have a negative impact on work performance. Provision of company
cars may reinforce a particular image for the sales force. Purchase
discounts on company products may prevent the potential
embarrassment of company employees purchasing products from a
competitor and also help give employees direct knowledge of the
company’s products. Compensation Today 4.1 gives more examples
of companies providing their own products as part of the employee
benefits package.
COMPENSATION TODAY 4.1
Pick Your Perk: Pork or Prozac?
Would you rather have free pork or free Prozac? Is that choice too tranquil? Then how about
free Viagra?
As part of their indirect pay packages, employees at Big Sky Farms of Saskatchewan receive
two sides of pork every year, while employees at Eli Lilly Corporation receive free Prozac (and any other drug the company manufactures). Employees at Pfizer Corporation receive free
Viagra (which retails at $15 a pill!) along with other drugs it manufactures, and employees of
auto manufacturers receive purchase discounts on new vehicles. Imperial Oil Canada offers employees discounts on Esso gasoline and home heating oil. In the travel business, employees
are eligible for free or low-cost flights and package tours, as long as they select them from
unsold inventory. Many retail stores offer employees discounts on the products they sell.
In addition to providing a valued benefit to employees and helping employees become
familiar with company products, most of these benefits carry no tax liability to the employee,
since companies are generally allowed to provide their own products to employees without
having to declare them as taxable benefits.
Disadvantages of Indirect Pay
So if indirect pay has all these advantages, why doesn’t every firm use it? Indirect pay has
numerous disadvantages, including these:
1. First and foremost, is the cost, which can be substantial.
2. Second is rigidity. Indirect pay is generally a fixed cost. Once a firm
commits itself to providing certain benefits (such as a pension plan), it
is liable for the costs of maintaining these benefits, even if the firm is
not performing well.
3. Once a benefit is provided, it becomes very difficult (and sometimes
even illegal) to eliminate it. Even if the benefit is not highly valued by
employees, simply eliminating it (without replacing it with something
else) is likely to cause a negative reaction among employees.
Moreover, where benefits are part of the terms and conditions of
employment, as they are in union contracts, to unilaterally
discontinue them may be illegal.
4. It is often difficult to develop a benefits package that meets the true
needs of employees and that does not waste money on benefits that
are not valued highly by employees.
5. Administration and communication of a benefits program can be much
more costly than simply providing higher direct pay, particularly for
smaller firms, which do not enjoy economies of scale when purchasing
the benefits and administering them.
6. There is virtually no direct link between indirect pay and specific
employee task behaviour. Since most or all employees in a firm are
typically covered by benefits, regardless of employee performance,
and since the amount of the benefits received does not vary with
performance, indirect pay is the opposite of performance pay and is
not a good motivator for task behaviour.
7. A benefits program may succeed too well at creating employee
stability, when unhappy employees remain with the firm simply
because they do not want to forgo the generous benefits package.
8. Certain specific benefits or the means of administering them may
actually promote undesirable behaviour. For example, an excessively
generous or poorly designed sick leave policy may encourage
absences by increasing the attractiveness of not coming to work and
may also indirectly penalize those who do come to work by requiring
them to do the work of the absentees.
9. Finally, despite the large amount of money expended on benefits, not a
lot is known about the impact of indirect pay on employee and
company performance. Nearly two decades ago, experts complained
that “the state of knowledge about the influence of benefits on
employee attitudes and behaviours is dismal.”10 Since then, with the
specific exception of pensions, not much has improved.
While we know that satisfaction with benefits is an important component of overall reward
satisfaction,11 there has been no research that might tell us whether eliminating the benefits system and adding the equivalent amount to salaries would contribute more to reward
satisfaction. In theory, a properly designed benefits system that provides valued benefits to
employees should deliver more reward satisfaction than simply adding extra pay, due to the
tax advantages of benefits plans and to the economies of scale when benefits are purchased.
However, this proposition has never been effectively tested.
But even if it is true that benefits are preferable to extra direct pay, there must be a point
beyond which the value of additional indirect pay declines below the value of additional direct
pay. Many employers believe that this point has now been reached. After a steady upward trend beginning in the 1960s,12 benefits costs peaked in 1995 at 21.4 percent of total
compensation.13 After that, they edged down every year until 2000, when they settled at 19.7
percent of total compensation in large firms14 and lower than that in smaller firms. In the 2000s, benefits costs began edging up again due to the increased costs of health benefits,
particularly prescription drug plans.15 Also, due to poor investment returns realized by pension
funds caused by the 2008–09 financial meltdown, coupled with increased employee longevity,
some types of pension plans (particularly those known as “defined benefit” plans) have
become much more costly for employers. Recent research suggests that these costs have
stabilized between 10 and 20 percent.16
In general, indirect pay is not a good investment for classical firms, since it provides no task
motivation. Perhaps the only circumstance in which it may be a good investment for such
firms is in situations involving high training costs. Since a classical firm is usually not a very satisfying organization to work for, the company needs some means of retaining its
investment in trained employees; thus, using indirect pay to tie the employee to the firm may
be a good strategy for protecting this investment. Of course, this commitment will likely be of
a grudging, continuance type.
This is why classical organizations normally minimize the use of indirect pay, except as a
means to retain key employees. But ironically, much to the dismay of classical managers, many classical firms have ended up with very extensive benefits programs as a result of unions
and the collective bargaining process. Most of these firms are probably aware that they receive
very little value from these programs, and some have likely attempted to use flexible benefits
as a ploy to cut costs.
If a classical organization must provide benefits, either as a result of the collective bargaining
process or in an effort to match the benefits of competitors, a traditional fixed benefits system will probably fit best, with employees sharing the costs of the benefits payouts (such as paying
a proportion of every dental claim) to discourage frivolous use of the system. In situations
where pay is tied to seniority and where employee productivity drops with age, generous
pension plans may be desirable in order to encourage highly paid employees to retire.
In contrast, for human relations firms, indirect pay is a cornerstone of the managerial strategy,
which is designed to show high concern for employees and to encourage high membership
behaviour. As discussed earlier, human relations strategies appear to be losing popularity due to changes in the work environment. But in firms where human relations is still an effective
managerial strategy, indirect pay remains a key part of the compensation strategy, although
efforts are made to contain the costs of benefits. While these benefits systems may include
some flexible elements, a fully flexible benefits system does not fit well with this approach.
The high-involvement firms face a dilemma regarding indirect pay. In some ways, indirect pay
does not fit with the high-involvement concept because it does not relate to company performance. However, the key asset of any high-involvement firm is its employees, so it
needs to be sure that the absence of a benefits system doesn’t cause them to leave. Such a
firm also needs to offer sufficient benefits that employees’ lower-order needs for security are
satisfied so that they can be motivated by their higher-order needs.
A high-involvement organization requires a high level of commitment from its employees, so
its benefits system needs to recognize and facilitate that commitment. For example, family- friendly benefits, such as child care, elder care, and flexible work schedules, help employees.
High-involvement firms also have a genuine concern for the well-being of their employees and
strive to help them deal with unforeseen problems.
In general, high-involvement organizations tend to structure benefits to reinforce the employer–employee partnership. Thus, a flexible benefits system with cost sharing on the
individual benefits is a good fit. But fixed benefits that encourage highly desired behaviours,
such as tuition reimbursement and educational leave plans, also have a role. A key point is that benefits programs in high-involvement companies are not focused on continuance
commitment. A high-involvement organization does not want to “trap” people who don’t fit
the organization.
Compensation Notebook 4.2 summarizes the advantages and disadvantages of the three
fundamental compensation mix components.
COMPENSATION NOTEBOOK 4.2
Advantages and Disadvantages of the Compensation Mix Components
// Base Pay Methods: Market Pricing
Suppose, like most employers, you have decided to include base pay in your compensation
system. How do you determine the value of each job to the organization so that it can be
compensated accordingly? There are three main methods. The first—market pricing—is to
simply offer the average of what other employers in the region are paying for a particular job. The second—job evaluation—is to systematically rank all jobs in the organization in terms of
their value to the employer and then calibrate this system to the labour market. The third is to
develop a system based on the total value of the skills and competencies that each employee
has acquired, known as a pay-for-knowledge system (PKS).
In the remainder of this chapter, we will discuss each of these three methods, focusing on the
major considerations in deciding which method(s) will best fit your organization. However, except for the pay-for-knowledge system, where an understanding of the design issues is
relevant in deciding whether to make it a part of your compensation strategy, we will defer
discussion of the technical aspects of these methods to Chapters 7, 8, and 9. Right now, we want to focus on factors that influence your decisions regarding which methods fit best with
your compensation strategy, as a foundation for learning how to use the compensation
strategy formulation process in Chapter 6.
Each of the three methods for determining base pay has advantages and disadvantages, and it
is essential to understand these when deciding which of these methods is best suited for your
firm’s compensation strategy. Compensation Notebook 4.3 summarizes these advantages
and disadvantages. We now discuss them for each method in turn.
COMPENSATION NOTEBOOK 4.3
Advantages and Disadvantages of the Methods for Base Pay
Market pricing is the simplest of the three methods and is the most common method used in
small firms. The method is straightforward: if you need a secretary or a machinist, you observe what other firms are paying for these jobs and then make similar offers. If you need
exceptional performance from your employees and you can afford it, you may pay somewhat
above the “going rate” in order to attract the most qualified individuals. But if you don’t need
exceptional performance and are prepared to put up with higher turnover, you may decide to
pay somewhat less than the going rate.
As the labour market changes over time, the employer simply adjusts the pay levels of current
employees and the starting pay levels for new employees in accordance with these changes.
To simplify the process of determining the “market rates” for each job, some companies use compensation consulting firms that specialize in collecting these data and making them
available to clients on a commercial basis. Data are also available through government
agencies (such as Statistics Canada), industry associations, organizations such as the
Conference Board of Canada, and websites.
Advantages of Market Pricing
Market pricing has two key advantages:
1. Relative simplicity and cost. Other methods are much more
complicated to design and apply, and all other pay systems must
ultimately include references to the market to calibrate their systems.
As an example of complexity, the job evaluation method depends on
formalized, detailed, and up-to-date job descriptions. But many firms
do not have such job descriptions and do not want to develop them.
Descriptions are not needed in pay-for-knowledge systems, but those
systems are difficult to develop and administer. Thus, market pricing
is usually a much cheaper system than either of the alternatives.
2. Market pricing keeps all jobs in the organization aligned with market
conditions. This prevents turnover caused by uncompetitive wages
and makes recruiting easier. For the other two base pay methods, not
all jobs are necessarily aligned with the market.
Disadvantages of Market Pricing
Market pricing has numerous drawbacks:
1. It is not as simple as it sounds. One difficulty (among many) is that
identifying one specific going rate for a given job can be elusive.
Different wage surveys turn up different results, because they make
different judgments about which jobs to survey and how to define
different labour markets. Labour markets can be defined in several
ways—in terms of industry type, occupational group, geographic area,
and firm size. So market pricing often does not result in standardized,
usable information.
2. Different employers define jobs differently. For example, a “secretary”
in some firms serves mainly as a typist or receptionist, while in other
firms, “secretaries” serve more as executive assistants or even as
office managers. Thus, one firm may report that it is paying its
“secretaries” $25,000 per annum, while another pays $45,000. For this
reason, a wage survey that indicates an “average” pay of $35,000 for
“secretaries” may be seriously misleading.
3. Getting a definitive market price for a given job may not be possible.
There is strong evidence that there is no such thing as a standard
“market wage” for a given job.17 Studies have found that even in a
single geographic area, wage rates for the same job titles vary
dramatically.18 For many job titles, some employers have been known
to pay two to three times what other employers do. Of course, some of
this discrepancy may be due to inconsistencies in job definitions or to
differences between industries. However, research shows that there
are often wide discrepancies in pay for identical jobs in a single
industry and geographic area.
Although this result is often mystifying for economists, it should
not be for human resources specialists. We know that membership
behaviour is motivated by the total mix of rewards from a job, not
from pay alone, and these “identical” jobs likely vary considerably in
the total package of rewards. Compensation surveys often do not
adequately account for performance pay, such as profit sharing, and
usually do not take indirect pay into account at all. Moreover, surveys
take no account of the other extrinsic rewards (such as job security or
opportunities for promotion) and intrinsic rewards (such as job
autonomy or skill variety) that some jobs may offer. Given that the
total spectrum of rewards varies widely across firms, it would be
extraordinary if there were not wide differences in cash compensation
across firms. All of this illustrates the problems inherent in comparing
compensation statistics across firms.
4. It does not address internal equity. When market-pricing jobs,
organizations make little or no attempt to weight the value of each
job to their own organizations. Thus, jobs that are vital to the
organization’s success may pay less than jobs of lesser importance,
simply because of data from the labour market. Furthermore, if a firm
is geographically dispersed, market conditions may vary in different
parts of the country, causing the same job to be paid differently in
other parts of the company. These differences can cause employee
resentment.
5. It results in a lack of control. A firm that uses only market pricing is
allowing competitors to set its compensation policy. Because it does
not tailor compensation to suit its own strategy and needs, it forgoes
the opportunity to use compensation as a source of competitive
advantage. By using only market pricing, an organization may be
allowing the market to drive its strategy.
6. The market does not necessarily produce pay systems that are
equitable from a societal point of view. Critics point to a “pay gap”
between jobs that have traditionally been performed by women and
those that have been performed by men. They argue that the market
has systematically undervalued work performed by women and that
when a firm adopts market-based pay, it perpetuates these inequities.
In response, many Canadian jurisdictions have passed pay equity
legislation (discussed more fully in later chapters), which requires that
jobs of equal value be compensated equally, whatever the market
may suggest. Firms in these jurisdictions must include some type of
job evaluation in their compensation systems, whether they want to
or not.
// Base Pay Methods: Job Evaluation
Job evaluation systems involve analyzing job descriptions and then comparing all jobs in the
organization in a systematic manner. The most common approach is to identify a number of
key compensable factors and then evaluate each job according to how much of each factor is present. This creates a ranking of all jobs, known as a “hierarchy of jobs.” Exact pay levels for
each job are determined by relating certain key jobs or benchmark jobs to the external market
and then interpolating the rest.
Job evaluation first gained popularity in the 1920s and 1930s as large classical organizations
began to dominate industry. For them, job evaluation provided a method for centralizing and
controlling compensation costs. Before this time, compensation was handled in a haphazard,
often chaotic manner, with individual supervisors and managers having the authority to pay
employees as they saw fit. Lack of control over such a key cost element was a major frustration
to top management in classical firms, and job evaluation was seen as a way of both gaining
control and ensuring that compensation costs would be no higher than they had to be. Job
evaluation also fit perfectly with the narrowly structured jobs that these types of organizations
tend to have.
In the 1940s and 1950s, human relations firms regarded it as an important tool for fostering a
sense of fairness among employees, thereby keeping them loyal and satisfied and preventing
unionization. While it was a means of controlling costs, its ability to foster a sense of reward
equity was seen by human relations firms as its most valuable feature.
Advantages of Job Evaluation
Job evaluation has several major advantages:
1. It enables centralized control of compensation costs and prevents jobs
from being overpaid relative to their value to the firm.
2. Because it links pay level to the importance or value of the job to the
organization, it signals the importance of jobs to employees and
motivates people to seek promotions.
3. It is a systematic way to promote equitable pay within the organization
and to reduce the impact of factors such as favouritism and nepotism.
When used effectively, job evaluation should also eliminate gender-
based pay inequities.
4. Its system of standardized jobs makes it easier to determine market
values for jobs after they have been subjected to job evaluation.
5. Because job evaluation is based on job descriptions, it encourages the
development of those descriptions, which can bring significant
broader advantages. When accurate and up-to-date, job descriptions
inform employees about their roles in the organization, guide
recruiters in hiring new employees, and provide some assurance
that all important tasks are being done. They also allow for tight
control of employees, if that is part of the firm’s managerial strategy.
6. Job evaluation provides a systematic way to determine pay for new
jobs.
7. Over time, a number of consulting firms that specialize in job
evaluation have emerged, with well-established technologies for
conducting job evaluations that organizations can use when
implementing job evaluation programs.
8. Job evaluation fits with and reinforces both the classical and human
relations managerial strategies particularly well, but can also be used
in high-involvement organizations to ensure fairness of pay.
Disadvantages of Job Evaluation
Job evaluation has numerous disadvantages, some related to the process itself and others
related to the organizational rigidity it can create:
1. Job evaluation programs require the use of comprehensive job
descriptions, which many organizations may not have. Developing
and continuously updating of job descriptions is an onerous process.
Job descriptions are costly to develop and maintain and involve
continual updating as jobs change. For organizations operating in
dynamic environments, this can be a significant problem.
2. Applying job evaluations can become an adversarial process, since it is
in the financial interests of employees to inflate their jobs whenever
possible. If job inflation occurs, it not only inflates the costs of the pay
system, but also causes inequity between inflated jobs and jobs more
honestly evaluated.
3. Although it is presented as a fair and scientific way of achieving
equitable pay, most employees realize that there is still substantial
subjectivity in the process. In the past, job evaluation systems, along
with market pricing systems, have been accused of perpetuating
rather than combating gender-based pay inequity.20 However, this is
not a problem inherent in job evaluation; rather, it’s the result of the
way job evaluation has been used.
4. The most important criticism of job evaluation systems is that they
inhibit change, flexibility, and skill development.21 Job descriptions
tend to create a “not my job” syndrome, as some employees use their
job descriptions to avoid taking on extra duties. When circumstances
change, job descriptions can slow organizational adaptation, because
employees remain unwilling to change until their current job
description changes. Professor Edward Lawler, one of the foremost
proponents of high-involvement management, argues that job
evaluation impedes the transformation of classical and human
relations organizations into high-involvement organizations.22 He
advocates the use of pay-for-knowledge systems instead. Critics of
job evaluation contend that there is no incentive for employees to
learn jobs that are not in the direct line of advancement. If
advancement to better jobs is not possible, there is no extrinsic
incentive to learn additional skills.
5. Finally, developing and maintaining a job evaluation system can be
costly, especially compared to the market pricing method. And, of
course, job evaluation does not entirely eliminate the need for
references to the market, which still must be done for a number of
benchmark jobs in order to align the job evaluation system with the
market.
Recently, some companies, such as General Electric, have
replaced job evaluation programs with “broad banding”—the practice
of reducing the dozens of pay grades used by some large firms to as
few as six large job bands.23 Some supporters of job evaluation argue
that broad banding can solve the rigidity problems it causes,24 but
others point out that it is illogical to go to all the trouble of making
fine distinctions between jobs and then throw jobs together into large
bands.25 For these reasons, some firms that adopt broad banding
simply eliminate job evaluation altogether. However, it appears that
most firms that say they use broad banding are keeping job evaluation
and are simply pruning down the number of pay grades they use to
some extent—but rarely to as few as six pay grades.
Despite its disadvantages, research by one of the authors shows that the great majority of
medium to large Canadian firms (75–80 percent) use job evaluation, and use of job evaluation actually appears to be growing. Some of this increase may be due to pay equity legislation
(enacted in a number of jurisdictions, including Ontario and Quebec), which requires the use
of a systematic method to compare job values within organizations.
Research by one of the authors also shows that about one-third of medium to large Canadian
firms use broad banding and that most of these firms (about 80 percent) also use job
evaluation. Interestingly, while broad banding has enjoyed a relatively high adoption rate, it also has a relatively high discontinuation rate, so the net effect has been very little change in
overall incidence over the past few years.
Overall, these results suggest that most medium to large Canadian firms believe that the
advantages of job evaluation outweigh its disadvantages. Clearly, job evaluation poses more
problems when the organization is faced with rapid change, so it seems most viable for firms
using classical or human relations managerial strategies. Interestingly, however, one of the authors found that high-involvement firms are actually more likely than other firms to use job
evaluation. This finding is quite surprising and may indicate that job evaluation is really not
incompatible with high-involvement management. It is possible that high-involvement firms see job evaluation as a way to maintain equitable pay relationships, which are essential for
these firms.
// Base Pay Methods: Pay for Knowledge
The third method for determining base pay is radically different from job evaluation. It
involves basing pay on the capabilities of individuals rather than on the characteristics of jobs. It is often called person-based pay, as opposed to job-based pay. There are various labels for
this method, including pay for knowledge, skill-based pay, and competency-based pay, and
these terms are often used interchangeably.
However, competency-based pay, usually applied at the managerial and professional level, is
distinct from skill-based pay (SBP), usually applied at the operational level. The term pay for
knowledge includes both competency- and skill-based pay, but most of the research has focused on skill-based pay. Under the right conditions, with the right plan design, it is clear
that skill-based pay can be successful and add value to an organization.26 By contrast,
competency-based pay is an unproven concept of questionable validity. Most of the
discussion here will therefore focus on skill-based pay, but we will touch briefly on
competency-based pay at the end of this section.
Advantages of Skill-Based Pay
The premise of skill-based pay (SBP) systems is that employees are paid according to their
skills, knowledge, and competencies, regardless of the job they happen to be doing at the
time. Utilizing an SBP system for base pay has a number of advantages:
1. It provides a major incentive for employees to learn a variety of skills, which then makes it
easier to shift employees from one job to another as needed. Recent research shows that SBP
promotes workforce flexibility, which often increases workplace productivity.27
2. SBP avoids the disincentive to movement caused by traditional job evaluation systems,
which result in strictly defined jobs that are “owned” by the people currently doing them.
Under traditional pay systems, if a nut on a machine needs tightening, someone has to call a mechanic, because maintenance is not part of the machine operator’s job description.
However, under SBP, an operator simply grabs a wrench and tightens the nut.
This flexibility is especially beneficial for organizations for which production and service processes peak and ebb unpredictably. For example, a company may have a big customer
order that needs expediting or is experiencing a parts shortage in a particular production
process; in both situations, SBP allows employees to move from idle functions to active functions. Of course, SBP also makes it easier to cover employee absences and vacations.
Because the system relies on flexible skills, SBP companies must use job rotation, and job
rotation itself has been shown to be beneficial for some organizations.28
Compensation Today 4.2 illustrates how SBP can facilitate flexibility and change, whereas
traditional methods for base pay can inhibit change.29
COMPENSATION TODAY 4.2
Headaches at Tylenol
As a result of the 1982 Tylenol poisoning tragedy (where persons unknown tampered with
bottles of Tylenol tablets, resulting in numerous deaths), Johnson & Johnson decided to
completely redo its Tylenol packaging to add greater security.
At the time, it had two packaging plants: one skill-based, the other job-based. The skill-based plant quickly installed the new technology and got back into production. Not so with the
traditional job-based, seniority-driven plant. Seniority rights and traditional pay grades
reduced employee flexibility in adapting to the new technology. In addition, unlike the skill- based plant, the traditional plant did not have a history of providing training, valuing personal
growth, and encouraging employees to do new things. So the transition to new packaging
equipment was a major challenge at this plant.
3. A major advantage over job evaluation is that it does not need job descriptions and thereby
avoids many of the problems of job descriptions. This is a significant advantage for organizations facing rapid change.
4. Jobs in SBP companies are broader and provide more intrinsic rewards. This advantage
comes with related advantages. For example, knowledgeable employees performing broader
jobs may be more effective at customer service, since they understand more of the business.
According to two prominent experts: “Skill-based pay prepares employees to handle a wider
range of customer issues without switching the customer from place to place. This is more
efficient for the organization and for the customer.”30
5. Because SBP allows individuals and teams to be more self-managing, and because it uses
the workforce more efficiently, a firm using SBP should be able to operate with a smaller labour force. This staffing reduction results from a reduced need for managerial, supervisory,
and inspection positions, as well as specialty positions, such as maintenance mechanics and
electricians. 6. A key advantage is that it supports behaviours needed by high-involvement firms. When
employees are knowledgeable about their organization, they can make more effective
decisions, exercise good judgment, and take quick action when necessary. For example, when Shell Canada wanted to build a new, high-involvement chemical plant, the company saw that
this would be difficult if not impossible using traditional pay methods, and made skill-based
pay a central part of this process, as Compensation Today 4.3 describes. 7. SBP not only fits with a high-involvement management strategy, but also helps promote
change to high-involvement practices. As one expert puts it:
[Skill-based pay] can be a powerful force in helping an organization live up to a
commitment to become a high-involvement organization. This is because employees, acting in their own self-interest, begin to exert pressure for greater training, information, and control over job rotation and other key decisions. In short, they begin to demand that
the organization behave more like a high-involvement organization.31
COMPENSATION TODAY 4.3
Skill-Based Pay Finds Good Chemistry at Shell Sarnia
One of the first organizations in Canada to implement skill-based pay was the Shell Chemical plant in Sarnia, Ontario, which opened in 1978. The plant produces polypropylene and
isopropyl alcohol in a 24-hour continuous process operation. The plant produces 75 grades of
state-of-the-art plastics in pea-sized pellets. It then sells these versatile polymers worldwide for use in products such as car door panels, carpets, toys, and pop bottles. Consistently high
product quality is essential. However, the production process is very complicated, and many
things can go wrong during the multistaged production process.
Quick and accurate reactions to production problems are essential at a major production
plant, but in the past, traditional plant design had made problem solving very difficult.
Production processes were usually divided into distinct departments, within which each
employee had a narrowly specified job. Few employees understood the entire production
process and the complex interrelations among the various production phases.
Shell had noticed numerous problems in its traditional plants, including slow responses to
production problems, underutilization of employees, high boredom levels, employee dissatisfaction, and employee turnover. To prevent these problems in the new plant, Shell
decided to base its new plant on the high-involvement model. At the same time, the company
also wanted to develop a collaborative relationship with the union (the Communications,
Energy, and Paperworkers Union) by involving it in the plant design process as well as in the
continuing operation of the plant.
The new design eliminated department separations and created 20-person “shift teams” to
operate the plant during each shift. These shift teams were supported by a craft team of electricians, pipefitters, and other specialized personnel, who were present only during the
day shift or during emergency situations. Each member of the shift team was expected to learn
to perform all necessary tasks in the production process.
The company recognized at the outset that the traditional approach to compensating
operators, which defined jobs narrowly and had a different pay grade for each job, would not
be compatible with this new system. Therefore, job categories on each shift team were reduced to one: shift team member. To foster employee multiskilling and flexibility, a pay-for-
knowledge system was developed.
Today, the system is still in place. When new employees start at the plant, they receive the training needed to perform a basic set of shift functions and are paid a base rate. To increase
their pay rate, workers need to demonstrate competence in one additional job knowledge
cluster and in four modules of a “specialty skill.” (For the purposes of training and compensation, the “operations” area of the complex is divided into 10 job-knowledge
clusters.) Each specialty skill (e.g., instrumentation, electrical, pipefitting) is further divided
into 40 skill modules, and every worker is expected to select one specialty skill. Thus, there are
10 levels in the pay progression system, and workers make the top pay when they have
mastered all 10 job-knowledge clusters and all 40 modules of their specialty skill. On average,
this takes about six years.
How well does the system work? When interviewed in 2001, company officials indicated that the original skill-based pay system, implemented more than 20 years previously, had shown
such success that it had been carried forward with very few changes.
Sources: Norm Halpern, “Sociotechnical Systems Design: The Shell Sarnia Experience,” in Quality of Working Life: Contemporary Cases, ed. J.B. Cunningham and T.H. White
(Ottawa: Labour Canada, 1984), 31–75; HRDC, “Moving Parts and Moving People:
Sociotechnical Design of a New Plant,” in Labour Management Innovations in
Canada (Ottawa: Human Resources Development Canada, 1994), 72–76; personal
communications with company officials.
Disadvantages of Skill-Based Pay
Skill-based pay also has a number of drawbacks:
1. Employees may be “overpaid” relative to competitor companies,
especially if SBP has been in place for some time and has resulted in
most employees earning the top pay level (“topping out”). In general,
employees operating under SBP earn considerably more than
employees not working under this system. However, SBP companies
feel that the flexibility gained outweighs the cost disadvantage.
2. When workers top out, or are earning the top pay level in the skill grid,
what is the incentive to continue learning and updating skills? Skills
can also become out of date, so there needs to be a system for
requiring topped-out employees to reskill.
3. If employees are not rotated through jobs regularly, then their skills
atrophy. However, senior employees may resent spending time doing
the less-advanced jobs in order for less-senior employees to perform
the more advanced jobs. As one pair of experts put it: “At some point,
having all chefs and no dishwashers (and having to pay chef wages to
those who are assigned to scrub pots and pans) is uncompetitive. And
probably dissatisfying to certified chefs with dishpan hands.”32
4. Skill-based pay systems lead to increased training costs, both in terms
of the cost of providing the training and in terms of lost work time, if
employees need to be taken off the job for training. For example, at L-
S Electro-Galvanizing (LSE) in Cleveland, a “fifth shift” had to be
created in order to provide the necessary time off the job for
training, even though the plant could run with four shifts. At LSE,
training costs run at about 12 percent of payroll, compared to less
than 1 percent in conventional firms in the same industry.
5. These systems are more complex to administer than job-based pay
systems, due to the need for certification procedures to determine
whether an employee is entitled to be paid for a new skill.
6. Aligning skill-based pay systems to the market may also be more
difficult than for a job evaluation system if there are no other firms
with skill-based pay systems to use as a comparison. Moreover, for
most firms, applying SBP to all jobs is not feasible, and this creates a
need to maintain dual skill- and job-based systems.
7. Not all employees may have the ability or desire to learn multiple jobs.
A firm wishing to use SBP must be sure it has a workforce that is
willing and able to continually learn new skills.
8. Unions may resist SBP because wages are based on skill levels instead
of seniority. But note that many SBP systems are found in unionized
firms.
9. Skill-based pay systems may appear to violate some pay equity laws,
which generally stipulate that employees should be paid for what they
actually do rather than for their capabilities.33 Thus, a woman
performing a bagging operation in a dog food plant who receives
lower pay than a man doing the same job may appear to be unfairly
treated. However, most pay equity laws do make exceptions for
factors such as skill levels and relevant experience, as long as these
are applied consistently to male and female employees.
10. SBP has a relatively high failure rate. Research by one of the
authors suggests that as many as 75 percent of SBP plans are
discontinued within four years.
This last disadvantage—that skill-based pay plans have a high discontinuation rate—should
not be that surprising. Given all the complexities and potential drawbacks of skill-based pay, it is likely to benefit only a limited number of companies—in particular, those that need a highly
flexible workforce. These would primarily be firms with complex technologies or
unpredictable production or service demands. Moreover, investing in more knowledgeable employees pays off only if the organization is structured in such a way as to use this
knowledge. Classical and human relations organizations would not receive much value from a
skill-based pay system. For all these reasons, the proportion of firms using skill-based pay has
not grown significantly in recent years.34
Research conducted by one of the authors indicates that, as expected, high-involvement firms
are most likely to use skill-based pay. Other Canadian research shows that firms with a participative culture are more likely to adopt SBP.35 Moreover, a study of 15 American firms
that implemented skill-based pay systems found that high-involvement management was a
key success factor for SBP compensation systems:
It is important to note that skill-based pay is not so much a compensation system as it is
a radical departure from traditional organizational design. It works best in work systems where there is a high level of employee involvement, where work has been organized in self-managed teams . . . and where there is a commitment to high levels of investment in
human capital.36
Some research has found that traditional, unionized organizations can benefit from SBP, but only if both management and the union are willing to adopt new, collaborative roles.37 Overall,
the keys to success appear to be implementation in the right circumstances, along with
effective plan design and effective implementation. When deciding whether SBP may fit, it is
important to understand the key issues involved in developing a skill-based pay system.
Issues in Developing a Skill-based Pay System
There are five main issues in developing a skill-based pay system: (1) deciding which employee
groups to include, (2) designing the skill blocks, (3) linking these skill blocks to pay, (4)
providing learning opportunities, and (5) certifying skill achievement.
To Whom Should Skill-Based Pay Apply?
The most active early adopters of skill-based pay systems were continuous process operations, with products ranging from chemicals to steel to dog food. Because of their high
task interdependence, high capital intensity, and overriding need to keep production running,
these operations are ideal sites for skill-based pay. Increasingly, though, SBP has also been
applied to other types of manufacturing firms and to the service sector.
Whenever the organization needs high-level and diverse employee skills and could benefit
from high employee flexibility, SBP may pay off. In their study of firms using skill-based pay in the United States, Jenkins and his colleagues found examples of successful SBP plans in a
wide range of manufacturing industries, as well as in many service industries, including
financial services, computer services, utilities, health services, and retailing.38 Probably the
most important factor in all of this is whether SBP will be part of a high-involvement
managerial strategy at the adopting firm.
Designing Skill Blocks
After deciding where to implement SBP, the next step is to identify the job skills that are required for effective performance of the work system and then to “bundle” them into
appropriate “skill blocks.” Skills can typically be differentiated along two dimensions—
horizontal and vertical. The horizontal dimension covers different types of skills, while the
vertical dimension covers the depth of each skill.
Generally, skill blocks are set out in a grid, defined by these two dimensions. Table
4.1 provides an example for a chemical plant. As the table shows, there are five horizontal skill
types and four vertical skill levels, with a total of 18 skill blocks. As employees complete each
skill block, they receive an increase in pay, as indicated by the dollar values shown in each block. (Although employees are usually expected to complete the horizontal row of skills
before moving vertically to the next higher row of skills, there may be some circumstances
where it makes sense to allow some vertical skill development before the entire row is completed.) In this illustration, a fully skilled chemical plant operator will be earning $17,000
more per year than an entry-level operator just starting out with the firm.
There are many possible ways to arrange a skill-based system. The Shell Sarnia chemical plant
(described in Compensation Today 4.3) has ten “job-knowledge clusters” for the basic
operation of the plant. In addition, it has three specialty skills (instrumentation, electrical, and
pipefitting), from which all shift team members must select one. To be fully qualified in a
specialty skill, team members must complete 40 training modules.
At Shell Sarnia, a shift team member receives a pay increase when he or she completes one job
knowledge cluster and four modules of a specialty skill. Thus, ten pay raises are possible beyond the entry-level base pay that each employee receives on joining the company. The
amounts of these raises are determined by collective bargaining. Employees can complete the
job-knowledge clusters in any order, but specialty modules normally have a specified
progression. Typically, it takes six or seven years for a shift team member to reach the top rate.
A system of skill blocks can range from simple to complex. A simple system was used by
General Mills at a plant producing fruit drinks.39 There were four main steps in the production process, and each step became a skill block. Within each skill block, there were three skill
levels, with a raise for completion of each. Employees could start in any skill block, complete
all skill levels within that block, or move to another skill block after accomplishing two levels
within that block.
In contrast, a much more complex system was developed at L-S Electro-Galvanizing
(see Chapter 2). When employees join the firm, they start as a “utility” person and receive a basic entry-level salary determined by collective bargaining. They start in one of five plant
areas (materials entry, process, inspection, delivery, or chemical plant), moving from one to
another as they master each one. Completion of each of these five blocks adds one-fifth of
the difference between the “utility” wage rate and the “process technician” wage rate (set
through collective bargaining) to the employee’s salary. Once they master all five blocks, they
receive the designation “process technician.”
At this point, employees are then expected to choose one of two intermediate skills: process/mechanical or electronic/instrumentation. The skills within each of these
intermediate skill blocks are classified as minor skills, medium skills, or major skills. For each
minor skill, there is a 2 percent increase in pay; for each medium skill there is a 4 percent
increase; and for each major skill there is an 8 percent increase. Once employees have
completed 80 percent of their intermediate skill, they may then start work on an advanced
skill in one of three areas: mechanical, chemical plant, or electrical.
At an information technology firm, the company wanted to design a skill-based pay system for
technical support engineers, but there was no established set of procedures from which to
form the skill blocks.40 So, instead, managers were asked to identify the key dimensions of this
work. They came up with seven dimensions: hardware, software, customer database,
documentation, network interface, written communication, and interpersonal interaction. For each dimension, they identified and ranked the specific skills needed, from simplest to most
complex. They arranged these into four vertical skill blocks, with the first block including the
simplest skills for each of the seven dimensions, with the second block including somewhat more complex skills for each dimension, and so on. Engineers received a pay increase on
completion of each skill block.
In designing skill blocks, you need to deal with numerous issues. One issue is how many skill
blocks to have. There is no clear answer, and it probably varies from case to case; research has found, however, that more successful plans have a slightly higher number of skill blocks (an
average of 11) than less successful ones (an average of nine).41 Generally, the more complex
and diverse the array of skills in a system, the more skill blocks are needed.
How long should it take to master a skill block? There is no hard and fast rule on this, but one
study found the average was 20 weeks.42 This finding suggests that the average plan requires
about four to five years for a worker to reach the top skill levels. Of course, the more complex the set of skills required, the longer it will take. At L-S Electro-Galvanizing, the first level,
process technician, can be achieved in three to four years, but reaching the top of the
system takes much longer. The general consensus on this matter is that for most skill-based
pay plans, an employee should be able to progress through the system in no more than six to
seven years.
Pricing the Skill Blocks
Once the skill blocks are established, they need to be priced—that is, the amount of money a
worker will receive from mastering that block needs to be established. The relative
amount of increase for each skill block should depend on how difficult the skill block is and/or
how long it usually takes for an employee to master that skill block, and on the value of that
skill block to the company. But how is the absolute amount of the pay for each skill block
determined? The most common method for determining this is the high–low method.
Let’s use the system depicted in Table 4.1 to illustrate this method. First, the firm would
determine the market pay rates for an entry-level chemical plant operator and for a job that
contains all of the skills in Level IV. Let’s suppose these annual rates are $40,000 and $50,833.
The firm then adjusts these amounts for its pay-level strategy—for example, to pay 10 percent
above the market at entry level and 20 percent above the market at top level. Thus, the entry- level pay would be $44,000, and the top-level pay would be $61,000, creating a difference of
$17,000. This $17,000 would then be allocated across the skill blocks according to their relative
importance or the amount of time required to master them.
This process may be complicated by the fact that it is often difficult to find market data for
jobs that precisely match the entry-level and top-level skill sets used under the SBP.
Another issue is whether to lead, lag, or match the market, and whether the same policy should apply at the entry and the top levels. In general, entry-level pay has to at least match
the market in order to attract employees with the learning abilities needed to progress
through the system, but it will probably be advisable to lead the market to some degree to be sure to attract employees with high learning potential. Typically, as the individual progresses
through the system, pay levels should lead the market more as the value of the employee
increases. One study revealed that, on average, SBP firms paid somewhat higher than the market median for their entry-level personnel (at the 63rd percentile), and much higher for
their employees at the top of the skill grid (90th percentile).43
One final question is whether SBP employees should also be paid on other individual bases,
such as seniority or individual merit. For seniority, the answer should almost always be “no,”
because progression by seniority is the antithesis to knowledge-based progression. In most
cases, the answer for individual merit pay should also be “no,” since it is at odds with the team approach that is usually essential for SBP to pay off. The exception to this rule may be where
each employee works separately and independently of other employees.
This is not to say that performance appraisal (beyond the skill certification process) should not
be used, but simply that it should generally not be linked to individual raises. In fact,
performance appraisal may be useful and even essential to make sure that skill levels are
being maintained and to identify and correct substandard performance. One major study
found that 45 percent of organizations with skill-based pay conducted regular performance
appraisals.44
However, while seniority or individual merit pay does not fit well with skill-based pay, group-
and organization-based performance pay fits very well.45 Gain sharing or goal sharing can
provide SBP employees with a financial reward for the increased productivity they are
expected to generate, and profit sharing and stock ownership can help reinforce the
citizenship behaviour that is so critical to the success of skill-based pay systems.
Providing Learning/Training Opportunities
Providing opportunities for employees to learn the requisite skills is essential in skill-based
pay systems. One expert argues that this is the single most difficult issue with pay-for-
knowledge plans.46 Since pay is tied to skill development, employees will want training opportunities. However, training can be very expensive, both in terms of the direct training
costs and in terms of time away from the job. This often conflicts with the productivity of the
unit and even with other reward systems.
For example, at an information technology firm, the company discovered that managers were
not using the employee training funds they had been allocated.47 Why? Time devoted to
training reduced the efficiency measures for their departments, so those managers who
encouraged the most training for their personnel received the lowest performance ratings! The problem was solved by revising the appraisal system so that the amount of training
undertaken by subordinates became a positive managerial performance indicator.
Companies using SBP have an array of training techniques to choose from. At L-S Electro- Galvanizing, training techniques include classroom training, interactive computer-based
training, and on-the-job peer training. On-the-job training is generally the largest component
in most plans, especially at the lower skill levels. But a problem that often arises is “bottlenecking” because some skills take longer to learn than others, and for some skills, there
are fewer opportunities to learn them.
For example, there may be a need for only two workers to perform the product-testing function at a given time, with one of them being a skilled employee to teach the unskilled
employee, and it may take six months to learn this skill. This may result in a whole queue of
employees waiting for an opportunity to learn this particular job before they can complete their current skill level. This happened at General Mills: although it was expected that
employees could reach the top rate in two to three years, the reality was four to five years,
which created employee frustration.48
How much paid time off should be provided for off-the-job training? And should employees
use some of their own time for training? In general, both are required; but if a high level of job
performance and involvement is expected as part of the system, it would be unfair to consume a major portion of an employee’s nonwork time for training. Often, the tradeoff made is that
work time is provided for training at the lower skill levels but not at the top skill levels, where
classroom training often plays a major role. Out-of-pocket costs, such as tuition fees, are
almost always covered, however.
Certifying Skill/Knowledge Block Achievement
A key concern for any firm using skill-based pay is to have a valid system for determining when
an employee has mastered a particular skill block (a process known as skill
certification) that is both valid and accepted as fair by employees. In some cases, an
employee must spend a minimum period of time working at a particular skill before
certification is granted. The purpose of this rule is to ensure proficiency in the skill and to
provide enough reinforcement in that skill that it will be retained.
Skill certification systems vary in their complexity and processes. Shell Sarnia has a relatively
straightforward three-step process. All employees are provided with self-training materials indicating the certification requirements for each skill block. When employees are ready to be
tested, they must ask a coworker (already certified for that skill) to confirm that they are ready.
If the shift team coordinator agrees, the final checkoff is done by staff experts who specialize in
the certification process.
L-S Electro-Galvanizing (see Chapter 2) uses detailed checklists for certifying each skill block.
To be certified in one of the five basic skill blocks, an employee must work for 1,200 hours in
that block. At 1,000 hours, a formal peer review is undertaken to gauge progress and to provide feedback on areas needing improvement. After 1,200 hours, an employee may apply
to be certified for that skill block. To do so, he or she must receive a positive checkoff by five
other certified operators and then by the process coordinator. Overall, it takes three to four
years to complete the five skill blocks necessary to become a process technician.
At General Mills, the system is almost completely peer-based. Peer trainers use detailed
checklists to certify employees. Although there is a possible concern that employees may “go easy” on one another to avoid conflict, the company does not believe this is a major problem
due to the safeguards built into the system.49 First, all team members must ratify the
certification. Second, employees must requalify whenever they rotate back into the skill again.
Third, if an employee is found to be unable to perform skills for which she or he is certified, the
employee and the certifier forgo their next pay increase. And fourth, the plant manager has
final authority for approving certifications, although few certifications have been refused by
the plant manager.
Other Skill-Based Pay Issues
Two other issues are important to the success of skill-based pay plans. First, almost all such plans require considerable refinement after initial implementation, so it is important to
monitor them on an ongoing basis. Many firms have found that the ideal vehicle is a joint
employee–management committee, such as that used at L-S Electro-Galvanizing.
Second, many human resource and management practices must be adjusted to fit with the
skill-based pay system if it is to pay off for the organization. The IT company example
illustrates how changes in one aspect of the system (adding SBP) can be hindered by failure to
change other parts (the managers’ performance appraisal criteria). Another example is hiring
practices, where the ability to perform the entry-level job (based on previous experience at other firms) should not be the sole criterion for selection. Instead, the key recruitment needs
are for employees with the ability to master all the necessary skills, a willingness to learn, the
ability to help and teach others, and a disposition to work cooperatively in a group setting. For this reason, many SBP firms give the group or team a major role in the hiring process. In
general, a whole range of human resource practices characterized by the high-involvement
managerial strategy need to be in place for SBP to realize its full potential.
Competency-Based Pay Systems
As mentioned earlier, a considerable number of firms are now attempting to apply the concept
of pay for knowledge to their professional and managerial personnel through the use of competency-based pay systems. These can vary greatly in format. For example, a defence
electronics firm has a master list of more than 30 competencies that apply to professional and
managerial staff, and each department selects those most relevant to its operations.50 Pay
raises are tied to achievement of each competency. In another case, a manufacturing firm pays managers for their degree of progress in mastering four managerial competencies
deemed applicable to all managerial jobs. In a third case, professional and managerial
employees negotiate “learning contracts” with their supervisor, and pay increases are based
on accomplishment of these objectives.
In general, competency-based systems are much more problematic than skill-based systems.
First of all, almost nothing is known about their effectiveness. This lack of research is partly due to the lack of precision and confusion regarding just what constitutes a “competency-
based system.” Some systems appear to be little more than a trait-rating appraisal system
under a new guise. For example, a list of possible “competencies” might include personality traits such as “self-confidence” and “assertiveness” as well as “flexibility” and
“initiative.”51 Although personality traits can be assessed with established psychometric
measures, these measures work better as part of the selection process than as part of an
ongoing competency-based pay program.
Thus, part of the problem of researching competency-based systems is the wide variation in
definitions of “competencies.” The following definition is adopted here: “competencies are demonstrable characteristics of the person, including knowledge, skills, and behaviours, that
enable performance.”52 Why not just pay people for their performance, rather than factors at
least one step removed from performance? An answer is that individual performance can be
difficult or even counterproductive to measure. Another answer is that identifying valid competencies can serve as the basis for an effective training and development program. When
specific competencies have a dollar value, both administrative and employee attention is
focused on exactly what needs to be learned, and this attention can increase the rate of skill
development.
In developing any competency-based pay system, there are four main issues:
1. identifying competencies that demonstrably affect performance,
2. devising methods to measure achievement of each competency,
3. compensating each competency, and
4. providing learning opportunities.
Unfortunately, many so-called “competency-based” systems fail on all four counts.
Many consulting companies sell “competency-based” systems that are simply menus of any kind of trait imaginable. Firms are expected to select “appropriate” competencies whether or
not they are valid for that employer. A better process is to develop a list of competencies that
distinguish high performers from other employees in a particular occupational group, then test all employees in that group on the presence of these competencies, and then statistically
identify the competencies that differentiate the top performers from the other employees. Of
course, to do this, you must already have valid performance measures for each employee. Another potential problem with this approach is that it is valid only as long as the factors that
differentiated performance in the past continue to be valid.
The second issue is measurement. For some competencies, it may be difficult to develop
reliable and valid measures that will be perceived as fair by employees.
Third, effectively linking achievement of competencies to pay is not a straightforward task;
there is no generally accepted method for so doing, unlike for skill-based pay. If a statistical process has been used to identify the key competencies, these data can be used to determine
the relative weighting of each competency relative to performance. However, deciding the
absolute dollar value for each competency is highly subjective, because there is no external test equivalent to the high–low method used for skill-based pay. Whether to reward
achievement of competencies with raises to base pay or with one-shot bonuses is another
question. If a competency is likely to be enduring, then an increase to base pay seems in order;
if not, a one-shot bonus is appropriate. A simple way of linking competencies to pay is to factor
achievement of competencies into an existing merit raise system.53
The fourth issue, providing learning opportunities, is not necessarily straightforward either,
because some competencies are more inherent than learnable. But as with skill-based pay,
providing opportunities to develop key competencies is essential to the success of the system.
Finally, not all organizations need all employees to have the full range of competencies
possessed by top performers. Thus, an overambitious competency-based pay system may cause a firm to pay for capabilities it cannot use, leading to employee frustration and higher
costs to the employer.
// SUMMARY
The purpose of this chapter was to provide you with a menu of compensation options, so that
you can select the most appropriate mix of compensation components to include in the
compensation strategy for your organization. You now know the possible roles of base,
performance, and indirect pay within a compensation system, along with motives for their use
and their advantages and disadvantages.
Although base pay remains the largest component in most pay systems, there has been a
trend toward supplementing it with performance pay. At the same time, some firms that
traditionally have not used base pay are adding it to their compensation mix. The goal is to capture the advantages of each component while cancelling out the disadvantages of each
component.
You also now understand the advantages and disadvantages of indirect pay and know why a properly designed indirect pay component can play a significant role in meeting
compensation objectives. However, the role to be played depends on the characteristics of the
firm, most notably its managerial strategy.
You have learned about the three methods for establishing base pay (market pricing, job
evaluation, and pay for knowledge) and the advantages and disadvantages of each. You have
also learned that some of these fit different managerial strategies (and different employee groups) better than others. All of this information should help you decide which base pay
method (or combination of base pay methods) will provide the best foundation for
compensation for your organization and for the different employee groups within your
organization.
Key Terms
• competency-based pay
• high–low method
• indirect pay
• job evaluation
• market pricing
• pay-for-knowledge system (PKS)
• salary
• skill-based pay
• skill block
• skill certification
• wage
Discussion Questions
Discussion Question 4.1
Review
Discuss why it is not always desirable or even possible to use output-based pay.
Your Answer
No answer submitted
Discussion Question 4.2
Review
Discuss why organizations would ever want to use indirect pay.
Your Answer
No answer submitted
Discussion Question 4.3
Review
Discuss why organizations might prefer job evaluation to market pricing.
Your Answer
No answer submitted
Discussion Question 4.4
Review
Discuss the key steps in designing a skill-based pay system.
Your Answer
No answer submitted
Using the Internet
Using the Internet Question 4.1
Review
Using Salary Wizard, identify four different types of jobs in which you have some interest. Choose jobs that
are as different from one another as possible. For each job, record the “median base salary.” Then click on
the “Bonuses” tab and record the “median total cash compensation.” (“Total cash compensation” represents base pay plus performance pay, but does not include indirect pay, which is not considered
“cash compensation.”) Your Answer
No answer submitted
Using the Internet Question 4.2
Review
For each job, subtract the “median base salary” from the “median total cash compensation” and then divide this difference by the “median total cash compensation” to derive the proportion of cash
compensation that is in the form of performance pay. You will likely see considerable variation in the
proportion of performance pay across the four jobs. Would this information affect your decision whether to
accept a particular job? What kinds of jobs seem to have more performance pay, and what kinds of jobs
seem to have less? Your Answer
No answer submitted
Exercises
Exercise Question 4.1
Review
Form small groups of four to six people. Each group member should describe the compensation mix for her
or his most recent employer, focusing on the extent to which base pay, performance pay, and indirect pay are utilized by each employer. What types of employers seem to use more or less of a particular
component? Do the different pay systems seem to fit with the firm’s managerial strategy, as far as you can
determine?
Your Answer
No answer submitted
Exercise Question 4.2
Review
In a small group, discuss how important benefits will be to you in choosing your next job. Then have each
member identify the three benefits that are most important to him or her. Do these vary across individuals
in your group? If so, discuss why. Your Answer
No answer submitted
Exercise Question 4.3
Review
Three firms are briefly described below. For each firm, identify the role (if any) that you believe indirect pay should play in the compensation system, and give examples of specific benefits to offer. Explain your
choices.
a. A chicken processing firm in British Columbia hires some employees to “de-gut” chickens. The jobs do
not require complex skills and turnover is almost 100 percent.
b. A retail clothing chain offers personalized service and caters to upscale customers. It is located in major cities across Canada and employs approximately 600 sales staff.
c. A computer software firm develops customized software for specialized applications for individual
clients. Located near Ottawa, it employs about 1,000 people.
Your Answer
No answer submitted
Case Questions
Case Question 4.1
Review
Analyze “The Fit Stop Ltd.” case in the Appendix and determine whether base pay should be an important component of compensation for the sales staff. If so, identify the most appropriate method for determining base pay for the sales staff. What factors did you consider in making these decisions? Your Answer
No answer submitted
Case Question 4.2
Review
Analyze the “Multi-Products Corporation” case in the Appendix and determine what would be the most
appropriate method for determining base pay. What factors led you to the choice you made?
Your Answer
No answer submitted
Simulation Cross-Reference
If you are using Strategic Compensation: A Simulation in conjunction with this text, you will
find that the concepts in Chapter 4 are helpful in preparing Sections C, D, and E of the
simulation.
// Notes
1. Richard J. Long and John L. Shields, “Do Unions Affect Pay Methods of Canadian Firms? A
Longitudinal Study,” Relations industrielles/Industrial Relations 64, no. 3 (2009): 442–65.
2. Daniel J.B. Mitchell, David Lewin, and Edward E. Lawler, “Alternative Pay Systems, Firm
Performance, and Productivity,” in Paying for Productivity: A Look at the Evidence, ed. Alan
S. Blinder (Washington, DC: Brookings Institution, 1990), 15–87.
3. Barry Gerhart and Charlie O. Trevor, “Employment Variability Under Different Managerial
Compensation Systems,” Academy of Management Journal 39, no. 6 (1996): 1692–712;
Frank Giancola, “Earnings-At-Risk Pay Plans: Use Only as Directed,” WorldatWork
Journal First Quarter, (2012); Christine Bevilaqua and Parbudyal Singh, “Pay for Performance:
Panacea or Pandora’s Box? Revisiting an Old Debate in the Current Economic
Environment,” Compensation and Benefits Review 41, no. 5 (2009): 20–26.
4. Mitchell, Lewin, and Lawler, 1990. “Alternative Pay Systems.”
5. Miall McGee, “Bonus Policy Sparks Discord,” The Globe and Mail, 20 May 2016, B.1.
6. Al-Karim Samnani and Parbudyal Singh, “Performance Enhancing Compensation Practices and Employee Productivity: The Role of Workplace Bullying,” Human Resource
Management Review 24, no. 1 (2014); 5–16.
7. Imperial Oil Canada website: http://www.imperialoil.ca/Canada-
English/workingwithus.aspx, accessed July 23, 2016.
8. Carolyn Baarda, Compensation Planning Outlook 2001 (Ottawa: Conference Board of
Canada, 2000); Karla Thorpe, “Employee Benefits—The Dragon Will Soon Awake,” Conference
Board of Canada,” http://www.conferenceboard.ca/topics/humanresource/commentaries/12-11-
02/employee_benefits%E2%80%94the _dragon_will_soon_awake.aspx, accessed
September 23, 2016.
9. Stephane Renaud, “Unions, Wages, and Total Compensation in Canada,” Relations
industrielles/Industrial Relations 53, no. 4 (1998): 710–29.
10. Barry Gerhart and George T. Milkovich, “Employee Compensation: Research and Practice,”
in Handbook of Industrial and Organizational Psychology, ed. M.D. Dunnette and L.M.
Hough (Palo Alto: Consulting Psychologists Press, 1992), 484–569.
11. Timothy A. Judge, “Validity of the Dimensions of the Pay Satisfaction Questionnaire:
Evidence of Differential Prediction,” Personnel Psychology 46 (1993): 331–55.
12. Robert J. McKay, Canadian Handbook of Flexible Benefits (New York: Wiley, 1996).
13. Nathalie B. Carlyle, Compensation Planning Outlook 1997 (Ottawa: Conference Board of
Canada, 1996).
14. Baarda, Compensation Planning Outlook 2001.
15. David Brown, “Benefits Providers Strive to Meet Clients’ Wellness Needs,” Canadian HR
Reporter 18, no. 6 (2005): 6–7.
16. Thorpe, “Employee Benefits—The Dragon Will Soon Awake.”
17. Sara L. Rynes and George T. Milkovich, “Wage Surveys: Dispelling Some Myths about the
Market Wage,” Personnel Psychology 39, no. 1 (1986): 71–90.
18. Luis Gomez-Mejia and David Balkin, Compensation, Organizational Strategy, and Firm
Performance (Cincinnati: South-Western, 1992).
19. K.E. Foster, “An Anatomy of Company Pay Policies,” Personnel, September 1995, 66–72.
20. Nan J. Weiner, “Job Evaluation Systems: A Critique,” Human Resource Management
Review 1, no. 2 (1991): 119–32.
21. Nina Gupta and G. Douglas Jenkins, “Practical Problems in Using Job Evaluation Systems
to Determine Compensation,” Human Resource Management Review 1, no. 2 (1991): 133–
44.
22. Edward E. Lawler, Susan A. Mohrman, and Gerald E. Ledford, Creating High Performance
Organizations (San Francisco: Jossey-Bass, 1995).
23. Gerald E. Ledford, “Designing Nimble Reward Systems,” Compensation and Benefits
Review 27, no. 4 (1995): 46–54.
24. George T. Milkovich and Jerry N. Newman, Compensation (Chicago: Richard D. Irwin,
1996).
25. Gerald E. Ledford, “Designing Nimble Reward Systems,” Compensation and Benefits
Review 27, no. 4 (1995): 46–54.
26. Frank Giancola, “Skill-based Pay: Fad or Classic?” Compensation and Benefits
Review 43, no. 4 (2011): 220–26.
27. Atul Mitra, Nina Gupta, and Jason D. Shaw, “A Comparative Examination of Traditional
and Skill-based Pay Plans,” Journal of Managerial Psychology 26, no. 4 (2011): 278–96.
28. Lisa Cheraskin and Michael A. Campion, “Study Clarifies Job-Rotation Benefits,” Personnel
Journal 75, no. 11 (1996): 31–38.
29. Edward E. Lawler, Strategic Pay: Aligning Organizational Strategies and Pay
Systems (San Francisco: Jossey-Bass, 1990), 161.
30. Jay R. Schuster and Patricia K. Zingheim, The New Pay: Linking Employee and
Organizational Performance (New York: Lexington Books, 1992), 108.
31. Gerald Ledford, “The Design of Skill-based Pay Plans,” in The Compensation
Handbook, ed. Milton L. Rock and Lance A. Berger (New York: McGraw-Hill, 1991), 199–217.
32. Milkovich and Newman, Compensation, 193.
33. Gerald Barrett, “Comparison of Skill-based Pay with Traditional Job Evaluation
Techniques,” Human Resource Management Review 1, no. 2 (1991): 97–105.
34. Frank R. Giancola, “Skill-based Pay: Fad or Classic?” Compensation and Benefits
Review 43, no. 4 (2011): 220–26.
35. Sylvie St-Onge, Victor Y. Haines, and Alain Klarsfeld, “Skill-based Pay: Antecedents and
Outcomes,” Relations industrielles/Industrial Relations 59, no. 4 (2004): 651–80.
36. Marc J. Wallace, “Sustaining Success with Alternative Rewards,” in The Compensation
Handbook, ed. Milton L. Rock and Lance A. Berger (New York: McGraw-Hill, 1991), 147–57.
37. Kenneth Mericle and Dong-One Kim, “From Job-based Pay to Skill-based Pay in Unionized
Establishments: A Three Plant Comparative Analysis,” Relations industrielles/Industrial
Relations 54, no. 3 (1999): 549–80.
38. G. Douglas Jenkins, Gerald E. Ledford, Nina Gupta, and D. Harold Doty, Skill-based Pay:
Practices, Payoffs, Pitfalls, and Prescriptions (Scottsdale: American Compensation
Association, 1992).
39. Gerald E. Ledford and Gary Bergel, “Skill-based Pay Case Number 1: General
Mills,” Compensation and Benefits Review 23, no. 2 (1991): 24–38.
40. Peter V. LeBlanc, “Skill-based Pay Case Number 2: Northern Telecom,” Compensation and
Benefits Review 23, no. 2 (1991): 39–56.
41. Jenkins et al., Skill-based Pay.
42. Ibid.
43. Ibid.
44. Ibid.
45. Ann Armstrong, “The Design and Implementation of Skill-Based Systems,” Proceedings of
the Administrative Sciences Association of Canada, Personnel and Human Resources
Division 12, no. 8 (1991): 21–31.
46. LeBlanc, “Skill-based Pay Case Number 2.”
47. Ibid.
48. Ledford and Gary Bergel, “Skill-based Pay Case Number 1.”
49. Ibid.
50. Gerald E. Ledford and Robert L. Heneman, “Pay for Skills, Knowledge, and Competencies,” in The Compensation Handbook, ed. Lance A. Berger and Dorothy R. Berger (New York:
McGraw-Hill, 2000), 143–56.
51. Richard S. Williams, Performance Management (London: International Thompson
Business Press, 1998).
52. Ledford and Heneman, “Pay for Skills, Knowledge, and Competencies.”
53. Duncan Brown, “Relating Competencies to Pay,” in The Compensation Handbook, ed.
Lance A. Berger and Dorothy R. Berger (New York: McGraw-Hill, 2000), 157–71.
Chapter 5: Performance Pay
Choices CHAPTER LEARNING OBJECTIVES
After reading this chapter, you should be able to:
• Define and discuss the applicability of the main types of individual
performance pay.
• Define and discuss the applicability of the main types of group
performance pay.
• Define and discuss the applicability of the three main types of
organization performance pay.
FUN AND GAMES AT THE EXHIBITION
A major soft drink maker has a prominent booth at the Canadian National Exhibition in
Toronto each summer. The company employs students at minimum wage to serve soft drinks
to customers. There are no benefits, and the only opportunity for advancement is to become a
shift supervisor, which pays only slightly more money. Shift supervisors are also temporary
employees. The jobs are dull and repetitive—simply serving soft drinks all day. A manager with
an enclosed office at the back of the booth is in charge but is frequently not around because
the booth operates 12 hours a day every day. Turnover is high on this job, with most
employees not lasting the whole summer.
Management does not trust these employees and makes this clear in many ways. For example,
to discourage employees from “pocketing” any receipts, they have sewn the pockets shut on all employee uniforms. As further insurance against employee dishonesty, a count is kept of all
the paper cups used in a day, and this is balanced against actual cash on hand.
Although employees are supposed to be friendly and courteous to customers, they frequently
are not. Furthermore, when the manager is not around, horseplay is frequent. The supervisors,
who are usually the same age as the servers, either tolerate or join in the horseplay. In some
cases, it gets so bad that customers are discouraged from approaching the booth.
Many employees have found a way to augment the meagre extrinsic rewards of the job by
simply retrieving used cups from the trash and reusing them. In this way, the employees
augment their income, while the official count of cups and the receipts still balance.
Not all employees participate in the horseplay or the cup fraud, because this behaviour would
violate their values, such as a strong work ethic or a strong sense of honesty—or simply because they are afraid of being caught. Denying themselves access to the extrinsic rewards
received by the other employees, these employees often quit, leaving only dishonest and/or
irresponsible employees. These are the only employees for whom the ratio of rewards to contributions is balanced—and the only employees likely to come back next summer! Thus,
the reward system used by this company ends up creating a workforce of dishonest,
irresponsible employees.
// Introduction To Performance Pay Choices
Clearly, the reward system at the soft drink booth at the Canadian National Exhibition is
dysfunctional, especially when combined with an incomplete attempt at classical
management. So here’s the question: How would you improve things?
Most of the behaviour problems occur when there is no supervision—as would be expected
under a classical management system—so an obvious approach is to hire more supervisors. However, hiring additional supervisors would add to costs, and it still would not solve the
problem of inadequate rewards and the inability to attract or retain conscientious employees.
Could we address this problem by changing the reward system? You will have no doubt noticed that rewards are not currently linked to good employee performance; in fact, quite the
opposite—those employees behaving in the worst manner receive the highest rewards, in
terms of both fun (the horseplay) and money (the cup scams). Is there some way we could
address the problems at the soft-drink booth by using performance pay?
Figure 5.1 shows the “menu” of performance pay choices that might be included in a
compensation strategy. Could any of these help produce the employee behaviour we want— that is, conscientious task behaviour and enough membership behaviour that most
employees will at least last out the summer?
The objective of this chapter is to provide you with enough knowledge of the various choices
you have for performance pay to be able to answer questions like this, and to decide which types of performance pay (if any) will be useful components of your compensation strategy.
The advantages and disadvantages of the various types of performance pay plans will be
discussed, along with the factors to consider when deciding whether a specific type of performance pay will suit your organization. We will focus on what you need to know when
formulating compensation strategy. Specific design issues for performance plans will be
covered later in the book. In this chapter we will discuss the advantages and challenges of profit sharing, an organizational level performance pay choice, and under what conditions
profit sharing works best. However, in Chapter 11, we focus on design and implementation
issues, such as deciding on the formula for the profit-sharing bonus and who would be eligible. Therefore, while the topics are similar, the focus is different. It is also important to point out
that the material in this chapter applies mainly to the private sector, as pay-for-performance is
very limited in the public sector, where it is mainly used at the individual level as merit pay and
bonuses. We will return to this issue in the next section when we discuss individual
performance pay.
We will start with pay plans that are geared to individual employee performance. After that, we
will examine pay plans geared to group or team performance, and then conclude with pay
plans geared to the performance of the organization as a whole.
// Individual Performance Pay
There are four main types of individual performance pay, two of which may substitute for
time-based pay, and two of which are always used in conjunction with base pay.
Instead of being paid by the amount of time worked, individual employees may be paid
according to the amount of output they produce. There are two main approaches to output-
related pay: piece rates and sales commissions. Piece rates and commissions need not supplant base pay entirely; they can be used in combination with base pay, which is the most
common arrangement. The other two types of individual incentives—merit pay and special-
purpose incentives—are always used in conjunction with base pay. Merit pay can be further differentiated into merit raises (which increase base pay) and merit bonuses (which do not
increase base pay). Although not strictly a form of merit pay, promotions (which typically
increase base pay) can serve the same purposes as merit raises, so they will also be discussed
in this section.
In Canada, merit raises are by far the most common form of performance pay (used by about
80 percent of medium to large Canadian firms), followed by sales commissions and merit
bonuses (both used by about 35 percent of firms). Special-purpose incentives are used by about one-fifth of Canadian firms, while piece rates are used by only about 10 percent of firms.
Sales commissions have become more popular over time, special-purpose incentives have
become less popular, and other plans have stayed about the same. It is interesting that piece rates, merit bonuses, and special-purpose incentives show high discontinuation rates: about
half the firms that had adopted these plans no longer had them four years later.
Piece Rates
Under piece rates, an employee receives a specified sum of money for each unit of output
produced or processed. The objective of piece rates is to maximize individual productivity by
linking output to reward. Piece rates are commonly associated with the manufacturing sector, but they are also used in the service sector. Barbers are paid per head, tree planters are paid
per tree, freelance journalists are paid per column inch in print media, and physicians are paid
per procedure. In the service sector, market pricing is generally used to set the piece rate,
although there are exceptions. For example, medical doctors negotiate with provincial
governments and provincial colleges of physicians and surgeons to set their fee schedules.
In the manufacturing sector, where piece rates were “invented” by Frederick Winslow Taylor at
the beginning of the 20th century, the process is more complicated. First, a job analyst or methods engineer times how long a particular task or job typically takes to perform, allowing
for factors such as operator fatigue, rest breaks, worker ability, and unavoidable delays. The
result is a production standard—that is, the number of units that could be produced in an
hour by a typical worker.
Next, the employer establishes the average amount of money that a worker with the skills and
ability to perform these tasks should earn hourly. This amount is typically based on the prevailing wage in the industry for this type of worker, although it may also be based on
negotiated union rates. This hourly amount is then divided by the production standard. The
result is the piece rate—the monetary payment per piece produced, in dollars and cents. This type of piece rate is the simplest and is known as a straight piece rate. A more complicated
type of piece rate is the differential piece rate, under which an employee receives a lower rate
if the production standard is not met and then a higher rate (for all pieces) once the
production standard is met. The idea is to encourage all workers to meet the production
standard.
Advantages of Piece Rates
Piece rate systems have several advantages:
1. If designed correctly and used in the right circumstances, they are
highly motivational in producing task behaviour. Because they tie
valued rewards (money) to clearly specified performance outcomes
(pieces produced), piece rates are in line with two of the key
conditions for motivation identified by expectancy theory—valence
and instrumentality—and have been generally found to increase
worker productivity.1
2. They reduce the need for external control of employees through
supervision.
3. They link compensation to output, thereby linking compensation to
employer ability to pay, which reduces employer risk.
4. They provide specific information about the “standard” level of output
expected, so that both supervisors and workers know what is
expected from a “day’s work.”
Disadvantages of Piece Rates
However, piece rates have many disadvantages:
1. They can be applied in only a limited number of circumstances. Jobs
with a high degree of interdependence are not good candidates for
piece rates, since an individual cannot control the rate of production,
nor can responsibility for productivity be attributed to a specific
individual. In jobs with diverse activities and tasks, keeping track of
progress in the various task areas would be very difficult. Jobs for
which only some tasks can be measured are not good candidates, nor
are jobs where quality cannot be monitored.
2. Jobs for which tasks are continually changing, or for which tools,
materials, and technologies are rapidly changing, are not amenable to
piece rates. Piece rates need to be recalculated each time a major
change occurs. However, the biggest problem with change is that each
change provides an opportunity for friction between employees and
management. For example, if a better machine is purchased and a
worker can now produce twice as much, it makes sense to cut the
piece rate in half. Although workers may understand this rationale,
they may not be pleased if their piece rate is cut. Moreover, if there is
little trust between management and workers, workers may suspect
that management is using new technology as an excuse to cut the
piece rate.
3. Setting the piece rate is not as “scientific” a process as it seems. For
example, timing jobs depends on worker participation. When jobs are
first timed, employees will probably not perform the work in the
shortest possible time, for fear that doing so will only help establish a
high or “tight” rate. Experienced industrial engineers compensate for
these tendencies by guessing how much the workers are slowing their
normal speed. Thus, the “scientific process” has already deteriorated
into a guessing game—and pits workers against management. In
addition, the allowances made for factors such as faulty materials and
machine breakdowns are often arbitrary. Thus, standards may only be
very rough estimates, with some jobs ending up with “tight” rates and
others having “loose” ones.
4. Despite the motivational potential of piece rate systems, they often do
not motivate maximum effort because of social forces within the work
group. Since production is an important part of the activity of the
work group, it is likely that group norms will define acceptable rates of
production. While a few members of the work group may be able to
produce far above standard, most will not, and they will exert
pressure on the high producers to moderate their production levels.
High producers are known as “rate busters” because other workers
fear that management will note their high performance and cut the
piece rate. If management has a history of cutting piece rates, workers
will not be motivated to increase productivity.
5. If management has laid off workers whenever productivity has
increased, workers will not favour high production since they do not
want to work themselves out of a job.
6. Piece rate systems can create conflict among workers. Workers may all
compete for the “loose” jobs and attempt to avoid the “tight” ones. In
addition, there is little incentive to advise or help new workers, or to
do any job that does not relate directly to production, such as
maintaining equipment or keeping the work area clean.
7. Issues related to product or service quality may arise. Since the
emphasis is on quantity, workers may be tempted to cut corners on
quality, which requires increased inspection and monitoring. In
addition, even with inspection or monitoring, quality is not likely to be
much above minimum acceptable levels. Of course,
inspection/monitoring and record keeping can increase overall
production costs considerably.
8. Problems may develop with equipment and material use. For example,
workers may find that they can reach the production standard on a
drilling job more easily if they replace their drill bits more frequently
or run their machines at high speed. However, drill bits are expensive,
and machines burn out more quickly at higher speed. Unless these
costs are incorporated into the pay system, the worker is unlikely to
be concerned about these issues. Incorporating these extra costs
increases the complexity of the system.
9. Piece rates may cause workers to be more concerned about production
than safety. For example, on-time delivery incentives for pizza delivery
drivers have been found to be related to reckless driving. In addition,
many mines do not use piece rates for fear that miners will sacrifice
safety for production in order to maximize their earnings. Research
shows that workers paid by piece rates do experience more health and
safety issues than other employees.2
In order for piece work to succeed in a manufacturing setting, there must be trust between
management and workers. This trust facilitates both rate setting and rate changes and assures workers that management will not cut rates arbitrarily. Piece rate systems also require job
security so that workers can be sure that increased productivity will not put them out of a job.
The irony is that the firms most likely to want to use piece rates—classical firms—are the firms least likely to provide these conditions. It should not be surprising that most manufacturing
firms have abandoned piece rates over the years.3 However, Compensation Today
5.1 provides an interesting exception to this trend and shows how piece rates can work well when utilized in a high-trust workplace in which management understands what it takes for
piece rates to succeed.
COMPENSATION TODAY 5.1
Piece Rates Spark Productivity at Lincoln Electric
Lincoln Electric, based near Cleveland, Ohio, is the world’s largest producer of arc welders.
While it is an acknowledged industry leader in its field, the company often attracts more attention for its reward system. The company provides no base pay and very little indirect pay
to its production workers; instead, all are paid on an intricate piece rate system. The firm
offers no paid sick days and only the minimum paid holidays allowed by law. Lincoln employees have to pay their own health insurance and have no choice about accepting
overtime work and unexpected job assignments. If older workers decrease in productivity,
they earn less. Management also does not take seniority into account for promotions. The firm
has no union to protect the interests of the company’s 3,400 employees.
This sounds like a classical manager’s dream. But what worker would want a job at a
sweatshop like this if he or she could find something better? Think of the employee turnover there must be! Imagine all the problems there must be with conflict over piece rates and
adversarial relations between workers and management.
But in fact, productivity is very high at this company, and hardly anyone ever quits. Workers
and management have an excellent relationship. Whenever jobs become available, there are
hundreds of applicants. Over the past 50 years, the company has never lost money. What is
going on? Doesn’t this example contradict research into the problems with piece rates?
In fact, this case actually reinforces the key points about piece rates. In reality, Lincoln is not a
classical organization, nor is it a human relations organization. Consider some of the other policies of the firm. First, job security. The company makes it a policy never to lay off
employees. According to a company spokesperson, “We don’t lay off anyone unless he steals,
lies, fights, or has a record of very low productivity.” The firm guarantees workers at least 30 hours of work a week, even in lean times. So workers don’t have to worry about working
themselves out of a job.
Employees don’t have to worry about cuts to the piece rate either. If workers think up a way to improve productivity, the company never cuts piece rates. But doesn’t this system cause
employees to think only about themselves, rather than the best interests of the firm? To avoid
self-centred motivation, the firm also provides profit sharing to all employees, which is distributed according to employee merit. In some years, this bonus can approach 100 percent
of regular earnings. Another feature is an employee stock purchase plan under which
employees own a large chunk of the company’s shares. Profit sharing and employee stock ownership balance the self-centred perspective caused by the piece rates and encourage
citizenship behaviour, with job security as the foundation. Extrinsically, the result is
production workers who are among the highest paid in the United States. Intrinsically, the
result is employees who are highly committed to their employer. Because of the self-control
these features generate, the company has very few supervisors.
Trust between management and employees is the foundation of this system, accompanied by
a system of open communication. For this reason, the company has an elected advisory board of employees that meets with top management twice a month. (There is no union, although
this type of manufacturing is normally unionized.) Mutual trust also allows adjustments to the
piece rates to be made in a nonadversarial way without the conflict that normally
accompanies this process.
One reason for the good employee–management relationship is the pay system for managers.
Managers are not treated much differently from workers. They too depend heavily on profit sharing for their income. They receive no executive “perks”—no cars, no executive dining
room, no club memberships, and no reserved parking. When new MBAs join the firm, they
must spend eight weeks on the welding line so that they truly come to understand and appreciate Lincoln’s unique shop-floor culture. Recruitment of both managers and workers is
a lengthy process, the key criterion being their “fit” with the high-involvement managerial
strategy.
Sources: Kenneth W. Chilton, 1994, “Lincoln Electric’s Incentive System: A Reservoir of
Trust,” Compensation and Benefits Review 26, no. 6 (1994): 29–34; The Globe and
Mail, October 21, 1996; Gary Johns, Organizational Behaviour: Understanding and
Managing Life at Work (New York: HarperCollins, 1996).
Applicability of Piece Rates
When are piece rates a viable option? Suitable options are those where individual workers control their own production, interdependence between workers is low, each unit of
production can be easily measured and priced, individuals perform a limited number of tasks
(all of which can be compensated with piece rates), tasks do not change frequently, increased productivity will not cause layoffs, and quality standards can be monitored efficiently and
effectively. Ironically, these conditions are more likely to prevail in the service sector, rather
than in the manufacturing sector, which is where piece rates originated.
Sales Commissions
Sales commissions are used to compensate sales personnel in many organizations, from auto
dealerships to real estate firms to stock brokerages. Typically, salespeople receive a certain percentage of their gross sales, with the commission rate often varying with the products or
services sold. In contrast to piece rates, commissions have remained a popular payment
system, although they are more popular as a complement to base pay than as a complete
substitute. When there is no base pay and the sales worker’s pay flows only from commissions,
this is known as straight commission.
Advantages of Commissions
There are many reasons commissions are popular:
1. Commission rates are relatively easy to set and measure.
2. There is usually less interdependence among sales employees than
among production workers, which means that their work output is
more distinct.
3. In theory, an almost unlimited number of sales can be made without
creating a need to reduce the sales force, so sales personnel don’t
have to worry about working themselves out of a job.
4. Commissions reduce the need for other control mechanisms, such as
supervision or internalized commitment. In many businesses where
selling takes place away from the business premises, direct
supervision is difficult; output-based control may be a good option for
these firms, especially if the sales force does not have an internalized
commitment to the company.
5. Commissions can serve as a source of feedback and as a self-correcting
mechanism. In other words, sales personnel can easily see whether
their performance is adequate and tend to leave the organization if
they are unsuccessful, since their earnings will be unsatisfactory.
6. Commissions reduce employer risk, since worker pay is linked directly
to sales revenue.
7. Finally, and most important, sales commissions increase sales. From a
motivational perspective, it is easy to see why. The necessary
behaviour (making sales) is clearly defined. The valence of successful
behaviour (earning more money) is very positive compared to the
valence of unsuccessful behaviour (earning less money). In addition,
instrumentality is high (successful behaviour leads to rewards).
Therefore, commissions fit well with motivation theory.
Disadvantages of Commissions
However, we should recognize some possible drawbacks to using commissions:
1. Income to the salesperson may be highly variable, making personal
financial planning difficult. Since most people prefer more predictable
pay, it may be difficult to attract high-calibre applicants. In addition,
sole reliance on commissions may cause high turnover. Some of these
problems are illustrated by the following quote, from a sales
representative who works on straight commission for a firm that sells
consumer telecommunications equipment: “If I go on vacation, I lose
money. If I’m sick, I lose money. If I am not willing to drop everything
on a moment’s notice to close with a customer, I lose money. I can’t
see how anyone could stay in this job for long. It’s like a trapeze act
and I’m working without a net!”4 In this person’s organization, half of
all sales reps quit within six months. However, because the costs of
recruitment and training are quite low, the company is willing to
accept this turnover since those who quit tend to be low performers.
2. To attract and retain top performers, firms that use individual
commissions often end up providing a higher total pay than would be
necessary if a different compensation mix were used.
3. During recessionary times, commission income may drop sharply
through no fault of the salesperson. This may compel good
salespeople to leave the firm.
4. During the period when they are learning the business and developing
customer contacts, new salespeople receive little income, which may
cause them to leave.
5. A salesperson may resist doing work that does not directly contribute
to new sales, such as training new salespeople, keeping up records,
and servicing clients.
6. Straight commission may encourage salespeople to be overly
aggressive, to make misleading claims about the product to
encourage sales, or to attempt to sell more units or more expensive
units than the customer needs.
7. Commission systems often produce intense competition among
salespeople, resulting in conflict and a lack of cooperation.
8. Apportioning responsibility for making sales can be a major problem.
Customers may be “sold” by one salesperson, but after taking a few
days to think it over, they may place the order with any salesperson
who happens to be available, who then gets the credit for the sale.
This can cause resentment and conflict among salespeople. To avoid
this problem, companies often devise systems for apportioning
customers or establishing sales territories. However, fair systems for
apportioning customers and setting up sales territories may be
difficult to devise, and use of fixed territories creates difficulties if
sales conditions change.
A variety of other issues can arise when using commissions, especially straight commissions.
For example, since the sales rep—not the firm—is absorbing the risk of poor performance, the employer may be less careful in recruitment and selection. When certain salespeople are not
performing well, instead of helping them improve (possibly through training and coaching),
management may be tempted to just let them “sink or swim” and simply hire other
salespeople to replace them when they sink.
Although this approach may seem viable, these practices may have hidden costs. First,
although the firm is not paying the sales rep when he or she makes no sales, the firm is also not receiving any sales revenue. Second, these practices may encourage high turnover, such
that recruiting and training new salespeople does become a significant cost. Third, customers
may be disconcerted by a continuing turnover of salespeople, and they may tire of always
having to deal with someone new.
Furthermore, employers should not be surprised when salespeople work the system to
maximize their own income rather than the company’s welfare. Under straight commission, the employer is showing very little commitment to the salesperson and is implicitly saying that
the only attachment between the firm and the salesperson is a financial one. In addition,
salespeople will be resistant to changes in the system, since they then need to learn all over
again how to maximize their income from it.
When the compensation system needs to be changed, salespeople may be suspicious of
management’s motives and see the changes as a disguised attempt to reduce their earnings.
The following incident illustrates the lengths to which one company went to try to deal with
this problem:
In one case ... the vice president of sales for a multi-media communications company
hired a professional wrestler to pose as a salesperson at the company’s annual sales meeting. When the sales VP announced the change in the compensation plan and started to go through the details, the wrestler-cum-salesperson charged to the front of the room, lifted the sales VP off the ground, held him over his head, and threatened to toss him to the back of the room if he didn’t leave the compensation plan well enough alone. At this point, the company’s regional sales managers rushed up to the front of the
room to calm the “angry” salesperson by explaining the virtues of the new plan.5
Interestingly, although this ruse did forestall questions and angry debate from the sales reps,
it did not eliminate the grumbling about the new plan.
A final problem is that commissions on sales volume focus attention on gross revenue
generation, not profitability of sales. Sales personnel may be tempted to focus on selling low-
margin, fast-moving items or to cut prices excessively. To avoid these problems, some
companies base their commissions on different indicators. For example, IBM shifted to a
system whereby commissions were no longer based on sales revenues,6 but rather on
profitability of sales (60 percent) and customer satisfaction (40 percent). IBM recognized that for this system to work, it would have to provide information on profit margins to each sales
rep—information that had long been a closely guarded secret.
In order to deal with income fluctuations, a company can provide a base salary with
commissions on top. This dual system also “pays” the individual for work not directly related
to sales. A variation of this is the “draw” system, whereby an employee receives regular
advances against future commissions to smooth out income fluctuations. Managers can also vary commission rates to reflect the profitability or the selling ease of particular products.
They can also reduce excessive competition among sales personnel by apportioning potential
customers on a systematic basis, such as by geographic district or customer type. The most important way of avoiding problems is not to use commissions in circumstances where they
are not appropriate.
Applicability of Commissions
In what circumstances are commissions appropriate? Coletti and Chicelli have suggested
three key dimensions: (1) degree of independence, (2) degree of persuasive skills required, and
(3) length of sales cycle (the time between meeting a new customer and closing the deal).7 The
more that each salesperson works independently of others, the higher the degree of persuasive skills required, and the shorter the length of the sales cycle, the greater should be
the proportion of commission to base pay.
Coletti and Chicelli also distinguish four types of selling, based on whether the product and customer are new or established. Maintenance selling is selling established products to
existing customers; conversion selling is selling established products to new
customers; leverage selling is selling new products to existing customers; and new market selling is selling new products to new customers. Coletti and Chicelli suggest that because new
market selling requires the most initiative on the part of the sales rep, it should have a high
incentive opportunity (high ratio of commission to base pay), whereas conversion selling and
leverage selling should have a moderate incentive opportunity, and maintenance selling
should have a low incentive opportunity.
The managerial strategy of the firm is another important criterion in selecting commission
systems. For example, the self-control that high-involvement firms generate may make extrinsic output-based controls like commissions unnecessary; therefore, commission
programs are unlikely to be beneficial. In contrast, classical firms need output-based control
wherever direct control is not feasible so they tend to use straight commissions. Similarly, human relations firms must show that they value employee loyalty by providing base pay, but
they can also provide some commissions to supplement behaviour control in circumstances
where there is no cohesive group to exert social control—for example, when sales reps work
alone.
One Canadian study of commission sales systems found they are seldom used for (1) sales jobs
that are highly programmable (i.e., behaviours can easily be observed but individual sales cannot easily be measured); (2) jobs that involve working inside the office; (3) jobs that include
important nonselling tasks or that require cooperation in closing sales; and (4) jobs in large
organizations. The researchers also found that organizations that use a higher proportion of
base pay have lower employee turnover than those that rely more heavily on commissions.8
Merit Pay
The objective of merit pay is to recognize and encourage continuing good performance by
individual employees. Merit pay includes merit raises, merit bonuses, and promotions, all of which are always used in combination with base pay. What differentiates merit pay from other
types of performance pay is that merit pay is generally based on appraisals of overall
employee performance, not just on specific aspects of it.
As mentioned in the introduction, the material in this chapter (and Chapter 11) applies mainly
to the private sector; however, the applicability and use of performance pay in the public
sector, mainly in the form of merit pay, has generated both academic and practitioner interest, so a quick discussion is useful here. There is a strong belief in some quarters that the public
and non-profit sectors can operate in a more businesslike manner so as to enjoy some of the
efficiencies of the private sector. This has led to some reform in public sector management
and the use of new performance management and incentive systems.9 Some authors note that
employees in the public sector and nonprofits tend to be motivated by different factors,10 thus
leading to variations in the effectiveness of pay for performance pay systems. There are
additional contextual factors that may cause variations in outcomes across sectors, such as the role of unions and limited funding in the public sector. The public and press are also more
vigilant and critical when taxpayers’ money is used to reward public servants. However, while
the context is different, the advantages and disadvantages discussed below are still relevant.
Merit Raises
Merit raises represent a permanent increase to base pay. Thus, merit raises are extremely
expensive for the employer, especially when given to young employees, who may benefit from
the same raise for 30 years or more. This expense is increased even more if indirect pay—such as pension benefits—is geared to direct pay levels, which is the usual practice. Merit raises are
normally based on employee performance during the previous year, but managers hope the
increased performance level will be permanent so that the permanent cost increase is justified. This is, of course, difficult to predict, and most organizations simply grant the
increase and hope for the best.
Merit raises offer one way for employees to advance their pay within their pay ranges. Other ways that employees can advance through the pay range include raises based on seniority or
skill improvements. Surveys have found that North Americans believe that being paid
according to merit is a good idea, as long as performance standards are fair and objective and
as long as performance appraisals help improve job performance. 11 While most organizations
say they use merit pay, research points to a high degree of skepticism among both managers
and employees regarding the extent to which pay is truly related to meritorious performance.12 However, a review of 42 empirical studies found that despite this skepticism,
there is a significant positive relationship between performance appraisals and prior
employee performance.13
Since merit raises are generally based on appraised performance, they can take into account
overall employee performance, rather than just a slice of it, as piece rates, commissions, and
special incentives tend to do. They can also provide feedback to employees on how they can
improve their performance to warrant a merit raise in the future, and can help retain high-
calibre employees.
There are many issues related to merit raises:
• Performance measurement. As will be discussed in Chapter 10,
performance appraisal is not an exact science. Studies have found
that both managers and employees often have little confidence in the
results of performance appraisals.14 This may explain why many
managers are reluctant to differentiate among employees in terms of
pay: they have doubts about the validity of the data on which these
differentiations are to be based. They may also be concerned about
antagonizing subordinates.
• Pay raises for above-average performers are similar to those given to
average performers. To be motivating, the difference in pay increase
between high level and average level performers must be perceived as
significant. Yet exactly how much this difference should be is not
always clear.
• Once an employee rises to the top of his or her pay range, there are no
more merit raises. An organization cannot afford to provide merit pay
raises indefinitely: it can only pay so much to a bookkeeper or a junior
supervisor, no matter how meritorious the individual. At that point,
what is the motivation to continue to improve performance or even to
maintain the high performance level that has earned the merit raises?
Traditionally, the answer is the carrot and the stick—the carrot of promotion to a higher-
paying job and the stick of dismissal. However, it is legally difficult to dismiss someone who is performing at an acceptable level, even if that person is being paid to perform at a superior
level. Even if it were possible, such action would tend to destroy the system’s motivational
value, for merit raises would be perceived as increasing vulnerability to dismissal.
Organizations are also becoming flatter and with many firms experiencing slow or even
negative growth, promotion opportunities are becoming increasingly rare. And even for
organizations that do offer opportunities for promotion, rewarding outstanding performance in a lower-level position with promotion to the next higher position is not necessarily a wise
policy, as will be discussed later in the chapter.
If merit raises are the only element of performance pay, an organization could rely on intrinsic motivation and organizational identification to maintain performance (in a high-involvement
organization), or possibly on social norms (in a human relations organization), but classical
organizations would not be able to do so. One solution may be merit bonuses, discussed in the
following section.
• Merit raises are usually based on a judgment by a superior, and could
cause antagonism between the superior and the other employees.
Merit raises can also cause divisiveness and resentment when only a
few of its members are singled out for merit raises.
• Rewarding only one or two employees when effective performance
depends on cooperation among all employees can lead to conflict and
reduced cooperation. This problem is severe when the amount of
money for merit raises is fixed for a given department or when the
supervisor is allowed to provide merit raises to only a fixed proportion
of the subordinates. This creates a zero sum game—if you get more, I
get less or none at all. This system does not encourage cooperation
among employees!
Although merit raises are appealing, the disadvantages may outweigh the advantages. For firms in which close collaboration among employees is necessary and separating out
individual performance is not feasible, it is best to substitute other methods of reward for
individual merit pay, as Toyota has done for its production workers (see Compensation Today
3.1 in Chapter 3). A debate has also been raging in Canada and the United States about the
need for merit pay for teachers (see Compensation Today 5.2 for a snapshot).
Merit Bonuses
Merit raises have many problems, including the topping-out problem and the risk of providing
a long-term future reward for short-term past performance. A merit bonus avoids these problems since they are granted only for the period in which good performance occurs, and
good performance must be repeated each year in order for employees to continue to receive
them. Merit bonuses can also be used in conjunction with a merit raise system. For example, for those employees no longer eligible for further merit raises, an opportunity to obtain an
annual merit bonus may keep them focused on performance.
Merit bonuses also have the advantage of not being a fixed amount; they can be varied from year to year depending on the employer’s financial circumstances. They can also be paid out
in lump sums, either quarterly or annually, and they may have more visibility as a result. Some
firms like to prepare completely separate cheques to reinforce this visibility.
However, merit bonuses still have many of the disadvantages of merit raises. They depend on
reliable and accepted performance appraisal measures, managers and employees may have
little faith in the available measures, or they can cause poor relations between supervisors and
their subordinates and between employees and their coworkers, especially if the bonus pool is limited. Merit bonuses are also not suited for work that depends on collaboration and
cooperation. Since bonuses apply only for one year, they will be seen as less valuable than
merit raises and will need to be much higher in dollar value to attract an equivalent amount of
attention from employees.
One key issue is how to set the amount of the total available bonus pool. If it is simply an
arbitrary decision by top management, this may cause dissatisfaction, especially if the decision results in low bonuses or limited numbers of bonuses. Some firms are now tying the
bonus pool to some measure of organizational performance, such as profitability, and then
allocating this amount to employees based on individual merit.
Basing the bonus pool on organizational performance does help gear employee compensation
to a firm’s ability to pay; the problem with this approach is that it weakens the instrumentality
of the merit system (i.e., the likelihood of good performance leading to a reward), thus making it less motivational than it would otherwise be. Furthermore, if the company is not making
profits, there will be no merit bonuses, which will make the merit system completely
irrelevant.
COMPENSATION TODAY 5.2
Grade The Teachers?
Performance pay for teachers comes up every few decades when politicians become worried about school performance. It has been a bigger issue in the United States, where teachers are
paid less than their Canadian counterparts. President Barack Obama’s education reforms
include $4 billion for states that make their schools more accountable and specifically link
standardized tests to teacher performance. One of the calls for linking teachers’ pay to performance in Canada comes from the private sector. A report by the Canadian Council of
Chief Executives says that the current teacher compensation model that is based on education
level and seniority is ineffective. While the report dismisses merit pay, it advocates for linking teacher evaluation to the speed of progressing through the pay grids and implementing levels
with greater responsibilities and higher pay at each level.
While the proponents cited improved teaching quality and increased professional status as the benefits of performance pay for teachers, the idea received widespread opposition from
teachers and unions, which cited a long list of disadvantages of performance pay. First and
foremost, opponents say that teachers enter the profession not for money but for the
satisfaction of making a difference in students’ learning. Wayne Phillips, a 25-year veteran
teacher in Alberta and the recipient of a teaching excellence award from the prime minister,
said that continuously looking for innovative ways to teach was a fact of life for the profession. Second, teachers worry that the focus on standardized tests will distort curriculum and
classroom time by taking time away from subjects like drama and music; and the emphasis on
individual financial awards will discourage teamwork and sharing of good ideas among teachers. Third, subjective evaluation such as the principal’s assessment and student
feedback may contain bias, and more sophisticated and objective evaluation may prove to be
too expensive to implement. Fourth, the results of the experiments in the United States are
mixed, with some reporting success, while others reporting no obvious student progress. The opponents suggest that rather than fiddling with the pay system, providing better professional
development and developing stronger practice standards will improve teaching quality and
produce better student outcomes.
The proponents of performance pay claim that the system rewards those who perform better
and puts pressure on those who do not, and cite successful examples of performance pay.
Some schools in the United States awarded performance pay to the entire school, which promotes schools paying close attention to their weakest students and encourages shared
responsibility for those students. In a rare Canadian instance of merit pay, the extra money
was used for professional development. At the Calgary Girls School, a privately run but publicly funded school in Alberta, teachers can receive $1,000 to cover the costs of attending
workshops and taking university courses. The debate and experiments are continuing as we
write this textbook.
Sources: Sources: Caroline Apphonso, “Teachers’ Pay Should Be Based on Performance, Not
Years Worked: Report,” The Globe and Mail, January 23, 2014,
http://www.theglobeandmail.com/news/national/education/teachers-pay-should-be-based- on-performance-not-years-worked-report/article16471184, accessed September 23, 2016; Ben
Levin, Canada Research Chair in Education Leadership and Policy, University of Toronto,
“Want Better Teachers? Merit Pay Isn’t the Answer,” The Blog, January 23, 2013,
http://www.huffingtonpost.ca/ben-levin/merit-pay-canada-teachers_b_2526852.html, accessed September 23, 2016; Erin Andersen, “Should Canada Offer Merit Pay to Teachers?”
The Globe and Mail, February 5, 2010,
http://www.theglobeandmail.com/news/national/should-canada-offer-merit-pay-to-
teachers/article4351807/?page=all, accessed September 23, 2016.
Promotions as Rewards
Another way of recognizing individual performance is through promotions. These can be
highly valued rewards and powerful incentives because they normally carry both extrinsic and
intrinsic rewards: extrinsic because they normally bring both recognition and a pay raise, and
intrinsic because higher-level jobs typically contain more of the elements of intrinsically
motivating work, such as more variety or more autonomy.
Since promotions bring many rewards, many organizations rely on them as their major reward
for superior individual performance. They expect a promotion-from-within policy to be a key factor in motivating good employee performance. The great majority of employees believe
that promotion-from-within policies are an important means to recognize the contributions
that existing employees have made to the firm. To refuse employees fair consideration for
promotional opportunities is very demotivating to a workforce. This can be a problem in
family-owned firms, where promotions may be limited to family members.
Even when promotions are not restricted, depending on promotions as the main source of
rewards for good employee performance can cause problems. First, heavy reliance on promotions in lieu of other rewards can result in a meaningless reward system if the
organization has few upper-level vacancies. This is a problem for firms that are expanding
slowly or not at all or that are reducing their hierarchy in order to cut costs or to move toward a high-involvement managerial strategy. Even in expanding firms, only rarely do firms have
sufficient upper-level vacancies to reward all deserving candidates. In addition, for high-
involvement firms, tying rewards mainly to movement up the hierarchy is inconsistent with
their managerial philosophy and sends the wrong message to employees.
In organizations where promotions are an important part of the reward strategy, the
psychological consequences for those not promoted can be detrimental to their future motivation. Suppose a company has one vacancy and three deserving candidates. No matter
how good they are, two will be turned down. What message do the rejected individuals take
from this? Probably that the firm does not value their contributions as highly as they thought. It may also shake their confidence in the fairness of the reward system. As discussed in
Chapter 3, perceptions of unfairness can cause performance to decline or even departure from
the firm.
Some employees may not see a promotion as a reward worth seeking. Promotions typically
don’t bring only pluses; they also bring negatives, such as longer hours or more stressful work.
In some cases, they may require the employee to relocate. For many employees the net
valence of a promotion is not positive; thus it is not seen as a reward; so it does not serve as an
incentive.
From the organization’s point of view, promoting an outstanding performer to a higher level
position (usually a managerial one) can lead to serious problems if the attributes required for
success in the higher position are different from those of the lower position. For example, an
outstanding salesperson might become a very poor sales manager. The skills and abilities that
make for a successful salesperson, such as independence, competitiveness, and aggressiveness, may be undesirable in a sales manager, whose success depends on
effectiveness at recruiting, training, coordinating, and supporting the sales staff. In addition,
the sales manager loses the satisfaction of dealing directly with customers and personally
closing sales, which may have been a strong motivating force as a salesperson.
In circumstances such as these, promotions based on outstanding performance in a
qualitatively different job from the new job can have negative consequences for both the employer and the employee. In addition, as an employee progresses up the hierarchy, the jobs
become systematically more different from those below them.
Lawrence J. Peter has summarized the results of a strict promote-from-within policy in what he has modestly dubbed the “Peter principle”: “In a hierarchy, every employee tends to rise to
his [or her] level of incompetence.”15 What he means is that individuals will be promoted only if
they are performing competently in their present job. If they are not performing well, they will stay where they are. Thus, “in time, every post tends to be occupied by an employee who is
incompetent to carry out his or her duties.” Although exaggerated, the Peter principle does
contain an element of truth.
For all of these reasons, it seems clear that promotions should not be used as the sole
component of a system for rewarding superior performance. Indeed, it may be preferable to
base promotions on factors other than current performance, assuming that the candidate is at
least competent in her or his current duties. However, this can create other difficulties, such as
the perception that the organization does not care about outstanding performance.
Outstanding performers must be considered for available promotions if they wish to be
considered for one. It may be possible to prepare such individuals through training and development programs. Failing this, management must provide the candidate with an
explanation of why she or he is unsuitable for the promotion. Ideally, unsuitable candidates
will reach this conclusion on their own after discussions with management.
In some instances, it may be desirable to place an individual in the higher position on a trial
basis. If so, that person should be given every possible opportunity to succeed in order to
prevent perceptions of injustice. But for this approach to succeed, a graceful way to return to the former job must be available. One way of doing this is to provide a title such as “acting
department manager.”
In order to avoid the problem of forcing employees to move up the managerial hierarchy because it is the only way to advance their pay levels, some companies have created dual-
track programs for advancement, with a technical track (sometimes known as a “technical
ladder”) and a managerial track. The technical track provides a series of steps through which employees can increase their contribution and value to the organization (and their pay)
without becoming managers. Similarly, pay-for-knowledge systems provide an avenue for
advancing pay levels without requiring promotion to management positions.
Applicability of Merit Pay
Although most companies claim to use merit pay, it rarely applies to all employees. Nor should
it. Applying merit pay to employee groups for whom it is unsuited is a recipe for frustration
and failure. How do you decide which employee groups (if any) are suitable for the application of merit pay? Compensation Notebook 5.1 lists eight questions that can help guide this
decision. In general, all of these questions should be answered “yes” before individual merit
pay is included in the compensation structure for a given employee group.
Is individual performance variable? In many jobs, performance variation may not be
possible, as in the case of many routine, lower-level jobs in traditional classical organizations.
If performance is not variable, why waste time and effort attempting to measure variations?
Is performance controllable by the individual? If circumstances affecting employee
performance are beyond the employee’s control, then gearing pay to individual performance
makes no sense.
Can individual performance be separated out? If the performance of individuals cannot be
separated out from the performance of others with whom they work, then an individually
based merit system cannot be used. However, some type of team-based performance pay
might work.
Can an accurate performance appraisal system be developed? Do jobs change so quickly
that it is virtually impossible to come up with valid, up-to-date performance measures and standards? Does the organization have the resources to develop a reliable and valid system
and to train raters in its use?
Will pay actually be linked to performance appraisals? Is the organization prepared to set
aside sufficient funds to justify the merit process and allocate the money to create meaningful pay differences between meritorious employees and other employees? If not, nobody will take
the process seriously.
Will the merit system serve a purpose that cannot be served in some other way? There are three main purposes for merit pay: to motivate employee performance; to maintain
equity by making rewards commensurate with contributions; and for salary progression—to
raise the pay of high performers so that they will not be lured away by other firms. Can these purposes be served in other ways? As was noted in Chapter 3, intrinsic rewards are generally
more effective than extrinsic rewards for motivating task behaviour. If intrinsic motivation
already exists, then merit pay may not add much motivation and could even detract from
motivation, especially if the merit pay system is not seen as fair.
If merit pay is intended to demonstrate equity, then the system needs to be monitored
carefully to ensure that it actually does so from the employees’ perspective. If persons perceived as undeserving receive merit increases, or those deserving do not, a merit system
may cause perceptions of inequity. An alternative method for recognizing differences in
employee value to the organization is through pay for knowledge.
As for retaining key employees, a variety of means (other than merit pay) are available to
foster membership behaviour, as discussed in earlier chapters. If pay ranges are used,
experience, seniority, and/or skill levels can be used as vehicles for movement through the
range, rather than merit raises.
Are any undesirable side effects readily manageable? One possible undesirable side effect occurs when employees concentrate only on aspects of the job most visible in the
performance appraisal process. For many organizations, organizational citizenship behaviour
may be far more valuable than simple task behaviour; yet most performance appraisal systems focus mainly on task behaviour. In fact, there is some evidence that appraisals that
focus on specific goals and performance improvements actually decrease citizenship
behaviour.16 Another side effect may be conflict or lack of cooperation among employees as
they jockey for scarce merit increases.
Will the merit system fit with the firm’s culture and strategy? In classical organizations,
merit pay for rank-and-file employees is often prohibited by union contracts, since employees in these organizations are usually skeptical about the organization’s ability to fairly administer
merit systems. Most classical organizations have found direct control of behaviour and job
simplification to be the most effective means of controlling and motivating behaviour. Many classical organizations have adopted computer monitoring of employee behaviour in
preference to traditional appraisal systems.
Individual merit pay does not fit with human relations organizations either, because supervisors are concerned about social unity within the organization. Although many human
relations firms use some form of merit pay, the reality is that either most individuals receive
high ratings and receive the same merit pay, or that there is very little distinction in merit
raises between those employees receiving higher ratings and those receiving lower ratings.
Interestingly, however, these practices are not necessarily dysfunctional for human relations
organizations. They recognize that their main control mechanism—cohesive groups and
positive work norms—could easily be subverted by an individual merit pay system.
At first glance, individual merit pay might appear to fit well with high-involvement
organizations because of their need for high-level employee performance. But a closer look
reveals that most high-involvement organizations have fluid jobs, team-based processes, interdependence among employees, and flat structures, none of which fit well with traditional
individual performance appraisal. Ability and willingness to perform as needed, along with
citizenship behaviour, are the keys to effective performance in these organizations. Motivation for task behaviour is best provided by intrinsic sources and internalized commitment to the
organization.
All of these issues and concerns may help to shed light on the mystery of why, after so many years of effort, merit pay systems based on performance appraisal are often unsatisfactory.
Optimal conditions for individual merit pay are rare, and they may become increasingly rare as
concepts like flextime and flexplace become more common. However, this does not necessarily suggest that performance appraisal should be dropped (see Chapter 10). All
organizations need some system for providing feedback to individuals and groups on their
performance; if done correctly, performance appraisal may be a satisfactory means of
providing this feedback. Of course, as discussed in Chapter 3, the best feedback occurs when
jobs themselves are designed to provide feedback directly.
COMPENSATION NOTEBOOK 5.1
Suitable Conditions For Individual Merit Pay
1. Is individual performance variable?
2. Is performance controllable by the individual?
3. Can individual performance be separated out?
4. Can an accurate performance appraisal system be developed?
5. Will pay actually be linked to performance appraisals?
6. Will the merit system serve a purpose that cannot be served in some
other way?
7. Are any undesirable side effects readily manageable?
8. Will the merit system fit with the firm’s culture and strategy?
Special-Purpose Incentives
In order to foster certain behaviours that are of special importance to an organization or to
counteract behaviours that are causing problems, some firms have developed special-purpose incentive programs (sometimes known as “targeted incentive programs”). For example,
bonuses can be provided for finding insects during vegetable processing, as seen in Chapter 1.
Employees can be given bonuses for minimizing waste or for high customer satisfaction ratings. Book sales reps can be given bonuses for bringing in new authors. Baseball players
can be given bonuses for scoring home runs. The possibilities are virtually endless.
Although the advantages and disadvantages of special-purpose incentives vary with the
specific nature of the plan, their overall advantage is that they focus employee attention on a behaviour of key importance to the firm. The disadvantage is they may focus employee
attention only on the specific behaviour being sought, potentially causing employee neglect
of other important behaviours. Poorly designed targeted incentives can have a variety of unanticipated consequences, as was the case at Green Giant, where employees “gamed the
system” in order to maximize their bonuses—but the company certainly did not get cleaner
product. As discussed in Chapter 3, getting people to do something they would not otherwise
do only using financial incentives is a process fraught with peril.
Two of the most common special-purpose incentives are suggestion programs (to encourage
creativity) and attendance programs (to discourage absenteeism).
Incentives for Creativity
Suggestion systems are intended to promote and reward innovative thinking by employees. In
general, if an employee has a suggestion that may improve organizational effectiveness, she or
he submits it through the suggestion system. It is then evaluated by a committee, and if it is implemented, the employee receives a percentage (usually between 10–20 percent) of the
projected cost savings during the first year. When the savings from the suggestion are difficult
to compute, a standard lump sum is awarded. Thus, suggestion systems have three components: a system through which suggestions are channelled, a systematic process for
evaluating them, and an incentive for submitting usable ideas.
Suggestions resulting in improvements in product/service quality or lower product/service costs can result in increased organizational effectiveness.17 Acting on employee suggestions
can lead to perceptions among employees that management is responsive and may have
positive impacts on increased employee participation and organizational culture.
While they can be effective, suggestion systems face several problems. First, although the
submitted ideas may seem like good ones to the submitter, most suggestions are not adopted,
usually for reasons of practicality or cost. Unless the reasons for rejecting a suggestion are explained to and accepted by the submitter, there may be resentment and a reluctance to
contribute further suggestions. Second, if a suggestion is adopted, it is often difficult to arrive
at a fair reward, and employees may feel that the reward amount is not equitable. Third, supervisors or staff specialists may resent employees who make suggestions, feeling that this
reflects negatively on their own performance. Fourth, coworkers may resent the individual
making the suggestion if implementing the suggestion disrupts existing work practices. Fifth,
there may be the issue of who receives the credit for the idea, since it may have been developed by several individuals. In some cases, employees (including supervisors) have been
accused by other employees of “stealing” their ideas.
These systems assume that people have useful suggestions but are not motivated to submit them without the carrot of an incentive. This assumption applies mainly to classical and, to
some extent, to human relations organizations. Ironically, the problems associated with
suggestion systems are most likely to occur in classical organizations, which may explain why many classical organizations do not bother with these systems and do not find them useful if
they adopt them.
In a high-involvement organization, employees are likely willing to submit suggestions regardless of whether there are bonuses because of their internalized commitment. Therefore,
a suggestion system is likely most useful to human relations organizations, particularly if it
group-based, where everyone in the group shares in the rewards from adopted suggestions.
Group-based suggestion systems avoid many of the problems discussed earlier and have been
found to be more effective than individual-based suggestion systems.18 Group-based
suggestion systems could suit high-involvement organizations. Indeed, many group-based performance pay plans include mechanisms for employee suggestions. These will be
discussed in the next section of this chapter.
Incentives for Attendance
Because of a concern with employee absenteeism, some organizations have started providing
incentives for regular attendance.19 For example, a collective agreement between La-Z-Boy
Canada (named for the recliners the company produces, not its employees!) and its union included a new clause providing for an attendance bonus. Employees who do not have
absences in a calendar year receive eight hours of their base rate deposited into their RRSP
account.
While attendance plans vary, one approach is to provide a bonus or prize to employees who
have a perfect attendance record in a given time period. One interesting system was used by a
manufacturing plant.20 Each day that an employee came to work on time, he or she was allowed to draw one card from a deck of playing cards. At the end of the week, the employee
with the best five-card poker hand in each department received a cash prize. This plan
reduced absenteeism by about 18 percent.
Other plans pay employees for any unused “sick” or “personal” leave days to which they might
otherwise be entitled. Typically, employees receive a proportion of their daily pay, although
sometimes a fixed amount is used. Overall, the purpose of an attendance incentive plan is not to encourage sick employees to come to work, but to discourage discretionary absences
(where people skip work because they want to, not because they have to) by putting a price on
these absences.
Therefore, the two main advantages to attendance incentive plans are that they discourage
discretionary absences, and they recognize employees who don’t miss work. Many employees
feel that this is inequitable, and an attendance program can at least partly rectify this inequity.
One of the drawbacks of attendance plans include the cost of the bonus and the extra paperwork involved. Another drawback is once an individual becomes ineligible for the bonus
(by exceeding the number of allowable absences), they no longer have any incentive to limit
absences during the review period. There is also the issue of whether “legitimate” absences should detract from the record, and if so, how they should be defined and verified is a
drawback. Some employers may have a philosophical objection to paying extra for something
(attendance) that should be taken as a given. However, perhaps the greatest drawback is that the incentive plan may treat only the symptoms, without getting at the true source of the
problem.
If absenteeism is a problem, a first step is to try to understand the cause. Attendance incentive programs assume that absenteeism is caused by a lack of employee will to attend. That may
be partly true, but there are other possible reasons for absenteeism. Are there more
appropriate solutions? For example, we know that reward and job dissatisfaction affect absenteeism, and high absenteeism may just be the tip of the iceberg of underlying and more
serious problems facing the organization.21
One possibility is that the workplace itself may be responsible for an excessive number of accidents or injuries, or it may provide conditions that promote illness. For example, the work
may be highly stressful or employees may not want to face another day of boring, tedious, or
repetitive work. Factors such as these, as well as factors like dissatisfaction with the boss or
dissatisfaction with rewards, have been shown to lead to negative group norms regarding
attendance, which influence individual attendance behaviour.22
Applicability of Special-Purpose Incentives
Special-purpose incentives may be useful in changing employee behaviour, but as discussed
in Chapter 3, they need to be carefully thought out. A potential problem is that where intrinsic motivation already exists, financial incentives may serve to replace this with extrinsic
motivation. Where intrinsic motivation does not exist, employees may attempt to “game the
system” by behaving in ways that maximize their incentive payouts while their performance suffers in other ways. Special-purpose incentives are therefore most appropriate in
circumstances where intrinsic motivation does not already exist, where both intended and
unintended behaviours are easy to observe, and where no other alternatives for inducing the desired behaviour are feasible. In general, they don’t fit with high-involvement organizations,
but may fit with classical and human relations firms under some circumstances.
Compensation Notebook 5.2 summarizes the advantages and disadvantages of the major
individual performance pay plans.
COMPENSATION NOTEBOOK 5.2
Advantages and Disadvantages of Individual Performance Pay Plans
// Group Performance Pay
In this section, we will first examine the oldest and best-known group performance pay plan—
productivity gain sharing—followed by goal-sharing plans, and then other group/ team pay
plans. Group/team performance pay plans are much less common than individual
performance pay and appear to have declined in popularity in recent years, with high discontinuation rates. This decline follows a period of rapid expansion in the latter part of the
20th century.
Gain-Sharing Plans
In gain-sharing plans, whenever employees in a work group are able to improve productivity
or reduce costs, the resulting savings are split between the company and the work group; then the employee portion is systematically shared among all members of the work group. While
gain sharing can cause employees to work harder, most of the productivity gains come from
working smarter and more cooperatively. Key to most gain-sharing plans is a mechanism (typically an employee–management committee) for encouraging employee participation and
productivity-enhancing or cost-saving suggestions. Gain-sharing programs depend on a
historical base line of cost per unit produced or processed to determine whether productivity has increased, and if so, by how much. Around 5 percent of medium to large Canadian firms
have gain-sharing plans.
Proponents argue that besides stimulating valuable suggestions, gain sharing contributes to productivity in a variety of ways.23 One source of this improved productivity, although perhaps
the least important, is the direct incentive: people work more productively because they
expect to receive a share of the financial benefit. But as critics point out, this source of
motivation is weak since the extent to which an individual’s increased effort will be reflected in
their overall income is small.
Gain sharing can help generate group norms that are favourable to productivity. These
positive group norms develop because gain sharing promotes the internalization of company objectives and, it follows, self-control. Positive group norms can enhance productivity by
stimulating work effort, promoting cooperation among employees and with management,
fostering increased employee acceptance of change, and reducing the need for supervisory control. Those employees who are not capable of self-control can still be controlled by group
norms (under behavioural theory) or mutual monitoring (under agency theory), where
employees monitor one another’s performance.
In support of this argument, a study of Canadian manufacturing firms found that those that
utilized gain sharing or profit sharing had significantly less formal hierarchy— and about 31
percent fewer managers—than firms that did not.24 Since external management controls are costly, reducing them should produce significant savings for the firm, whether or not other
productivity improvements occur.
Advantages of Gain-Sharing Plans
In sum, gain-sharing plans offer firms many advantages:
1. From an employer’s point of view, the most attractive feature is that
when properly designed, they are self-funding. The plans themselves
produce the funds from which the gain-sharing bonuses are paid.
2. Gain-sharing plans can generate productivity-enhancing or money-
saving suggestions.
3. Gain sharing can help create positive work group norms, leading to
more worker effort, cooperation, and receptivity to change.
4. Gain sharing can lead to internalized worker commitment, which can
lead to self-control and reduced costs of external management
control. Increased employee commitment also reduces costs by
reducing turnover and absenteeism.
5. Gain sharing can lead to increased employee awareness of the business
and improved communication between management and employees.
6. Unlike organizational performance pay, gain sharing can also be
applied to not-for-profit and government organizations.
Disadvantages of Gain-Sharing Plans
However, gain sharing has these potential disadvantages:
1. There are the costs of establishing and administering the program and
the costs of the managerial and employee time devoted to the
program (including time spent in gain-sharing committee meetings,
preparing for meetings, evaluating suggestions, and communicating
about the program), and often, for gain sharing to work well, the cost
of additional employee training.
2. Gain sharing is not very open to rapidly changing circumstances
because it relies on a historical base line to measure productivity
changes. When products or technologies change frequently, it is very
difficult to determine whether productivity gains (or losses) are due to
increased worker input or to other factors. Management will not want
to pay out productivity bonuses if causes and effects cannot be
defined clearly.
3. Workers may focus only on what they can do to maximize their
bonuses, even if their actions have negative consequences for the
organization as a whole. For example, a shipping team at a trucking
firm may load shipments very quickly, thus increasing their
productivity but in such a way that more breakage occurs once the
truck is moving; or a customer service team may handle more
customer calls by reducing the quality of the team’s assistance.
4. Labour–management conflict may increase since it provides additional
matters to argue about. When poorly implemented, gain sharing can
become a dissatisfier and a demotivator rather than a motivator. Even
in firms where there is trust between management and workers, this
trust can be tested by all of the changes necessary to get a gain-
sharing system working properly.
5. Collective reward systems such as gain sharing can open the door to
“free riding”—that is, individual employees may shirk or otherwise
restrict their work effort, thus becoming “free riders.”25 Any additional
effort expended by an individual employee will have only a negligible
effect on the reward he or she receives, yet because that employee
still shares in the benefits of the cumulative efforts of other
employees, there is little cost to that individual in minimizing his or
her work effort. If this can’t be controlled by group norms, the firm
may need to incur the expense of additional supervision.
6. Getting gain-sharing plans to work effectively is difficult, as indicated
by their high discontinuation rates. Research by one of the authors
found that 78 percent of firms that had gain sharing no longer had it
four years later. It appears that many of the firms that adopted gain
sharing may not have been suited for it.
Applicability of Gain Sharing
The evidence is clear that gain sharing can have positive results, but not always.26 So where is gain sharing likely to succeed? Some studies have found that gain sharing is less successful in
unionized settings;27 however, it is not clear whether gain sharing is less successful because a
firm is unionized or because unionized firms tend to practise classical management.
Classical firms generally do not look favourably on gain sharing because it doesn’t allow
individual accountability and because it permits free riding. However, human relations
organizations may find gain sharing attractive because it aligns with their concept of group cooperation. At human relations firms, some of the foundations for effective gain sharing are
likely already in place, such as trust between managers and employees. Also, strong and
favourable social norms may be able to prevent free-riding, and job security may calm fears of
layoffs arising from productivity increases.
But it is in high-involvement organizations that the payoff for gain sharing is potentially
greatest, since almost all of the conditions for its success are already in place, including trust, communications, training, a participative culture, broad-based jobs, and reasonable job
security. Also, these organizations are likely to be favourably disposed toward gain sharing
because it aligns with their managerial philosophy of encouraging teamwork, participation, innovation, and problem solving. Gain sharing also supports the use of work teams, which are
often a prominent feature of high-involvement firms.
However, high-involvement firms are often operating in a dynamic environment where rapid
change is a defining feature. This makes it difficult to establish the historical base lines on
which gain sharing depends. An analysis of data from the Workplace and Employee Survey (WES) found that group pay (unfortunately, the WES does not distinguish between the
various forms of group pay) was related to profitability in firms not pursuing an innovator
business strategy, but not in firms that were.
Goal-Sharing Plans
In goal-sharing plans, management sets goals for one or more performance indicators for a
work group or team, to be met within a specified time period; if the goals are met, all team
members receive a bonus.28 Goal-sharing plans are quite different from gain-sharing plans. In gain sharing, cost savings are quantified and then shared between the company and the
employee group; also, unlike in goal sharing, there are no set goals other than to improve as
much as possible relative to the historical base line. Thus, goal sharing is much more of an “all or nothing” type of plan than gain sharing. Under gain sharing, the employees receive a
portion of any productivity gain, whereas under goal sharing, employees receive nothing if the
group goal is not met, even though the employee group may have made significant progress
toward meeting the goal.
Like gain sharing, goal sharing grew rapidly in the last two decades of the 20th century but
may now be waning in popularity. It is likely that 10–12 percent of medium to large firms now
have goal-sharing plans, which still makes it the most common type of group pay plan.
Advantages of Goal Sharing
Goal-sharing plans have some of the same advantages as gain-sharing plans, as well as several
advantages over gain-sharing plans:
1. Goal-sharing plans are more flexible and are simpler to develop than
gain-sharing plans. They can therefore be applied in a much broader
set of circumstances. They can also be tied to specific objectives that
support the company’s strategy, besides increased productivity or
cost savings.
2. Because they are less complex, goal-sharing systems are less costly to
operate than gain-sharing systems. Also, since meaningful
performance increases must take place before any bonus is paid out,
the company retains 100 percent of the gains below the bonus target.
3. Goals and goal-sharing bonuses can be adjusted as circumstances
require.
4. Goal setting is a powerful motivational tool for stimulating the
performance of employee groups as well as individual employees.29
5. Goal sharing, like gain sharing, can help generate positive group norms
relating to employee performance, cooperation with management,
and receptivity to change; it can also result in less need for
supervision. Furthermore, it motivates group members to help new
employees learn their jobs quickly and effectively. A collaborative
attitude results, and workers who develop better ways of performing
their jobs are more likely to share their knowledge than otherwise.
Disadvantages of Goal Sharing
Goal-sharing plans also have many disadvantages:
1. While flexible, these plans can be much more arbitrary than gain-
sharing plans. The goal levels necessary to qualify for a bonus and the
sizes of bonuses are often the result of arbitrary management
decisions rather than a clearly spelled-out formula. In addition, goal-
sharing plans may be modified or dropped at any time. These
characteristics do not enhance motivation. For example, if employees
perceive goals to be unrealistic (low expectancy), or the bonus
sufficiently attractive relative to the effort required (low valence), they
will not exert extra effort to meet them. In addition, if employees
believe the program can be modified or ended at any time, they will be
skeptical whether the promised rewards will actually materialize or
continue once goals are met (low instrumentality).
2. Goal-sharing systems often have no established basis for judging the
value of meeting a particular goal, as well as no fixed, mutually
agreed-upon formula for apportioning gains between the company
and employees. Employees may doubt whether they are being fairly
compensated for meeting goals and may feel that the company is
trying to “rip them off ” by providing token rewards for major gains in
productivity; this can lead to reward dissatisfaction.
3. Setting goals appropriately can be very difficult. If goals are seen to be
too difficult, they will be ignored by employees. If goals are too easy,
the firm will pay out money unnecessarily, and these easy goals will
set a de facto limit on performance. Going beyond the specified goal
brings no additional pay and may cause management to increase
goals in future years, so why make the extra effort?
4. Many situational factors can affect goal achievement, so using identical
goals for different work groups may be unfair. However, attempts to
correct this unfairness by developing “easier” goals for some work
groups simply builds resentment elsewhere.
5. Employee dissatisfaction may develop if everyone worked hard to
reach the goal but didn’t quite succeed and therefore received no
reward. Managers may be tempted to redress this resentment by
lowering the goal and providing the reward anyway, but this could
teach employees that they need not attain the goal in order to receive
their bonuses.
6. Goal sharing can produce conflict. A work team may become frustrated
if one or two workers who are unwilling or unable to perform at the
necessary level prevent the group from attaining the goal. On the
other hand, conflict may occur if the group believes that some
members are pushing “too hard” to achieve or surpass goals.
7. Goal-sharing plans have a high discontinuation rate.
Many of the issues with goal sharing can be overcome. Extensive employee participation in the
development of these plans can help create realistic goals and increase employee motivation for goal achievement. Multitiered goals can be used to recognize different goal achievement
levels; this can reduce frustration if a team can’t meet a top goal. Also, management can
quantify the value of the specified goals in order to give some assurance of equity when
determining reward size.
Applicability of Goal Sharing
Most experts suggest that to work well, group goal-sharing plans must be designed with input
from employees, should clearly communicate factors affecting goal achievement and ways that employees can influence these factors, and should communicate progress toward
meeting goals on an ongoing basis.30 The key factor for success is a high level of trust between
management and employees. Thus, goal sharing is likely to be most effective in high- involvement organizations, somewhat effective in human relations organizations, and
ineffective in classical organizations. A caveat to this is that goal-sharing plans may not work
well in highly dynamic firms (which high-involvement firms tend to be), since this makes it
difficult or impossible to set realistic goals.31
Other Types of Group Performance Pay Plans
Besides gain sharing and goal sharing, there are many other types of group bonus plans. These
can be placed in two main categories: competitive bonus plans and pooled performance
plans.
A competitive bonus plan rewards work groups or teams for outperforming other work groups
or teams. For example, many real estate firms with multi-office operations encourage
competition among sales offices by providing a bonus to all sales personnel in the highest- producing office each month. In retail chains, all employees in a particular store may receive a
bonus if their store has the highest customer satisfaction ratings in the chain in a given time
period.
Competitive bonus plans are most suited to circumstances in which the groups do not need to
work closely with one another. In general, competitive bonus systems that pit one group
against another should be used only when the groups are truly independent and never need to cooperate with one another. These plans do not fit well with human relations organizations or
high-involvement firms.
The other type of team-based reward system is pooled performance pay. One example of pooled performance pay is group commissions, where the pay for a group of sales reps is
based on the total sales the group generates, with each member receiving an equal share of
the resulting commissions. Another example is group piece rates, in which group members are paid based on the number of completed products or components produced by the group. For
example, tree planters might be paid according to the total number of trees planted by a team
of planters, with the money then shared equally among members of the planting team.
The value of these plans is that each group member wants the other group members to
succeed, and each shares tips and techniques for better performance. In other words, this type
of plan encourages teamwork. The danger with these plans is that they may encourage free
riding. However, this may not be a problem if the groups are kept relatively small and if members understand that their well-being is maximized when all perform to the best of their
abilities.
Compensation Notebook 5.3 summarizes the advantages and disadvantages of group
performance pay plans.
COMPENSATION NOTEBOOK 5.3
Advantages and Disadvantages of Group Performance Pay Plans
// Organization Performance Pay Plans
Organization performance pay plans include profit-sharing plans, employee stock
plans (sometimes called “employee share plans”), and other plans, often known as long-term
incentives. Profit-sharing and employee stock plans experienced growing popularity in the latter decades of the 20th century; however, research by one of the authors suggests that their
popularity may have levelled out in the past few years. Among medium to large Canadian
firms, profit-sharing and employee stock plans are about equal in popularity: nearly 25
percent of firms report profit-sharing plans and about the same proportion report having at
least one employee stock plan.
Profit Sharing
To be recognized as having an employee profit-sharing plan, a firm must have a formal
program in which payments are made to a broad cross-section of employees on at least an
annual basis, based on a formula that relates the size of the bonus pool to the profitability of the business. While it is not necessary that all employees or groups be included, plans that
restrict profit sharing only to managers are generally not considered “true” employee profit-
sharing plans.
Profit-sharing plans may take one of three forms. The current distribution profit-sharing
plan (also called a “cash plan”) pays a portion of company profits to employees in cash or
occasionally in company shares. (When shares are used, it is also considered a type of employee stock plan.) In most firms, the distribution is annual, but it can be more frequent,
depending on the availability of profit data.
In a deferred profit-sharing plan (DPSP), an employee’s share of the profit bonus pool is placed
in a trust fund to be distributed at a future date, usually on the employee’s retirement or on termination of employment. This type of plan is often used as a type of retirement savings
plan. A combination profit-sharing plan provides both cash (or shares) and a deferred
component. A combination plan gives the employee the opportunity to take advantage of the
provisions for tax deferral in federal tax legislation to help build some retirement income; it
also provides a more visible incentive to employees through the cash portion.
Advantages of Profit-Sharing Plans
As part of a study about profit sharing, researchers asked a business owner whether his firm
had employee profit sharing.32 His reply: “Give away my profits to employees? Why would I
want to do that? ” Why indeed would employers want to share their profits with their
employees?
1. When the interests of employees are aligned with those of the
employer, employees may be more motivated to improve company
performance. Profit sharing can contribute to the development of
favourable group norms, improved cooperation among employees
and between employees and management, improved labour–
management relations, and greater organizational identification,
which may strengthen organizational citizenship behaviour.33
2. Improved norms can reduce the need for supervision, thereby reducing
costs. Profit sharing also aligns with and supports a move toward
high-involvement management for firms moving in that direction.
3. Profit sharing is a reward related to company ability to pay. By adding
profit sharing to its compensation mix, an employer can offer a more
lucrative compensation package when conditions permit, but is not
locked into higher fixed pay, since it doesn’t have to continue profit-
sharing payments when business conditions are unfavourable and the
firm makes no profits. In the same vein, profit sharing is the only way
that some organizations can afford to offer a retirement plan, since it
means they have no obligation to contribute to the pension plan when
they cannot afford to do so.
4. Recent Canadian research shows that, on average, employees in firms
with profit sharing have higher total earnings than those in firms that
do not provide profit sharing.34 This helps the firm attract and retain
employees.
5. Profit sharing may reduce the need for layoffs in poor economic
circumstances, since labour costs are automatically adjusted
downward. This reduces the risk of losing good employees because of
layoffs; it also provides employees with greater job security.
6. If profit sharing helps create a more cooperative workplace, employees
may gain greater job satisfaction from working in a harmonious
environment.
7. Finally, profit sharing is far simpler to set up and administer than plans
such as gain sharing. Profit measures are readily available in virtually
all firms. There is no need to compute base lines or to try to quantify
the value of cost savings. In addition, administration is relatively
simple, and the plan and its results are relatively easy to communicate
to employees.
Disadvantages of Profit Sharing
As with all performance pay plans, profit sharing also has its disadvantages:
1. It may not pay off for the employer. The costs of the profit-sharing
bonus and for administering the profit-sharing system may exceed the
benefits.
2. As a collective reward system, profit sharing may actually reduce
employee performance by causing free riding, just as in group-based
pay systems. Because the connection between individual
performance and the expected reward for that performance is more
fragile, profit sharing has a weaker “line of sight” between individual
employee performance and the bonus amount than group pay and so
may have little direct impact on employee performance. So many
factors intervene between worker performance and company
profitability that worker performance can improve dramatically while
profits actually go down or even disappear—owing, for example, to
market conditions or poor management decisions.
3. Unions may oppose profit sharing because its results are subject to
management manipulation, or because employers will be tempted to
substitute uncertain rewards from profit for certain rewards from base
pay.
4. Profit sharing requires employers to share financial information about
the company. This is a concern mainly for classical employers, who do
not feel that employees can be trusted with financial information.
Applicability of Profit Sharing
Many firms seem to believe that profit sharing is applicable to them. In a major study, the CEOs of Canadian firms that had adopted profit sharing said that they saw profit sharing as a way
either to increase company performance (by improving employee motivation, promoting
teamwork, or helping employees understand the business) or to provide better rewards to
employees, thereby improving employee commitment and loyalty. Most CEOs said they
believed profit sharing had helped their companies achieve these goals.35
COMPENSATION TODAY 5.3
How Many Stock Analysts Does It Take to Change a Light Bulb?
How many stock market analysts does it take to change a light bulb? The answer: None. If the
bulb really needed changing, the market would have already changed it.
The humour in this joke relies on stock market analysts’ belief in the “infallibility of the
market”—the notion that the stock market takes account of all information about a company and accurately incorporates it into the valuation of the company’s shares. Yet the “infallibility
of the market” is in fact a fiction. Through their own individual actions, stock analysts
continually pass collective judgment on the decisions of company management and influence
changes in the firm’s share price. Investors are the market!
Management decisions in publicly traded corporations are evaluated in terms of whether they
“add value” to a company—whether they cause a company’s share price to go up or down.
Therefore, researchers have started to examine the quality of management decisions in terms of the market’s reaction to them. However, is the market always right? Or does the market
sometimes act on erroneous assumptions?
An interesting study by Theresa Welbourne and Alice Andrews examined the five-year survival rate of firms that were first listed on a stock exchange in 1988. The study then related this rate
to the extent to which these firms had organization-based performance rewards, such as
profit-sharing and employee stock plans. Their results were impressive. They found that the use of organization-based performance rewards significantly increased the likelihood of
company survival.
This is an interesting finding in its own right, but the researchers made another interesting discovery. They examined whether the stock market had valued the shares of companies with
organizational rewards more highly than those of firms without organizational rewards at the
time of the initial public offering. It should have, since these firms ended up with a higher
survival rate.
But it did not. In fact, firms with organizational rewards were valued significantly lower than
firms without these rewards. The researchers concluded that “investors seem to respond negatively to a factor that actually has a positive impact on survival chances.” They also found
that despite believing that organizational rewards had played some role in their company’s
success, the top executives of survivor companies substantially undervalued the role that
organizational rewards had actually played in company survival. This suggests that business
culture itself may have a tradition of discounting the impact of organizational rewards.
Source: Theresa M. Welbourne and Alice N. Andrews, “Predicting the Performance of Initial
Public Offerings: Should Human Resource Management Be in the Equation?” Academy of
Management Journal 39, no. 4 (1996): 891–919.
These results fit well with an American study (described in Compensation Today 5.3) which
found that companies that made extensive use of organization-based performance rewards— such as profit-sharing and employee stock plans—showed a much higher five-year survival
rate than firms that did not use organization-based performance pay—a finding that would
come as a surprise to stock analysts and investors! Studies have also shown that profit sharing
improves employment stability.36
However, while the research is clear that profit sharing can help company performance, 37 it
also suggests that profit sharing is ineffective in between one-quarter and one-third of the firms in which it has been implemented.38 Research also shows that the most important single
factor in the success or failure of profit sharing is practice of a high-involvement managerial
strategy.39 Given this, it is not surprising that high-involvement firms are the ones most likely to implement profit sharing.40 Overall, profit sharing seems particularly important in
companies where a high level of cooperation is needed across company units, between
management and employees, and among employees, and where much or most of the work is performed in teams. Profit sharing helps promote the internalization of company goals and
provides a mechanism for keeping employees informed about the financial state of the
business. A recent Canadian study suggests that profit sharing can foster a positive
organizational culture that promotes teamwork and increased employee participation.41
Yet profit sharing may also be useful in human relations organizations to the extent that it
serves as an additional means of cementing loyalty to the firm and fostering positive work
norms. However, the impact of profit sharing is not likely to be dramatic, since the participative culture that is necessary to maximize the contribution of profit sharing is not
generally in place at human relations firms.
For classical firms, profit sharing yields few benefits. It is not compatible with the classical managerial philosophy, which views workers and management as adversaries and which
requires that individuals be accountable for their own performance. In situations of low trust,
profit sharing becomes another source of conflict: employees believe that management is trying to use profit sharing to reduce other compensation or to weaken union allegiance, and
that management will find ways to manipulate the system to cheat them out of their rightful
share of the profits. In addition, management’s reluctance to release financial information fosters mistrust and makes it difficult for employees to understand how they could contribute
to profitability. In addition, a major potential benefit of profit sharing—the ability to operate
with less hierarchy and fewer supervisors—is not viable in classical firms.
For profit sharing to succeed, there must be some expectation of profits in at least the first one
or two years of the plan. The profitability level should be sufficient to afford a noticeable
annual payout amount—at least 3–5 percent of total compensation for each employee. Firms
with highly unstable profits and a weak “line of sight” between employee performance and
profitability are not ideal candidates. Finally, there must be reasonably good relations
between management and employees, and management must be willing to share financial
information and value employee input.
Economists contend that profit sharing would have more impact if it substituted for base pay;
however, consultants and practitioners universally oppose this practice,42 arguing instead that competitive base pay and an equitable compensation system are preconditions for successful
profit sharing. Interestingly, research based on Canadian WES data found that firms that pay
above the average for their industry are more likely to adopt profit sharing than other firms.43 The same study found that firms pursuing a low-cost strategy were more likely to
adopt profit sharing, consistent with the notion that profit sharing fits better with firms that
have less volatile profits, as innovator firms tend to have. Other research based on the same
data set found that growth in total employee earnings in the five years after a firm had
adopted employee profit sharing was significantly higher than that of firms that had not
adopted profit sharing, indicating that profit sharing does, on average, increase total
employee earnings.44
Employee Stock Plans
An employee stock plan is any type of plan through which employees acquire shares in the
firm that employs them. There are three main types of employee stock plans: employee stock
bonus plans, employee share purchase plans, and employee stock option plans.
An employee stock bonus plan is very simple in concept: an employer provides company
shares to employees at no cost to the employee, either by outright grant or in conjunction with some other performance pay plan, such as profit sharing. In an employee share purchase
plan, employees provide some kind of direct payment in return for company shares, but they
usually do not have to pay full market price for these shares. (Compensation Today 5.4 describes two typical employee share purchase plans—one in a private corporation and
one in a public corporation.) In an employee stock option plan, employees are provided with
options to purchase company shares at some future time at a set price, which they will
exercise if the market price rises to exceed this price.
Employee stock plans enjoyed rapid growth during the latter part of the 20th century, but their
popularity appears to have levelled out during the last decade.
This is not surprising in light of the down-market conditions that have prevailed in the new
millennium. In addition, there has been controversy regarding whether employee stock plans
(particularly executive stock plans) actually serve the interests of shareholders. Of the three
main types of employee stock plans, employee share purchase plans are the most common (used by about 20 percent of medium to large Canadian firms), followed by employee stock
option plans (used by about 10 percent of firms), and employee stock bonus plans (used by
about 2 percent of firms).
COMPENSATION TODAY 5.4
Ownership Eggs on these Employees
At Vanderpol’s Eggs in Abbotsford, British Columbia, most employees are shareholders in this privately held firm. A typical employee may hold $75,000 worth of company shares, and many
own much more than that. Most of this ownership results from employees choosing to invest
their allocations from the company profit-sharing plan in company shares. (Because the company wishes to preserve working capital, the employees’ other alternative for the profit-
sharing payout is to lend it back to the company, which pays interest of prime plus 1 percent
on these funds.)
Although the company provides no discount on the shares that are purchased with profit-
sharing money, the B.C. government does provide a 20 percent tax credit on funds so invested.
Employees are allowed to remove their funds at retirement or termination. The company finds
that share ownership creates a keen interest in company performance among employees.
Similarly, RBC Financial, a publicly traded firm, has for many years had an employee savings
program under which employees may purchase bank shares. All employees with at least six
months’ service have the option of placing up to 10 percent of their annual earnings in a savings plan, which may be invested in deposit accounts, mutual funds, or bank shares. The
bank matches the shares by 50 percent, up to a limit of 3 percent of the employee’s annual
earnings. That is, if an employee invests 6 percent of his or her earnings, that person receives
additional bank shares amounting to 3 percent of his or her gross earnings at no extra cost.
If the employee’s annual RRSP allowance is not used up, these shares are placed in a deferred
profit-sharing plan, and there is no income tax liability for the employee until redemption. If the RRSP allowance is used up, the shares are placed in an employee profit-sharing plan, and
income taxes are not deferred.
Advantages of Employee Stock Plans
Employee stock plans can bring a number of advantages to firms:
1. By aligning the goals of employees with those of the owners, share
ownership may cause employees “to think like owners” and
internalize company goals. This can lead to enhanced citizenship and
membership behaviours.
2. Employee share ownership can create a stronger understanding of and
concern for overall company performance and promote cooperation
among employees and between employees and management.
3. Especially if accompanied by employee participation, share ownership
can provide employees with a say in the enterprise and a sense of
control over their own destiny.
4. Employee stock plans can improve the compensation package, making
it easier to attract and retain employees. The financial gains to
employees can be enormous—the employee share plan at Microsoft
has created thousands of employee millionaires. A stock plan can also
serve as a retirement plan, which is especially valuable in firms that do
not want to commit to formal pension plans.
5. Companies with a significant amount of employee ownership have
been found to provide better job security to their employees.45
6. Employee stock plans may lead to improved management, because
share-owning employees may hold managers to a higher performance
standard than they otherwise would.
7. Unlike most forms of performance pay, employee stock plans do not
require the company to lay out cash. Thus, for companies that are
cash-poor and that cannot afford pay raises, shares may be one way to
reward employees.
8. Large-scale employee ownership plans, in which employees acquire a
significant portion of the ownership, can serve as the catalyst for a
more flexible and entrepreneurial high-involvement type of
organization.
Disadvantages of Employee Share Plans
Employee stock plans have some general disadvantages and some specific disadvantages
pertaining to each type of plan:
1. Establishing and administering these plans carries a cost. In addition,
providing a large number of shares to employees at a below-market
price can dilute the holdings of other shareholders. This is particularly
true for stock bonus or stock option plans.
2. If the share price declines, employees may become demoralized or
disgruntled, especially when the decline in share prices is due to poor
management performance rather than general market conditions.
3. If employees want to participate in decision making to improve
company performance but management does not provide them with
opportunities to do so, then employee backlash may occur.
4. For share purchase plans, a problem may be that employees do not
have the money to invest in these plans, even if the shares are offered
to them at a significantly discounted price.
5. For employees, investing in their employer may be risky, since they risk
losing not only their jobs if the firm performs poorly, but also their
savings. (Of course, this is a concern only for share purchase plans, not
stock bonus or stock option plans.) Risks of share ownership are
particularly high for employee–owners in privately held corporations,
where no outside market exists for their shares.
6. For privately held corporations, utilizing share plans is more
complicated than for publicly traded corporations, because many
necessary mechanisms are not in place and have to be created.
Procedures for issuing, pricing, selling, and trading shares need to be
developed, as well as procedures for shareholder voting and
communication of financial information. In addition, many owners of
privately held corporations do not want to give up any control of their
companies.
Applicability of Employee Stock Plans
Employee stock plans are used by firms in a wide variety of industries and in both publicly traded and privately held firms. Various studies have found that the effects of employee stock
plans on company performance range from moderately positive to neutral.46 However, when
combined with employee participation, employee share ownership can have dramatic results. For example, one American study found that firms that introduced employee ownership and
that practised employee participation in decision making grew 11–17 percent faster than their
competitors, whereas firms that simply introduced employee ownership showed no difference
from their competitors.47
Many other studies have consistently found that combining an employee stock plan with
employee participation greatly increases the performance effects of employee ownership.48 Moreover, firms that combine ownership with employee participation have been
found to provide a significantly greater financial return (including both employment earnings
and share earnings) to their employees than comparable conventional firms.49
What about the results of employee stock options? A major study conducted at Rutgers
University, using a matched-sample longitudinal design, found that firms that adopted broad-
based stock option programs were more productive—by about 6.3 percent—than comparable firms even before they adopted the programs. Then, after adopting stock option programs,
these companies more than doubled their productivity advantage (to 14 percent) over their
competitors.50
As with profit-sharing plans, employee stock plans fit best with high-involvement organizations. In fact, the idea of ownership fits even better with high-involvement
organizations than profit sharing does, because it connotes a greater degree of unity of
purpose between employees and the other owners. It also carries expectations about information and control rights. Overall, employee ownership on its own has the potential to
deliver to employees three of the four elements that Edward Lawler, a leading compensation
scholar, deems essential for high-involvement organizations: power, information, and rewards (the other key element is knowledge); thus, it can help organizations move toward high
involvement.51
For human relations organizations, employee stock plans may hold some benefits, especially if employees regard these plans as an attractive part of the compensation system. They may
help retain employees and foster positive group norms. However, because these organizations
are not likely to provide opportunities for participation, nor the information and training needed for effective participation, the positive consequences are likely to be limited. There is
also the risk of damage to morale if share prices drop.
In classical organizations, given the adversarial nature of employee–management relations, employee share ownership is not likely to be offered, nor is it likely to be greeted with much
enthusiasm by employees, especially if they are required to give up something in exchange.
Unless the share plan is very generous, there is not likely to be much interest among
employees. If stock bonuses or stock options are granted outright, employees in a classical
firm are likely to sell their shares at the first possible opportunity.
Employees in classical firms who do retain their shares and who attempt to improve company
performance are likely to experience hostility from their peers, since coworkers are likely to be concerned that productivity increases may lead to negative consequences such as layoffs.
Attempts to increase employee involvement in decision making will likely be met with
indifference or resistance from classical managers, since these managers are unlikely to believe that the workers are capable of making useful suggestions or participating responsibly
in decision making. These attitudes are likely to lead to frustration on the part of employee–
owners.
Other Organization Performance Pay Plans
In the latter part of the 20th century, it became evident that the organization performance pay
plans in place at that time did not do enough to encourage a long-term perspective on
organization performance. Noting that many company initiatives may take years to bear fruit, they asked themselves whether incentives could be developed that would look at
performance from a longer perspective. The most prominent of these are now known as long-
term incentives (LTIs). In essence, these plans are set up so that a payout is contingent on the
achievement of three- to five-year performance goals.52
Long-term compensation has traditionally involved stock options and stock grants. However,
LTIs may use performance units rather than shares. A performance unit plan grants an
organization member (usually an executive) a number of performance units, each of which carries a monetary value to be realized if certain performance targets are met. There are two
ways to establish a value for these units. One way is to issue units where the value of each unit
is constant but the number of units actually payable depends on the degree of attainment of targeted goals. The second way is to vary the value of each unit based on the degree of goal
attainment.
A performance share plan uses company shares instead of units. Depending on the degree of goal attainment, the individual receives a certain number of company shares at the end of the
performance period. This plan has a double-barrelled incentive: to meet targeted goals and to
increase company share value.
As with stock options, LTIs were originally granted only to the three or four top executives (as
will be discussed in Chapter 6, where we devote a special section (“Executives”) to executive
compensation). But in 1996, a major departure from this practice occurred when apparel giant Levi Strauss announced a six-year, long-term incentive plan that
included all employees.53 Unfortunately, by 1999, the company was so far from meeting its LTI
goals that the program was cancelled.54 Nonetheless, it appears that the Levi Strauss example may have caused some firms to follow suit. According to research conducted by one of the
authors, about 5 percent of Canadian firms had adopted broadbased LTIs (those that include
nonmanagerial employees) by 2000. However, growth in these plans subsequently appeared
to level off and may have since declined.
Because the use of LTIs as broad-based employee performance pay plans is relatively new,
almost nothing is known about their effects on corporate performance. One challenge for
researchers is to separate the impact of LTIs from that of the many other factors that affect
firm performance over a three- to five-year period.
Most of the advantages and disadvantages of goal sharing can be expected to apply to broad-
based LTIs, with a particular disadvantage being the difficulty of estimating realistic goals for the three- to five-year period that LTIs cover. Realistic goals are hard enough to estimate for
the one-year period that goal-sharing programs typically cover, let alone a longer period. In
addition, many employees may leave the firm during the performance period and may not expect to see any benefit from the plan. Overall, such plans are useful only for firms with a very
stable workforce in a very stable industry, where events are predictable over the longer term.
Given the economic volatility of the past few years, such circumstances would seem rare, so
such plans may be of little value to most firms.
Compensation Notebook 5.4 summarizes the advantages and disadvantages of the main
types of organization performance pay plans.
COMPENSATION NOTEBOOK 5.4
Advantages and Disadvantages of Organization Performance Pay Plans
// SUMMARY
With its review of performance pay plans, this chapter has completed our discussion— begun
in the previous chapter—of the menu of compensation options available for inclusion in a
compensation strategy. You are now ready to tackle the compensation strategy formulation
process, which is the focus of the next chapter.
In this chapter, you have learned about the four main types of pay that are geared to the
performance of individual employees, the three main types of pay that are geared to the
performance of groups or teams of employees, and the three main types of pay that are geared to the performance of the organization as a whole. You have learned that each type of
performance pay has distinct advantages and disadvantages, tends to serve different
objectives, and is applicable to different circumstances.
Individual performance pay plans—piece rates, sales commissions, merit pay (which includes merit raises, merit bonuses, and promotions), and special-purpose incentives— generally
focus on promoting task behaviour. While each type of individual performance pay can be
effective when properly designed and applied in the right circumstances, each can also cause a variety of unintended negative consequences if poorly designed or applied in the wrong
circumstances. Whenever possible, intrinsic motivation to motivate task behaviour is superior
to extrinsic motivation.
Key factors for individual performance pay plans include the extent to which individual
employees have exclusive control over the desired performance outcomes and whether it is
possible to separate out and measure individual performance outcomes. In general, individual performance pay fits best with classical organizations, although it might serve a useful role in
high-involvement organizations under the right circumstances, if balanced with group or
organization performance pay. However, it is not generally suitable for human relations
organizations.
Because many individual performance plans tend to foster an adversarial employee-
management relationship, classical firms need to constantly watch for loopholes in the plans and develop ways to close them. But this often requires increased inspections, monitoring,
and record keeping, the costs of which may outweigh any benefits. Given these problems, it is
not surprising that many classical firms have moved away from individual incentives and
output-based control systems and have chosen to regulate behaviour directly through rules
and supervision.
Group performance pay—which includes gain sharing, goal sharing, and other group
performance pay plans—promotes task behaviour, positive social behaviour within groups/teams, and favourable group norms. Group performance rewards are appropriate
where good individual performance is not possible without effective cooperation from other
members of the work group or team, and where it is difficult or impractical to measure the performance of individuals. It fits well with high-involvement firms and probably can be used
effectively by most human relations firms. Group performance pay does not fit classical
organizations well.
Organization performance pay—which includes profit sharing, employee stock plans, and
long-term incentives—is intended to promote organizational citizenship behaviour and
membership behaviour, as well as positive group norms. It fits well with high-involvement management, but may also bring some benefits for human relations firms, depending on the
type of plan selected and how it is designed. Organization performance pay does not suit
classical organizations.
Finally, keep in mind that each of the ten types of performance pay may produce different
results in different circumstances. Be aware of the factors that influence the appropriateness
of each performance pay plan, since they vary for each type of pay plan. The key for
compensation strategy is to select those pay plans that fit your organization best, and apply
them only to those employees for whom they are a good fit.
For example, in a classical firm, piece rates might fit some employees, sales commissions
might fit other employees, and merit pay might fit still others. For high involvement or human
relations firms, gain sharing might fit some employee groups, goal sharing might fit other employee groups, and neither might fit some employee groups. Finally, for organization
performance pay, profit sharing might suit some firms while employee stock plans might
better suit other firms. Moreover, within each firm, the extent to which organization performance pay is utilized might vary for different employee groups, depending on the other
components of performance pay available to each group. All of these considerations—and
more—need to be taken into account when formulating compensation strategy, which is the
subject of the next chapter.
Key Terms
• combination profit-sharing plan
• competitive bonus plan
• conversion selling
• current distribution profit-sharing plan
• deferred profit-sharing plan (DPSP)
• differential piece rate
• employee profit-sharing plan
• employee share purchase plan
• employee stock bonus plan
• employee stock option plan
• employee stock plan
• gain-sharing plan
• group commissions
• group piece rates
• goal-sharing plan
• leverage selling
• long-term incentives (LTIs)
• maintenance selling
• merit bonus
• merit raise
• new market selling
• performance share plan
• performance unit plan
• piece rates
• pooled performance pay
• sales commissions
• special-purpose incentive
• straight commission
• straight piece rate
• suggestion system
Discussion Questions
Steeping some tea...
Discussion Question 5.2
Review
Discuss the considerations you would use in deciding whether to apply gain sharing or goal sharing to a
particular work group.
Your Answer
No answer submitted
Discussion Question 5.3
Review
Discuss the considerations you would use in deciding whether to apply profit sharing or employee share ownership to a given organization.
Your Answer
No answer submitted
Using the Internet
Using the Internet Question 5.1
Review
Implemented for the right reasons, an employee share plan can be an effective organizational pay plan. Using the ESOP Association of Canada website, explain the four main motives for implementing
employee share ownership plans in Canada.
Your Answer
No answer submitted
Exercises
Exercise Question 5.1
Review
Form small groups of four to six people. Then develop several alternative ways of using the reward and compensation system to solve the problems identified at the CNE soft-drinks booth, described in the
opening vignette.
Your Answer
No answer submitted
Exercise Question 5.2
Review
Form small groups of four to six people. Each group member will contact one local retailer and find out
about its pay system for its sales staff. Compare the systems and discuss whether any of these systems are
linked to the type of product sold and the type of sales activity. Do they fit with the advice offered in this chapter? Do they fit with the firm’s managerial strategy, as far as you can determine? Get together with other groups and share your conclusions.
Your Answer
No answer submitted
Exercise Question 5.3
Review
Form groups of six to eight people. Divide each group into two, or three to four people, with one group proposing and one group opposing and debate this topic: “University professors should be paid only
through merit pay.”
Your Answer
No answer submitted
Case Questions
Case Question 5.1
Review
Analyze the pay system at Alliston Instruments in the Appendix. Why is the new pay system apparently not working? Do you think that the individual production bonus system could work if some changes were
made? What changes? Is individual performance pay suitable for this company? If management insists on some type of individual performance pay system, what type would you recommend?
Your Answer
No answer submitted
Case Question 5.2
Review
Suppose that management at Alliston Instruments (Appendix) has decided to scrap the current individual
performance pay system. However, the company has not decided what, if anything, will replace this
system and have called you in to advise them. They want you to examine the group and organization
performance plans available and recommend the one that fits best with Alliston and the problems it is
facing. In preparing your report, be sure to include the pros and cons of each approach and reasons that your recommended approach is the best.
Your Answer
No answer submitted
Case Question 5.3
Review
Do you think that The Fit Stop Ltd. (Appendix) would be a suitable organization in which to implement an
organization performance pay plan? Explain why or why not. If The Fit Stop is suitable, what type of
organization performance plan would be most appropriate? Describe the key elements of this plan as applied to The Fit Stop.
Your Answer
No answer submitted
Simulation Cross-Reference
If you are using Strategic Compensation: A Simulation in conjunction with this text, you will
find that the concepts in Chapter 5 are helpful in preparing Sections C and K of the simulation.
// Notes
1. Bo Johansson, Kjell Rask, and Magnus Stenberg, “Piece Rates and Their Effects on Health
and Safety—A Literature Review,” Applied Ergonomics 41 (2010): 607–14.
2. John S. Heywood, Xiangdong Wei, and Guangliang Ye, “Piece Rates for
Professors,” Economics Letters 113 (2011): 285–87.
3. Susan Helper, Morris M. Kleiner, and Yingchun Wang, “Analyzing Compensation Methods in Manufacturing: Piece Rates, Time Rates, or Gain Sharing?,” National Bureau of Economic
Research, Working Paper #16540 (2010).
4. David A. Harrison, Meghna Virick, and Sonja William, “Working Without a Net: Time,
Performance, and Turnover Under Maximally Contingent Rewards,” Journal of Applied
Psychology 81, no. 4 (1996): 331–45.
5. William Keenan, “Beyond the Basics,” in Commissions, Bonuses, and Beyond, ed. William
Keenan (Chicago: Irwin, 1994), xv–xviii.
6. Ira Sagar, “IBM Leans on Its Sales Force,” Business Week, February 7, 1994, 110.
7. Jerome A. Coletti and David J. Chicelli, “Increasing Sales Force Effectiveness Through the
Compensation Plan,” in The Compensation Handbook, ed. Milton L. Rock and Lance A.
Berger (New York: McGraw-Hill, 1991), 290–306.
8. Michel Tremblay, Jerome Cote, and David Balkin, “Explaining Sales Compensation Strategy
Using Agency, Transaction Cost Analysis, and Institutional Theories,” paper presented at the
Academy of Management Annual Meetings, Boston, 1997.
9. Antoinette Weibel, Katja Rost and Margit Osterloh, “Pay for Performance in the Public
Sector: Benefits and (Hidden) Costs,” Journal of Public Administration—Research and
Theory 20, no. 2 (2010): 387–412.
10. Parbudyal Singh and Natasha Loncar, “Antecedents of Pay Satisfaction in a Unionized
Environment,” Relations Industrielles/Industrial Relations 65, no. 3, (2010), 470–90; Michael
Atkinson, Murray Fulton, and Boa Kim, “Why Do Governments Use Pay for Performance? Contrasting Theories and Interview Evidence,” Canadian Public Administration 57, no. 3
(2014): 436–58.
11. Robert L. Heneman, “Merit Pay Research,” Research in Personnel and Human
Resources Management 8 (1990): 203–63.
12. Steven Kerr, “On the Folly of Rewarding A, While Hoping for B,” Academy of Management
Executives 9, no. 1 (1995): 7–14.
13. Robert L. Heneman and Jon M. Werner, Merit Pay: Linking Pay to Performance in a
Changing World (Reading: Addison-Wesley, 2005).
14. Edward E. Lawler, Rewarding Excellence: Pay Strategies for the New Economy (San
Francisco: Jossey-Bass, 2000).
15. Lawrence J. Peter and Raymond Hull, The Peter Principle (New York: William Morrow,
1969).
16. Henry M. Findley, William F. Giles, and Kevin W. Mossholder, “Performance Appraisal
Process and System Facets: Relationships with Contextual Performance,” Journal of Applied
Psychology 85, no. 4 (2000): 634–40.
17. Richard J. Long, “Group-Based Pay, Participatory Practices, and Workplace Performance,” paper presented at the Conference on the Evolving Workplace, Ottawa, September 28–29,
2005.
18. See ibid; see also Jerry L. McAdams, “Employee Involvement and Performance Reward
Plans,” Compensation and Benefits Review 27, no. 2 (1995): 45–55.
19. Patricia L. Booth, Employee Absenteeism: Strategies for Promoting an Attendance
Oriented Corporate Culture (Ottawa: Conference Board of Canada, 1993).
20. See Edward E. Lawler, “Reward Systems,” in Improving Life at Work: Behavioral
Sciences Approaches to Organizational Change, ed. J. Richard Hackman and J. Lloyd
Suttle (Santa Monica: Goodyear, 1977). For a more recent example of an attendance lottery that also showed positive results, see Wolter H.J. Hassink and Pierre Koning, “Do Financial
Bonuses Reduce Employee Absenteeism? Evidence from a Lottery,” Industrial and Labor
Relations Review 62, no. 3 (2009): 327–42.
21. Paul S. Goodman and Robert S. Atkin, Absenteeism: New Approaches to
Understanding, Measuring, and Managing Employee Absence (San Francisco: Jossey-
Bass, 1984).
22. Ian R. Gellatly and Andrew A. Luchak, “Personal and Organizational Determinants of
Perceived Absence Norms,” Human Relations 51, no. 8 (1998): 1085–102.
23. Brian Graham-Moore and Timothy L. Ross, Gainsharing and Employee
Involvement (Washington, DC: BNA Books, 1995).
24. Richard J. Long, “Gain Sharing, Hierarchy, and Managers: Are They Substitutes?”
in Proceedings of the Administrative Sciences Association of Canada, Organization
Theory Division, 15, no. 12 (1994): 51–60.
25. See M. Olson, The Logic of Collective Action (Cambridge, MA: Harvard University Press,
1971); see also M. Jensen and W. Meckling, “Theory of the Firm: Managerial Behavior, Agency
Costs, and Ownership Structure,” Financial Economics 3 (1973): 305–60.
26. See Denis Collins, Gain Sharing and Power: Lessons from Six Scanlon Plans (Ithaca:
Cornell University Press, 1998); see also Susan W. Bowie-McCoy, Ann C. Wendt, and Roger Chope, “Gain Sharing in Public Accounting: Working Smarter and Harder,” Industrial
Relations 32, no. 3 (1993): 432–45; or M. Wallace, Rewards and Renewal: America’s Search
for Competitive Advantage Through Alternative Pay Strategies (Scottsdale: American
Compensation Association, 1990).
27. See Dong-One Kim, “Determinants of the Survival of Gainsharing Programs,” Industrial
and Labor Relations Review 53, no. 1 (1999): 21–42; “Factors Influencing Organizational
Performance in Gainsharing Programs,” Industrial Relations 35, no. 2 (1996): 227–44; or William N. Cooke, “Employee Participation Programs, Group-Based Incentives, and Company
Performance: A Union-Non-Union Comparison,” Industrial and Labor Relations Review 47,
no. 3 (1994): 594–609.
28. John G. Belcher, How to Design and Implement a Results-Oriented Variable Pay
System (New York: American Management Association, 1996).
29. Kathryn M. Bartol and Edwin A. Locke, “Incentives and Motivation,” In Compensation in
Organizations: Current Research and Practice, ed. Sara L. Rynes and Barry Gerhart (San
Francisco: Jossey-Bass, 2000), 104–50.
30. John G. Belcher, How to Design and Implement a Results-Oriented Variable Pay
System (New York: American Management Association, 1996).
31. Michael Beer and Mark D. Cannon, “Promise and Peril in Implementing Pay-for-
Performance,” Human Resource Management 43, no. 1 (2004): 3–48.
32. Richard J. Long, “The Incidence and Nature of Employee Profit Sharing and Share
Ownership in Canada,” Relations industrielles/Industrial Relations 47, no. 3 (1992): 463–88.
33. David E. Tyson, Profit Sharing in Canada: The Complete Guide to Designing and
Implementing Plans That Really Work (Toronto: Wiley, 1996).
34. Richard J. Long and Tony Fang, “Do Employees Profit from Profit Sharing? Evidence from
Canadian Panel Data,” Industrial and Labour Relations Review, 65, no. 4 (2012): 899–927.
35. Richard J. Long, “Motives for Profit Sharing: A Study of Canadian Chief Executive
Officers,” Relations industrielles/Industrial Relations 52, no. 4 (1997): 712–33.
36. See James Chelius and Robert S. Smith, “Profit Sharing and Employment
Stability,” Industrial and Labor Relations Review 43, no. 3 (1990): 256–74; see also Barry
Gerhart and Charlie O. Trevor, “Employment Variability Under Different Managerial
Compensation Systems,” Academy of Management Journal 39, no. 6 (1996): 1692–712.
37. See Michel Magnan and Sylvie St-Onge, “The Impact of Profit Sharing on the Performance
of Financial Services Firms,” Journal of Management Studies 42, no. 4 (2005): 761–91; or C. Doucouliagos, “Worker Participation and Productivity in Labour-Managed and Participatory
Capitalist Firms: A Meta-Analysis,” Industrial and Labor Relations Review 49, no. 1 (1995):
58–77; or Douglas L. Kruse, Profit Sharing: Does It Make a Difference? (Kalamazoo: W.E.
Upjohn Institute, 1993).
38. Kruse, Profit Sharing.
39. Richard J. Long, “Employee Profit Sharing: Consequences and Moderators,” Relations
Industrielles/Industrial Relations 55, no. 3 (2000): 477–504; see also Seongsu Kim, “Does
Profit Sharing Increase Firms’ Profits?” Journal of Labor Research 19, no. 2 (1998): 351–70.
40. See also Richard J. Long, “Performance Pay in Canada,” in Paying for Performance: An
International Comparison, ed. Michelle Brown and John S. Heywood (Armonk: M.E. Sharpe, 2002); or Long, “Motives for Profit Sharing: A Study of Canadian Chief Executive
Officers,” Relations industrielles/Industrial Relations 52, no. 4 (1997): 712–33; or Terry H.
Wagar and Richard J. Long, “Profit Sharing in Canada: Incidence and Predictors,” Proceedings
of the Administrative Sciences Association of Canada (Human Resources Division) 16,
no. 9 (1995): 97–105.
41. Jennifer Harrison, Parbudyal Singh, and Shayna Frawley. “Employee Ownership and Organizational Culture: The Role of Profit Sharing,” Canadian Journal of Administrative
Sciences (2016), doi: 10.1002/cjas.1371.
42. Tyson, Profit Sharing in Canada.
43. Richard J. Long and Tony Fang, “Is Compensation Actually Strategic? The Case of
Employee Profit Sharing,” Proceedings of the Administrative Sciences Association of
Canada (Human Resources Division) 28, no. 9 (2007).
44. Long and Fang, “Do Employees Profit from Profit Sharing?”
45. Douglas L. Kruse, Richard B. Freeman, and Joseph R. Blasi, “Do Workers Gain by Sharing?
Employee Outcomes Under Employee Ownership, Profit Sharing, and Broad-based Stock
Options,” in Shared Capitalism at Work: Employee Ownership, Profit and Gain Sharing,
and Broad-Based Stock Options, ed. Kruse, Freeman, and Blasi (Chicago: University of
Chicago Press, 2010), 257–91.
46. See Joseph Blasi and Douglas Kruse, “Economic Performance and Employee Ownership, Profit Sharing, and Stock Options: The NBER Study,” Journal of Employee Ownership Law
and Finance 20, no. 4 (2008): 31–40; or Andrew M. Robinson and Nicholas Wilson, “Employee
Financial Participation and Productivity: An Empirical Reappraisal,” British Journal of
Industrial Relations 44,
no. 1 (2006): 31–50; or Doucouliagos, “Worker Participation and Productivity.”
47. Corey Rosen and Michael Quarrey, “How Well Is Employee Ownership Working?” Harvard
Business Review 65 (1987): 126–30.
48. See Joseph Blasi and Douglas Kruse, “Economic Performance and Employee Ownership,
Profit Sharing, and Stock Options: The NBER Study,” Journal of Employee Ownership Law
and Finance 20, no. 4 (2008): 31–40; or Robinson and Wilson, “Employee Financial
Participation and Productivity.” See also P.A. Kardas, K. Gale, R. Marens, P. Sommers, and G.
Winther, “Employment and Sales Growth in Washington State Employee Ownership Companies: A Comparative Analysis,” Journal of Employee Ownership Law and Finance 6,
no. 2 (1994): 83–131.
49. P.A. Kardas, A.L. Scharf, and J. Keogh, “Wealth and Income Consequences of Employee
Ownership: A Comparative Study from Washington State,” Journal of Employee Ownership
Law and Finance 10, no. 4 (1998): 3–52.
50. Joseph Blasi, Douglas Kruse, James Sesil, and Maya Kroumova, “Broad-based Stock
Options and Company Performance,” Journal of Employee Ownership Law and
Finance 12, no. 3 (2000): 69–102.
51. Edward E. Lawler, The Ultimate Advantage: Creating the High Involvement
Organization (San Francisco: Jossey-Bass, 1992).
52. Charles Peck, Long-Term Unit/Share Programs (New York: Conference Board, 1995).
53. Keep Your Pants On! Levi Offers Huge Employee Bonus,” StarPhoenix [Saskatoon], June
13, 1996, C11.
54. Karl Schoenberger, “Levi Strauss Stitches Together Turnaround Plan,” The Globe and
Mail, July 4, 2000, B11.
Chapter 6: Formulating the
Reward and Compensation
Strategy CHAPTER LEARNING OBJECTIVES
After reading this chapter, you should be able to:
• Describe the constraints that limit the design of a compensation
strategy.
• Explain the compensation strategy formulation process and describe
each step.
• Discuss the considerations in deciding whether to adopt a lead, lag, or
match compensation-level policy.
• Describe utility analysis and explain how it can be used.
• Apply the compensation strategy formulation process to specific
organizations.
• Explain how to evaluate a compensation strategy prior to
implementation.
• Discuss the special issues involved in compensating contingent
workers, executives, and international employees
COMPENSATION STRATEGY AT WESTJET AIRLINES
Many people have probably watched on YouTube the hilarious safety demonstration by a
WestJet flight attendant. How did WestJet create such a fun work culture? How does the
culture contribute to business success?
WestJet was founded by Clive Beddoe and a group of entrepreneurs who understood customers’ needs for low cost frequent flight travel, because Clive was a customer himself.
The airline industry is a tough business because of deregulation, fluctuating fuel costs and a
challenging labour relations climate. From the very beginning WestJet created an “Owners
Care” brand and used human resources practices to foster a unique culture that fostered its
competitive advantage. Their motto is: “We take care of our people. Our people take care of
our guests. Our guests take care of our business.” Their four-pillar business strategy consists of
people and culture, guest experience and performance, revenue and growth, and cost and
margins.
People and culture is front and centre in WestJet’s business strategy. The company’s
compensation program is built on offering a competitive compensation package oriented toward developing a culture of ownership. Employees—whether full-time, part-time, or
casual—become owners through a generous share purchase plan; they also share company
profits. The Employee Share Purchase Plan (ESPP) lets employees purchase company shares starting from $25 per pay up to 20 percent of their salary. The company matches the
employees’ contribution dollar-for-dollar. WestJet also shares 10–20 percent of its profit with
the employees, paid out twice a year with big celebrations.
WestJet’s other people practices, such as recruiting, training and development, and talent
management, all reflect and reinforce the “Owners Care” culture. One particular practice is
worth mentioning. The employees are given a voice in company decisions through an internal association: PACT (Pro-Active Communication Team). The board of directors includes an
employee representative. The current employee board member is a flight attendant who
joined WestJet in 2002. Important business decisions are not only communicated to
employees but also determined by employees through a vote.
The focus on people and culture has brought WestJet strong results in guest experience and
performance, revenue and growth, and cost and margins. In 2015, WestJet flew more than 20
million guests servicing more than 100 destinations. It has reported profits in 19 of 20 years
since inception. In 2015, Waterstone Human Capital named WestJet one of Canada’s 10 most-
admired corporate cultures for a record sixth time.
In this high-involvement firm, employees participate in many aspects of the business, including compensation decisions. Employees are committed to company goals; they
understand the company’s context and the kind of behaviour that is required. With this type of
involvement, and with management understanding the compensation options and legal constraints facing the firm, we have many of the ingredients for good compensation decision
making.
Sources: Parbudyal Singh (2012), Case—WestJet Airlines: Clear Skies or Turbulence
Ahead? 1st Edition, ISBN-10: 0-17-668150-7, ISBN-13: 978-0-17-668150-0; WestJet 2015 Annual
Report; WestJet 2016 Management Information Circular; Marty Parker, “Employee
Compensation Is an Integral Part of Corporate Culture,” Financial Post, March 19, 2012, http://business.financialpost.com/uncategorized/employee-compensation-is-an-integral-
part-of-corporate-culture, accessed July 28, 2016.
// Introduction to Compensation Strategy
There are many approaches to compensation strategy development. WestJet’s route involves
employee participation. An equally viable alternative is for the CEO, with a small team, to
analyze the firm’s financial situation and other aspects of its context, and decide what the compensation strategy will be for the coming year or years. Whoever develops the
compensation strategy must understand the organization, its employees, its context and
constraints, and the compensation options available.
Recall from Chapter 1 that the reward strategy is the plan for the mix of rewards that the
organization intends to provide its members—and for how those rewards will be provided—in
order to elicit the behaviours necessary for success. The compensation strategy is one part of the reward strategy and has two main aspects: the mix of base pay, performance pay, and
indirect pay to be used, and the total amount or level of compensation to be provided to
employees. Thus the two key questions for compensation strategy are “How is compensation
to be paid?” and “How much compensation is to be paid?”
Answering these questions effectively is not a simple matter, and the purpose of this chapter is
to provide an approach to doing so—a compensation strategy formulation process. However, to apply this process effectively, you need a foundation of four basic understandings: (1) an
understanding of your organization and its context, (2) an understanding of your workforce,
(3) an understanding of your compensation options, and (4) an understanding of your compensation constraints. Chapters 1 through 5 focused on the first three understandings,
and the fourth—compensation constraints—will be discussed next. We will then introduce the
compensation strategy formulation process and discuss the special issues involved in
developing compensation for three unique groups—contingent employees, executives, and international employees. The chapter concludes with an extended example to show how to
apply the compensation strategy formulation process to a specific organization.
// Constraints on Compensation Strategy
The owners of the Screaming Tale Restaurants (Compensation Today 6.1) claimed the
restaurants had no employees, just “volunteer workers” or “commission agents” working only for the tips that customers provided, thus relieving the firm of the need to pay even minimum
wages or any mandatory benefits. It turned out, however, that this arrangement was illegal,
and the restaurants closed just as they were being investigated for violations of the Ontario
Employment Standards Act. This case illustrates that employers cannot do whatever they
want in regard to compensation, even if they can find employees willing to accept the
compensation arrangements. There are a number of constraints that establish the boundaries
within which the compensation system must be designed. There are four main kinds of constraints: (1) legislated (as in the Screaming Tale case), (2) labour market, (3)
product/service market, and (4) financial. Before formulating your compensation strategy, it is
essential that you have an understanding of these constraints.
COMPENSATION TODAY 6.1
Is This Legal?
A while back, management at the Screaming Tale Restaurants in Port Hope and Belleville, Ontario, cooked up a great recipe for cutting labour costs: Don’t pay your staff! They
eliminated payroll for serving staff by utilizing “volunteer” staff who worked solely for the tips
they received. Aside from the obvious advantage—it saved the wages that would otherwise have been paid to servers—this arrangement eliminated the mandatory benefits and payroll
taxes that would have to be paid to the government (which can add nearly 20 percent to
compensation costs), as well as the administrative work of calculating pay and preparing
paycheques. Quite a competitive advantage!
However, after two “volunteers” complained, the Ontario Ministry of Labour launched an
investigation to determine whether this arrangement violated provincial employment standards legislation, which requires that a minimum wage be paid to all persons considered
to be employees. Under the law, money received as tips does not count toward this minimum
wage.
One of the restaurant chain’s owners, Aldo Mauro, said that the restaurants had come under attack because they had learned to operate more efficiently by reducing labour costs. In an
interview with The Globe and Mail, Mauro said that his company specialized in rescuing
distressed restaurants and turning them into profitable ones and that it had used “volunteer”
workers in the past throughout southeastern Ontario.
Brent Bowser, a manager of the chain’s restaurant in Port Hope, said that the restaurant
provided a location where workers could act as service agents and do their business. The
complaints, Bowser said, had come from employees who didn’t hustle.
Was this practice legal? Take a “guess” before reading the text below.
Source: “‘Volunteer’ Staff: One Way to Cut Costs,” Human Resources Management in
Canada, Report Bulletin 161 (1996): 3.
Legislated Constraints
In Canada, jurisdiction over labour markets is split between the federal government and the
provincial/territorial governments. The federal government has the power to pass labour
legislation covering all federal employees (including those in federal Crown corporations) as
well as workers in a number of specified industries, including transportation, communications, defence, uranium mining, and firms engaged in interprovincial or
international trade. In addition to employees of the federal government and its agencies,
federal labour law covers about 10 percent of private sector employees. All other employees
are covered under provincial and territorial legislation.
Four main types of legislation affect compensation systems. First, every province has an employment standards act, which sets minimum standards for wages; hours of work;
termination benefits; and vacation, statutory holiday, and leave entitlements, as well as the
minimum age for employment. (The equivalent federal legislation is known as the Canada Labour Code.) Second, all jurisdictions have human rights acts, which prohibit employment
discrimination based on factors such as gender, ethnicity, and age. Some jurisdictions also
have specific pay equity legislation, which is aimed at redressing past pay inequities
experienced by female employees.
Third, all jurisdictions have legislation relating to unions and collective bargaining. This
legislation affects compensation in unionized firms by requiring that all compensation arrangements be approved by the union. It also has an indirect impact on compensation, in
that some non-union firms match the settlements negotiated by unionized competitors in
order to reduce the incentive for unionization. Finally, all jurisdictions have income and
corporate tax laws, which can have a strong influence on the type of compensation offered.
While we will focus on legislation in this chapter (and the text), it is important to note that pay
decisions may also be influenced by common-law constraints through the courts and/or quasi-judicial bodies such as labour relations boards and pay equity tribunals. While the
various legislatures across Canada craft labour and employment law, it is sometimes up to the
courts and other bodies vested with similar powers to interpret these laws when there are
challenges. The decisions coming out of these institutions are binding on the parties and
establish precedence for similar cases. Over time, a large body of common law related to
compensation (and other fields) has developed. We will not deal with the common law in
detail in this text; however, you will see examples of court decisions in this chapter (see, for example, Compensation Today 6.1, 6.2 and 6.3) and pay equity in Chapter 7. If this material
sparks an interest for you, then a program or course in labour and employment law—or even a
law degree—may be a career path!
Employment Standards Legislation
Employment standards legislation stipulates the minimum standards for pay and other
conditions of employment by which every employer must abide. These standards relate to paid time off, maximum hours of work before overtime pay provisions take effect, minimum
levels of overtime pay, and the minimum wage. Currently, the provincial minimum hourly
rates range from $10.50 in Saskatchewan and Newfoundland and Labrador to $12.20 in Alberta. In the territories, the minimum hourly wage ranges from $11.07 in Yukon to $13 in
Nunavut.1
Although minimum wage legislation applies to most workers, there are some exceptions.
Some jurisdictions exclude domestic servants, in-home caregivers, some types of farm
labourers, and students in training programs. Also, in some jurisdictions, minimum wage rates
are lower for certain classes of workers (e.g., Ontario students under 18 years who work fewer than 28 hours a week) and higher for others (e.g., Ontario employees who work from their
homes). Employers do not have to pay minimum wages (or other mandatory benefits) to
persons who are classified as contractors or agents, since they are exempted from
employment standards legislation.
What is the legal difference between an employee and a contractor? According to the Canada
Revenue Agency (for whom the employee/contractor difference is important for tax purposes), a contractor need not work at the payer’s premises, can accept or refuse work from the payer,
can choose the time and manner in which the work will be completed, and may hire another
person to complete the work. By contrast, a person is deemed an employee if the payer directs how and where the work is performed, controls the worker’s absences, establishes the work
schedule and the worker’s rules of conduct, or can impose disciplinary actions on the worker.2
By this standard, the “volunteer workers” at the Screaming Tale Restaurant clearly should have been classified as employees rather than as self-employed “commission agents.”
Moreover, although restaurant employees must declare gratuities for income tax purposes,
gratuities do not count toward employee earnings to help satisfy minimum wage requirements. Thus, employers must always pay employees the minimum wage, regardless of
any gratuities that employees may receive.
So where does this leave employees who are paid only commissions or piece rates? For
example, what happens if sales personnel who are compensated only by commission—such as
automobile salespeople—achieve very few or no sales in a given period? The procedure for checking whether the minimum wage is being paid is to take the total amount earned by an
employee during a workweek, then divide that by the number of hours worked. If that amount
comes out to less than the minimum wage, the employer is required to pay the difference to
the employee.
Another important issue covered by employment standards laws is overtime pay. Rather than
hiring new employees, many firms use overtime when additional production is needed. This avoids the cost of hiring new employees as well as the problem of layoffs if the amount of
available work declines. However, employees cannot be forced to work overtime, nor can any
employee who is covered by the Employment Standards Act voluntarily waive the right to
overtime pay.
Employment standards laws normally require higher rates of pay (usually 1.5 times normal
earnings) for hours worked in excess of stipulated limits—generally eight hours per day and 40–48 hours per week, depending on the jurisdiction. However, many workers are exempted
from this part of employment standards laws, including professionals, teachers, supervisors,
managers, residential care workers, students, certain agricultural workers, and commission sales workers when they work away from the employer’s place of business. (But note that
other commission sales workers as well as piece rate workers are covered.) Employees
covered under employment standards laws are not allowed to waive their rights under the
legislation (with one exception—unionized employees in British Columbia).3
Although many employers believe that salaried workers are exempt from overtime, this is not
necessarily the case. Moreover, simply calling an employee a manager or a professional does
not necessarily end the obligation to pay overtime. The key criterion is the nature of the work performed and the amount of independent control the worker has over it. For example,
employees who are deemed “accountants” do not have to be paid overtime; but a 2008 class
action suit against KPMG found that accounting technicians do have to be paid overtime, and KPMG agreed to pay a $10 million settlement. For many other employers—such as the
Canadian Imperial Bank of Commerce (see Compensation Today 6.2)—overtime has been a
controversial issue, to be decided by long and drawn-out court battles.
COMPENSATION TODAY 6.2
Think Your Employer Owes You Overtime but Won’t Pay? Sue the Boss!
After 10 years of employment as a teller at the Canadian Imperial Bank of Commerce (CIBC), Dara Fresco calculated that her employer owed her about $50,000 for overtime that she was
discouraged from recording. So in June 2007, she did something that few employees would
dare—she launched a class action suit from her vantage point as head teller at a Toronto
branch of the CIBC—a position she continues to hold as the lawsuit wends its way through the
courts.
Fresco contends that she and many other employees at the CIBC are assigned heavy workloads that cannot be completed during standard business hours, and have to work
several extra hours every week to keep up. However, she alleges that her managers at the
branch discourage her from reporting these hours as overtime.
The CIBC’s response to this allegation is that discouraging the reporting of overtime is not a
policy of the CIBC, and that all employees are properly paid for any overtime hours they work.
The bank has committed itself to fighting this suit—in which the plaintiffs are claiming $600 million—for as long as it takes, which may be a long time indeed. For example, it wasn’t until
June 2012 that the Ontario Court of Appeal ruled that the lawsuit could go forward as a class
action. This decision did not reflect any judgment on the merits of the case; it just meant that the suit could proceed to the next stage, which is putting the arguments of the plaintiffs and
defendant before the courts.
As of the time of writing the text, this case had not concluded. However, another class action lawsuit by Scotiabank employee Cindy Fulawka was settled in 2014, where current and former
employees who were similarly affected can submit claims for any unpaid overtime that was
required or permitted by Scotiabank, regardless of whether it was pre-approved at the time by
their manager. And the claims period goes back to 2000.
Sources: Laura Fric and Adam Hirsh, “Settlement Approved in Overtime Class Action.” Posted
in Class Action Settlement, August 12, 2014,
http://www.canadianclassactiondefence.com/2014/08/settlement-approved-in-overtime- class-action, accessed September 26, 2016; Roy O’Connor LLP website,
http://royoconnor.ca/cases/unpaid-overtime-class-action-cibc-canadian-imperial-bank-
commerce, accessed September 26, 2016.
There are many other employment standards that affect pay, such as the requirement to pay a
certain minimum amount of “call-out” pay whenever an employee is called out to work (although this does not apply to all employee groups). Also included in employment standards
or equivalent laws are employee layoff and severance provisions (discussed in more detail in
Chapter 12).
Human Rights Legislation
Even when employers comply with employment standards laws, they are still not free to pay
employees whatever they want. Every Canadian jurisdiction has human rights legislation that prohibits discrimination in hiring and employment on the basis of race, ethnic origin, religion,
gender, marital status, or age (within specified age ranges—normally 18–65). Some
jurisdictions have placed sexual orientation in this list as well.
To prove compliance with human rights laws, employers must be able to demonstrate that
differences in pay among employees are related solely to factors such as job duties,
experience, qualifications, seniority, or performance. For example, if a member of one ethnic group is paid significantly less than a member of another ethnic group with similar job duties,
the employer must be able to prove that this difference is due to one or more of the factors
just noted.
All Canadian jurisdictions have some form of equal pay legislation aimed at addressing wage
inequality between male and female employees. These laws prohibit employers from paying
male and female employees differently if they do “identical, similar, or substantially similar work.” The original federal legislation—the Canadian Human Rights Act—was enacted in 1976
and went one step further, stipulating that male and female employees must receive equal
pay for work of equal value, even if the work is not substantially similar.
More recently, the Canadian Human Rights Act has been superseded in the area of pay equity
by the Public Service Equitable Compensation Act, which makes “employers and bargaining
agents jointly accountable for ensuring equitable compensation through established wage- setting practices, rather than through a separate pay equity process or through complaint-
based litigation.”4 Reactions to this new law have been mixed, however, with many legal
scholars arguing that it will not effectively promote pay equity in the federal public sector.5
Many provinces and territories have enacted pay equity laws whose specific intent is to
redress gender pay inequities, although in some of these jurisdictions (Manitoba, New
Brunswick, Nova Scotia, and Prince Edward Island), the law applies only to governmental
bodies and agencies. Quebec and Ontario have enacted pay equity legislation that applies to
all employers (in Quebec) or all employers with at least ten employees (in Ontario). Pay equity
schemes require the employer to divide the workforce into job classes designated either as
male or female. (A job class is designated male or female if at least 60 or 70 percent [varying by jurisdiction] of the occupants of that job class are male or female.) After that, a gender-neutral
job evaluation system is applied to each job class.
If a female-dominated job class that is evaluated as equal to a male-dominated job class is less well compensated than the male class, the imbalance must be redressed. Although it is
theoretically possible to redress this imbalance by reducing wages in the male-dominated
class, this practice is prohibited. As Compensation Today 6.3 indicates, employers face heavy restrictions regarding how they are permitted to deal with the imbalance, once it has been
formally identified. (How to comply with pay equity laws will be covered in more depth in
Chapter 7.)
COMPENSATION TODAY 6.3
Don’t Cross These Workers!
In 1994, the Nova Scotia Pay Equity Commission awarded a substantial wage increase, to be
phased in over a four year period, to female crossing guards employed by the City of
Dartmouth. The commission concluded that these workers were being paid significantly less
than male employees of the City who were doing work of equal value.
In response, the City of Dartmouth decided to lay off all the crossing guards and contract the
work to a private company that paid lower rates and was not covered by the Pay Equity Commission ruling. However, the Nova Scotia Court of Appeal disallowed this course of action
on the grounds that once the award was issued, the City was prohibited from entering into
contracts for reasons intended to “defeat the purpose of the Pay Equity Act.”
Trade Union Legislation
When a group of employees is represented by a union, according to trade union legislation, any changes to pay, hours of work, and working conditions must be negotiated with the union.
Employers cannot change these things unless the union agrees. Also, employers cannot make
separate compensation arrangements with individual members of the bargaining unit. A unionized firm that wants to change its compensation system must first convince the union to
accept these changes. This can be a long process, and in many cases, it rules out certain types
of pay practices—such as individual performance pay and profit sharing—that unions have traditionally opposed. Such opposition stems, in part, from unions not wanting employers to
have absolute power over pay decisions for employees, as performance is usually decided
upon by management.
Unions once had a strong impact on the structure and level of employee and even executive compensation.6 Unionized employees still tend to receive more extensive employee benefits
than non-union employees and also in the past enjoyed a wage premium, with wages
averaging about 10 percent higher than those of comparable non union employees, although this varies greatly across industries.7 However, the union wage premium appears to have been
declining in recent years8 and may have disappeared entirely in some industries.
Unionized employees have been more likely to work under a seniority-based system rather than a performance-based pay system, because unions believe that seniority-based systems
are fairer to members and as well as easier to monitor than performance-based ones.
However, this too appears to be changing; research shows that unionized firms do not differ significantly from other firms in the proportions of base pay, individual performance pay,
group performance pay, and organizational performance pay, although unionized firms
continue to provide a significantly higher proportion of indirect pay than do non-union employers.9 Unions also continue to allow employees, through the unions, to have a say in the
employment relationship.
Tax Legislation
The final way that legislation can influence the pay system is through income and corporate
tax laws, which encourage certain pay approaches and discourage others. For example, tax
laws have played a significant role in the movement away from direct pay (which is fully taxed) and toward indirect pay (which often is not). However, this role may have diminished in recent
years, now that employee benefits are increasingly becoming subject to income tax. At the
same time, changes to tax laws enacted in 2000 are encouraging the use of stock options
(see Chapter 11).
As a final note, changing a worker’s status from “employee” to “independent contractor”
(“self-employed” is the term used in the Income Tax Act) can have significant income tax benefits for workers. An employee can apply very few tax deductions against income; an
independent contractor enjoys many more potential deductions. For example, if an employee
uses a portion of his or her home for an office, there is no tax deduction, but an independent
contractor who does the same can deduct all costs related to that space. Employees cannot
deduct the cost of transportation to and from work, but independent contractors can do so for
any work-related travel. Thus, independent contractor status may be attractive to some
employees.
Labour Market Constraints
Another key constraint on compensation decisions is the labour market. The labour market is
the available pool of labour from which employers choose their employees. Labour markets are normally segmented by occupational type and geographical area. In a given geographical
area, both supply of and demand for a particular type of labour may be high or low. Each
combination of supply-demand factors creates a unique situation for employers. For example, when demand is high but supply is low, the labour market is considered tight, which means it
is difficult to attract qualified employees without raising compensation levels. Conversely,
when demand is low and supply is high, the labour market is considered loose, which makes
it much easier to attract employees at compensation levels favourable to the employer.
Labour markets vary by region; thus, firms that operate on a national level must decide
whether to adjust compensation based on the local labour market or to keep standard compensation levels across the country. For example, a bank may determine the pay for
customer service representatives based on the market rate for these employees in Toronto,
where the firm’s head office is located. But in many local labour markets, such as a small town in Nova Scotia, attracting the necessary employees may be possible for much less than is
being offered to Toronto employees. Should the bank therefore pay lower rates to its Nova
Scotia employees than to its Ontario employees? Is this fair? Is it worth the trouble? Questions
like these need to be resolved when setting compensation levels.
As discussed in Chapter 4, identifying market pay is more complex than it sounds. The
specifics of a given labour market pose a real constraint for firms, for a compensation system
that is too far below market will not attract the necessary employees, and one that is too far above market will unduly increase costs. Paying above market is especially a problem when
product/service markets are highly competitive. (We will discuss issues involved in evaluating
the labour market in Chapter 9.)
Product/Service Market Constraints
Another key constraint is the market for an organization’s products or services. When demand
is low and/or supply is high, the result is a highly competitive business environment, and firms that pay more for their labour than competitors may be at a serious disadvantage unless they
are more productive.
Product/service market constraints are especially severe in industries that are highly labour- intensive, since labour costs constitute a higher proportion of total costs in these firms. These
constraints are even more severe if competitors are able to move their production to labour
markets where the cost of labour is much lower, or where legislated constraints (such as minimum wage laws and mandatory benefits) are less onerous. In contrast, firms in markets
where demand for their product is high, supply is low, and competitors are few have much
more latitude when designing their compensation systems.
Another product/service factor that affects compensation is volatility. Firms that experience
severe swings in demand for their products/services need to be able to adjust. Some firms use
a high proportion of contingent workers, who are subject to different compensation
constraints than core employees; other firms include more variable pay in their compensation
systems.
Financial Constraints of the Organization
Many organizations face financial constraints that affect the compensation system they use. In
the private sector, the financial performance of the organization is a constraint: unprofitable
firms are much more limited in their compensation options than profitable ones. The
company’s stage of growth (for example, new or fast-growing firms are often short of cash) is
another constraint.
For public sector organizations, financial constraints are usually the result of the funding
limitations placed on them by those providing the funds. Many public sector organizations, such as hospitals, postsecondary institutions, and the Canadian military, face funding
restrictions that severely limit the compensation they can offer.
Rather than accepting these financial constraints, organizations try to change them. Private sector firms may relocate to areas where labour is more plentiful or where employment
standards are less costly. Some firms may resort to tactics of debatable ethicality by, for
example, classifying employees as independent contractors to escape having to pay
mandatory benefits. Finally, some firms attempt to escape union constraints by weakening the union or by contracting work to non-union enterprises. Public institutions may seek
additional sources of funding.
// Formulating the Compensation Strategy
Now that you understand your organization, people, compensation choices, and
compensation constraints, you are finally in a position to formulate your compensation
strategy. This section discusses the process of formulating compensation strategy by taking
you through the five steps depicted in Figure 6.1.
First, we need to define the employee behaviours necessary for organizational success and
identify the characteristics and qualifications of the people who will be able to perform those
behaviours. Second, within the system the firm develops, we need to define the specific roles to be played by the reward system and compensation system. Third, we need to determine the
most appropriate mix of the three compensation components. Fourth, we need to develop
policies for establishing the total amount of compensation that employees will receive. Fifth, we need to conduct a pre-implementation evaluation of the proposed strategy to verify that it
meets our criteria for success.
Define the Required Behaviour
The first step is to define the behaviour your organization needs. Recall from Chapter 3 that
organizations need three main types of behaviour: membership behaviour, task
behaviour, and citizenship behaviour. The importance of these behaviours varies across
different organizations:
• Membership behaviour: What are the costs of turnover? Is affective
commitment necessary, or is continuance commitment sufficient?
• Task behaviour: Are tasks simple or complex? Do employees work
under supervision? Are high performance levels required?
• Citizenship behaviour: How important is cooperation for each company
unit and the individuals in it? To what extent can extra employee
initiative or ideas make a difference to organizational performance?
For some firms, high levels of membership, task, or citizenship behaviour may be nice but not
worth the cost; for others, high levels of one or more of these are essential. To understand the relative importance of the three types of behaviour, you need to understand the organization’s
context, the most important aspect of which is the managerial strategy. As discussed in
Chapter 2, classical organizations need only minimal membership behaviour, only adequate task behaviour, and no citizenship behaviour; human relations organizations need high
membership behaviour, adequate task behaviour, and some citizenship behaviour; and high-
involvement organizations require high levels of all three.
While every organization needs its employees to perform task behaviours, the nature of these
behaviours can vary enormously. Obviously, gutting a chicken is different from designing a
computer program, piloting an airplane, writing a newspaper editorial, or performing surgery. Tasks vary in terms of complexity, skill, performance level, material (i.e., things or people), and
consequences of errors. Packing a chicken wing in a box of chicken legs is an error, as is
removing a patient’s healthy kidney instead of the diseased kidney (as actually happened at
an American hospital in 2008), but the consequences of these two errors differ dramatically.
In addition, the task behaviours required have implications for the organizational and reward
systems needed to produce those behaviours. Compensation Notebook 6.1 lists 16 dimensions of task behaviour. In general, the first choice in each of these dimensions (e.g.,
tasks that are simple, procedural, low-skilled, narrow, and have low interdependence and
individual output) is suited for a reward system consistent with the classical school of thought,
whereas tasks characterized by the second choice in each dimension (e.g., tasks that are complex, creative, highly skilled, broad, and have high interdependence and team-based
output) are suited to reward systems associated with the high-involvement management
strategy.
Employers often do not understand their real behavioural needs and have established
recruiting systems that work at cross-purposes to those needs. For example, many university
graduates have been told by recruiters that the firm is seeking creative, innovative, free- thinking employees, only to discover that what the organization really wants are people who
will do what they are told in a reliable manner. Perhaps these recruiters believe that
statements about creativity and innovation are an effective way to attract high-quality recruits; if that is so, they are failing to consider the potential costs of creating disillusioned
employees who are likely to quit when they discover the discrepancy between their
expectations and those of their bosses. (Or even worse, those bosses will be stuck with
disillusioned and disgruntled employees who do not quit.)
COMPENSATION NOTEBOOK 6.1
Dimensions of Task Behaviour
Jobs that match the first characteristic of each pair are more suited for a classical
compensation system.
Jobs that match the second characteristic of each pair are more suited to a high-involvement
compensation system.
1. Are tasks simple or complex?
2. Procedural or creative?
3. Low or high skill requirements?
4. Narrow tasks or broad?
5. Low or high task interdependence?
6. Individual or team-based output?
7. Low or high cost of errors?
8. Adequate or high performance required?
9. Low or high employee risk taking desired?
10. Low or high customer contact?
11. Low or high impact on organizational performance?
12. Low or high employee discretion over work process?
13. High or low ability to supervise employees?
14. Individual output identifiable or not?
15. Short-term or long-term results?
16. Tasks deal with things or people?
Once the required behaviours have been defined, you need to identify the education, skills,
and other characteristics these employees will need if they are perform those behaviours.
Those are the people the organization must attract, retain, and motivate, so it is important to understand their needs. Without that understanding, the organization may end up providing
rewards these people do not value highly, a result that is both ineffective and costly.
In the past, firms have relied on promises of rapid advancement in order to attract and retain employees. But with many firms becoming flatter and experiencing slower growth, they have
needed to develop other types of rewards (including compensation) to make up for the loss of
advancement opportunities. As discussed in earlier chapters, some firms have turned to pay-
for-knowledge systems, while others have developed technical ladders—that is, defined progressions of skills development and workplace movement intended to keep work
interesting (and provide higher compensation) by allowing the employee to master new jobs
and work activities.
Define the Role of Compensation
All organizations must have some system for generating the behaviour they require. As
discussed in Chapter 2, there are three main organizational systems (managerial strategies) that can be used to generate the required behaviour, and the reward system plays a different
role within each. Classical organizations tend to focus on economic needs as the main
motivator of behaviour; human relations organizations, on social needs; and high-
involvement organizations, on employee needs for participation, growth, and development.
In defining the role that compensation will serve in our reward strategy, we need to consider
to what extent intrinsic versus extrinsic rewards can be used to motivate behaviour. What
intrinsic rewards does the organization offer? These may be extensive or nonexistent. (Of course, where intrinsic rewards are nonexistent, it may be possible to create them through
employee participation in decision making or work redesign, as was discussed in Chapter 3.)
Where intrinsic rewards are not as available, the compensation system needs to be relied on
more heavily to motivate behaviour.
Tradeoffs are possible between compensation and other rewards. For example, some firms
want to hire employees who are equipped with the skills and experience to perform the needed behaviours immediately upon joining the firm. Other firms are willing to hire
employees who possess the ability to develop the necessary skills and then train them to
perform the needed behaviours. Potential employees may see this training as an intrinsic reward (an opportunity for learning and growth) or as an extrinsic one (since it will likely lead
to a better-paying position) or as both. Training programs make it possible to attract
employees for less compensation than would otherwise be necessary. In contrast, hiring fully skilled and experienced employees requires much higher compensation, although this may be
offset by lower training costs and more immediate productivity.
Table 6.1 provides six examples of how the role of compensation can vary across
organizational settings.
Role of Compensation for the UNICEF Store
The first example in Table 6.1, a gift shop operated by UNICEF to generate funds to help
children around the globe, provides no role for compensation. Membership and task behaviour are motivated by intrinsic rewards, including the knowledge that volunteers are
helping save young lives; in addition, there is a high degree of congruence between
organizational goals and personal goals, which also stimulates organizational citizenship
behaviour. This type of organization suits the high-involvement managerial strategy.
The task behaviour (serving customers, ringing up sales) does not necessarily contain many
intrinsic rewards (although volunteers are given considerable autonomy in how they perform their roles), so the direct motivation from the task itself is moderate. But this task behaviour is
motivated by the knowledge that performing these mundane tasks is helping save the lives of
children globally. Membership behaviour may also be motivated by the extrinsic social
rewards (from mingling with like-minded volunteers, for example) that result from membership in this organization. Of course, the success of this reward strategy depends on
the availability of people who have time to contribute, whose goals and needs are congruent
with those of the organization, and whose economic needs have already been met by other means.In fact, this group has been shrinking as busy dual-income families have become the
norm.
Role of Compensation for the Chicken-Processing Plant
This example is similar to the one described in Compensation Today 2.4. At this organization,
there are no intrinsic or extrinsic rewards for production-line workers other than
compensation, so the only way to motivate membership behaviour is through pay. However, because the costs of turnover are so low, there is no need to offer compensation beyond the
minimum level necessary to attract a sufficient stream of applicants who are able to perform
the necessary task behaviours. The compensation system is not used to stimulate task behaviour; that is done directly by the technology and the supervisor. Compensation-based
behaviour control (such as piece rates) is not really viable due to the interdependent nature of
the work. This classical firm is not concerned about citizenship behaviour, so it does not waste
money promoting it.
Role of Compensation for the Tree-Planting Firm
The third example is a tree-planting firm, which has contracts with major forestry firms to
undertake reforestation work. While there may be some intrinsic motivation for individual tree planters, to the extent that they see reforestation work as socially valuable and that they enjoy
the autonomy and task identity the job provides, this alone would never motivate the
necessary membership and task behaviour. Since tree planters work and live together in camps in remote areas, some may perceive some extrinsic social rewards. On the other hand,
because of the remote locations, many tree planters experience negative social rewards
arising from isolation from friends and family.
Clearly, the key motivator is money. Pay can be used both to foster the necessary membership
behaviour and to direct task behaviour. Both of these can be accomplished through piece
rates, where tree planters are paid according to number of trees planted. Their output is identifiable, and the tasks are not interdependent. This approach fits with a classical
managerial strategy.
Role of Compensation for the Vacation Resort
The fourth example is a popular vacation resort that employs seasonal service workers. The work itself does not provide many intrinsic rewards, although there may be some satisfaction
in helping guests enjoy their stay. But there are high extrinsic rewards, because the locale in
which the resort is located has many attractions and the resort allows free use of recreational facilities for off-duty employees. The resort also encourages friendly social relations among
staff. The role of pay in attracting employees is moderate. Pay also plays a moderate role in
motivating task behaviour, through the tips that workers receive from guests and the small bonuses that the firm provides to employees who receive outstanding service ratings from
guests. The firm does not expect or require much citizenship behaviour from employees. This
firm practises a human relations strategy.
Role of Compensation for the Hospital
Nursing staff receive many intrinsic rewards from the role they play in their organization,
because of the work they do and the congruence between their goals and those of the
organization. However, there are few extrinsic rewards and many undesirable features, such as shift work. Along with intrinsic rewards, compensation is used to elicit membership
behaviour, but it is not used to direct task behaviour or to foster citizenship behaviour;
intrinsic rewards serve this purpose. This approach fits best with a high-involvement strategy.
Role of Compensation for the High-Tech Electronics Firm
The high-tech electronics firm practises a high-involvement strategy because the success of
any new product depends on creativity, innovation, and cooperation among all parts of the
organization. For design engineers, there is considerable intrinsic satisfaction in designing a successful product, and they derive some extrinsic rewards from advancing their own
expertise and knowledge through the extensive training the firm provides. The firm also
provides a substantial degree of job security. The primary purpose of compensation is to motivate membership and to foster citizenship behaviour through profit-sharing and
employee stock ownership programs.
Behavioural Objectives for Compensation
Once the role of compensation has been defined, organizations can develop specific
behavioural objectives. These objectives flow from the analysis just completed and may be
rudimentary or comprehensive. For example, the chicken-processing firm may be perfectly happy if the compensation system generates a minimum level of membership behaviour, as
task behaviour will be shaped by other means. The tree-planting firm goes a step further,
relying on its compensation system not only to attract employees but also to direct and
control employee task behaviour.
In contrast, the electronics firm views its compensation system as an important part of the
rewards it offers to attract high-calibre, committed employees. The firm also views it as a major part of its rewards strategy to foster high organizational citizenship and team-oriented
behaviours. The firm may also use compensation to promote learning and development
(through a pay-for-knowledge system or payment of tuition fees) and to promote risk-taking
behaviour. But unlike the tree-planting firm, it will not depend on its compensation system to
promote specific task behaviours. As discussed in Chapter 3, using the compensation system
to promote specific task behaviours is a risky process and is suitable in only a very limited
number of circumstances.
Table 6.2 illustrates the behavioural objectives that each of these organizations might set for
its compensation system, along with some indicators of goal achievement.
Determine the Compensation Mix
Once an organization has identified the behaviours it requires and defined the role the
compensation system will play in generating those behaviours, the next step is to identify the mix of compensation components that will elicit that behaviour in the most effective and
efficient way. (Figures 4.1 and 5.1 in Chapters 4 and 5 have summarized the choices available.)
A number of questions must be addressed. What role will be played by base pay, performance pay, and indirect pay? How will each component be structured? For example, will the
foundation for base pay be job evaluation, market pricing, or pay for knowledge? Will
performance pay be linked to individual, group, or organizational performance? What specific benefits or services will be included in indirect pay, which benefits will be shared-cost, and
what degree of choice will employees have in the benefits they receive?
The answers to these questions depend on the behaviours the firm requires, the
organizational context (especially managerial strategy), the needs of the employees being
sought, and the constraints facing the organization. Unfortunately, there is no simple formula for finding these answers: management must rely on a high degree of informed judgment at
this point in the process. A further complication is that the mix of principal compensation
components also needs to be considered in the context of the total level of compensation to be provided. For example, the greater the variable portion of the compensation, the greater
the total compensation generally necessary to compensate employees for the resulting
uncertainty and risk.
Determine the Compensation Level
How much compensation should be offered? Within the constraints discussed earlier, policies
need to be established for determining the total amount of compensation that individuals or groups of employees will receive. In general, the question to be asked is: Will we lag, lead, or
match our relevant labour market in terms of total compensation levels? This question is
complicated by the fact that an employer may not have the same lead, lag, or match strategy
for all employee groups.
Lagging the Market
When considering whether to use a lag compensation-level strategy, the first question is: Do
we have a choice? In some cases, the organization’s financial circumstances are such that there is no choice but to lag the market. A key question is whether the organization can offer
noncash rewards (perhaps including some indirect pay items) to make up for this lag. For
example, the organization may sweeten its total package by offering items that cost the firm little or no cash, such as purchase discounts on company products. Or these firms may offer
flexible schedules or useful training to employees. When cash is short, provision of extrinsic
rewards other than money, along with intrinsic rewards, becomes even more important.
It is common for small, rapidly growing firms to have cash shortages. To entice crucial
employees, these firms often offer company stock, which has no current cash cost. They may
also offer other types of performance pay payable only when and if the company can afford to pay. To make this worthwhile in the eyes of employees, the future payout typically needs to be
set quite high in order to compensate employees for the risk of not receiving anything at all.
Another potentially valuable reward that this type of firm can offer is advancement
opportunities, in addition to intrinsic rewards such as task variety or participation in decision
making.
Research consistently shows that smaller firms pay less than large firms do. For example, a
Statistics Canada study revealed that in the manufacturing sector, small firms paid 24 percent less than the average pay in their sector.10 This difference may be due to a higher unionization
rate in large firms (which can force wages up), tighter cost controls in small firms, or lower
ability to pay in small firms. In fact, while their savings in labour costs might appear to be a competitive advantage, small firms appear to pay a steep price for their compensation
savings.
Statistics Canada also found that productivity in small firms was 32 percent lower than
industrial averages. Research indicating small firms have higher turnover rates and less-
qualified employees than larger firms helps explain their lower productivity.
But what about firms that do have a choice in pay level? Many firms that could pay more make
a conscious decision to pay below market. The motive for doing so is obvious—to save on
compensation costs. But there are costs to this strategy. On average, firms that pay below market have a lower quality of applicants and higher turnover than other firms do. Not
surprisingly, employees also experience more reward dissatisfaction than employees at other
firms do. Unless a firm has carefully analyzed these costs, it may find that the costs of this strategy exceed the benefits. Firms that find lag strategies cost-effective are firms where the
costs of both turnover and recruitment are low, where labour constitutes a high percentage of
total costs, and where it is possible to contain the negative consequences of reward
dissatisfaction.
Other firms that find below-market pay policies viable are those that offer other types of
rewards that are highly valued by employees. With these alternative rewards, these firms may
avoid the problems of poor-quality applicants, high turnover, and reward dissatisfaction.
Leading the Market
Why would an organization ever choose a lead compensation policy? There are actually many reasons. An organization may need to lead the market if it offers poor noncompensation
rewards, if there are negative aspects associated with employment by this firm, or if the firm
needs very high-quality applicants. Firms where recruiting costs, turnover costs, and
consequences of reward dissatisfaction are all high may find this approach cost-effective. Firms that value employee stability or whose customer service needs employee stability may
also favour this strategy. In addition, firms in which labour costs are low as a proportion of
total costs find this strategy less costly than firms that are labour-intensive.
High compensation may be necessary to the organization’s goals or to its total reward
strategy. Firms seeking employees who have abilities beyond those required for their entry-
level jobs or who require heavy training investments may wish to secure their work force with high compensation. For example, firms using a pay-for-knowledge system consistently pay
above market. Some firms with performance pay plans, such as profit sharing, may also end
up paying above the market. Many firms gear base and indirect pay to the market and then
add profit sharing, which causes total pay to exceed the market in profitable years.
In some cases, firms do not intend to lead the market in total compensation but end up doing
so nonetheless. This can occur if the compensation structure results in increases beyond market increases, if there is no systematic assessment of market trends, or if there is a strong
union. Firms can also end up paying over market if they have poorly designed compensation
systems—ones that include rewards that do not add value for the employee or the employer
but that still cost money.
By maintaining the same pay scales across Canada, large firms that are geographically
dispersed can end up leading the market in parts of the country, even if they are only matching
the market in other parts of the country. But from their point of view, the cost of determining a
market-matching wage for every branch of the organization is not worth the effort.
Furthermore, inconsistent wages for similar jobs may create perceptions of inequity and make
it difficult to transfer employees to branches in lower-wage areas.
Matching the Market
Many firms settle on a “match the market” compensation level policy as a way of “playing it
safe.” A match compensation policy avoids the possible disadvantages of paying below market while enabling them to remain cost-competitive by not offering excessively high
wages. They are not sure whether a lag or a lead policy will pay off, so they stick to the middle.
In some cases, of course, this is the optimal solution, but this cannot be confirmed without
systematic analysis.
Utility Analysis
To help managers determine which compensation-level strategy is most appropriate which can be a complicated process—computer-based utility analysis models have been
developed.11 Utility analysis is an approach to analyzing whether a lead, lag, or match strategy
would be most efficient for a given organization. Here is how it works.
Suppose you are the head of compensation at a credit union, and you are trying to decide on
the pay level strategy for your 400 tellers. Currently, your policy is to match the market. But
would the credit union be better off to switch to either a lead or a lag policy? You anticipate that changing the policy would have an impact on turnover and on the quality of employees
you hire. You have examined other financial institutions that pay more or less than you do and
have found that firms that pay 20 percent more have a 10 percent lower turnover rate than you
do, and that firms that pay 20 percent less have a 10 percent higher turnover rate. Your current turnover rate for tellers is running at 30 percent per year, so each year you have to replace 120
tellers.
You first need to calculate the costs of turnover. What is the cost of recruiting each teller, and what is the cost of training him or her? Let’s assume that it costs around $1,000 to replace each
teller, including advertising, interviewing, and the administrative costs of putting the new
employee on the payroll and taking the former employee off the payroll. Let’s suppose that training costs $4,000 per employee, counting out-of-pocket training costs and reduced
productivity during the training period. Currently, you are paying each teller $26,000 direct pay
per year, with benefits adding another $6,000, for a cost per employee of $32,000 per year. The
total cost for tellers per year is the cost of their compensation (400 × $32,000 5$12,800,000)
plus the costs of turnover (120 × $5,000 5$600,000) for a total of $13,400,000.
You now need to estimate the change in performance that will result from a change in the quality of your workforce due to a lag or lead policy. You anticipate that if you lag the market
by 20 percent, your new workforce will produce 5 percent less work and make 7 percent more
errors. Considering the time needed to identify and correct the errors, you calculate that the new workforce will be 12 percent less productive. You also need to consider whether the lead
pay policy would improve productivity by the same amount. Let’s suppose that it does. Now,
let’s analyze the lag and lead policies.
Suppose we decide to lag by 20 percent. Because productivity is 12 percent less, we will now
need 448 tellers. At 33 percent turnover, we will need to replace 149 tellers per year. With the
20 percent wage reduction, it will now cost us $25,600 per employee per year in salary and benefits. So the total cost will be 448 × $25,600 ($11,468,800) + 149 × $5,000 ($745,000), which
totals $12,213,800—considerably lower than our current costs of $13,400,000.
But wait! If we have 12 percent more employees, then we need 12 percent more office space, and 12 percent more office equipment, and so on. Assuming that it costs an additional $3,000
per employee per year for computer equipment and support, and $3,000 for office space and
miscellaneous expenses, we can expect additional costs of $288,000, resulting in a total cost of $12,501,800. This is still a saving of nearly a million dollars per year compared to a match-the-
market strategy.
Now, suppose we decide to lead by 20 percent. Because productivity is 12 percent higher, we will now need only 352 tellers. Around 95 will need to be replaced each year. So our costs will
be 352 × $38,400 ($13,516,800) + 95 × 3$5,000 ($475,000) for a total of $13,991,800. Even after
allowing for reduced office space and equipment ($288,000), this is still the most expensive
policy, at $13,703,800.
The actual calculations would be more complex than this. For example, the lag policy would
normally apply only to new hires, and the pay of the existing employees would reduce gradually over time, during which no scale increases would be granted. Thus, the saving in
wage costs would phase in over time, along with the increases in turnover and the declines in
productivity. In contrast, for the lead policy, it would be necessary to raise the wages of all
employees immediately. Costs would rise immediately and the turnover rate would decline
immediately, but the improved quality of employees resulting from this policy would phase in
only over time. Because of this complexity, computer models have been developed to handle
these calculations.
In this example, it appears that adopting a lag strategy would be the most efficient, eventually
generating a saving of nearly $1 million per year relative to the present “match” policy. But we
have not included some intangible costs, such as customer reaction to finding a favourite teller gone. Furthermore, we have not included any costs of reward dissatisfaction other than
turnover. We can predict that organizational commitment will be adversely affected, but what
is the cost of that? Would cooperation with management drop? Would absenteeism increase?
Would attitudes toward customers deteriorate, and what might this cost in lost revenue?
What about the cost of mistakes? We have already included the time needed to discover and
correct them in our productivity calculations. But what impact does a mistake have on customers and their confidence in and satisfaction with their credit union? How many credit
union errors would your customers tolerate?
Furthermore, what if our assumptions are wrong? Is it reasonable to assume that employees earning direct pay of $20,800 (and knowing that most financial institutions pay higher wages)
would have a turnover rate of 33 percent, while employees earning direct pay of $32,200 (and
knowing that virtually no financial institution pays higher wages) would still have a turnover
rate of 27 percent? In our hypothetical example, the 10 percent change in turnover for a 20
percent change in pay was based on research in the United States,12 since no Canadian data
were available. Would it in fact be the same here?
And what about economic conditions and unemployment? Were these figures calculated to include information about labour surpluses or shortages? If there is now a labour shortage, it
may be almost impossible to recruit qualified individuals at 20 percent less than market, and
selection standards may need to be lowered dramatically. Furthermore, as these employees gained experience and training, the best of them would be offered jobs at other financial
institutions. Only those who couldn’t get such offers would stay. How would this affect our
productivity estimates? In contrast, if there were a labour surplus, there would be virtually no turnover in the leading firms, since employees would be doubtful about being able to find
another comparable job.
So what would happen if turnover changed by 20 percent for a 20 percent change in wages? What if productivity dropped by more than 12 percent with a 20 percent drop in wages?
Furthermore, perhaps the changes are not symmetrical. For example, with a 20 percent lead
policy, would the firm be able to attract all the best employees from the competitors? We all know of instances where the best employee in a unit can do much more work than the worst,
sometimes twice as much. Would it be unreasonable to expect that staffing ourselves with
only top-notch employees would cause a 24 percent productivity gain? (This assumes, of course, that our selection procedures are good enough to pick out the best performers from
the large pool of applicants.)
Running the analysis again, we can see that changing the productivity increase to 24 percent
for a lead policy results in a total annual cost of $11,507,600 (compared to $13,703,000
calculated earlier). This compares favourably with $12,501,800 for a lag policy and $13,400,000
for a match policy. Interestingly, the analysis now indicates that there are savings in either a
lag or a lead strategy, but that the lead strategy is now optimal from a cost perspective.
As these calculations illustrate, a major advantage of utility analysis is the ability to answer
“what if” questions. Normally, the analysis is run for a whole range of estimates, including
worst-case and best-case projections. Analysis also helps identify the minimum conditions necessary for a change in policy to pay off. For example, we might determine that we need a
productivity gain of at least 18 percent to move to a lead policy. We can then ask: How likely is
that?
But before making the final decision, we must come back to a basic point: that the pay level
strategy chosen must also support the corporate and managerial strategies and must fit the
organizational context. If we are practising a high-involvement management strategy, a lag strategy may destroy the close, carefully nurtured relationship between the organization and
the employees. However, firms using a classical strategy may have no such concern and have
much less to lose by choosing a lag strategy. The organization’s business strategy could also be relevant: Is the firm’s strategy based on friendly, knowledgeable tellers or on low-cost
service?
Given the complexity and uncertainty of this analytical process, is it any wonder that many
firms throw up their hands and just stick with their current policy unless they are forced to
change?
Hybrid Compensation Policies
Instead of choosing a straight lead, lag, or match strategy, firms may choose a hybrid
compensation policy. For example, a firm could choose to lag for entry-level positions, especially if applicants are plentiful, but to lead in higher-level positions in order to avoid
turnover of highly trained personnel. Or, a firm may have different policies for different
compensation components—for example, to lag in base pay, to lead in performance pay, and to match in indirect pay. The firm may also choose to have different pay level policies for
different employee groups.
Read the following scenario to test your understanding of the close links between method of
pay and amount of pay.
Imagine that you are the owner of a medium-sized firm in the service sector and that you have
hired two different compensation consultants to devise a compensation strategy for you. Each has come up with a separate plan (let’s call them Plan A and Plan B) in which employees will
receive an average $4,000 per month in total compensation, but there are some differences
between the plans. You now submit each plan to a different independent expert for
evaluation.
One expert, reviewing Plan A, reports that you are very lucky you consulted her, because
$4,000 per month is too high a pay level! But the other expert, reviewing Plan B, reports that a $4,000 pay level is just fine! In confusion, you submit their reports to your next-door
neighbour, who happens to be the compensation manager for a prominent local firm. He tells
you that both independent experts are right! What is going on here?
Plan A calls for the $4,000 to be distributed as 67 percent to base pay and 33 percent to indirect pay. In Plan B, the distribution is 50 percent base pay, 25 percent performance pay,
and 25 percent indirect pay. Plan B is projected to produce value for the organization in excess
of $4,000 per employee (because of its performance pay component), whereas Plan A is
projected to produce value of less than $4,000 per employee. Thus, the nature of the
compensation mix affects the amount of compensation you can afford to pay.
Evaluate the Proposed Compensation Strategy
Compensation Notebook 1.1 in Chapter 1 listed eight goals for a compensation system. At this
point, before implementation, it is important to review the proposed strategy against these
criteria.
Three Basic Screens
Three of these criteria—affordability, legality, and employee attraction—can be considered
screens through which the strategy must pass. If it can’t pass all of these, the strategy is a
nonstarter.
Clearly, if a compensation strategy results in costs beyond the financial means of the
organization, it can go no further. To determine whether the compensation strategy passes
this screen, management needs to project the cost of the system and then compare it to what
the organization can afford. However, this is often not a clear-cut process, since both the costs
of the system and the funds available are often difficult to determine in advance. In many cases, the success of the compensation strategy itself plays a major role in determining
whether the funds are available to meet the payroll. In a business organization, future
revenues and profitability can be difficult to predict, especially for firms in turbulent environments. And although public sector organizations may be able to predict their budgets
more accurately, many of them are prone to sudden budget cuts, which have a direct impact
on what they can afford.
Before making the final decision, you need to derive a cost estimate of the new compensation
system. This requires knowledge of the number and types of employees who will be employed
over the next year. To make these estimates, you need to project the volume of business or
service to be provided over the coming year. Once you have done this, multiply the projected
total compensation for each employee by number of employees. The resulting number should
indicate whether the program is affordable.
Although there can be areas of ambiguity, legality is more straightforward to determine than
affordability. Does your plan meet the minimum standards under the employment standards
legislation in your jurisdiction? If piece rates or commissions are used, do they meet the standards for minimum pay and overtime under the relevant employment standards
legislation? Does your plan comply with human rights legislation and pay equity legislation? If
your firm intends to use independent contractors, do they meet the necessary criteria to be so
classified? If there is any uncertainty at all, many experts recommend getting an advance
ruling from the appropriate federal or provincial/territorial government body.
Regarding the third important criterion, when coupled with the other rewards the
organization will offer, will the reward and compensation system really be able to attract employees with the necessary qualifications? There are many ways of testing the labour
market to assess this (see Chapter 9).
Other Evaluation Criteria
After passing through these basic screens, you need to review the other criteria. Will the
resulting behaviour contribute toward the achievement of organizational goals? Could the
system end up promoting behaviour that is detrimental to goal achievement? Might the system promote some behaviours at the expense of other important behaviours? Does the
compensation system match your managerial strategy and organizational structure?
Another issue is equity. Will the system be seen as equitable by those in it? Of course, no system will be considered completely equitable by all employees. But to what degree will it be
perceived as equitable, and by how many employees? A major issue to consider is the value of
an equitable system to the organization. As discussed earlier, some organizations can tolerate perceived inequities in their compensation systems, but others cannot. For those
organizations that cannot, equity is another screen through which the strategy must pass
before final approval. One way of checking for equity is to present the proposed plan to focus
groups of employees.
Finally, even if the compensation strategy meets all of these criteria, one question remains: Is
it the most cost-effective strategy for meeting all of them? The only way to answer this is by
identifying all the viable alternative compensation strategies and evaluating them against these same criteria. But given the complexity of this process, few firms have the resources or
energy to do so. This is why many of them rely on compensation consultants; however, there is
no guarantee that consultants will come up with the optimal plan either.
Once the strategy has been implemented, it will need ongoing evaluation to determine
whether it is performing as planned and whether adjustments need to be made. It is a rare
compensation system that doesn’t have some wrinkles to be ironed out. As discussed earlier, even a strategy that was optimal when implemented can become ineffective if circumstances
change. The evaluation and adaptation of compensation systems is discussed in Chapter 13.
Who Develops the Compensation Strategy?
If compensation is to serve as a strategic tool, it needs to fit together with and support the
organization’s corporate and managerial strategy. For this to happen, those developing the
optimal compensation strategy must have all four of the key understandings as discussed at
the beginning of the chapter: an understanding of the organization, its people, its
compensation options, and its compensation constraints.
This suggests that the body charged with developing the overall compensation strategy
should be the same one responsible for the other strategic decisions in the organization. In many organizations, this means the CEO. The key contribution that top management brings to
the compensation strategy process is an understanding of the strategic context for
compensation. But, normally, top management does not have expert knowledge in the other three necessary understandings; therefore, human resources and compensation specialists
must bring this knowledge to the process. Compensation specialists must carry out the
detailed design of the compensation system within the parameters set by the compensation strategy. These specialists may be in-house or outside consultants; however, if outside
consultants are used, it is crucial that the process be actively managed by the firm itself.
Another important issue is the stage at which broad employee representation is included in the design process. If the organization is unionized, the compensation system must be
acceptable to the union members. But organizations vary greatly in the degree of employee
involvement they provide prior to adopting a proposed compensation system. In traditional
classical organizations, there is usually no such involvement.
Since an understanding of both employee needs and acceptance by employees is necessary
for the compensation system to achieve maximum success, many compensation experts
recommend extensive employee involvement right from the early stages. But this is possible only in high-involvement organizations. There are many different stages at which employees
can be involved, and it is rare for them to be involved in the initial formation of the
compensation strategy.
It is more common for employees to be involved in the design of the specific elements of the
compensation system. For example, employees are often involved in developing and
managing employee benefits or designing and managing a profit-sharing plan, often through
joint employee—management committees. In general, the more employee involvement in the
development process, the more likely the plan will address important employee needs and the
more likely it will be seen as equitable.
Not all organizations are able to generate effective employee involvement. Three critical
conditions are employee commitment to organizational goals, trust between management and employees, and open and effective communication and information sharing. In general,
high-involvement organizations are able to work with the most employee involvement,
classical organizations with the least, and human relations organizations somewhere in
between.
// Compensation Strategy for Special
Employee Groups
Should the compensation strategy be different for different employee groups? Traditionally,
this has been the case for most organizations. Employees are usually categorized into several
groups, usually known as job families, and a separate compensation system is used for each
group. There are six generic groups: hourly paid employees, clerical employees, sales employees, professional employees, managerial employees, and executives. Most firms also
differentiate between permanent full-time employees and contingent workers—that is,
workers who are part-time or temporary. Some even have separate systems for new hires and
existing employees.
Traditional hierarchical organizations (which include both classical and human relations
organizations) have always based compensation on hierarchical level, on the assumption that
jobs (and employees) higher in the organization are more valuable and thus should be
compensated at a higher level. Classical organizations typically pay their lowest-level
employees based on individual performance (piece work or commission) if they can, or on the
number of hours worked. Employees higher in the hierarchy are provided with salaries and limited indirect pay. Top management is provided base pay, indirect pay, and a large
component of organizational performance pay. The logic behind providing organizational
performance pay to only top management is that—in classical organizations—only they are in
a position to significantly affect the organization’s success.
The compensation system in human relations firms is not much different, except that there is
a greater tendency to put all employees on salary. Also, indirect pay is typically more generous than in classical firms. But organizational performance pay is still confined to senior
management.
Over the years, two major trends have emerged: a greater tendency to extend group and organizational performance pay throughout the organization, and a trend toward greater
similarity of treatment for employees within the compensation system. Sales employees often
have base pay included in their compensation plans, while other employees have an element
of performance pay added to their compensation. Stock options used to be provided only to
senior management; today, many firms provide them to all employees. Perks that were once
restricted to top management are now either being offered widely or are being eliminated. Some firms are moving away from hourly pay toward “all salary” systems to reduce
distinctions among employee groups. In many cases, these changes are being made to create
a greater sense of cohesion and unity among the workforce, particularly in firms that adopt
the high-involvement model.
According to the framework developed in this book, the compensation system for a given
employee group should differ from that of other employee groups if the behaviour required of it differs significantly from that of others or if the needs of the employees in the various
employee groups are significantly different. If the required behaviour is similar, then the
compensation system should reflect that similarity. Aside from sales employees (discussed in
Chapter 4), there are three main groups for whom the compensation system often differs
dramatically from the compensation norm—contingent workers,
executives, and international employees (expatriate and foreign employees).
Contingent Workers
One trend is the increasing use of contingent workers—that is, workers who are not employed
on a full-time permanent basis. For example, by 1996, around 19 percent of Canadian
employees were part-time workers, an increase of nearly 50 percent since 1976.13 Other types of contingent workers—temporary full-time employees, independent contractors, and persons
hired from temporary help agencies—also made up an increasing proportion of the
workforce.14 Some observers have even wondered whether this trend heralded the end of the full-time permanent job as the standard model of employment.15 There seems to be a new
trend toward what some refer to as “precarious work,” a concept that captures a broader
spectrum of work that’s not standard—such as part-time employment, self-employment, contract work, and temporary work—where the work is not generally well paid, is insecure,
and not is well protected by the law.16 In some sectors, such as the knowledge and creative
sectors, there are some estimates that precarious work accounts for as much as 40 percent of
all workers.17
However, the trend toward contingent workers (sometimes known as “nonstandard workers”)
appears to have levelled off in more recent years, at least with respect to some types of contingent workers. For example, the proportion of part-time employees did not grow at all
between 1996 and 2015, holding steady at about 19 percent of the employed workforce.18
Why do firms employ contingent workers? In some cases, contingent workers are hired to
handle highly skilled work for which the skills do not exist within the organization—such as designing a new computer system or planning a plant expansion—because the organization
cannot afford to maintain or utilize their skills on an ongoing basis. In other cases, contingent
workers are hired to help regular employees handle overflow work and temporary peaks in workflow. Contingent workers are also hired as temporary replacements to handle vacations,
parental leaves, and other forms of leave. The key difference from regular, permanent
employees is that contingent workers are employed only when needed and are released when
they are not.
However, sometimes contingent workers are hired to do the regular work of the organization
on an ongoing basis. For example, retailers may hire a few full-time cashiers but have most of
this work done by part-timers. Using part-timers helps deal with a workload that fluctuates with time of day, day of the week, and even day of the month. Often these employees are not
really temporary, nor are they peripheral to the main operations of the business; they are
employed only at the will of the organization. However, some firms differentiate between casual part-time and permanent part-time employees. Members of the latter group are not
really contingent workers, since the firm makes a commitment to provide at least a certain
minimal level of employment on a continuing basis.
Use of contingent workers generally frees employers from many of the legal constraints that
apply to permanent employees. For example, contingent workers are typically exempt from
severance pay provisions, as well as from employee benefits. Contract employees (although
not part-time employees) are exempt from employment standards provisions and mandatory
benefits. No cause is needed for dropping a contingent worker from the workforce, so this
makes it easy to correct selection errors. Some employers, especially those from the classical school, may believe that contingent workers are easier to manage because the employer can
hold the threat of dismissal over their heads.
Some firms see contingent workers as a way to reduce the cost of labour, and attempt to substitute contingent workers for regular employees whenever possible. For other firms, the
motives are more complicated. These firms see their labour force as consisting of two groups
of employees. One group consists of core employees, who are committed, loyal, and highly
knowledgeable, with skills and training that have taken years to acquire. They are compensated accordingly. But it is too expensive to use these core employees for routine,
repetitive, low-skilled work, so contingent workers (the second group) are used for this type of
work. Using contingent workers to do a portion of the organization’s regular work also protects core employees if product/service demand drops. Research in the United States
showed that firms offering the most costly benefits to permanent employees used significantly
more contingent workers than employers offering more modest benefits.19
The key issue is how to pay these employees. If the work they are doing is the same as that of
permanent employees and the current compensation system is effective, management will
want to use the same compensation system for both groups of employees. But if management believes that the compensation system has become too generous or expensive, particularly
for some types of work, they may deal with this problem by using a different compensation
system for contingent workers. Of course, if the behaviour expected of contingent workers is significantly different from that of regular employees, then a different compensation system
may well be justified.
In organizations where contingent workers perform regular, important functions, such as in
banking, the same compensation system is often extended to all employees. For example, the Royal Bank has introduced a “one employee” policy, where all employees participate in the
same compensation system. But this is not the norm. In the Conference Board study, only 20
percent of respondents indicated that their firms offered the same benefits to contingent
workers who worked side by side with regular employees. Other research has shown that
contingent workers are often paid less than regular workers and receive fewer benefits.20
According to equity theory, this discrepancy in pay should lead to perceptions of inequity among contingent workers, from which negative consequences might arise. Interestingly,
while a recent analysis of 62 studies found that workers employed by temporary help agencies
did have lower job satisfaction than permanent employees, the job satisfaction of temporary workers hired as contractors did not differ from that of permanent employees.21 Another study
found that hiring contingent workers to reduce labour costs actually caused higher quit rates
among permanent employees (who may see this practice as a signal that their work is not
highly valued by their employers), but lower quit rates when contingent workers were hired for
the purpose of providing more employment stability to permanent workers.22
Unfortunately, there has been little direct research into this issue, although studies have found that turnover is much higher among part-time workers than among full-time workers,23 and
that job satisfaction is lower.24 However, a study in the United States found no difference
between the task performance of contingent and permanent office workers at a large
university.25
One factor that may influence employee reactions is whether the employees are doing
contingent work voluntarily or involuntarily. Research indicates that the majority (73 percent) of part-time employees in Canada are engaged in part-time employment because they prefer
it or because their circumstances prevent them from accepting full time employment.26 One
can expect that involuntary part-time employees will be less satisfied with part-time work and exhibit higher turnover than employees who prefer part-time employment. But while some
studies have borne out this expectation, such as studies of Canadian nurses27 and temporary
help employees,28 others have not.29
Executives
Another issue that has been attracting a lot of attention for the past few years is executive pay.
This is partly because executive pay has been escalating while the pay of rank-and-file
employees has been stagnating, partly because disclosure laws have made executive pay more visible, and partly because some top executives have profited handsomely while
managing their companies right into bankruptcy. Compensation Today 6.4 describes one
particularly egregious example.
COMPENSATION TODAY 6.4
The 47-Million-Dollar Man
Ever hear of the six-million-dollar bionic man? Well, that is small change compared to what
many corporate executives have been making in recent years.
Take Martin Sullivan, for example. As CEO of corporate insurance giant AIG, he presided over the near-death experience of the largest insurance company in the world. When he was ousted
from office in June 2008, he left behind the wreckage of a venerable 100-year-old firm that
required a transfusion of an incredible $170 billion of U.S. taxpayer money just to keep it alive.
Sullivan’s reward for this “performance”? In his last year in office, he walked away with $47 million, including $15 million in severance pay. Apparently being named as one of the “worst
CEOs of all time” by U.S. news channel CNBC did not warrant “dismissal for cause,” under
which no severance pay need be paid.
His successor, Robert B. Willumstad, had the good grace to turn down a severance payment of
$22 million from AIG for the three months of work he put in before being replaced by Edward
M. Liddy, former head of Allstate Insurance. So what is Liddy, the man charged with one of the toughest executive jobs in the world, being paid for cleaning up the mess left behind by the 47-
million-dollar man? One dollar per year. Executive pay is truly a strange thing.
Until the financial meltdown of 2008–09, the most striking case of executive mismanagement
was Enron Corporation, where mismanagement and fraudulent accounting practices caused
the collapse of the firm in 2002, along with the collapse of its auditing firm, Arthur Andersen.
Just before thousands of Enron employees lost their jobs, life savings, and pensions, corporate
executives were receiving bonuses and cashing in stock options worth millions of dollars.
In the wake of the Enron collapse, some changes were made to financial accounting standards in the hope of preventing a replay of this collapse. However, what legislators did not realize at
the time—although some insightful observers did—was that the root of the problem is
the system for executive pay (which has been very resistant to change), under which executives have huge incentives to take risky, dubious, or even fraudulent actions. The
problem is not so much that executives make “too much money,” but that the huge amounts
of money at stake magnify the detrimental effects of poorly designed compensation systems.
In the United States, which leads the world in executive pay, executive compensation jumped
from an average of 43 times the pay of the average worker in 1960 to more than 100 times by
1990.30 Executive pay also soared in Canada, resulting in a doubling of the gap between
workers and top corporate executives between 1970 and 1990.31
Today, the average executive pay for large firms is approximately 340 times the average
worker pay in the United States (https://www.theguardian.com/us-news/2016/may/17/ceo-
pay-ratio-average-worker-afl-cio), while the figure in Canada is 184 times
(https://www.policyalternatives.ca/ceo).32
Coming at a time when many employers were downsizing and evidence that executive pay
often bears little relationship to company performance, this newfound awareness of executive salaries caused a major outcry. In 1992, the U.S. Securities and Exchange Commission (SEC)
toughened its already stringent requirements for disclosure of top executive salaries in
publicly traded corporations. Then in 1994, the SEC took this a step further by limiting the tax deductibility (for corporate taxes) of nonperformance-related executive compensation to $1
million per year. In 1993, the Ontario government passed similar legislation, which resulted in
the Ontario Securities Commission establishing the first disclosure requirements ever imposed
on top executive salaries in Canada.
The outcome of all this? By 2002, the average compensation of CEOs in publicly traded U.S.
corporations was more than 500 times the pay of the average worker,33 and by 2007, it was 521 times the pay.34 All of this during a period when compensation for most workers had shown no
real gain. This figure has fallen in recent years to 335 in 2015.35 In Canada, it is estimated that in
2015, on average, the 100 highest paid CEOs made more than 184 times a worker.36
What message does this send to employees? How do you think they are react to exhortations from their CEO that “we all need to pull together” to ensure the success of “our company”?
Sure, workers are likely to be disgruntled, but at least managers will side with the executives,
since they understand how important the work of executives is.
Or will they? Listen to a manager at United Technologies, which had downsized by 30,000
employees over the past six years. A 20-year veteran of the firm, with good performance
reviews, he was doing slightly better than his industry’s average, with increases of about 4 percent a year over the previous three years. At the same time, though, the pay of the
company’s CEO had increased dramatically:
I used to go to work enthusiastically. Now, I just go in to do what I have to do. I feel
overloaded to the point of burnout. Most of my colleagues are actively looking for other jobs or are just resigned to doing the minimum. At the same time, the CEO is paid millions, and his salary is going up faster than anyone else’s. It makes me angry and
resentful.37
In Canada in the 1990s, the divergence between the pay of top executives and that of other
employees was not as large as in the United States. Canadian executive compensation did not rise to the heights enjoyed by U.S. executives. In 2000, Canadian executives earned about half
what CEOs in comparable U.S. firms received.38 However, the pay of the top 50 Canadian
executives went from 85 times the pay of the average Canadian worker in 1995 to 398 times in
2007,39 and by 2009, the pay of executives in Canada had risen to the same heights as that of
U.S. executives.40 A major reason for this was a surge in the use of executive stock options in
Canada following a legislative change in 2000 that made those options much more tax-
favourable and that brought Canadian tax treatment of options in line with U.S. tax treatment.
One thing to note is that the salary levels enjoyed by Canadian and U.S. corporate executives
are not enjoyed by the top executives of all organizations. Take Mark Carney, a former
Governor of the Bank of Canada. Carney had 13 years’ experience in senior positions with private financial firms as well as a doctorate in economics from Oxford University. His actions
could make or break the Canadian economy and could affect the lives of millions of Canadians
and their families, as well as the success of tens of thousands of businesses. Yet his salary range was $425,300 to $500,300—a major drop from his previous private sector pay.
Nonetheless, he was one of the most highly paid executives in the federal government, earning
more than his boss, the Minister of Finance ($233,247)—more, even, than the prime minister
($315,462).
Carney’s pay may sound pretty good to the average Canadian wage earner, who received
about $43,680 in 2011. But compare Carney’s compensation with that of William Downe, CEO of the Toronto-Dominion Bank, who earned $11,420,242 in 2011, and Carney’s salary doesn’t
seem quite so high.
Why Do Corporate Executives Make So Much?
So why do corporate executives make so much? Much of the answer has to do with bonuses
and incentives. Let’s look at the most recently available (2015) data on the compensation of
ten of Canada’s highest-paid executives (see Table 6.3). Their base pay, while substantial,
amounted to a very small portion of their total compensation.
COMPENSATION TODAY 6.5
Executive Bonuses—Playing Games with the Numbers?
The 2015 Pan American Games involved 6,132 athletes representing 41 National Olympic
Committees (NOCs) in the Americas, making it the largest multi-sport event hosted in Canada,
in terms of athletes competing. Yet controversy over executive bonuses also caught public attention. The province, the opposition parties, and the auditor general debated the need to
pay $5.7 million in bonus pay to 53 senior executives. Pan Am senior managers were paid a
base salary, and a bonus that in some instances equalled the base pay if the games were on
schedule and on budget, and if the executives stayed with the Games until they were
completed.
While the opposition and the auditor general believed that the Games went over budget, the province insisted that the Games stayed within budget. The opposition parties criticized the
practice of paying bonus by stating that bonuses are not available for many ordinary
Ontarians. The province pointed to practices of other sporting events around the world and
advice from a human resources consulting firm to “attract the unique skills and experience” required to do the job and ensure “certain targets and certain achievements will be
accomplished.” Despite the debate, the auditor general said that Ontarians can take pride in
the Games as they were on time, with no major incidents and with Canada earning its best-
ever medal count.
Sources: “Ontario Auditor General Finds Pan Am Games $342M over Budget, But Bonuses Still Paid,” The Canadian Press, June 8, 2016, http://www.cbc.ca/news/canada/toronto/ontario-
auditor-general-finds-pan-am-games-342m-over-budget-but-bonuses-still-paid-1.3621851,
accessed September 27, 2016; Adrian Morrow, “Wynne under Fire over Bonuses to Pan Am Executives,”The Globe and Mail, September 16, 2015,
http://www.theglobeandmail.com/news/toronto/wynne-says-pan-am-games-appear-under-
budget-but-final-cost-not-yet-tallied/article26377992, accessed September 27, 2016; Paul Bliss and Kendra Mangione, “Pan Am Games Exec Had $239K Salary Before Bonus:
Documents,” CTV Toronto, September 25, 2015, http://toronto.ctvnews.ca/pan-am-games-
exec-had-239k-salary-before-bonus-documents-1.2582013, accessed September 27, 2016;
2015 Pan American Games, Wikipedia,
https://en.wikipedia.org/wiki/2015_Pan_American_Games, accessed July 29, 2016.
So, what constitutes the majority of compensation that is not base salary? While Table 6.3
doesn’t break this out, data published by The Globe and Mail indicate that the largest chunk
of this was earnings from stock grants and stock options, followed by annual cash bonuses. See Compensation Today 6.5 for an example of controversial bonuses. Executive pensions
and “other compensation” (which includes the value of benefits received by the executives,
such as car and housing allowances, interest-free loans, and insurance premiums) accounted
for the remainder. Overall, the proportion of pay accounted for by stock grants and stock options has actually declined over the past few years, mainly due to poor stock market
performance.
What factors determine how much executives receive? As already discussed, the sector in which they work makes an enormous difference, with executives in the private sector receiving
much more than executives in the public sector. What else? Some observers argue that
executive pay should be tied to the financial performance of the corporation, but research in both the United States41 and Canada42 shows little or no relationship between executive
compensation and company performance once stock options are excluded. When these
are included, there is a significant relationship between the stock value and executive
compensation, although it is more likely that stock value is affecting the value of executive
compensation than the other way around.43
Rather than ability, the most important factor affecting executive compensation is firm size: CEOs of large firms make more than CEOs of small firms.44 Another important factor is whether
the firm is controlled by management or the owners. In many large firms with widely dispersed
ownership (known as “management-controlled firms”), there is no single owner with the power to significantly affect management decisions. In general, all other things being equal,
top executives in management controlled firms earn significantly more than top executives in
owner-controlled firms.45 In other words, firms in which top executives determine their own
salaries set those salaries higher than firms where top executive salaries are set by owners.
Studies in the United States suggest two other important factors.46 Firms with fewer
hierarchical levels (after controlling for size) pay their top executives less than firms with more
hierarchical levels, and firms that are more diversified pay their CEOs more than firms that are less diversified. The first factor makes sense when you consider that hierarchical organizations
must increase pay at each hierarchical level in order to provide an incentive for employees to
move up the hierarchy; the second makes sense because more diversified organizations are
more complex to manage than less diversified ones.
But these factors still do not explain all of the variations in executive pay nor all of the
escalation that has taken place.47 One way of examining this is to understand how large corporations set executive pay. The board of directors sets up a compensation committee
consisting of several directors. The committee then hires a compensation firm to provide data
on how “comparable” CEOs are being compensated and uses these data as a basis for their
decisions. This sounds like a rational and reasonable process.
However, the process may not always be as “rational” as it sounds. First of all, the
compensation consultants hired are often recommended by the CEO, and it is in consultants’ best interests to keep the CEO happy if they want to do other business with the firm. So, when
looking for appropriate comparators, the consultant will certainly not be interested in erring
on the low side. Furthermore, many boards (especially in management-controlled firms) are populated by directors recommended by top management, and these directors will not wish
to incur ill will by being stingy with executive pay. One prominent observer48 —a former
compensation consultant now highly critical of executive compensation practices—also points
out that no board of directors wishes to believe that it has an average or below-average CEO, and that most firms attempt to pay above the median market value. If the majority of firms do
this, then a continually rising “market” for executive compensation is
inevitable.49 Compensation consulting firms then use this rising “market” to justify more
increases to executives, and so it goes.
Moreover, many corporate directors are often themselves CEOs and can be expected to be
highly sympathetic to other CEOs. And of course, high executive salaries can be used as evidence favouring higher compensation when it is their turn to be compensated as CEOs. All
told, unless someone on the compensation committee is representing the owners’ interests,
there is little incentive to hold executive pay down.
Perhaps all of this will change as shareholders become more militant and as institutional
investors, such as pension funds, take a more active role in corporate affairs to push for better
corporate governance, as the Ontario Teachers’ Pension Fund50 and the Canada Pension Plan Investment Review Board51 (Canada’s largest institutional investor) are already attempting to
do. Another possibility is to give shareholders the opportunity at the company’s annual
meeting to have a “say on pay”—that is, the opportunity to vote on and possibly reject the proposed executive compensation. In response to shareholder pressure, many Canadian
companies have voluntarily adopted a nonbinding version of this policy,52 and proponents are
arguing for laws that would require such a vote, similar to the one passed in the United States
in the wake of the 2008–09 financial meltdown.
Executive Pay and Performance
It was noted earlier that CEO compensation does not necessarily bear any relationship to
company financial performance. But should it? The obvious answer would seem to be “yes,”
but is this really correct? One prominent commentator in this area argues that “contrary to much of what one reads in the academic and practitioner press, there is no sound theoretical
basis to expect a strong relationship between executive pay and firm performance.”53
To what extent can a top executive actually influence organizational performance? In the short run, not much, especially in large organizations. In most organizations, financial performance
is a function of many factors, many of which are beyond the control of the CEO, especially in
the short run. But research does show that CEOs have an increasing impact over longer time periods.54 This is not surprising. In general, the role of a top executive is to formulate the
strategy that will best achieve the organization’s goals and then create an organizational
system for carrying out that strategy. Especially in large organizations, this process may take
years to pay off.
The current conditions facing the firm are another important consideration. A CEO who takes
over an organization in a tailspin may be considered a great success if he or she can slow the descent in the first year and start to turn things around in the following two or three years.
Does this CEO really deserve less than a CEO who takes over a prosperous firm operating in a
highly favourable competitive environment?
Moreover, it may not be in the best interests of the organization or the shareholders to tie
executive pay too closely to current or short-term performance. There are all kinds of tricks
and manoeuvres to make short-run performance look good that could ruin the firm in the
longer run. For example, a CEO could cut research and development expenditures, saving
money now but causing a shortage of new products when the old ones become obsolete. A
CEO could also cut employee compensation, causing the most talented employees to
gradually leave, which will affect long-term productivity. In addition, a CEO could forgo long- term capital investments that might be very beneficial to the firm but that would take years to
pay off.
Problems with Executive Stock Options
To encourage a long-term perspective, many firms incorporated extensive stock options into
their executive pay. Contributing to their popularity was that stock options were seen as an
almost costless way of compensating executives. But as shareholders came to realize that stock options had a very real cost in terms of dilution of equity,55 stock options increasingly
came under critical scrutiny. Also, in a declining stock market, executives may be penalized
despite good performance, while in a rising stock market, they may reap windfall gains unrelated to their personal performance. Moreover, in recent years some executives have
turned to “zero cost collars”—hedges that tend to decouple performance of the company
shares from financial returns, effectively reducing risk.56 Because hedges do not have to be publicly reported, other shareholders may not know that the CEO is decoupling his or her
financial returns from those of the company. As Lavelle puts it: “An executive who hedges is a
little bit like the captain of a ship who sees an iceberg up ahead and heads for his lifeboat
without waking the sleeping passengers.”57
However, the biggest problem with large-scale executive stock options is not their cost, and it
is not the negative impact they may have on employee morale; rather, it has to do with their
hidden incentives for mismanagement. As the final report of the court appointed examiner for
the Enron inquiry stated:
The evidence suggests that the compensation system provided what proved to be an
overpowering motivation for implementing [accounting] transactions that distorted Enron’s reported financial results. Evidence further shows that flawed or aggressive accounting ... enabled the Enron officers to obtain greatly inflated bonuses and to realize substantial proceeds from the sale of Enron stock they received as part of their compensation packages. In fact, during a three-year period from 1998 through 2000, a group of twenty-one officers received in excess of $1 billion in the form of salary, bonus,
and gross proceeds from the sale of Enron stock.58
As a result of problems such as this, there has been some investor backlash against executive
stock options. For example, the Ontario Teachers’ Pension Fund, the second largest
institutional investor in Canada, has been pressing for changes so that the basis for CEO compensation depends on whether the firm outperforms competitors, not simply on whether
the stock price goes up.59 And the Canada Pension Plan Investment Board (the largest
institutional investor in Canada) has urged that stock option plans be discontinued entirely: “Stock options are problematic in many areas, including their effectiveness in aligning
management interests with those of the shareholders, the potential dilutive impact on existing
shareholdings, their tendency to focus management on short term performance, their use as a cash incentive rather than an ownership incentive, and intractable accounting issues.”60 After
extensive study, Canada’s Institute for Governance of Private and Public Organizations also
recommended, in a 2012 policy paper, that executive stock options be phased out.61 While
both prominent academics62 and corporate executives, such as Bill Gates of Microsoft,63 also
now support the elimination of executive stock options, some experts go even further than
this. Roger Martin, former Dean of the Rotman School of Management at the University of Toronto, has urged that the use of all stock-based compensation for executives be
discontinued entirely.64 His argument is that any type of stock-based compensation for
executives is flawed, because these systems create incentives for executives to manipulate
stock prices, which is relatively easy for them to do even without resorting to overtly fraudulent practices. As Martin explains: “Stock-based compensation creates the direct and
clear incentive to raise expectations of future earnings and then sell the stock before
expectations fall—and then do it all over again.”65 Not all executives succumb to this temptation, but why structure executive compensation in such a way that dishonest
executives are rewarded for their misdeeds, while honest managers are penalized for their
honesty? Martin suggests that executives of publicly traded firms be compensated for real, long-term earnings growth, in the same way that executives of corporations that are not
publicly traded are often rewarded.
Interestingly, empirical evidence to back up Martin’s perspective on executive stock options is now available. Researchers in the United States have found that the likelihood of a firm using
questionable accounting practices is directly related to the amount of stock options that
executives have been granted.66 Other researchers have found that stock options are in fact a
very expensive way to motivate executives, and that restricted stock is much superior.67
Restricted stock is an alternative to stock options. The essence of restricted stock is that
executives are granted shares of company stock but are not allowed to actually receive them
unless certain conditions are met. Sometimes the condition is a holding period—say, of three years—during which the stock is forfeited if the CEO leaves the firm. In other cases, the
executive will not receive the shares unless certain performance targets are reached.
In addition, as a result of the problems inherent in stock options, long-term unit/share plans
have become increasingly popular (see Chapter 5). If structured properly, long-term unit/share
plans can provide a longer-term perspective (three to five years) to counterbalance the short-
term perspective that other types of incentives promote.68
Of course, a more fundamental question can also be asked: Why should it be necessary to
provide incentives to individuals who are already being compensated handsomely for doing their jobs? Is there a concern that without multimillion-dollar stock packages, executives will
simply goof off? The response to this question usually focuses on attraction and retention. But
even here, there is room for debate. American researchers found that a CEO’s total
compensation relative to that of others in the industry had no effect on CEO retention, suggesting that when CEOs leave a company, they do so for reasons other than
compensation.69
Other Executive Perks
Indirect pay can be another important component of executive pay, especially for executives
who are not in the top pay echelon. Many executives receive a number of perks of
considerable value, the most common of which are company cars, country club memberships,
access to the company plane, free travel for family members, payment of financial planning
fees, and supplemental executive retirement plans. In Canada, one significant form of indirect
pay for some executives (mainly those who are lured from the United States) is the equalization of personal income taxation rates with those in the United States, so that these
executives end up receiving the same amount of after-tax income as they would have if they
were living in the United States. This is achieved by simply reimbursing executives for the
difference between income taxes in Canada and the United States.
One controversial item of indirect pay for executives is known as the “golden parachute.”
Golden parachutes may be structured in many ways, but the essence is that an executive who is dismissed for any reason within a certain time frame (for example, five years) is guaranteed
a large severance payment, usually amounting to three to five years’ pay. Sometimes there is
no time limit on these payments, and they kick in whenever the CEO is dismissed.
Many observers argue that such “parachutes” take away the incentive for good performance,
since the executive will be paid very nicely regardless of performance. Opposing observers
argue that these parachutes encourage executives not to fight takeover bids that may be beneficial to shareholders but that would cause the CEO to lose his or her job. In addition, they
argue that it would be difficult to lure good executives away from highly paid jobs with other
firms without some financial guarantees to protect them if things do not work out. But opponents ask: Why would you want to hire an executive who has so little faith that an
ironclad guarantee is required?
Decision Issues for CEO pay
So how should a CEO be paid? There are six main issues to decide:
1. the amount of performance pay relative to base pay and indirect pay,
2. the amount of short-term (annual) performance pay versus longer-
term performance pay,
3. the nature of the performance pay itself,
4. the specific performance indicators used as criteria for the
performance pay,
5. the stringency of the performance criteria,
6. the time period to be used as the performance period for the incentive.
How do you decide the best way to handle each of these decision issues? As with all types of
compensation, the first question is, What do we want the executive compensation system to accomplish? Besides attraction and retention, there are two main aspects to consider: a
behavioural one and a symbolic one.
The behavioural aspect addresses the kind of executive behaviour the company wants. Research has shown that executives, like most people, tend to pursue actions that maximize
their compensation. Therefore, the compensation system should promote executive
behaviour that fosters the achievement of organizational goals and that serves the
organization’s long-term interests.
Moreover, the way top executives are compensated influences the rest of the firm’s compensation system. An executive tends to design the firm’s compensation system to foster
employee behaviour that in turn helps the executive achieve his or her compensation rewards.
This is known as a “cascading effect.” Of course, a cascading effect in a compensation system is fine as long as both executive and employee behaviours are in line with the objectives and
strategy the organization is pursuing.
The executive compensation system also has very important symbolic value. Because of its visibility, executive pay is seen as a signal of the kinds of behaviours the organization values.
The behaviours for which top executives are rewarded tend to be emulated by subordinates.
Another symbolic aspect is an equity or fairness dimension. If executive pay is structured very differently from the pay of other employees, this may cause serious motivational problems
and other negative consequences that result from reward dissatisfaction. Recall the manager
at United Technologies (see “Executives” in the chapter) who had reduced his commitment to the organization because of his dissatisfaction with top executive pay levels. Other employees
at the same firm were actively seeking other jobs or were reducing their effort to the minimum
for the same reason.
The need for perceived equity is a much bigger problem in some types of organizations than in
others. In classical organizations, perceived inequity is a minimal problem: as long as the cost
of turnover is low, extra job effort and citizenship behaviour are not really needed, and
controls constrain dysfunctional behaviour. In human relations firms, perceived equity may
not be a big problem either, as long as the firm has traditionally demonstrated high concern
for employees and has paid relatively well.
But excessive CEO compensation can be a big problem for high-involvement organizations, where a sense of equity is essential for generating the cooperative and citizenship behaviour
that is crucial for success. As Lawler puts it: “High involvement management requires that
senior managers . . . give up some of the special perquisites and financial rewards they receive.”70 This is because extreme divergence between executive pay and that of other
employees makes it almost impossible for a commonality of interests to emerge.
Some experts are now calling for executive pay to be geared to subjective indicators (such as employee morale and organizational culture) as well as financial performance indicators. The
Institute for Governance of Private and Public Organizations is a leading proponent of this
approach, and has presented a variety of thoughtful recommendations for executive pay in its
2012 policy paper.71
Expatriate and Foreign Employees
As Canadian companies respond to globalization, an increasing number have established
operations outside Canada. Of course, employees of these foreign operations must be paid, but compensation practices that are suitable in Canada may not be appropriate in other
countries. Labour market conditions, product market conditions, and legal and cultural
conditions vary dramatically between countries.
A key question is whether the employees are foreign nationals or expatriate Canadians sent to play a role in operating foreign subsidiaries. The compensation policy issues are very different
for each of these groups. For firms creating compensation packages for home-country
expatriates (those who are sent to foreign countries from Canada), the key question is how to create a compensation package that ensures that expatriates do not lose financially compared
to their home-country peers but is still cost-effective for the company. There are four main
approaches to expatriate compensation: (1) balance sheet, (2) negotiation, (3) localization,
and (4) lump sum.
1. Balance Sheet Approach
The most common approach has been the balance sheet approach. The objective of the balance sheet approach is to create a compensation system that enables expatriates to
maintain a standard of living comparable with what they would enjoy in their home country,
regardless of the host country they are sent to. Expatriate expenses are broken down into four main categories: (1) income taxes, (2) housing, (3) goods and services, and (4) a “reserve” or
“discretionary” component. Costs of comparable income taxes, housing, and goods and
services in the host country are calculated and then converted into Canadian dollars, and the “reserve” amount is added. This total amount (paid in Canadian dollars) is the base pay for the
expatriate. The reserve amount is calculated by determining how much a comparable Canada-
based employee would have left as discretionary income. In some cases, an additional amount
may be added to base pay as a “hardship allowance” to compensate expatriates who are sent
to locations that have health and safety risks or other undesirable aspects.
There are several potential problems with this procedure, including changes in the currency
exchange rates in the period after conversion to Canadian dollars, as well as changes in tax rates, housing costs, or other living costs. To deal with these problems, management can take
an equalization approach. For example, for income taxes, the company can deduct the cost
of Canadian income taxes from the expatriate’s pay and then pay the expatriate’s actual income taxes in the host country, which could be more or less than the Canadian amount. This
creates a tax-neutral treatment from the expatriate’s point of view.
An equalization approach for housing expenses is similar. Reasonable Canadian costs are calculated, and this amount is deducted from the expatriate’s income. The company then
pays whatever it actually takes to provide comparable housing in the host country, either
directly to the foreign property owner or through payment to the employee in the local currency. The same basic procedure can be followed for other living expenses. The key
advantage of this approach is that expatriate employees are treated equally regardless of the
host country, and that compensation does not need to change as exchange rates or local circumstances change. Employees can also be transferred from one host country to another
without changing the way they are compensated.
2. Negotiation Approach
Besides the balance sheet approach, several other approaches to expatriate pay have been
developed. Negotiation is a process in which the employer and employee negotiate a mutually
acceptable package. However, there are numerous problems with this approach. First, the employee may not be very knowledgeable about conditions in the host country and thus may
find it difficult to judge whether a package is reasonable or not. Second, there is the potential
for inequity if different packages are negotiated for different employees, especially if the differences are based only on the negotiating skills of the employees. Third, the packages
often have no systematic procedure for changing them in response to changes in host-country
conditions.
3. Localization Approach
Localization is the practice of paying expatriate employees the same compensation as local
nationals in equivalent positions. This method fits best with assignments that will be long term, with companies that have extensive operations (and well-developed compensation
systems) in the host country and in host countries that have higher compensation levels than
Canada, as is generally the case with Canadian employees assigned to the United States. Localization to home-country (i.e., Canadian) rates is also often done for foreign nationals who
have been assigned work in Canada on other than a temporary basis.
4. Lump-Sum Approach
Another approach to expatriate compensation is the lump-sum approach. This method differs
from the balance sheet approach in that the various allowance amounts (such as for housing)
are paid directly in home-country (i.e., Canadian) dollars to the employee, who may then
decide to live in a lower standard of housing than the norm and pocket the remainder of that allowance. Problems with this approach include changes in foreign exchange or local
conditions, and possible losses of some tax advantages. For example, in some countries,
housing allowances are not taxed as income to the employee, although salary paid directly to
the employee is.
Other Issues in Expatriate Pay
One issue common to all approaches is the amount of premium to pay for foreign assignments. These premiums are paid over and above the standard compensation that
preserves the employee’s standard of living, and they vary considerably for different countries.
There is no system for determining the amounts of these premiums, and the only method may
be to assess employees’ degree of aversion to each country. Of course, what may be paradise
to one employee may be purgatory to another, so this is a subjective process.
The usual method for paying foreign premiums is to prorate them and add the prorated amount to the monthly paycheque. However, this method artificially inflates monthly pay and
may make employees reluctant to transfer from a high-premium country to a lower-premium
country or to repatriate to Canada. To deal with this problem, some firms use “mobility bonuses”—employees are paid the premium as an up-front bonus, thus removing
disincentives for transfer.
Besides financial considerations, it is important to consider a variety of other factors that may
affect whether an employee will find a foreign posting attractive and rewarding. For example,
to what extent will the posting contribute to career development and opportunities for advancement? To what extent will such a posting be intrinsically rewarding, through the
experience of a different cultural environment? Recent research has shown that those firms
adopting a “total rewards” approach to compensating expatriate employees generate much higher affective commitment to the firm than those firms relying solely on financial
considerations.72
“Third-country nationals”—employees of the firm not based in the home country who are assigned to a third country—are treated differently from expatriates. For example, suppose
that a Canadian firm assigns a Spanish employee from its Spanish subsidiary to its operation
in Chile. Should the employee be compensated in Spanish currency using a balance sheet
approach, or should the employee be localized? While the same decision rules could be used
as for Canadian expatriates, this does get very complicated, especially if the balance sheet
approach is used. Another problem occurs when employees from two or more foreign countries are assigned to the same third country. For one, the balance sheet approach may be
most appropriate, while for another, the localization approach is best. However, unless
localization is used for both employees, they will have very different compensation levels, even if they perform the same work. To avoid this problem, some companies use the same
rates as would apply to Canadian expatriates in Chile, but this may not be fair to third-country
nationals from high-wage countries such as the United States. Unfortunately, there are no
simple solutions.
A final issue is compensation of local nationals in foreign countries. The home country
(Canadian) compensation system would probably be inappropriate, but this is not to say that
the most appropriate compensation strategy is to simply copy local competitors. The same understandings discussed earlier in the chapter—understanding your context, people,
compensation options, and compensation constraints—need to be applied to the foreign
subsidiary, along with the five steps in the compensation strategy formulation process. The resulting compensation system could be different from that used in the home country and
from that used by local competitors.
Note that because of the complexity of international compensation, the objective of this section has been to acquaint the reader with some of the key issues; more detailed
information is available elsewhere.73
// Compensation Strategy Formulation: An
Example
Congratulations! You’ve now toiled through six chapters of heavy compensation knowledge,
and you now know everything you need to know to develop a compensation strategy. But can
you actually do it? If you are like most people, everything still feels pretty abstract. In this last section it is time to see if you have what it takes to be a compensation strategist. So, let’s try to
get real by putting you in the hot seat. But be forewarned: not everyone will be up to this
challenge!
Your Challenge
You are president and CEO of Canada Chemicals Corporation, a firm that produces industrial
chemicals. Although the firm is profitable, profits have been slipping in recent years, and you
see some other disturbing signs. While there could be many causes for these problems, at least part of your problem may be your compensation strategy. But be wary: things are seldom as
simple as they seem! Formulating a new compensation strategy (and deciding whether to
actually go ahead with it) is a complex task requiring concentration, so be prepared for a whopping headache before you are done! You may even find it useful to input the data into a
computer spreadsheet for easier manipulation.
Your Company
Canada Chemicals Corporation produces two main categories of industrial chemicals. Some of
the chemicals are off-the-shelf (OTS) products, while others are custom developed in
conjunction with purchasers. Custom-developed chemicals take much longer to sell, because
their specifications have to be worked out between the purchaser and your company.
The Sales Process
The chemical sales engineer’s job is to interface with customers, assess their needs, and
determine whether an off-the-shelf product would suit their needs. If not, she or he must identify the technical requirements for the product and then develop preliminary chemical
specifications for a product that meets these requirements. In some cases, a minor
modification of an OTS product does the trick. In others, modification of a previous custom
product works. In still other cases, a new custom product needs to be developed from scratch.
This custom-product information is then sent to the Chemistry Department, which further
refines the product formulation, examines whether there is a cheaper way of producing the product (e.g., modifying a custom product that the sales engineer wasn’t aware of), verifies
that it will meet customer needs, and then develops the production specifications. These
specifications are then sent to the Production Department, which develops a cost estimate for the product, plus a preliminary estimate of how long it will take to produce the product. These
estimates go to the Vice President of Sales, who develops a price and delivery date based on
these estimates and relays this information to the district sales manager. All of this
information then goes back to the sales engineer, who prepares a detailed proposal for the
customer.
But there may be other steps. Often this proposal is reviewed by the customer’s chemists, who
may suggest changes to the product formulation. If they do, the whole process needs to be repeated. Sometimes the customer balks at the price or delivery date, and it is up to the sales
engineer to discuss this with the district sales manager to see whether any break on price or
change in delivery date can be negotiated. If the sales manager recommends a new price, the
revised proposal goes back to the Vice President of Sales for approval. If it is a timing problem,
the sales manager takes it up with Production, which can either refuse or agree to changes in
the delivery date but may impose extra costs for doing so. This all then goes back to the sales
engineer, who then goes back to the customer.
Despite the complexity of the custom product process, the company actually makes a much
higher margin of profit on custom products than on off-the-shelf products because there has been increasing competition in OTS products, which has caused prices to be cut to the bone.
For OTS products, production costs (including labour and materials) account for 55 percent of
the final selling price, resulting in a gross margin of 45 percent. For custom products,
production costs amount to 35 percent, leaving a gross margin of 65 percent.
The Production Process
Production for both OTS and custom products is complex, for it uses an array of complex mixing and refracting equipment, much of it computer-controlled. Products are made in
batches of varying sizes, ranging from 10 litres to 50,000 litres. In addition, a wide array of
production processes are used. Production employees require a considerable amount of skill
and experience, and many of them have certificates from technical schools.
The production employees unionized about two years ago and are paid an hourly wage, which
matches the wage levels at other unionized plants but is about 10 percent higher than at two non-union chemical plants that have recently opened. The company has a modest pension
plan and some health and life insurance benefits, but total indirect pay is relatively modest for
the industry, amounting to about 15 percent of total compensation. Tasks have been
subdivided into many different jobs, and pay rates for each job are set by job evaluation. Jobs are defined narrowly and are considered boring by most production workers. Turnover among
production workers is about 20 percent per year, somewhat high for the industry.
Company Size
Overall, the company has about 360 employees, and total compensation runs at about
$27 million per year. There are 100 sales engineers, 160 production employees, 25 chemists
and lab technicians, 40 managers and supervisors, and about 15 other administrative staff. Administrative and technical staff are paid a salary that is based on job evaluation and that is
intended to match the market. Turnover among these employees is about 15 percent per year.
The company does about $60 million of business a year, and earned a before-tax profit of about $7.5 million last year. The company is capitalized at $45 million and is listed on the
Toronto Stock Exchange.
The Problems
Although the company’s financial performance was good in the past, you see several
disturbing signs. Total sales revenue has stagnated over the past three or four years, and
profits have been declining steadily. (They peaked at $12 million three years ago.)
The reduced profits are occurring for two reasons. First, additional competitors have entered
the field for OTS products, driving prices down. Second, the proportion of custom product
sales has declined from about 40 percent to about 25 percent over the past three years. Customers are complaining about slow service and misformulated products. They can now go
to alternative suppliers, whereas several years ago there were virtually no other suppliers. (A
product’s failure to meet customer requirements is very costly for Canada Chemicals, because the entire purchase price must then be refunded and sometimes damages must be paid.
Almost always, the firm loses the customer.)
Problems in Attracting and Retaining Sales Engineers
You believe that some of these problems may have to do with your sales engineers. Sales
engineers have a bachelor’s degree in chemical engineering. When they join the firm, they are
given a two-month intensive course on company products, ways to assess customer needs, and related skills. They are then assigned a territory, under the supervision and guidance of a
senior sales engineer in a nearby territory. Canada is divided into five sales regions, with a
regional sales manager for each region.
Currently, each sales engineer averages about $75,000 in total compensation, approximately
40 percent of which is base pay, 40 percent is commission based on volume of sales, and 20
percent is indirect pay. (Most sales engineers consider the free use of a company car as their most important benefit.) Base pay is $30,000, indirect pay is $15,000, and commissions are 5
percent on gross sales (the average annual sales per sales engineer is $600,000), which results
in an average of $30,000 in performance pay per sales engineer (which of course varies for
each sales engineer, depending on their sales). This system matches industry standards.
However, you perceive problems with the current sales compensation system. First, it is
becoming difficult to attract sales engineers, who are usually hired right from university. Last
year, there were only 160 applicants for the 30 vacancies, and three out of every four job offers
the company made were rejected.
Many of those who refused job offers cited the compensation system as a deterrent. They
indicated that while the average direct compensation of $60,000 plus car sounded okay, and while they were impressed that some sales engineers earned as much as $90,000 in direct pay
(the company has about 10 sales engineers in this league), most were concerned about the
uncertainty of their pay, given that they had high student loans to pay off. They were concerned that pay might be low in the first couple of years (direct pay in the first two years
averaged $45,000 per year) and therefore, most new graduates turned down the firm’s offers.
You are concerned about the high turnover rate of new sales engineers—many are leaving in their first year. In fact, of the 30 you hire each year to fill vacancies, only 10 remain after the
first year. The company also loses about 10 experienced sales engineers each year. Job stress
is often cited as a reason for leaving.
Other Concerns with Sales Engineers
Besides the problems attracting and retaining sales engineers, there are a number of other
concerns regarding the sales engineers. New sales engineers report that senior sales engineers
show very little interest in helping them do their jobs, even though advice and tips from them
would be very valuable. When questioned about this problem by their district managers, the
experienced sales engineers defend themselves vigorously, arguing that the only way they can make enough money is to spend all their time selling and that they have little time to help
anyone else.
Another concern is that most sales engineers seem to be focusing on the OTS products, even though the custom-designed products carry a much higher profit margin for the company.
Sales engineers report that selling custom products is just too time consuming and frustrating,
citing lack of cooperation from the other departments. As one sales engineer put it, “With friends like those [in the Chemistry and Production Departments], who needs enemies? They
don’t seem to understand what it takes to sell a product, and seem to work against me more
than with me. Besides, with prices dropping on the OTS products, I’ve got to pay most of my
attention to moving these products if I want to make a living.”
Finally, high animosity and conflict among the chemists, the production personnel, and the
sales engineers has you very concerned. Production accuses the sales engineers of always trying to cut prices on their products to stimulate sales and accuses the chemists of coming up
with production specifications that are overly complex and that do not meet customer
requirements, resulting in wasted product. The chemists accuse the sales engineers of not taking the time to really find out customers’ needs and turning in poorly defined customer
requests, which often result in the wrong type of product. They view the Production
Department as technically incompetent, fouling up the final product.
The sales engineers accuse the chemists of being too fussy in what they want, too slow to
formulate the product, and too likely to misformulate products. They accuse Production of
overpricing products, being too slow in delivery, and producing poor quality products. Also,
the sales engineers deeply resent top management for leaning on them to sell more custom products, although there is little money in it for them, and for making them scapegoats for the
company’s drop in profitability.
Formulating the New Compensation Strategy at Canada
Chemicals
You believe that most of the problems the firm is facing are due to the poor performance of the
sales engineers. But when you call in the VP of Sales and ask him to explain this poor
performance, he repeats the party line that the problems are not of his making. Rather, they
are caused by the other departments and by the poor quality of sales engineers that the
Human Resources Department is recruiting.
You then march into the Human Resources Department and demand to know why it is failing
to do its job effectively. “If we are matching the market in total compensation, why can’t we find decent sales engineers? Maybe something is wrong with our recruitment and selection
procedures or with our recruiters. Maybe we even need a new head of Human Resources!” But
like everybody else, HR claims that it is not its fault! So you reply, if it is not HR’s fault, whose
fault is it?
After some hesitation, the Human Resources personnel begin to reply. You know what they are
going to say: “We need to pay our sales engineers more money.” More money! Always more
money! Don’t they know our profits are going down? But they reply that there is more to it
than that. It is the whole managerial system. “Aha,” you reply, “so now it’s all my fault!”
But after calming down, you start to realize they are making sense. They talk about how the
organization seemed to function fine when the environment was stable and there were few competitors. But with the increasingly competitive environment, the classical structure just
doesn’t seem to be performing well.
Defining the Required Behaviour
The Human Resources manager explains: “We have a small-batch, intensive technology. We
want our competitive strategy to be more like a prospector than a defender. Most of the task
behaviour that we need requires creativity, high interdependence, and high skill. We require well-educated, highly skilled people who need to collaborate across departments. High
membership, task, and organizational citizenship behaviour are needed. We are a relatively
small organization, so do we really need all the hierarchy and centralized decision making? Shouldn’t we be moving toward a more high-involvement, flexible, collaborative managerial
strategy?”
When they put it that way, you can’t help but agree. So how do you get there? There are many things that need to be changed, but none of them will work unless you also change your
compensation system. To do that, you put together an executive task force, consisting of you,
the manager of Human Resources (just now promoted to VP of Human Resources, reporting
directly to you rather than to the VP of Finance and Administration), and the VPs of Sales,
Chemistry, Production, and Finance and Administration.
First, the task force examines the whole array of rewards—both intrinsic and extrinsic—that
the organization provides. They are depressed by what they find. At the moment, the only
reward perceived by employees as having any value is compensation, and almost nobody is
satisfied with that either. The jobs are seen as boring, promotions are rare and based mainly
on whether top management likes a person, and training is infrequent. The VP of Human Resources suggests that by moving to a high-involvement strategy, the firm could offer many
new intrinsic and extrinsic rewards. But it is also clear that the compensation strategy itself
must also change.
Determining the Compensation Mix
To redesign the sales compensation system, you create a design task force, which includes
you, the VPs of Human Resources and Sales, several regional sales managers, and several sales engineers, especially several younger ones. Its first decision is to create teams of five to eight
sales engineers who will be responsible for sales in a given geographic area. Although each
engineer will have her or his own territory, all will also be expected to help cover the territories
of other team members when they are away or need help.
Using the template illustrated in Figure 6.2, the task force formulates the following sales
compensation strategy. To improve income stability, the new strategy will redistribute pay
between base pay and performance pay, by increasing base pay to 50 percent of
compensation (from 40 percent) and reducing performance pay to 30 percent (from 40
percent). There will also be a major redistribution within performance pay, aimed at improving teamwork. Only 10 percent will now be allocated to individual commissions, and a group
commission plan targeted to comprise about 10 percent of compensation will be introduced.
Under the group commission plan, all members of a sales team will share equally in
commissions based on the total sales of that team.
To encourage more sales of custom products, commissions will now be based half on total
sales volume and half on gross margin. The actual commission rates will be as follows:
individual commissions—0.75 percent of individual volume, 1.45 percent of individual gross margin; group commissions—0.75 percent of sales team volume, 1.45 percent of sales team
gross margin. Thus, total commissions for each sales engineer will be 1.5 percent of volume
and 2.9 percent of gross margin, compared to the previous 5 percent of total volume.
After considering the options, the task force decides to recommend profit sharing for all
employees; this will increase employee interest in the bottom line and create greater cohesion
and cooperation within the firm. The task force also proposes a company stock plan to reinforce this interest. The hope is that these organizational performance pay plans will create
a commonality of goals with the organization and serve as a source of retirement savings,
since most employees regard the current pension plan as inadequate.
The design task force then sets up an employee task force to help design the specific features
of the profit-sharing and stock plans. The union is cautious about participating in this process
but finally agrees to allow two union officials to sit in on these meetings as “observers.” However, they make it clear that this does not necessarily mean they will sign on to any plan
that is developed, especially if they have to give up any direct wages. They also make it clear
that their preference would be to improve the regular, defined benefit pension plan.
The proposed stock plan will allow employees to invest up to 5 percent of their total
compensation in company shares, and the company will match each share one-for-one. If
employees take full advantage of this plan, it will amount to a 5 percent increase in their total
compensation. There will be a minimum one-year holding period for the shares, and
employees will be able to place these shares in an RRSP. This will allow them to deduct their
contributions from income tax; it will also serve as a vehicle for retirement savings.
The profit-sharing plan will pay out in cash every quarter and will be designed to amount to at least 5 percent of pay in a typical year. (One purpose of this plan is to provide a source of funds
to invest in company shares, since many employees have indicated that it would be very
difficult for them to do so out of their current earnings.) Based on projected profits for the coming year, the rate needs to be set at 14 percent of pre-tax profits in order to amount to 5
percent of total compensation. You worry about this, especially when you realize that the
stock plan could cost an equivalent amount if all employees participate, but you agree that
there is no point in doing any of this if it does not make a noticeable difference to employees.
Determining the Compensation Level
To improve its ability to attract and retain top-calibre sales engineers, the company decides to substantially lead the market in total compensation for sales engineers by 20 percent.
However, 10 percent will be provided by the new profit-sharing and stock plans, so half of the
20 percent lead is certainly not guaranteed and will be paid out only if the company succeeds.
This reduces the risk to the company of such a high lead policy.
Evaluating the Proposed Compensation Strategy
The following table shows what the typical sales engineer is projected to earn under the
proposed new compensation system, compared to the average under the current system.
The firm now must assess the impact of the new plan on the company. It will cost at least $1.5
million more in sales compensation annually. Will it be worth it?
Answering that question is not easy and we have to make many assumptions. Table 6.4 illustrates an attempt to generate some projections. The second column represents the
current system as a basis for comparison, while the next two columns provide “best guess”
projections of what might happen in years 1 and 2 under the new sales compensation plan. The same table has columns showing what might happen under pessimistic expectations. (Of
course, we have no guarantee that the past year’s results will be repeated this coming year if
we don’t change anything, but let’s leave that issue aside for now.)
PROJECTIONS FOR YEAR 1 Our first assumption is that total sales volume in year 1 under the
new system will remain constant. This will be the result of two opposing forces. On the one
side is improved employee relations: more cooperation among sales engineers; more training
by senior engineers; better cooperation among sales engineers, chemists, and production; a
higher calibre of sales engineers hired; and lower turnover of new sales engineers—all of which should work to increase sales. But against that, we expect sales engineers to devote more time
to selling custom products, which is more time consuming. In addition, the sales levels of
senior sales engineers may drop somewhat as they spend more time helping junior sales
engineers. And, of course, the new compensation system may result in the loss of some senior
sales engineers, also reducing sales.
These factors will certainly reduce sales of OTS products—but by how much? We are
estimating that the new system should boost the mix of custom products sold in the first year
by 33 percent, from $15,000,000 to $19,950,000, and that sales of OTS product will drop to
$40,050,000, resulting in no net change in sales volume.
These projections will depend on our turnover assumptions. We are assuming that the new pay system will cut the annual turnover of first-year sales engineers from 20 engineers to 10,
and of middle-level sales engineers from 10 to 5. But what about senior sales engineers? Under
the proposed new plan, their compensation will actually drop, since their earnings are currently based mainly on high-volume, low-margin OTS products. Furthermore, part of their
commissions will now be based on the average in their sales team (which is the effect of the
group commissions), which will also bring down their pay.
For example, consider a sales engineer who is currently selling $1,050,000 worth of OTS
product and $150,000 worth of custom product, thereby earning direct compensation of
$90,000 (i.e., 5 percent of $1,200,000 plus $30,000 base pay). Even if that engineer maintains these sales volumes, his or her direct pay will drop to $86,582 under the new plan. But these
sales volumes are unlikely to be maintained, since senior engineers will be expected to shift
their focus to custom products and to spend more time training new sales engineers. As a
result, their income will likely drop more than this.
How will they react to this? Let’s assume the worst—that we lose all ten of our top producing
sales engineers. This will increase turnover to 25 sales engineers in the first year of the new plan and exert a downward push on total sales at least in year 1, until they are replaced by new
sales engineers.
What about other costs? Currently, sales training costs about $7,500 per new engineer, most of
which is the cost of base pay and benefits during the two-month training period. However, this cost will actually go up in year 1 under the new plan, even though we need to train only 25
engineers, rather than 30. This is because base pay and indirect pay will be higher under the
new plan. We may save a little on recruiting costs, which have been running at $6,000 per recruit, but in order to get the new system working, it will need to be explained to all sales
engineers, who will need training for their new roles. Let’s allocate a week to that—the cost of
which will be at least $150,000, probably more.
On the positive side of the ledger, the profitability of sales is expected to go up as more custom
product is sold. If we reach our 33 percent increase target for custom products in year 1 and
have no loss in total volume, gross margin will increase from $30,000,000 to $30,990,000. But after direct sales costs are included, gross margin will actually decrease from $22,095,000 to
$21,390,000. Thus, if all the assumptions work out the way we expect them to, the new
compensation system will decrease profits by about $705,000 in year 1 compared to what they
would have been with no change in the compensation system—not a very promising result.
But wait one minute! We haven’t considered that the new sales compensation may produce
improvements in other areas, such as production costs. Currently, the chemists and production staff are wasting considerable time and effort because the sales engineers are
bringing in sloppy custom orders that have not carefully assessed customer requirements. In
some cases, the result has been unacceptable product, which is also costly.
You believe that production costs can be cut by at least 2 percent in year 1 as a result of
higher-calibre sales engineers, lower turnover, and more motivation to sell custom products.
This would increase the net margin to $21,969,000. That means the firm would almost break even in year 1 of the new compensation system—not bad when you consider that most
organizational changes result in an initial dip in productivity because of the costs and turmoil
involved in getting the new system up and running.
But the sales compensation system is not the only aspect of compensation being changed. We
are also extending profit sharing and stock ownership to everybody (assuming the union signs
on). Beyond the projected cost of the new sales compensation system (which includes the costs of profit-sharing and stock plans), these two plans will cost an additional $1,932,081 to
extend to the other 260 employees. Can we afford this?
Well, we may be able to if we assume that profit sharing and stock ownership will together reduce turnover, improve cooperation among departments, and improve productivity among
the production and administrative employees (we have already included the projected impact
of these plans on the sales engineers). We estimate that this should result in a 5 percent reduction in production costs as well as a 5 percent reduction in administrative costs in year 1.
This slightly outweighs the costs of these two programs, so the net effect of all this will be
virtually no change in profitability in year 1.
But what if we are being too optimistic? Can we really shift attention toward custom products,
with all the extra work that entails, and lose some of our top-producing sales engineers, and
still expect to maintain total sales volume? And what if the productivity increases and cost
savings don’t materialize the way we expect them to? Are we risking the company?
Let’s see what happens when we change some key assumptions to be more pessimistic. This is
what column 4 in Table 6.4 does. We are still assuming that the volume of custom products
will increase to $19,995,000; but we are now assuming that total sales volume will drop by $4,995,000 to $55,050,000. Instead of a 2 percent drop in production costs due to better work
by the sales engineers, we’ll project a 1 percent reduction. Changing these two assumptions
drops sales compensation to $8,688,000 (compared with $9 million in the first projection) but also drops net margin to $19,737,735—a drop of over $2.25 million compared with what it
would be if we carried on with the current system.
But that’s not all! Let’s tone down the productivity and administrative cost savings for the nonsales employees to 3 from 5 percent. All of this results in a reduction of projected profit
from $7.5 million under the current system to just over $4.5 million under the proposed new
system. It won’t put us out of business, but shareholders won’t be happy.
But what if no cost savings at all materialize? We will still make a profit of more than $3 million.
So it doesn’t look as if we are risking the company, even if everything goes wrong. Of course, if
everything does go wrong, you will likely be looking for another job, unless you own enough
shares to control the board of directors!
To sum up the results of all these projections: if all goes well, we gain nothing; if all goes badly,
we suffer reduced profits of nearly $4.5 million. Would you take that deal? Not likely! So far, it
doesn’t seem as if the new compensation strategy would be worth all the trouble and turmoil
it would likely cause. But we were not expecting it to pay off in year 1 anyway. Changes in
behaviour take time, and getting everyone up to speed on the new system won’t happen
overnight. Let’s do some projections for a two-year period. (Luckily, you have this all loaded
on a computer spreadsheet!)
PROJECTIONS FOR YEAR 2 Column 3 in Table 6.4 provides projections for year 2 of the new
system. It assumes that turnover of sales engineers will drop to half the original level, that sales engineers will work together to help one another, and that working with the other
departments will become significantly easier. Total sales are assumed to increase by 5 percent
to $63 million, and 40 percent of that is assumed to be custom products. Although sales compensation by these calculations exceeds $9 million, gross margin after sales costs rises to
$23,708,633. In addition, we expect more experienced sales engineers to be able to provide
better custom proposals and to reduce production costs by 4 percent compared to the current
system. All of this results in a net margin of $24,893,033—a gain of $2.81 million from what
would have happened without the new system.
For the rest of the picture, we expect administrative and overhead costs to rise by 5 percent to accommodate the higher sales volume, but then to be reduced by 7 percent as the impact of
reduced turnover and more committed and cooperative employees becomes significant. For
the same reasons, we expect a 7 percent drop in production costs from pre-implementation levels. The net effect is profitability almost $3 million higher than it would have been without
the new system. This should make shareholders happy, as well as employees (who will also be
shareholders). What’s more, we will have a more flexible, cooperative company that is better
suited for the contextual variables it faces.
But let’s be pessimistic again. Let’s see what happens in year 2 under pessimistic assumptions.
That’s what column 5 in Table 6.4 shows. We are assuming that after the disastrous first year
(shown in column 4), sales volume recovers to the original levels but that custom work stays steady at $19,950,000. Assuming that the improved performance of sales engineers reduces
production costs by 2 percent, the net margin is $22,150,200—virtually identical to what it
would have been with no changes in compensation. Assuming other cost savings of 5 percent, total profit for year 2 amounts to just over $7.5 million, similar to what it would have been
without the new system. Of course, because of the nearly $3 million profit shortfall in year 1
(under the pessimistic projections), we are behind about $3 million over the two years.
Making the Decision
Do we go ahead with the new compensation system? If our expected projections represent
reality, then of course, the answer is “yes.” But there are so many assumptions that could be wrong. How much confidence do we have in our “best-guess” projections? What if the
pessimistic estimates are closer to the truth? Why not just play it safe and stick with the
current system? What would you do?
There is one key assumption we have not examined. For comparison purposes, we have
assumed that if we do nothing, things will stay the same, including our $7.5 million profit. But
is that really a good assumption? Consider that profitability has been dropping by a million
dollars per year for the past three years. Consider all the problems that are emerging. Consider the fact that application of the strategic framework (described in Chapter 2) predicts that the
performance decline will continue because of a mismatch between the contextual variables
and the classical school of management the organization has been practising.
If this is true, then even with the pessimistic projections, the new system looks good. Overall, it appears that the risks of not doing anything are greater than the risks of going ahead. If you
fail to act because you are not completely sure about the consequences of your actions, then
you will never act. In short, whatever your decision, you will lose some sleep over it. But
making decisions like this is the reason you are paid the big bucks!
There are still a few things that you need to do before going ahead. One is to develop goals
and indicators for evaluating your strategy, as will be discussed next. Another is to check the legality of the new plan, even if there seem to be no obvious legal problems with it. If the
position of sales engineer is a primarily male job class, and if you are in a jurisdiction with pay
equity laws, you may have to modify pay levels of some of your female job classes (although this won’t affect many employees in this particular company), since pay is going up for your
male group. However, this adjustment may not be possible until the system has been in place
for a year, since you don’t know whether the pay of sales engineers will actually go up, or by
how much.
Setting Goals for the New Strategy
You’ve decided to go ahead, but you are still aware that this is not a sure thing. You need to design a process for evaluating the success of the new compensation system once it has been
implemented. To do this, you need to develop the specific goals you hope the plan will
achieve, along with performance indicators for evaluating whether these goals are being
achieved. This should enable you to evaluate whether modifications to the compensation plan are needed and identify what those modifications should be. Examples of possible
compensation goals and performance indicators are shown in Table 6.5.
Remaining Tasks
Before the new sales compensation plan is implemented, you need to identify the other
variables in the managerial strategy that must change in order to make the compensation
system work. You may also need to modify the compensation strategy for other employee groups in the firm. Afterwards, the most important tasks will be to develop the
implementation plan, create the necessary infrastructure for operating the new compensation
system, and then manage it on an ongoing basis. Even a sound compensation strategy can be torpedoed by poor implementation and weak ongoing management. These issues are covered
in depth in Chapter 13.
// SUMMARY
After studying this chapter, you should understand the process for building an effective
compensation strategy. Four key understandings form the necessary foundation of knowledge
for compensation strategy formulation—understanding your organization, your people, your compensation options, and your constraints. The first five chapters of this book covered the
first three understandings, while this chapter identified four types of constraints that set the
parameters for compensation strategy—legislative, labour market, product/service market, and financial constraints—and illustrated how understanding them is essential for formulating
the compensation strategy.
Next, you learned about the five main steps in formulating the compensation strategy: (1) define the behaviour that the organization requires; (2) define the role the compensation
system will play in eliciting that behaviour; (3) determine the best mix of compensation
components; (4) determine policies for compensation levels; and (5) evaluate the proposed
strategy against effectiveness criteria. As part of this process, you learned who should be
involved in the compensation strategy formulation process.
Next, you examined some of the issues related to developing compensation strategy for three special employee groups—contingent workers, executives, and international employees.
Finally, you learned how to apply the five steps of the compensation strategy formulation
process by appointing yourself CEO of Canada Chemicals Corporation and working your way
through to a decision on a compensation strategy for the firm.
The remaining three parts of this book focus on how to convert the compensation strategy
from a blueprint into an operational compensation system. Part Three covers the technical
processes for evaluating jobs, evaluating the market, and evaluating individuals. Part Four
discusses the key issues in designing effective performance pay plans and indirect pay plans.
Part Five covers the processes for implementation, ongoing management, evaluation, and
adaptation of the compensation system.
Key Terms
• balance sheet approach to expatriate pay
• contingent workers
• employment standards legislation
• human rights legislation
• hybrid compensation policy
• labour market constraints
• lag compensation-level strategy
• lead compensation policy
• localization approach to expatriate pay
• lump-sum approach to expatriate pay
• match compensation policy
• negotiation approach to expatriate pay
• product/service market constraints
• technical ladder
• trade union legislation
• utility analysis
Discussion Questions Discussion Question 6.1
Review
Managers need to possess four key understandings in order to formulate an effective compensation strategy. Discuss how each understanding contributes to effective compensation strategy formulation.
Your Answer
No answer submitted
Discussion Question 6.2
Review
Discuss the legislated constraints that set the parameters for the compensation strategy.
Your Answer
No answer submitted
Discussion Question 6.3
Review
Discuss and explain the five main steps in the compensation strategy formulation process (Figure 6.1).
Which do you think is the most difficult step? Your Answer
No answer submitted
Steeping some tea...
Steeping some tea...
Discussion Question 6.6
Review
What are the key problems with executive stock options?
Your Answer
No answer submitted
Using the Internet
Using the Internet Question 6.1
Review
How do the employment standards in your province vary from those in other provinces? Go to the Employment and Social Development Canada (ESDC) website, and compare the minimum wages aspect of
employment standards in your province with those of your neighbouring provinces.
Your Answer
No answer submitted
Exercises Exercise Question 6.1
Show Correct Answer
In your role as CEO of Canada Chemicals Corporation (described earlier in the chapter), you have just
finished formulating a new compensation strategy for sales engineers. It occurs to you that given your
movement toward high-involvement management, your firm may also need a new compensation strategy
for production workers, administrative staff, and technical staff. Using a strategic compensation template
similar to that used in Figure 6.2, formulate a compensation strategy for each of these employee groups.
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Exercise Question 6.2
Review
You are a prominent compensation consultant and you have been hired by the board of directors of
Canada Chemicals Corporation to recommend a compensation strategy for the firm’s top executives. In your report, be sure to provide the reasoning for each of your recommendations, along with the
advantages and disadvantages of each recommended compensation element.
Your Answer
No answer submitted
Exercise Question 6.3
Review
Canada Chemicals Corporation has decided to move to a high-involvement managerial strategy and has
hired you as a consultant to implement that process. Aside from the compensation strategy, what other
changes need to be made if this conversion is to succeed? Is there any way to increase the intrinsic and
extrinsic rewards (besides through compensation) provided by the firm? How could this be done? Your Answer
No answer submitted
Case Questions Case Question 6.1
Review
Susan Superfit, CEO in “The Fit Stop Ltd.” case in the Appendix, has hired you to formulate a compensation
strategy for her firm. Using the five-step compensation strategy formulation process (Figure 6.1), formulate
such a strategy, and summarize it using a strategic template similar to that shown in Figure 6.2. Give your rationale for each element of the strategy.
Your Answer
No answer submitted
Case Question 6.2
Review
Using the five-step compensation strategy formulation process (Figure 6.1), formulate a compensation
strategy for production workers in the “Multi-Products Corporation” case in the Appendix and summarize it using a strategic template similar to that shown in Figure 6.2. Justify your recommendations.
Your Answer
No answer submitted
Simulation Cross-Reference
If you are using Strategic Compensation: A Simulation in conjunction with this text, you will
find that the concepts in Chapter 6 are helpful in preparing Sections C and N of the simulation.
// Notes
1. For the latest information on employment standards, including minimum wages, go to
Employment and Social Development Canada (ESDC), Current and Forthcoming Minimum
Hourly Wage Rates for Experienced Adult Workers in Canada, at
http://srv116.services.gc.ca/dimt-wid/sm-mw/rpt1.aspx, accessed September 26, 2016.
2. For more details on the distinction between employees and contractors, go to the Canada
Revenue Agency website, at http://www.cra-arc.gc.ca/E/pub/tg/rc4110, accessed October 19,
2016.
3. David B. Fairey, “Exclusion of Unionized Workers from Employment Standards
Law,” Relations Industrielles/Industrial Relations 64, no. 1 (2009): 112–33.
4. Treasury Board of Canada, at https://www.tbs-sct.gc.ca/psm-fpfm/modernizing -
modernisation/ec-re/psecarpe-lerspres-eng.asp, accessed October 19, 2016.
5. See http://ir.lib.uwo.ca/cgi/viewcontent.cgi?article=1119&context=uwojls, accessed
October 19, 2016.
6. Parbudyal Singh and Naresh Agarwal, “Union Presence and Executive Compensation,” Journal of Labor Research 23, no. 4 (2002): 631–46; Rafeal Gomez and
Konstantinos Tzioumis, “What Do Unions Do to CEO Compensation,” CEP Discussion
Paperno. 720 (2006): 1–31.
7. Stephane Renaud, “Unions, Wages, and Total Compensation in Canada,” Relations
Industrielles/Industrial Relations 53, no. 4 (1998): 710–29.
8. Anil Verma and Tony Fang, “Union Wage Premium,” Perspectives on Labour and
Income 14, no. 4 (2002): 17–23. See also Scott Walsworth and Richard J. Long, “Is the Union
Employment Suppression Effect Diminishing? Further Evidence from Canada,” Relations
industrielles/Industrial Relations 67, no. 4 (2012): 654–80.
9. Richard J. Long and John L. Shields, “Do Unions Affect Pay Methods of Canadian Firms? A
Longitudinal Study,” Relations industrielles/Industrial Relations 64, no. 3 (2009): 442–65.
10. See “Wages, Productivity Fall at Small Firms,” StarPhoenix [Saskatoon], October 4, 1996, D9; and David S. Evans and Linda S. Leighton, “Why Do Smaller Firms Pay Less?” Journal of
Human Resources 24, no. 2 (1989): 299–318.
11. Brian S. Klaas and John A. McClendon, “To Lead, Lag, or Match: Estimating the Financial
Impact of Pay Level Strategies,” Personnel Psychology 49, no. 1 (1996): 121–41.
12. Klaas and McClendon, “To Lead, Lag, or Match.”
13. Isik Zeytinoglu, “Flexible Work Arrangements: An Overview of Developments in Canada,”
in Changing Work Relationships in Industrialized Countries, ed. Isik Zeytinoglu
(Amsterdam: John Benjamins, 1999), 41–58.
14. Sharon Lebrun, “Growing Contract Workforce Hindered by Lack of Rules,” Canadian HR
Reporter, May 19, 1997, 1–2.
15. Zeytinoglu, “Flexible Work Arrangements.”
16. Cynthia Cranford, Leah Vosko and Nancy Zukewich, “Precarious Employment in the
Canadian Labour Market,” Just Labour 3 (2003): 6–23.
17. Aleksandra Sagan, “Precarious Work in Canada Now a White-Collar Problem,” Huffington
Post, March 28, 2016, at http://www.huffingtonpost .ca/2016/03/28/librarians-fight-
precarious-work-s-creep-into-white-collar -jobs_n_9553272.html, accessed September 26,
2016.
18. Statistics Canada, “Full-Time and Part-time Employment,” at
http://www.statcan.gc.ca/tables-tableaux/sum-som/l01/cst01/labor12-eng.htm, accessed
July 31, 2016; Human Resources and Skills Development, at
http://www4.hrsdc.gc.ca/.3ndic.1t.4r@-eng .jsp?iid=13. For earlier data, see Statistics
Canada, Labour Force Survey Statistics, 1996–2000 (Ottawa: 2001).
19. Susan N. Houseman, “New Institute Survey on Flexible Staffing,” Employment
Research 4, no. 1 (1997): 1–4.
20. Isik U. Zeytinolgu and Gordon B. Cooke, “Non-Standard Work and Benefits: Has Anything Changed Since the Wallace Report?” Relations industrielles/Industrial Relations 60, no. 1
(2005): 29–60.
21. Christa L. Wilkin, “‘I Can’t Get No Job Satisfaction’: Meta-Analysis Comparing Permanent and Contingent Workers,” Journal of Organizational Behavior (online, 2012), DOI:10.1002/
job.1790.
22. Sean A. Way, David P. Lepak, Charles H. Fay, and James W. Thacker, “Contingent Workers’ Impact on Standard Employee Withdrawal Behaviors: Does What You Use Them For
Matter?” Human Resource Management 49, no. 1 (2010): 109–38.
23. Chris Tilly, “Dualism in Part-Time Employment,” Relations industrielles/Industrial
Relations 31, no. 2 (1992): 330–47.
24. Anne Bourhis, “Attitudinal and Behavioural Reactions of Permanent and Contingent
Employees,” Proceedings of the Administrative Sciences Association of Canada, Human
Resources Division 17, no. 9 (1996): 23–33.
25. Bourhis, “Attitudinal and Behavioural Reactions.”
26. Katherine Marshall, “Part-Time by Choice,” Perspectives on Labour and Employment 1,
no. 2 (2000): 1.
27. M. Armstrong-Stassen, M.E. Horsburgh, and S.J. Cameron, “The Reactions of Full-Time and
Part-Time Nurses to Restructuring in the Canadian Health Care System,” in Academy of
Management Best Paper Proceedings, ed. D.P. Moore (Dallas, 1994), 96–100.
28. Moshe Krausz, “Effects of Short- and Long-Term Preference for Temporary Work upon
Psychological Outcomes,” International Journal of Manpower 21, no. 8 (2000): 635–47.
29. Bourhis, “Attitudinal and Behavioural Reactions.”
30. Derek Bok, The Cost of Talent (New York: The Free Press, 1993).
31. S. Lohr, “Executive Pay Becomes a ‘Hot-Button’ Issue,” The Globe and Mail, January 22,
1992, B1.
32. Jana Kasperkevic, “America’s Top CEOs Pocket 340 Times More Than Average
Workers,” The Guardian, May 17, 2016, at https://www.theguardian.com/us-
news/2016/may/17/ceo-pay-ratio-average-worker-afl-cio, accessed October 19, 2016; CCPA,
The Pay Clock: CEO vs. Average Pay in Canada, at https://www.policyalternatives.ca/ceo,
accessed October 19, 2016.
33. Christopher Farrell, “Stock Options for All!” Business Week Online, September 20, 2002.
34. Franz Christian Ebert, Raymond Torres, and Konstantinos Papadakis, Executive
Compensation: Trends and Policy Issues (Geneva: International Institute for Labour
Studies, 2008).
35. AFL-CIO, “CEO Paywatch,” at http://www.aflcio.org/Corporate-Watch/Paywatch-2016,
accessed July 31, 2016.
36. Canadian Centre for Policy Alternatives, “The Pay Clock: CEO vs Average Pay in Canada, at
https://www.policyalternatives.ca/ceo, accessed September 26, 2016.
37. John A. Byrne, “How High Can CEO Pay Go: Special Report,” Business Week, April 22,
1996.
38. “50 Best Paid Executives,” Report on Business Magazine, July 2000, 135–36.
39. Hugh Mackenzie, Banner Year for Canada’s CEOs: Record High Pay
Increase (Toronto: Canadian Centre for Policy Alternatives, 2009).
40. Yvan Allaire, Pay for Value: Cutting the Gordian Knot of Executive
Compensation (Montreal: Institute for Governance of Public and Private Organizations, 2012).
41. Luis R. Gomez-Mejia and David Balkin, Compensation, Organizational Strategy, and
Firm Performance (Cincinnati: South-Western, 1992).
42. See Parbudyal Singh and Naresh Agarwal, “Executive Compensation: Examining an Old
Issue from New Perspectives,” Compensation and Benefits Review, March/April, 2003, 48– 54; Parbudyal Singh and Naresh Agarwal, “The Effects of Firm Strategy on Executive
Compensation, Canadian Journal of Administrative Sciences 19, no. 1 (2002): 42–56; Michel
L. Magnan, Sylvie St-Onge, and Linda Thorne, “A Comparative Analysis of the Determinants of Executive Compensation Between Canadian and U.S. Firms,” Relations
industrielles/Industrial Relations 50, no. 2 (1995): 297–319. See also Zhou Xianming, “CEO
Pay, Firm Size, and Corporate Performance: Evidence from Canada,” Canadian Journal of
Economics 33, no. 1 (2000): 213–51.
43. Zhou, “CEO Pay.”
44. See Gordon Wang and Parbudyal Singh, “The Evolution of CEO Compensation over the Organizational Life Cycle: A Contingency Explanation,” Human Resource Management
Review 24, no. 2, (2014): 144–59; Marko Tevio, “The Difference That CEOs Make: An
Assignment Model,” American Economic Review 98, no. 3 (2008): 642–68. See also Magnan
et al., “A Comparative Analysis”; and Zhou, “CEO Pay.”
45. Magnan et al., “A Comparative Analysis.”
46. Gomez-Mejia and Balkin, Compensation.
47. Lucian Bebchuk and Yaniv Grinstein, The Growth of Executive Pay, Discussion Paper
#510 (Cambridge, MA: Harvard Law School, 2005).
48. Graef S. Crystal, In Search of Excess: The Overcompensation of American
Executives (New York: W.W. Norton, 1991).
49. John C. Bogle, “Reflections on CEO Compensation,” Academy of Management
Perspectives 22, no. 2 (2008): 21–25.
50. Katherine Macklem, “Teachers’ Pet Peeves,” Maclean’s, April 30, 2001, 32–33.
51. Canada Pension Plan Investment Board (CPPIB), Proxy Voting Principles and
Guidelines (Toronto: 2003).
52. Janet McFarland, “Executive Compensation: Shareholders Have Their Say,” Globe and
Mail, June 11, 2012.
53. Luis R. Gomez-Mejia, “Executive Compensation: A Reassessment and a Future Research
Agenda,” Research in Personnel and Human Resources Management 12 (1994): 161–222.
54. Gomez-Mejia and Balkin, Compensation.
55. Jennifer Reingold, “Executive Pay: Special Report,” Business Week, April 21, 1997.
56. Louis Lavelle, “Executive Pay,” Business Week, April 16, 2001, 76–80.
57. Louis Lavelle, “Undermining Pay for Performance,” Business Week, January 15, 2001, 70–
71.
58. Neal Batson, Final Report of Neal Batson, Court-Appointed Examiner (New York: U.S.
Bankruptcy Court of New York, 2003), 91.
59. Macklem, “Teachers’ Pet Peeves.”
60. CPPIB, Proxy Voting Principles and Guidelines,15.
61. Allaire, Pay for Value.
62. Recently, Michael C. Jensen, a professor at the Harvard Business School who is regarded as
the “father” of executive stock option plans, has recanted, believing them to damage
corporate performance and shareholder interests. See Claudia C. Deutsch, “An Early Advocate
of Stock Options Debunks Himself,”New York Times Online, April 3, 2005.
63. “Gates Regrets Paying with Stock Options,” CNN Money Online, May 3, 2005.
64. Roger L. Martin, “Taking Stock: If You Want Managers to Act in Their Shareholders’ Best
Interests, Take Away Their Company Stock,” Harvard Business Review 81, no. 1 (2003): 1–19.
65. Roger L. Martin, “The Fundamental Problem with Stock-based Compensation,” Rotman
Management, 2003, 7–9.
66. Jared Harris and Philip Bromiley, “Incentives to Cheat: The Influence of Executive Compensation and Firm Performance on Financial Misrepresentation,” Organization
Science 18, no. 3 (2007): 350–67.
67. Brian J. Hall and Kevin J. Murphy, Stock Options for Undiversified Executives (National
Bureau of Economic Research, 2000).
68. Bogle, “Reflections.”
69. Maria Hassenhuttl and J. Richard Harrison, “Exit or Loyalty: The Effects of Compensation on CEO Turnover,” paper presented at the Academy of Management Conference, Toronto,
2000.
70. Edward E. Lawler, The Ultimate Advantage: Creating the High-Involvement
Organization (San Francisco: Jossey-Bass, 1992), 329.
71. Allaire, Pay for Value.
72. Christelle Tornikoski, “Fostering Expatriate Affective Commitment: A Total Reward Perspective,” Cross Cultural Management: An International Journal 18, no. 2 (2011): 214–
35.
73. See Peter J. Dowling, Marion Festing, Allen D. Engle, and Stefan Groschl, International
Human Resource Management: A Canadian Perspective (Toronto: Nelson Education, 2009); or David E. Tyson, ed., Carswell’s Compensation Guide (Toronto: Thomson Carswell,
2008).
Chapter 7: Evaluating Jobs:
The Job Evaluation Process CHAPTER LEARNING OBJECTIVES
After reading this chapter, you should be able to:
• Explain the purpose of job evaluation and the main steps in the job
evaluation process.
• Understand job analysis and the key steps in that process.
• Prepare useful job descriptions.
• Identify and briefly describe the main methods of job evaluation.
• Describe the key issues in managing the job evaluation process.
• Understand the key reasons for pay equity and the general process for
conforming to pay equity legislation.
HOW DO YOU COMPARE APPLES AND ORANGES?
At a secondary school, how valuable is a school secretary relative to an audiovisual
technician? What about a law clerk and an investigator at a law firm? How about an HR
manager and a service manager at a baked goods manufacturer? How about a health technician compared to a transportation worker at a hospital? Given that the jobs in each of
these pairs differ considerably in the nature of their duties and necessary skills, are we not
trying to compare apples and oranges when we compare the value of each job to the other?
In fact, that is precisely the kind of task that job evaluation is designed to accomplish. In
Ontario, application of a gender-neutral job evaluation system, in conformance with the
procedures applied under pay equity legislation in Ontario, determined that the jobs in each pair are similar in value, despite their other differences and despite the fact that they had
previously been paid significantly differently. As a result of this process, the first job in each
pair (which was held primarily by females) received substantial raises to bring it in line with the pay of the second job in each pair (which was held primarily by males). The secretaries
received a raise of $7,680 per annum, the law clerks received a raise of $4.28 an hour, the HR
managers received an increase of $4.65 an hour, and the health technicians received a raise of
$2.79 an hour.
// Introduction to Effective Job Evaluation
By now, you have formulated a compensation strategy for each of your major employee
groups. This is a milestone on your road to effective compensation. But you don’t yet have a
compensation system. The first six chapters of the book were designed to provide the
foundation and conceptual toolkit for developing a compensation strategy, without being distracted by the technical issues involved in transforming a compensation strategy into an
operational compensation system. The second half of this book turns its attention to how you
can transform your compensation strategy into a successful compensation system.
The four chapters in Part Three of this book describe the technical processes necessary
to measure the value of each job to your organization and, within each job, to measure the
contribution made by each employee. Determining what each employee should be paid is a
function of three key factors: the relative importance of the employee’s job to the
organization, the value placed on that job by the labour market, and the performance of the
employee doing that job.
This chapter and Chapter 8 focus on how to establish the relative value of different jobs to the organization—the job evaluation process—as well as how to apply dollar values to your job
evaluation system. Chapter 9 describes how to collect and interpret relevant labour market
data to determine how the market values the jobs that your organization has. Chapter 10 describes how to evaluate individual employee performance to produce a solid foundation for
a merit pay system.
Following that, Part Four discusses how to design effective performance pay and indirect pay
plans, and Part Five discusses how to successfully implement your compensation system.
Let us now turn to our first order of business for Part Three—job evaluation. In conducting job
evaluation, key objectives are to ensure that all jobs in the organization are compensated equitably and are perceived by organizational members as being compensated equitably.
Effective job evaluation should ensure that jobs are not underpaid—which would make it
difficult to attract qualified employees—and not overpaid—which is important from a cost and
competitive viewpoint. The output of the job evaluation process is a hierarchy of jobs, where
all jobs of a similar value to the organization, however different they may be from one
another, are located at the same level on the jobs hierarchy. This jobs hierarchy provides the
foundation for the development of pay grades and pay ranges.
This chapter covers job analysis, the foundation for all job evaluation systems, and the
different job evaluation methods. The processes and issues involved with conducting and
managing job evaluation, and the necessary steps for conforming to Canadian pay equity legislation, using the Ontario Pay Equity Act as a model, will also be examined. Chapter 8
focuses on how to design and apply the most commonly used job evaluation system—the
point method— and how to convert the results of job evaluation into a base pay structure.
// Job Analysis
A precondition for job evaluation is accurate information about the jobs to be evaluated. The
purpose of job analysis is to obtain this job information, which is usually summarized in the form of a job description. A job description is a summary of the duties, responsibilities, and
reporting relationships that pertain to a particular job. Derived from the job analysis and
description are the job specifications, which are the employee qualifications deemed
necessary to successfully perform the duties the job involves. The qualifications required for a job are sometimes summarized by the acronym KSAOs, which stands for “knowledge,” “skills,”
“abilities,” and “other” characteristics necessary for job performance.
Beyond establishing compensation, job descriptions can serve a wide variety of organizational purposes. These include attracting and selecting employees, developing training programs,
providing guidance to employees and supervisors, developing employee performance
standards, and helping ensure that all necessary organizational activities are being
undertaken and that no important activities are falling between the cracks. As was discussed
in Chapter 4, job descriptions are time consuming to prepare and maintain, especially in
dynamic firms where jobs and task demands change frequently, and they can cause rigidity if
they are defined too narrowly or interpreted too literally.
Nature of Required Information
What information is needed for effective job evaluation? If job descriptions are accurate and
up to date, they may provide all the necessary information for evaluating jobs. However, experience suggests that this is rare, even though many organizations expend considerable
effort on developing job descriptions. As one compensation practitioner puts it:
More time, money, and patience are wasted on job or class descriptions than on any
other aspect of personnel administration. [Yet] in almost twenty-five years of consulting, my firm has never had a client lay claim to an up-to-date and complete set of job descriptions. [Moreover,] job descriptions never contain all the information required to
evaluate jobs for compensation.1
Just why is using job descriptions for job evaluation likely to prove so problematic? First, some
firms are not willing to put in the effort it takes to develop and update job descriptions. But a bigger problem is that in many organizations, especially those in more dynamic environments,
job duties are changing all the time—something that often escapes the notice of the Human
Resources Department. Moreover, as this chapter will show, conducting an effective job analysis is an onerous task, for there are many obstacles to the collection of valid data.
Sometimes, considerable effort is expended yet the resulting job descriptions omit certain
pieces of information that are essential for effective job evaluation.
COMPENSATION NOTEBOOK 7.1
Basic Elements of a Useful Job Description
1. Job title, department or location, reporting relationships, and date
when job analysis was originally completed or updated.
2. A brief statement of job purpose or objectives.
3. A list of the major duties of the job, in order of priority or importance.
Some indication of the proportion of time spent on each duty may be
useful, although this may not be feasible for some jobs. In describing
these duties, be sure to include the tools, equipment, or work aids
that are utilized in performing these duties.
4. An indication of responsibilities for people, results, and organizational
assets, including cash, tools, equipment, and facilities, along with the
spending or budget authorities attached to the job. The consequences
of error or poor performance could also be explained. Included here is
the nature and extent of supervision given and received.
5. The mental and physical effort demanded by the job.
6. The conditions under which the work is performed, including the
quality of the work environment and any hazards or dangers that may
be involved in job performance.
7. A specification of the qualifications needed to perform the job,
including skills, training, education, and abilities, as well as any
certificates or licences required.
Compensation Notebook 7.1 lists the key elements of a useful job
description; Compensation Notebook 7.2 lists some important considerations when
developing job descriptions; and Figure 7.1 shows a detailed example of a job description.
Methods of Job Analysis
If the necessary information to conduct job evaluation does not already exist, how can it be
obtained? This is where job analysis comes in. There are four principal methods of job
analysis: observation, interviews, questionnaires, and functional job analysis. However, the
first three can be conducted only in organizations that already have examples of the jobs that
need to be evaluated. Organizations that are just being created or that are introducing new
jobs must depend on the fourth method, functional job analysis.
The job analysis process can be conducted by HR personnel from the Human Resources Department or by outside consultants. Often, managers and supervisors (as well as the job
incumbents) may do most of the actual work in collecting the job information, but there
always needs to be some central body to ensure consistency of results.
COMPENSATION NOTEBOOK 7.2
Important Points to Remember About Job Descriptions
1. Describe all ongoing aspects of the job. Also include duties or
responsibilities that you are expected to carry out, even if on an
infrequent basis. For example, you prepare a report once every two
months; this report is usually 20 pages or longer, requires statistical
research and analysis, and takes four to six days to prepare.
2. List each job duty and its related tasks, starting with the duties that
take the largest portion of time. A duty is a distinct area of
responsibility; a task is a particular work action performed to
accomplish the duty.
3. Include enough detail about the job. Be clear and concise. For example,
“handles mail” could mean any or all of the following: receiving,
logging, reading, and distributing mail, and locating background
material related to the correspondence and attaching it for the
reader’s information.
4. Show how often, how much, or how long a task or a responsibility takes
to perform.
5. Indicate the approximate amount of working time spent on each major
duty, using percentages, number of hours per day, frequency (daily,
weekly, monthly).
6. Explain technical terms, describing processes and equipment in easy-
to-understand language. Be specific about the degree of responsibility
involved and the equipment, processes, and work aids used.
7. Ask yourself “how” and “why.” This may help you more accurately
describe aspects of the job. Use an alternative task statement format
where there is too much information in a single sentence.
8. Define abilities that had not been previously rated or that are now
being realigned due to changes in the job environment or
requirements.
9. Focus on the facts. Do not overstate or understate duties, knowledge,
skills, abilities, and other characteristics.
10. Avoid general references to personality, interest, intelligence, or
judgment.
11. Avoid use of ambiguous or qualitative words, such as “assist” or
“complex” without providing clarifying examples.
12. Begin each task statement with an action verb in the first-person,
present tense (e.g., write, calibrate, analyze). Use the Glossary of Active
Verbsto help clarify actions and tasks.
13. Exclude duties and responsibilities no longer performed, or any
future requirements, in the description.
14. Exclude skills, education, or experience a staff member has or
may acquire that are not required by the current position.
15. The supervisor may develop a composite position description
representative of a group when two or more individuals hold the same
type of position (e.g., customer service clerks).
16. Employees should not assume responsibilities and authority that
is not theirs. However, supervisors should make clear those
responsibilities that are required.
Source: © Queen’s Printer for Ontario, 2016. Reproduced with permission. This information is
subject to change without notice. The most current version can be found at http://www.payequity.gov.on.ca/en/tools/Pages/guide_info.aspx and
http://www.payequity.gov.on.ca/en/tools/Pages/glossary_verbs.aspx.
Observation
Observation involves watching the employee as the job is performed and noting the kinds of
activities performed, with whom they are performed, and with what tools or equipment. The extreme version of this process is the time-and-motion study (see the discussion of piece rates
in Chapter 5). Observation is mainly useful for jobs in which the activities can be easily
observed and for which the work cycle is short (i.e., all of the important activities of the job can be seen in a short period of observation). For most jobs, observation is useful only as a
supplement to other methods.
Interviews
Interviews can be conducted with a sample of employees, or their supervisors, or both. Interviewing only one or the other of these groups has drawbacks. Interviews with employees
can generate valid information, but the employee perspective on the importance of various
job duties may be different from that of the supervisor. Moreover, if employees know that the job analysis is being conducted for the purpose of job evaluation, it is in their interest to
portray the job in a way that maximizes its value. Interviewing supervisors may produce more
objective information, but supervisors may not be as aware of the realities of the job as the
employees.
So in the interests of accuracy, interviewing both the supervisor and a representative sample
of employees for each job being analyzed is best. (Of course, it may turn out that employees who were seemingly doing the same jobs are actually doing different jobs, and it is important
for the job analysis to be able to pick up this difference so that the jobs can be formally
differentiated.) The main drawback to interviewing so many people is the cost of the time
involved, both for the job analyst and for the interviewees. A structured interview format
reduces the time requirement and provides more consistent information.
Questionnaires
Questionnaires vary on two dimensions. They may be open-ended or closed-ended, and they may be firm-specific or proprietary. An open-ended questionnaire asks the respondent (either
the supervisor or the job incumbent) a series of questions, such as the purpose and main
duties of the job. A closed-ended questionnaire asks the respondent to select from a list the
phrases that best describe the job. To cover the variety of jobs in an organization, the
questionnaire must contain a wide variety of possible duties and activities. Care must be taken to ensure that the questionnaire is both reliable (i.e., that two independent observers would
answer it in the same way) and valid (i.e., that the information collected accurately reflects
reality.)
Because the development of reliable and valid questionnaires is a complex process, many
organizations use proprietary questionnaires developed by outside specialists. Perhaps the
best known is the Position Analysis Questionnaire (PAQ) developed more than 30 years ago by industrial psychologist Ernest J. McCormick.2 The PAQ focuses on the behaviours that make
up a job and utilizes 187 items (called “job elements”) to describe work activities.
There are other standardized instruments. For example, the Management Position
Description Questionnaire (MPDQ) focuses on the task-centred characteristics of managerial
jobs.3 The Executive Position Description Questionnaire (EPDQ) focuses on the behaviours
of senior managers.4 Many consulting firms have developed their own versions of standardized instruments. Some consulting firms are willing to customize their basic instruments when
individual employers have special needs.
Functional Job Analysis
Functional job analysis (FJA) is an attempt to develop generic descriptions of jobs using a
common set of job functions. FJA was pioneered in the United States in the 1930s when the
federal government created the Dictionary of Occupational Titles, which has now been
replaced by a system known as O*Net (with the “O” standing for occupation). A version of this system was used by the Canadian federal government to create the National Occupational
Classification, which includes more than 30,000 descriptions of jobs in 520 occupational
groups.
FJA has been refined over the years. The current system uses a series of task statements that
contain four elements for each job: (1) who performs what, (2) to whom or what, (3) with what
tools, equipment, or processes, (4) to achieve what purpose or outcome. The following is an example for the job of “residential counsellor” in a group home for “wayward youth”: “The
Counsellor (1) records behaviour (2) of group home residents (3) using standardized record
sheets (4) to determine the cause of undesirable behaviours.”5 FJA produces a series of
statements like this one that, taken together, describe the job.
Managers can then analyze these statements to draw conclusions about the nature of the job,
as well as the skills, effort, responsibility, and working conditions associated with it. However, depending on the job, it may be difficult to draw conclusions about all of these factors, such as
working conditions or responsibility. Organizations will have to modify the standard job
descriptions to suit their specific circumstances and the specific responsibilities they plan to
attach to each job.
Identifying Job Families
For administrative purposes (such as recruitment, selection, and training, as well as
compensation), it is often convenient to identify jobs that are related to one another and then to cluster them in “job families.” The key thing relating jobs in a job family is that the level and
type of skill and/or knowledge required for the jobs in that family is quite similar. For example,
a chemical plant may have the following job families for nonmanagerial staff: clerical (clerks, receptionists, secretaries), trades (plumbers, electricians, welders), technical (lab technicians,
instrumentation technicians), operators (production control workers), professionals
(chemists, plant engineers), and maintenance (janitors, cleaners). However, regardless of the number of job families an organization has, it is important that as many job families as
possible be included under the same job evaluation system. As you will see from the opening
vignette in the next chapter, using different job evaluation systems for different job families is
a recipe for inequity.
Unless there is a compelling need to compensate different job families in different ways—for
example, when sales personnel work on commission—jobs should be grouped in such a way
as to minimize, as much as possible, the number of job families. Differentiation of employee groups for compensation purposes should be based on strategic or behavioural
considerations, as discussed in Chapter 6, not simply on job differences. Many organizations
will find that all of their jobs can actually be slotted into eight job families or less: (1) executives, (2) managers, (3) professionals, (4) technical staff, (5) sales staff, (6)
production/operations workers, (7) trades, and (8) support staff. “Executives” includes senior
managers; “managers” includes the remaining managerial staff and supervisors;
“professionals” includes employees with professional designations, such as accountants,
engineers, IT specialists, and human resources professionals; “technical staff” includes lab
technicians, control room operators, and engineering assistants; “sales staff” includes sales representatives and sales engineers; “productions/operations workers” includes production
workers, labourers, and delivery truck drivers; “trades” includes electricians, plumbers, and
mechanics; and “support staff” includes secretaries, clerks, and janitorial staff.
Pitfalls in Job Analysis
There are several possible pitfalls in the job analysis process. The first is the risk of analyzing
the jobholder instead of the job. For example, the jobholder being interviewed may go above
and beyond the call of duty, doing much more than the job calls for. Conversely, some
jobholders may perform only a portion of the intended job duties. But the analysis of the job
should not be unduly influenced by either case.
Another problem is that job descriptions have been subject to gender bias. For example, Kelly claims that “it has been well-documented that job analysts are particularly prone to allow
gender bias to influence their analysis of jobs unless trained to do otherwise.”6 Traditionally,
different language has been applied to duties performed by men and women even though the actual duties may be virtually identical. For example, when men direct the work of employees,
they “manage” these employees; when women do so, they “supervise” employees. These
types of language differences must be avoided. Also, jobs traditionally held by males are often described in technical terms that sound impressive, while female jobs are often described in
simpler, less impressive language, even though the importance and difficulty of the duties are
similar.
Regardless of possible gender bias, technical jargon is an impediment to effective understanding of jobs and needs to be translated into everyday language for the job
description. For example, instead of “calibrates the FP25 flow meter and adjusts circulant flow
commensurate with these calibrations,” try “performs simple tests of the measuring accuracy
of the water meters and adjusts the water flow accordingly.”
But while simplifying the language as much as possible, avoid oversimplifying job duties. For
example, “performs general office duties” would be more informative expressed as follows: “answers incoming telephone calls from clients and redirects to the appropriate information
officer, operates word processing equipment to prepare letters and reports, utilizes
spreadsheet programs to prepare drafts of department budget,” and so on. In the process, it is essential to ensure that both women’s and men’s jobs are described accurately, using simple,
straightforward, precise, and bias-free language. There should also be a check on job titles to
make sure they are gender-neutral.
Another issue has to do with jobs that are dynamic. Job analysis and the information it
produces is useful only as long as the job stays constant.7 When the job changes, this
information may become not only obsolete but also misleading, causing a variety of inappropriate decisions in areas such as recruitment and selection, training, and
compensation. This problem is most likely to occur in high-involvement organizations, since
they tend to operate in the most dynamic environments. To avoid this problem, the updating
of job descriptions needs to be an ongoing process, and supervisors and workers need to be
reminded to report significant changes in job duties as they occur. They may fail to do this,
however, or duties may change gradually and thus go undetected.
// Job Evaluation Methods
Over time, five major methods for job evaluation have evolved: (1) ranking, (2) classification or
grading, (3) factor comparison, (4) statistical/policy capturing, and (5) the point method. In
addition, compensation consulting firms have developed numerous proprietary systems, all of
which use some variation of the five basic methods. For example, the Hay Plan (or Profile
Method), developed many years ago by Hay Associates, combines features of the factor
comparison and point methods and is intended mainly for management and executive jobs.
Kelly provides a thorough description of the Hay Plan, as well as ten other proprietary plans offered by consulting firms operating in Canada.8 However, this chapter focuses on the five
most commonly used generic methods.
These five basic job evaluation plans can be divided into two main categories: “whole job” methods, in which human judgment is the main determinant of the job hierarchy, and
methods that use quantitative factors to establish the job hierarchy. Ranking and
classification/grading are whole job methods; the factor comparison, statistical/policy
capturing, and point methods are quantitative methods.
Ranking/Paired Comparison
Simple ranking is the least complicated system for deriving an ordering of jobs. The ranking
method involves asking a group of “judges” (e.g., managers, human resource specialists) to
examine a set of job descriptions and to rank jobs according to their overall worth to the organization. The specific criteria are left up to each judge, and often these criteria are not
formally identified. Using a group of judges is believed to cancel out individual biases in
ranking.
One variant of this approach is the paired comparison method, in which each job is compared
with every other job, one pair at a time. The number of times each job is ranked above another
job is recorded, and these pair rankings are used as the basis for ranking the entire set of jobs. This method is more systematic than simple ranking; one drawback to it is the very large
number of comparisons that must be made if a large number of jobs are being evaluated.
Once a hierarchy of jobs has been created, new jobs can be added using a method known as
“slotting.” New jobs are compared with the hierarchy of existing jobs and “slotted” into the
most appropriate level.
Although less complex than many other systems, ranking and paired comparison methods
have a number of drawbacks. First, it may be difficult to get the group of judges to agree on
rankings, since the relative importance of each job factor may be weighted differently by each
judge. Second, this method does not establish the relative intervals between jobs. For
example, the ninth-, tenth-, and eleventh-ranked jobs may be quite close in terms of importance, while the eighth-ranked job may be much more important than the ninth. This
method would not recognize that difference.
Perhaps most important, this method provides no explicit basis for explaining why jobs are ranked as they are, which leaves the results of the plan open to charges of inequity. Indeed,
because of its subjectivity, the ranking/paired comparison method is not deemed an
acceptable method for job evaluation for organizations in jurisdictions covered by pay equity legislation. Under pay equity legislation, four categories of factors must be taken into account
when evaluating jobs—skill required, effort, responsibility, and working conditions—and
whole job ranking does not take these factors separately into account.
This problem could be rectified by comparing each job to the others using each of the four
factor categories separately, providing a separate ranking on each factor category. The factors
could then be weighted in terms of importance, and then a composite score could be
developed for each job. However, although this would satisfy pay equity provisions, it would not be useful for firms with large numbers of jobs or where jobs change quickly, since a change
in any job would require a new ranking for each factor category for every job in the system
(although an adapted version may be acceptable, as will be discussed later in the chapter).
Classification/Grading
The classification/grading method establishes and defines general classes of jobs (e.g.,
managerial, professional, technical, clerical) and then creates a series of grade descriptions for each class. Different grades possess different levels of knowledge and skills, complexity of
duties, supervision, and other key characteristics. Organizations compare jobs using these
grade descriptions within the appropriate job class and then select the pay grade that best
matches them. Jobs in the same grade within a given class receive the same remuneration.
Figure 7.2 illustrates a hypothetical classification guide for employees in the
“nonprofessional” job class at an electrical utility. There are five pay grades, each of which would carry a different pay range. Let us assume that we wish to determine the appropriate
salary for the job of computer operator. The job description indicates that some training and
skill are necessary, but tasks are simple, errors are easily detected, and operators work under
direct supervision of the senior computer operator. Which grade would you place this job in?
Did you pick NP-2? This job description appears to match that grade most closely. Pay ranges
(in terms of dollar values) for each pay grade are usually set by identifying the market rates for
typical or “benchmark” jobs in each pay grade. Where employees are unionized, pay ranges
are set through collective bargaining.
The number of job classes used depends largely on the nature of the organization and on the
variety of jobs found. Many organizations that use this system have separate classes for managerial, professional, clerical, and blue-collar jobs. The number of pay grades usually
depends on the skill range and the number of jobs in each job class.
This method has the advantage of being straightforward and inexpensive, besides being flexible enough to encompass a large number of jobs. Since the basis for a particular job rating
is spelled out, the results are easier to defend than those derived by simple ranking. However,
descriptions of pay grades must be general in order to encompass several types of jobs, so there still may be disagreement about the exact grade placement for each job. As well, since
this method considers the job only as a whole, no weighting is applied to different job factors,
some of which may be more important than others.
Depending on the grade descriptions (i.e., on whether they contain the four essential factor
categories required for pay equity) and the breadth of the job classes (the broader, the better),
this method of job evaluation may or may not be acceptable for pay equity purposes. However, this system has historically been very popular with government civil service
organizations.
Factor Comparison Method
Because of its complexity, the factor comparison method is used less often than the other
methods. This method identifies several major factors against which all jobs in a job class can
be assessed and then rates the extent to which each factor is present in each of a large set of
“key jobs” thought to be properly compensated at the present time.
Organizations use statistical analysis (multiple regression) to determine the dollar value of
varying degrees of each factor. Then they rate the remaining jobs for each factor and
determine compensation by applying the dollar values derived by the multiple regression analysis. The use of these factors is what distinguishes this method from the previous two
methods (which are “whole job methods” in that they attempt to compare one whole job
against other whole jobs). Depending on whether the factors conform to the four required
factor categories, this method may be acceptable under pay equity legal requirements.
Statistical/Policy Capturing Method
The statistical/policy capturing method is perhaps the most complicated method of job
evaluation. This method uses questionnaires to gather information about the task elements of
each job to be evaluated, as well as the typical time spent on each task and the relative
importance of each task. Information is also collected regarding the level of skill or education required for each job, and possibly data on the quantity and quality of output expected for
each job. Market data for certain jobs that match well (in terms of job characteristics) with jobs
in the external market are incorporated, and multiple regression analysis is applied to derive a
formula for the value of the different job characteristics. This formula can then be used to
evaluate the jobs that do not have good market matches.
This approach can also be used in conjunction with internal data based on current pay rates to
identify and rectify inequities within current pay structures. Used properly, this method is acceptable under pay equity legislation, as confirmed by a ruling by the Ontario Pay Equity
Hearings Tribunal.9
The Point Method
The point method of job evaluation (sometimes known as the “point-factor method”) is the
most widely used system of job evaluation. This method identifies key job characteristics
(known as “compensable factors”) that differentiate the value of various jobs, weights these factors, and then determines how much of each factor is present in a given job by assigning a
certain number of points to each job for that factor. The point totals are used to create a
hierarchy of jobs. As discussed in the next chapter, this hierarchy of jobs is then transformed into a set of pay grades and pay ranges, based on the market rates of certain key or
benchmark jobs. Because the point method is by far the most commonly used job evaluation
system in Canada and is generally the most appropriate job evaluation method for most
organizations, Chapter 8 is devoted to this method of job evaluation.
// CONDUCTING AND MANAGING THE JOB
EVALUATION PROCESS
There are three main purposes for conducting job evaluation: to control wage costs, to create
an equitable pay structure, and to create perceptions of equitable pay among those covered
by the system. Whether all three of these objectives are achieved depends on the processes used to conduct job evaluations and to manage them on an ongoing basis. Organizations need
to answer five main questions before setting up a job evaluation process: (1) Who conducts the
job evaluations? (2) How should the process be communicated? (3) How should the job evaluation results be applied? (4) What appeal/review mechanisms have been (or need to be)
established? and (5) How should job evaluations be updated?
Who Conducts the Job Evaluations?
Most organizations create a job evaluation committee to oversee the job evaluation process,
although some firms assign the task exclusively to their compensation manager, while others
use outside consultants. When a committee is used, it typically consists of experts in job evaluation (from either inside or outside the company), the compensation manager, and a
representative sample of supervisors from the departments where jobs are being evaluated. In
some cases, rank-and-file employees are included.
In unionized firms, there is usually a joint union–management job evaluation committee, although some unions may prefer not to participate in the process. However, at the least,
there should be continuing two-way communication with the union to try to prevent
misunderstandings.
Employee participation in developing the job evaluation method and carrying out the process
usually leads to greater employee satisfaction with the results. However, this participation
may not be helpful in classical organizations, which often have an adversarial culture and lack common goals. Also, employee participation will not be effective unless the committee
members receive training in job evaluation and understand its goals.
Several conditions are necessary for a job evaluation committee to succeed. First, the parameters and terms of reference for the committee, including its authority, must be spelled
out. This is often vague because top management is unsure how much authority they should
delegate to the committee. This authority question is a common problem for both classical and human relations firms. Second, technical and clerical support resources need to be made
available to the committee. Third, the committee needs training in job evaluation, as well as in
effective group functioning, including areas such as open communication and active
involvement.
Communicating the Job Evaluation Process
A key issue in conducting job evaluation is communicating the process. To foster perceptions
of equity, communication is essential. In general, employees must have an opportunity to understand the job evaluation process and its scope and parameters, including the type of
results that will likely occur. But just as important, the committee members need to know
what will not happen. For example, job evaluation will not be used as a ploy to cut jobs or to
ferret out individual employees with performance deficiencies.
A variety of methods can be used to ensure adequate communication. Of course, if employees
sit on the job evaluation committee, they can serve as a conduit for information to the rest of
the staff. In addition, small group meetings led by a member of the job evaluation committee can help communicate to staff; so can formal written reports and policy documents. Overall, it
is important to establish two-way communications so that employee concerns and questions
can be received and addressed.
A concern for many employers is whether they should reveal the detailed results of job
evaluation to employees or simply present the outcome in terms of which pay grade their job
has been placed in. The answer depends on the nature of the organization as well as on the purposes of the job evaluation. If the organization is a classical one and the main objective is
to develop an internal pay structure that controls labour costs, management will conduct the
job evaluations and not release the detailed results. For these organizations, this is probably
best approach, since the lack of trust and poor relations that often exist would likely lead to
this information being misinterpreted or used in unproductive ways.
But if perceptions of compensation equity are important, as they are in human relations and high-involvement organizations, then more open transmission of information is desirable.
Employees will doubt that the system is fair unless they understand how it works.
Applying Job Evaluation Results
After the new base pay structure has been completed, the pay for some jobs will likely
increase, while the pay for others will likely decrease. How to handle employees whose current
pay is out of line with the new pay ranges for their jobs is an important issue for the future
success and perceived fairness of the new pay structure.
Employees Below the Range
Employees who are currently paid below the new pay ranges for their jobs are referred to as
“green-circled employees,” and they should be moved up to at least the minimum of the pay range for their jobs as soon as possible. (If these employees are experienced and performing
well, they should be moved up well past the minimum, since new employees will be coming in
at that level.) This move would normally be the first priority with the compensation funds that are available. It would be very inequitable for experienced employees to be left below new
employees coming in at the bottom of the new pay range.
Employees Above the Range
A trickier problem is what to do with individuals who are currently being paid above the
maximum of the new pay range for their jobs. The most direct way to address this inequity
would be to reduce their pay to the maximum of the job’s pay range. However, this approach
can cause serious morale problems, since most people regard pay reduction to be unfair if it doesn’t apply to everyone or if it doesn’t seem necessary from an economic point of view. In
this case, opposition to the new pay structure could result.
Moreover, unilateral reduction of employee pay is illegal for unionized employees and for
employees with specific written contracts. And unilateral reduction of pay for other employees
could expose the employer to accusations of “constructive dismissal.” According to this legal concept, an employer who unilaterally worsens an employee’s terms and conditions of
employment is really dismissing that employee. An employee who finds the new terms of
employment unacceptable and terminates his or her employment has grounds for an unjust dismissal suit against the employer. Depending on the employee’s seniority, the nature of the
job, and other factors, court-imposed settlements can be quite costly.
An employer can avoid this by offering severance pay, but this can also be costly (see Chapter 12). The only situations where an employer can avoid paying severance are at the end of fixed-
term contracts or in cases of just-cause dismissal. No severance payment at all is required if it
can be established that the employer had just cause for dismissing an employee. However,
after reviewing recent court cases, some legal experts have concluded that proving “just
cause” is so difficult that an employer will generally be better off just to “pay severance and
get it over with.”10
Pay cuts are also not illegal if they are voluntarily accepted by the affected individuals.
However, there can be no duress—such as threatening to fire or demote the employee if he or
she doesn’t take a pay cut—or constructive dismissal may be charged. When the employee agrees to a pay cut, this is known as “mutual rescission”—that is, both employer and
employee have agreed to end the current employment agreement and negotiate a new one.
Because of these legal issues, a common approach is to “red-circle” individuals who are being
paid above their pay range and freeze their pay at current levels until salary scales catch up
(due to adjustments for inflation). While this works quite well in times of high inflation, it
doesn’t work well in times of low inflation or when pay levels are static. It is particularly
unsatisfactory when there are many red-circled employees and when the firm’s financial viability is at stake. However, there may be no good alternatives. To avoid this problem and
maintain flexibility, some employers are now attempting to free themselves from the
constraints of constructive dismissal law by putting all employees on revolving fixed-term
contracts.
Although employers may feel that they are being more than generous by red-circling rather
than reducing pay, this practice can still cause serious motivational problems for the affected employees. Nobody looks forward to a static income (or a declining one, when inflation is
considered). In addition, there is no potential for financial reward for good performance
during the period it takes for the pay scale to catch up and possibly not even afterward, since most systems do not allow raises for employees who have reached the maximum of their pay
range.
A compromise solution is to continue to grant raises based on performance, but not to adjust the base pay rate for inflation. Of course, this lengthens the period of adjustment, increases
compensation costs, and prolongs inequity. Other employees may start to ask why they
should receive less money than somebody else who is doing the same work. So a better
approach might be to treat red-circled individuals as if they are at the maximum of their pay range and therefore ineligible for merit raises (or scale increases) but still eligible for merit
bonuses.
Other solutions may be available, depending on circumstances. For example, if some red-
circled employees are close to retirement, the problem for them will be resolved when they
retire. It may be desirable to hasten this process by offering early retirement incentives, thus allowing the firm to bring in a new person at the bottom of the pay range. In other cases, it
may be possible to promote the red-circled employee into a job in the next-higher pay grade
or to add temporary duties to their jobs that would justify their current pay level.
Another approach is to examine employee performance levels. Perhaps red-circled employees
who are performing very well can be allowed to maintain their current pay level until inflation
solves the problem, or until they can be promoted to a job in a higher pay grade. Other employees might be offered a buyout severance package; however, deciding who should be
offered buyout packages requires careful consideration of the costs of the buyout. Chapter 12
provides some examples of what these costs might be.
Developing Appeal/Review Mechanisms
One key element of procedural justice is the opportunity for an individual or group to appeal
decisions they believe to be unfair. The logical body to approach first is the job evaluation
committee, which can review its decisions in light of the concerns expressed and any new information the complainant provides. Sometimes the problem is not due to the final decision
itself but rather to misunderstandings about the process used to make the decision. At this
point, effective communication may solve the problem. Of course, it may be that the
complainant is actually correct, and the decision should be changed.
If the complainant does not receive satisfaction at this level, at least one other avenue of
appeal should be available. For unionized employees, the typical recourse is to initiate a grievance. In a non-union firm, it may be appropriate to designate a senior company official
(often the head of Human Resources) to review the matter and make a final decision.
However, overruling the job evaluation committee is not something to be taken lightly, because committee members may interpret such decisions as undermining their authority or
showing a lack of confidence in their decisions. When the committee is often overruled,
committee members will grow increasingly cynical about the role they are playing, and it may
become difficult to find good members willing to serve.
Updating Job Evaluations
At least four events can trigger a need to re-evaluate jobs:
1. The job itself has changed significantly. It is important to have some
procedure for identifying jobs that have changed, because this
information may not always reach those who are tasked with
maintaining the job evaluation system.
2. The organization’s strategy has changed, such that certain behaviours
have become valued more or less highly than in the past.
3. There are signs that the job evaluation system is no longer working
effectively. These signs could include a high level of appeals, or an
inability to fill certain jobs with competent individuals.
4. Legislative conditions require it, such as when new pay equity
legislation is introduced in a given jurisdiction.
Failure to update job evaluations is most likely to occur in organizations that have depended
on outside consultants to develop and implement their job evaluation systems. Once the consultants leave, the tendency is to just forget about the system, especially if the consultants
have not provided internal employees with the expertise to maintain the job evaluation
system. As a part of any consulting contract, the organization should ensure that the consultant trains internal staff so that they have a full understanding of the job evaluation
system and are able to maintain it. Otherwise, provisions will have to be made to retain the
consultant on a continuing basis.
// CONFORMING TO PAY EQUITY
REQUIREMENTS
Up until now, we have described generic job evaluation procedures. Using them
effectively should ensure gender equity. However, given concerns about gender bias in pay in
Canada,11 many Canadian jurisdictions do not want to leave this to chance and have imposed
specific procedures on employers for ensuring pay equity.12 In this final section, we address
the complexities of conforming to specific pay equity requirements—a subject that is not well understood by the general public.13 Although some experts remain to be convinced that
gender bias is a problem, or that pay equity laws are an appropriate solution, many studies
have found that gender bias exists.14 Compensation Today 7.1 provides an example of a
unique approach to researching this issue.
COMPENSATION TODAY 7.1
Would I Be Treated This Way if I Were a Man?
Many female employees have asked themselves this question. In the past, studies purporting
to find gender bias in pay have been criticized on the grounds that any differences found between pay for males and pay for females doing work of a different nature but of “equal
value” have not been able to use proper experimental designs. The best experimental design
is where the key variable of interest (in this case, gender) is changed for some members of the
experimental group but not for others, and the before and after results are compared for each
group of subjects. Obviously, this experimental design is not feasible here.
Or is it? Two researchers have come up with a unique solution to this problem of experimental
design. Their subjects consist of people residing in the United States who did change genders, about half from male to female, and half from female to male. What they found was that the
average earnings of female to male subjects increased slightly, while the pay of male to female
subjects dropped by about a third. While women who became men didn’t gain much, at least
in terms of pay, men who became women lost a lot.
Source: Kristen Schilt and Matthew Wiswall, “Before and After: Gender Transitions, Human
Capital, and Workplace Experiences,” The B.E. Journal of Economic Analysis and Policy 8,
no. 1 (2008): Article 39 (online).
We focus on compliance with the Ontario Pay Equity Act (OPEA) to illustrate the process because Ontario is the largest jurisdiction, because the original Quebec legislation is
patterned after Ontario’s (Quebec recently made changes to the legislation that are different
from Ontario’s approach, including child care policies), and because the OPEA has broad application (i.e., it covers all employers with ten employees or more). In contrast, most of the
other jurisdictions that have pay equity legislation (Manitoba, New Brunswick, Nova Scotia,
Prince Edward Island, Yukon, and the federal jurisdiction) cover only public sector employees.
(The exception is the Northwest Territories, where the legislation applies only to private sector workers.) The Pay Equity Task Force, commissioned by the federal government, concluded in
2004 that the Ontario model should be applied to all employers under federal jurisdiction15;
however, this change has not occurred as yet even though the current federal government has
recently revisited the issue. Recent research has shown that the OPEA has succeeded in
reducing (but not eliminating) the gender wage gap in Ontario.16
Listed below are the main steps in the Ontario process. Each will be discussed in turn.
(Extensive further information is available on the website of the Ontario Pay Equity
Commission.)
1. Determine what rules apply.
2. Identify female and male job classes.
3. Establish a body for conducting the pay equity process
4. Select a gender-neutral job comparison system.
5. Collect job information.
6. Compare jobs.
7. Check for permissible differences.
8. Adjust compensation.
9. Communicate the results.
10. Maintain pay equity.
COMPENSATION TODAY 7.2
The Gender Pay Gap in Canada—it Matters Where You Live!
According to a study by Catalyst Canada, a Toronto-based research organization, Canadian working women are making about $8,000 less a year than men doing equivalent job. This
makes the gender pay gap in Canada twice the global average pay gap, which is around
$4,000. Women’s decisions to take time off to have children or choose jobs that do not lead to
advancement are often blamed for the gap. Alex Johnston, Executive Director of Catalyst Canada, says that the gap exists even when these factors are removed. Citing a recent study
that tracked MBA graduates since 2008, Johnston says that the differences can be seen in the
different opportunities that men and women are offered early in their careers. As a result, even though women comprise nearly half of the Canadian labour force, they made up just 5.3
percent of Canadian CEOs and held just 15.9 percent of board seats in S&P/TSX 60 companies.
Another research project by Canadian Centre for Policy Alternatives shows a ranking of Canadian cities by the gender wage gap. Victoria takes overall top spot in the survey in terms
of success in addressing this issue—it is the only major Canadian city where there are more
women than men on municipal council. Gatineau comes in a close second and while it has the lowest gender wage gap in the country, women can still expect to make only 87 percent of
what men make. Oshawa can be proud of its efforts in getting women into executive seats—44
percent of senior managers are women. On the other side of the ranking, women in Kitchener-
Waterloo face the biggest gender pay gap in the country—earning just 66 percent of what men
do.
Sources: Mary Beach, “Gender Pay Gap More Than Twice Global Average.” The Globe and
Mail, May 5, 2015, http://www.theglobeandmail.com/news/british-columbia/gender-pay-gap-
in-canada-more-than-twice-global-average-study-shows/article24274586, accessed August 14, 2016; Nicola Middlemiss, “Kitchener-Waterloo Worst for Women,” HRM Canada, July 20,
2015, http://www.hrmonline.ca/hr-news/kitchenerwaterloo-worst-for-women-
193358.aspx?keyword=gender pay gap, accessed September 28, 2016.
Determine What Rules Apply
If your organization employs fewer than ten people in Ontario (including part-time
employees), Ontario pay equity laws do not apply. They also do not apply if your organization
is in the federal jurisdiction. Slightly different procedures apply to private sector employers
with 10–99 employees than to employers with 100 or more. The differences relate to the
requirement that the pay equity plan be “posted.” All public sector employers and all private sector employers with 100 or more employees must formalize their pay equity plan in a format
outlined by the OPEA and post it where all employees have easy access to it. Smaller private
sector employers have the option of posting a plan or not posting. Those that do not post it are required to inform any requesting employee of the process that was conducted to achieve
pay equity and the results of this process.
These differences aside, the general process for pay equity is the same for all employers covered by the Act. First, the number of pay equity plans needs to be determined. If the
organization is unionized, it needs one pay equity plan for each bargaining unit in an
establishment, and one for all non-union employees within the same establishment. If the firm is not unionized, there will generally be only one pay equity plan. A single employer may
differentiate employees by geographical region and thus may have two or more
“establishments” within the province. This would entitle the employer to have different pay
equity plans for each establishment.
Identify Female and Male Job Classes
The second step in the pay equity process is to determine whether your organization has any
female job classes within each pay equity plan. A job class is a group of jobs that have similar duties, require similar qualifications, are filled by similar recruitment procedures, and have the
same compensation schedule. Female job classes are those in which (1) at least 60 percent of
employees holding them are women, (2) females have traditionally dominated this job class,
or (3) most people commonly associate the job with female employees.
Thus, you may have no job classes that are 60 percent female, but if you have jobs that are
covered under points (2) or (3), then you still have a female job class. For example, if your
company has two secretaries, one of whom is male, you still must consider “secretary” a female job class. Even if your organization employs just one nurse, who happens to be male,
the “nurse” job class must be considered a female job class.
If your organization has no female job classes, then there is no need to go any further in the pay equity process. But if it does, the next step is to determine whether there are any male job
classes in the same pay equity plan. Male job classes are defined by the same criteria as above,
except that 70 percent is the minimum proportion of male jobholders necessary for a job class to be considered a male job class. If there are no male job classes in that pay equity plan, then
the pay equity process does not apply unless the firm has two or more pay equity plans and
one of those has a male job class, or unless the firm is in the public sector and is allowed to use
the “proxy approach” to job comparison (see later in this chapter). Of course, if the firm later
creates any male job classes, pay equity will then apply.
Establish a Body for Conducting the Pay Equity Process
If pay equity laws do apply, the next step is to carry out the pay equity process. If there is a
bargaining agent, the Act requires that that agent be fully involved in all aspects of the pay
equity process. This is usually done through a joint union–management pay equity committee.
Although not required for non-union employers, it is strongly recommended that employers
also establish a joint employee–management pay equity committee.
The benefits of such a committee were discussed earlier in this chapter in the section on job
evaluation committees. However, it is probably even more important to establish such a committee for the pay equity process. The diverse viewpoints likely to be found among
committee members will help ensure that potential pay inequities are identified. This body
can also serve as a communications mechanism and create more employee confidence in the
process and its results.
This committee should have a mix of employees who hold various jobs throughout the
organization and should include both female and male members if possible. Training in the pay equity process is essential for members. Moreover, it is useful to establish some ground
rules for committee operation, covering issues such as confidentiality, decision-making
processes, and the role of the committee and its members.
Select a Gender-Neutral Job Comparison System
The committee needs to identify and develop a gender-neutral job evaluation system that
allows comparison of job classes in terms of the four required factor groups: skill, effort,
responsibility, and working conditions. The most commonly used system for pay equity is the point method. While the ranking and classification methods can be adapted to meet the
requirements of pay equity laws, these are probably worthwhile only if the organization
already uses them and is happy with them.
Collect Job Information
The next step is to gather information for evaluating the jobs. This is the process of job
analysis described earlier in the chapter. Key here is avoiding gender biases as well as the
pitfalls in the job analysis process that were described earlier.
Compare Jobs
After the information has been collected, the committee applies the job evaluation system to
each job class and develops a job hierarchy (one for each pay equity plan). There are three
main approaches to comparing female and male job classes: job to job, proportional value, or
proxy (only for public sector employers).
Job-to-Job Method
In the job-to-job method, a male job class “comparator” is sought for each female job class.
This comparator male class needs to be similar to the female class by having an equal or
comparable number of points as the female job class, not by job similarities. For example, if the “electrician” job class has a similar point total to the “nurse” job class, then the
“electrician” class can serve as the comparator job class for the nurse class. If there are two or
more male comparator classes similar in point totals to one female class, the appropriate one is the lower paid. (Incidentally, neither the OPEA nor the Pay Equity Commission provides any
guidance on exactly how similar the point totals have to be before the female and male job
classes are considered “equal or comparable.”)
The committee then compares total compensation (including benefits) for the two jobs. If the
male job class (electrician) is receiving higher pay than the female job class (nurse), then pay
inequity may exist and, if so, will need to be corrected.
What if there is no male job class at the same level in the job hierarchy to use as a comparator?
In this case, if the organization has other pay equity plans at other establishments, the other
pay plan(s) should be checked to see if an equivalent male comparator job class can be found there. If not, an attempt should be made to identify male job classes that are of lower value
(according to job evaluation) but that are being paid more than the female job class. If several
male job classes match this criterion, the appropriate comparator is the one with
the highest pay rate. But what if a suitable comparator still cannot be found?
Proportional Value Method
The next course of action is the proportional value method, which was introduced in mid-1993
to deal with the problem of lack of a male comparator, which can occur in the job-to-job method. The proportional value method requires the employer to calculate what a male job
class at the same point in the job hierarchy where the female job is placed
would theoretically pay, based on data only from the other male job classes.
Let’s use a simple example. Suppose that an organization has one female job class (let’s label
it “F1”) and two male job classes (“M1” and “M2”). The job evaluation points and hourly pay
rates (including benefits) for these jobs are as follows:
• M2: 800 points ($24 per hour)
• F1: 600 points ($15 per hour)
• M1: 400 points ($12 an hour)
As can be seen, there is no equivalent male comparator for the female job class, so the job-to-
job method cannot be used. There is a gap in the male job hierarchy at 600 points, but we can use proportional value to fill this gap by examining classes M1 and M2 to see what a male class
evaluated at 600 points would theoretically pay. Job classes M1 and M2 would be plotted on a
graph, a straight line would be drawn that fits these points (very simple in this example, with
just two points), and then 600 points would be read from the graph, which would be $18 per
hour. (In fact, in this example, no complicated calculations are really necessary to show that a
male job midway between 400 and 800 points would pay $18 an hour.)
What we have apparently found is pay inequity, since class F1 is receiving only $15 an
hour. This $3 inequity must be corrected, unless it is found to stem from what are known as “permissible differences.” If the entire difference does result from permissible differences, it is not considered to be a pay inequity, and no pay adjustments are required.
Proxy Comparison Method
What if the proportional value approach doesn’t work either, because there are no male job classes (or only one)? For most organizations, this brings the pay equity process to a halt. But
in what is known as the “broader public sector” (which includes municipal governments,
colleges, hospitals, and the like), the proxy comparison method must then be used. In this
method, the employer must select another public sector employer that has completed pay
equity procedures and collect information on the female job classes in that “proxy”
organization. This information is then subjected to job evaluation, and the proportional value method is used to calibrate the employer’s female job classes. The key issue in this process is,
of course, selection of the proxy employer.
Check for Permissible Differences
Pay differences are not considered pay inequities if they are due to “permissible differences.”
So, what are these permissible differences? In the words of the Ontario Pay Equity
Commission, permissible differences are allowed “where the employer is able to show that the
difference is the result of the following: a formal seniority system, a temporary training or developmental assignment, a merit compensation plan, red-circling, or a temporary skills
shortage.”17 (The “merit compensation plan” must be based on formal criteria and be
communicated to all employees in order to be eligible as a permissible difference.)
Note, however, that the use of a permissible difference does not necessarily exclude a male
job class from being used as a comparator. In some cases, permissible differences will account
for the entire gap between a female job class and a male one; in other cases, however, they
will account for only a portion of the difference. In such cases, the remaining portion must be
addressed.
Besides those reasons cited above, there are two other allowable reasons for a difference
between female and male pay. One is bargaining strength. Under the Act, after “pay equity has
been achieved in an establishment, differences in compensation between a female job class and male job class are permissible if the employer is able to show that the difference is the
result of differences in bargaining strength.”18 But just how does an employer show that?
Neither the OPEA nor the guidelines provided by the Pay Equity Commission offer any guidance on that question, although both emphasize that the onus is on the employer to
prove that an exception based on bargaining strength meets the requirements of the Act. It
appears that this section of the Act has never been used successfully.
The other allowable reason is very rarely encountered. Where an arbitrator or other
tribunal not related to interest arbitration (interest arbitration is used to determine pay and
benefits when the union and management reach an impasse in the bargaining process) raises the pay of a male comparator job class, the employer may select a different male comparator
job class and, if one cannot be found, may use the proportional value method instead. This
provision can be used only after pay equity has been achieved in the first instance, and it may
serve to limit the requirement to maintain pay equity over time.
There is one other possible exception in the pay equity process. An employer (in conjunction
with the bargaining agent, if any) may designate certain jobs as “casual.” Casual jobs do not
fall under the purview of pay equity legislation. However, there are strict limitations on using
this designation. A job cannot be designated as casual when:
• a.the work is performed for at least one-third of the normal work
period that applies to similar full-time work; or
• b.the work is performed on a seasonal basis in the same position for
the same employer; or
• c.the work is performed on a regular and continuing basis, although for
less than one-third of the normal work period that applies to similar
full-time work.
Given these constraints, very few jobs can be classified as “casual.”19
COMPENSATION TODAY 7.3
Negotiating Pay Equity Agreements With Bargaining Agents
Following a pay equity complaint in 2002, Ottawa Public Library (OPL) reached an agreement
with Ottawa-Carleton Public Employees’ Union (CUPE) Local 503 in January 2006 to
implement a pay equity plan. The parties agreed that the City of Ottawa would be the establishment for the purposes of pay equity, and male comparators were chosen from the
City of Ottawa (the City), who were also represented by CUPE Local 503. The pay equity plan
gave retroactive increases to applicable employees, set a 2.25 percent and 2.75 percent increase for 2005 and 2006, respectively, and set out a salary adjustments formula with
respect to the years 2005 and 2006. At the time the agreement was negotiated, the parties
were aware that an interest arbitration was going to determine wage increases for the Inside/Outside Unit male comparators. In March 2006, the interest arbitration awarded the
Inside/Outside unit a 3 percent wage increase in each of 2005 and 2006. A second interim
award released in December 2006 resulted in a further 3 percent wage increase for 2007, and the final award, issued in December 2007, awarded a 3.25 percent wage increase for 2008. The
collective bargaining process involving the CUPE Local 503 and the OPL resulted in lower
negotiated wage increases for the years 2005, 2006, and 2008 than were achieved for the Inside/Outside unit through interest arbitration. Consequently, a pay equity gap was created
between the OPL’s female job classes and the City of Ottawa’s male job class comparators.
The Review Officer’s Order (the directive from the officer assigned by the Pay Equity Commission) determined that the pay equity agreement reached in January 2006 achieved
pay equity, and therefore the OPL was not required to eliminate the gap created by the 2005
and 2006 wage adjustments awarded to the City of Ottawa’s Inside/Outside unit. The union
made an application to dispute that part of the Order. The Review Officer also found that the Library Board failed to maintain pay equity with respect to matching economic increases
awarded to male comparators since 2008 in the Inside/Outside unit with the rates of
compensation of female job classes in the OPL’s bargaining unit. The employer took issue with that conclusion in its application, and the matter was decided by the Pay Equity Tribunal. The
key rulings were:
• a. The Tribunal found that the wording of the agreement of the parties
was not clear and after hearing evidence of the negotiations,
determined that there was no agreement that pay equity was
achieved. Since not all of the adjustments contemplated under the
pay equity plan had been implemented, under the PEA, pay equity is
not achieved until all adjustments owing are paid out. Therefore, the
Tribunal found pay equity was not achieved. Accordingly, the Tribunal
found the agreement was intended to provide a point-in-time
comparator to allow the parties to immediately implement retroactive
payments and left open the possibility of subsequent maintenance
adjustments if the Inside/Outside plan pay rates were subsequently
altered.
• b. With regard to bargaining strength (a defence brought up by OPL and
a “permissible difference” that may be allowed under the Act), since
the Tribunal had determined that pay equity had not been achieved,
the OPL arguably could not rely on this defence [section 8(2)]. The
Tribunal did assess the issue and found that even if the defence was
available, the OPL had not met the burden to demonstrate on a
balance of probabilities that the differences in wages achieved by the
union in 2005, 2006, and 2008 for the Inside/Outside unit as compared
to the OPL unit over the same period were due to a differences in
bargaining strength. The OPL argued the Inside/Outside unit is bigger
(in the sense that it contains far more employees), more diverse in
jobs and services, and has a greater impact on the health and safety of
the citizens of and visitors to the City of Ottawa; the collective
agreement covering the Inside/Outside unit has an interest arbitration
clause whereas the collective agreement applicable to the OPL unit
does not.
What are the take-aways from this story? When negotiating pay equity agreements, be clear as
to the intentions of the parties. In the absence of an agreement, the provisions of the PEA will apply. Pay equity once achieved, must be maintained with rare exceptions as the exemptions
under bargaining strength [s. 8 (2)] will rarely be successful.
Sources: Ottawa Public Library Board v. Ottawa-Carleton Public Employees Union, http://www.canlii.org/en/on/onpeht/doc/2015/2015canlii6950/2015canlii6950.html, accessed
September 28, 2016; Ottawa Citizen, “Ottawa Library Faces $2.3 Million Pay Equity Tab,”
February 11, 2015, http://ottawacitizen.com/news/local-news/ottawa-library-faces-2-3m-pay-
equity-tab, accessed September 28, 2016.
While pay equity must be applied to all except designated “casual” employees, it does not have to be applied to all independent contractors. However, the conditions for this exclusion
are stringent. For example, in a recent case, individuals who provided day care for children in
their own homes were deemed to be employees of an Ontario county (and thus subject to pay
equity provisions); they were not deemed to be independent contractors, as the county had
maintained. The day care providers filed their income tax returns as self-employed persons,
held their own general liability insurance, and purchased most of their own equipment. However, because the county had a rigorous selection process for providers, often had a
lengthy relationship with them, exercised control through its placement procedures, held
regular mandatory orientation and training sessions, made regular inspection visits, and had
established discipline and termination procedures, the Pay Equity Tribunal deemed them to
be employees, not independent contractors.20
Adjust Compensation
The Ontario pay equity legislation does not necessarily require employers to correct the full
extent of pay inequities immediately (although the employer may well decide to do so, if this is within its financial means), as long as the employer has “posted” its pay equity plan.
Essentially, this means that all employees have been provided access to the process that was
conducted in determining pay equity and have received their own personal copy if they have requested it. (New employers coming under the purview of the Act are expected to correct pay
inequities immediately, regardless of whether they post a pay equity plan.)
If an employer has posted a pay equity plan, it must devote at least 1 percent of the previous year’s payroll toward correcting pay inequities. This must then be done every year until all
inequities are corrected. If the 1 percent is not sufficient to correct the inequities, the OPEA
specifies how the available money will be distributed:
• The [inequitable female] job class or classes with the lowest job rate in
the plan must receive a greater adjustment than other [inequitable
female] job classes in the same plan until pay equity is achieved.
• Each female job class must receive an adjustment each year until pay
equity is achieved.
• All positions in a job class will receive the same adjustments in dollar
terms.21
Finally, with regard to employers who are tempted to avoid higher compensation costs, the
Act specifically prohibits the achievement of pay equity through the lowering of pay levels for
male comparator jobs.
Communicate the Results
Once the pay equity plan has been developed, it should be communicated to employees so
that they understand both the process and the results. The only organizations required to post their pay equity plans are public sector employers and private sector employers with 100
or more employees. However, an employer that does not post its plan is obligated under the
Act to disclose both the process undertaken to ensure pay equity and the results of that
process to any employee who asks.
Maintain Pay Equity
Even organizations that have achieved pay equity are not free of their OPEA obligations.
Employers are responsible for actively ensuring that pay equity is maintained over time. Many
changes can occur in an organization that can affect pay equity. These include:
• restructuring within the organization
• certification of a bargaining agent after a deemed-approved plan
changes in the gender of a job class,
• new or vanishing job classes,
• a new male comparator job class for a female job class,
• a change in the value of work performed in a job class,
• a change in compensation system or compensation levels.22
Let us now examine each of these briefly.
Structural or Bargaining Agent Change
Various types of organizational restructuring may trigger a review of pay equity. For example,
when one firm takes over or merges with another, the pay system must be reviewed for equity, looking at all jobs under the new structure. When a new bargaining agent is certified, or an old
bargaining agent is decertified, it will be necessary either to create another pay equity plan or
to merge the previous pay equity plans.
Gender Changes in a Job Class
If the workforce changes such that the percentage of males and females in a particular job
class changes, then this class may change from male to female, from female to male, from one of these to gender-neutral, or from gender-neutral to one of these. However, a change in the
percentage of males and females does not automatically change the gender status of the job
class. For example, if the percentage of secretaries who are female changes from 95 percent to 50 percent, this does not mean that the secretary job class will be reclassified as gender-
neutral. In this case, “secretary” would stay a female job class because historically this has
been a female job and because of the existence of a stereotype that this is a female job.
New Job Classes
Sometimes an employer creates a new job class, which then must be assessed for gender. If it
turns out to be a female job class, then the process described earlier applies, where the job-to- job or proportional value approach must be used to check for inequity. If a new male job class
is created, two questions need to be asked: Should this job be used as a comparator to a
female job class (if the job-to-job method is used)? And does this job affect the value for jobs
established through a proportional value system?
Vanishing Job Classes
Sometimes a job class will vanish. Reasons may include technological change, company restructuring, or the sale or closure of a business or unit. If a female job class vanishes or its
gender changes, “its incumbents must be paid the full amount of their pay equity adjustments
owing up until the date on which the job class disappears.”23
If a male job class vanishes, the implications depend on whether the job-to-job or proportional value method has been used. If the job-to-job method has been used and the vanished male
job class had been used as a comparator, a new comparator must be found. But if the new
comparator is paid less than the female class, compensation for the female class cannot be lowered. If the proportional value method has been used, the usual procedure is to remove
that class from the male job pay line (as discussed earlier in conjunction with the
“proportional value method”) and then to reassess female jobs against the new male pay line. But if the results indicate a lower pay level for the female job class(es), their pay cannot be
reduced from their original pay equity entitlement.
Job Value Changes
Sometimes a male or female job class changes in value, especially if duties or job
requirements change. If the change is significant enough to warrant a change in position in the
job hierarchy (the employer determines this repositioning through its gender-neutral job evaluation process), the pay level needs to be reassessed in the manner described earlier.
Then, depending on whether it is a female or male job, the procedures described above apply.
Compensation Changes
Various changes in the compensation system or compensation levels may have implications
for pay equity. For example, if a male job class comparator receives a compensation increase
greater than that received by the female job class, pay equity is threatened. Even when the female job class and its comparator receive equal percentage increases, if these percentages
apply before the female job has achieved full pay equity, the pay increase actually widens the
pay gap between the male and female jobs. In both these cases, money must be found to reclose these gaps, and this money cannot be deducted from the 1 percent minimum of
annual payroll already dedicated to eliminating pay equity gaps.
Communication About Pay Equity Plan Changes
If any of these changes occur and have pay equity implications, the employer (or, if there is a
bargaining agent, the employer and the bargaining agent) must revise the pay equity plan
accordingly and repost it. The only employers not required to repost changes to their pay equity plan are those employing fewer than 100 employees and those that did not post a plan
originally.
// SUMMARY
The purpose of this chapter has been to start developing your understanding of the key
technical processes necessary to transform the compensation strategy into an operating
compensation system, beginning with the process for evaluating jobs. Not all organizations
will decide to use job evaluation. But for those that do, this chapter has provided the fundamentals of how to develop an effective job evaluation system. It has explained the
process of job analysis, which provides the information (known as a “job description”) that is
the foundation for any effective job evaluation system. It has described various job analysis
methods, and it has outlined some possible pitfalls in the process.
This chapter has provided you with an overview of the main methods for job evaluation:
ranking/paired comparison, classification/grading, factor comparison, statistical/policy
capturing, and the point method. Because it is the most common method, Chapter 8 will be
devoted to the point method.
For job evaluation to be both equitable and seen to be equitable, a process for conducting and
managing job evaluation is crucial. Organizations need to work out procedures for who will conduct the job evaluation, how it will be communicated, how results will be applied, how
procedural justice can be established, and how job evaluations will be updated.
Finally, many jurisdictions have laws pertaining to pay equity, which mandate specific procedures for identifying jobs for which there is gender inequity in pay and for correcting any
inequities thereby detected. Although these laws vary somewhat across jurisdictions, most of
them are patterned after Ontario’s pay equity legislation. Because of this, and because Ontario is the largest single jurisdiction, this chapter has presented you with an overview of the
process for achieving and maintaining pay equity in Ontario.
Key Terms
• classification/grading method
• factor comparison method
• job analysis
• job description
• job specifications
• job-to-job method
• paired comparison method
• permissible differences
• point method
• proportional value method
• proxy comparison method
• ranking method
• statistical/policy capturing method
Discussion Questions
Discussion Question 7.1
Review
Discuss the purpose of job evaluation and the main steps in conducting job evaluation.
Your Answer
No answer submitted
Discussion Question 7.2
Review
Discuss the advantages and disadvantages of job analysis.
Your Answer
No answer submitted
Discussion Question 7.3
Review
Discuss the key issues in managing the job evaluation process.
Your Answer
No answer submitted
Discussion Question 7.4
Review
Discuss the issue of red-circled employees and the way they should be handled. Assume that your current
or most recent employer has developed a new pay structure and that 20 percent of current employees are
above their new maximum pay ranges. How should you deal with this problem?
Your Answer
No answer submitted
Discussion Question 7.5
Review
Discuss the general process for conforming to pay equity legislation. Does legislating pay equity seem like
a good idea to you?
Your Answer
No answer submitted
Using the Internet
Using the Internet Question 7.1
Review
To trace the steps required to create a gender-neutral job evaluation system that complies with Ontario Pay Equity legislation, go to the Pay Equity Office. Your Answer
No answer submitted
Using the Internet Question 7.2
Review
To see how information for job analysis is collected, apply a position analysis questionnaire to your most recent job. To find the form to use, go to the Position Analysis Questionnaire.
Your Answer
No answer submitted
Exercises
Exercise Question 7.1
Review
As individuals at home, complete the “position analysis questionnaire,” as found in the website indicated
at “Using the Internet” Question 2 above, for your most recent job. Then bring the results to class. In small
groups, share your position analysis information, and develop a job description for each job from that information.
Your Answer
No answer submitted
Exercise Question 7.2
Review
In your class, do a quick anonymous survey of the pay of students (in their current or last job). You can do so, for instance, by asking each student to write only his/her gender and pay on a piece of paper without
personal identifiers. Is there a gender pay gap? Discuss your results. If there is a gap, what could be some of
the reasons for it?
Your Answer
No answer submitted
Exercise Question 7.3
Review
Examine the job description presented below. Using the information in Compensation Notebook 7.1, assess whether this is a good job description and what improvements could be made to it.
Your Answer
No answer submitted
Case Question
Case Question 7.1
Review
Examine the job descriptions that are used in the “Eastern Provincial University” case in the Appendix.
What are their strengths and weaknesses? What would you change about them?
Your Answer
No answer submitted
Simulation Cross-Reference
If you are using Strategic Compensation: A Simulation in conjunction with this text, you will
find that the concepts in Chapter 7 are helpful in preparing Sections D, I, and M of the
simulation.
// Notes
1. Ian King, Compensation Administration and Equitable Pay Programs—A Practical
Guide (Toronto: CCH Canadian, 1992), 4.
2. S.M. McPhail, P.R. Jeanneret, E.J. McCormick, and R.C. Mecham, Position Analysis
Questionnaire: Job Analysis Manual (Palo Alto: Consulting Psychologists Press, 1991).
3. W.W. Tornow and P.R. Pinto, “The Development of a Managerial Job Taxonomy: A System
for Describing, Classifying, and Evaluating Executive Positions,” Journal of Applied
Psychology 61 (1976): 410–18.
4. J.K. Hemphill, “Job Descriptions for the Executive,” Harvard Business Review 37 (1954):
55–69.
5. Sidney A. Fine, A.M. Holt, and M.F. Hutchinson, “Functional Job Analysis: How to
Standardize Task Statements,” Methods for Manpower Analysis (Kalamazoo: W.E. Upjohn
Institute for Employment Research, 1974).
6. John G. Kelly, Pay Equity Management (Toronto: CCH Canadian, 1994), 23; see also Nan
Weiner, “Effective Redress of Pay Inequities,” Canadian Public Policy 28 (2002): S101–S115
for a discussion on how job descriptions can be biased.
7. Parbudyal Singh, “Job Analysis for a Changing Workplace,” Human Resource
Management Review 18, no. 2 (2008): 87–99.
8. Kelly, Pay Equity Management.
9. “Policy-Capturing Job Evaluation Methodology Considered,” Focus on Canadian
Employment and Equality Rights 5, no. 28 (2000): 222–23.
10. Howard Levitt, “Pay Severance and Get It Over With!” Financial Post Online, April 25,
2007, online.
11. Pay Equity Task Force, Pay Equity: A New Approach to a Fundamental Right (Ottawa:
Department of Justice, 2004).
12. Tammy Schirle, “The Gender Pay Gap in the Canadian Provinces, 1997–2014,” Canadian
Public Policy41, no 4 (2015): 309–319.
13. Anne Forrest, 2001. “Pay Equity: The State of the Debate,” in Industrial Relations in the
New Millennium: Selected Papers from the XXXVIIth Annual CIRA Conference, ed. Y.
Reshef, C. Bernier, D. Harrisson, and T.H. Wagar, 65–78.
14. Kristen Schilt and Matthew Wiswall, “Before and After: Gender Transitions, Human Capital,
and Workplace Experiences,” B.E. Journal of Economic Analysis and Policy 8, no. 1 (2008):
Article 39 (online).
15. Pay Equity Task Force, Pay Equity.
16. Parbudyal Singh and Ping Peng, “Canada’s Bold Experiment with Pay Equity,” Gender in
Management: An International Journal 25, no. 7 (2010): 570–85.
17. Pay Equity Commission, Maintaining Pay Equity: Using the Job-to-Job and Proportional
Value Comparison Methods (Toronto: Ontario Pay Equity Commission, 1995), 32.
18. Ibid., 33.
19. Ibid.
20. “Home Care Providers Entitled to Pay Equity,” Ontario Pay and Employment Equity
Guide, February 2000, 3.
21. Pay Equity Commission, Step by Step to Pay Equity: A Guide for Small Business, vol. I:
The Workbook (Toronto: Ontario Pay Equity Commission, 1993), 23.
22. Pay Equity Commission, Maintaining Pay Equity, 6.
23. Ibid.
Chapter 8: Evaluating Jobs:
The Point Method of Job
Evaluation CHAPTER LEARNING OBJECTIVES
After reading this chapter, you should be able to:
• Describe the steps in designing a point system of job evaluation.
• Identify the possible pitfalls in designing a point system of job
evaluation.
• Design a base pay structure, including pay grades and pay ranges.
NURSES OR PAINTERS: WHO IS MORE VALUABLE TO A
HOSPITAL?
Who performs work that is more valuable to a hospital, nurses or painters? Intuitively, we
might think nurses. But that is not what the job evaluation system at a U.S. hospital
concluded, and certainly not what their pay scales indicated, as painters were paid
considerably more than nurses at that hospital.
Is this really fair? How could we objectively determine which job is more valuable to a
hospital? Let’s compare the jobs systematically, using the four basic categories of
compensable factors required under pay equity legislation:
• Skill: To perform a nurse’s job requires medical skills (including a
licence and postsecondary training), interpersonal skills, and
communication skills. A painter’s job requires manual dexterity and
the ability to mix paint.
• Effort: A nurse’s job requires some physical effort, such as helping to
lift patients and standing or walking for extended periods of time.
Painters are required to be on their feet constantly, to climb ladders,
and to exercise continuous repetitive movement over the entire
duration of their shift. However, painters do not need to expend much
mental effort, while nurses must continually be alert to monitor
patients’ health and provide correct dosages of medication.
• Responsibility: Nurses are responsible for the health and welfare of
human beings. Painters
are responsible for neatly painted walls and ceilings.
• Working conditions: Working conditions for painters are often smelly,
unpleasant, or dangerous, especially when working at heights, such as
when painting ceilings. Working conditions for nurses may also be
smelly, unpleasant, or dangerous, as when they need to empty
bedpans, clean or bathe patients, clean up pus and vomit, and suffer
the risk of contracting communicable diseases from patients. Other
unpleasant working conditions of the nurse’s job include dealing with
patients in severe pain and their distraught family members, in
addition to discovering dead patients.
This analysis suggests that a nurse’s job should be evaluated more highly than a painter’s job
on all factors except physical effort, and therefore should be paid more, not less. Why didn’t the hospital’s job evaluation system pick this up? Because two separate job evaluation
systems were used—one for nursing staff and one for maintenance staff.
Source: Nan J. Weiner and Morley Gunderson, Pay Equity: Issues, Options, and
Experiences (Toronto: Butterworths, 1990).
// Using The Point Method to Design a Job
Evaluation System
With a properly designed job evaluation (JE) system and base pay structure, inequities such as
those found at this hospital should not occur. The purpose of this chapter is to, first, describe
how to design a job evaluation system using the point method of job evaluation; second,
identify the pitfalls in so doing, so that you can avoid them; and third, show how to develop a
base pay structure.
The point method of job evaluation has many advantages, including its high degree of
precision in measuring jobs. This method can be applied with a high degree of consistency, removing one possible source of employee–management conflict. As well, this system
provides not only an ordering of jobs but also the relative value of each job. This information
allows jobs to be clustered in pay grades more easily, as discussed later in the chapter. It also
helps to establish internal equity through a systematic process of evaluating and ranking jobs
in terms of their value to the organization.
Another potential advantage of the point method is that a large body of knowledge has been
built up about it. Many “ready-made” plans are offered by compensation consulting firms, although using these can be costly and there is no guarantee that the consultant’s system will
be the best fit with the organization. For firms that cannot afford these services, some good
guidebooks are available, as well as Web-based materials.1
There are five main steps in developing a job evaluation system using the point method:
1. Identify key job characteristics (known as “compensable factors”) that
differentiate the value of various jobs.
2. Develop a measuring scale for each factor (a process known as “scaling
the factors”) so that the extent to which each factor is present in a job
can be quantified.
3. Weight each factor according to its importance to the firm. This
produces a system that can be used to provide a point total for each
factor for each job.
4. Apply the job evaluation system to every job included under the JE
system. This generates a point total for each job, which then forms the
basis for a ranked list of all jobs (the “hierarchy of jobs”) included in
the JE system.
5. Test the resulting jobs hierarchy for reliability, validity, and market fit,
and make any necessary revisions to the JE system. (Revisions are
almost always necessary!)
Once the job evaluation system has been finalized, all jobs are scored on the JE system to
derive a final hierarchy of jobs, which then serves as the foundation for the base pay structure
(see later in the chapter). We now discuss each of the job evaluation steps in turn.
Identifying Compensable Factors
Compensable factors can be defined as “those characteristics in the work that the
organization values, that help it pursue its strategy and achieve its objectives.”2 Compensable
factors are based on the work performed, support the strategy and values of the organization,
distinguish between jobs, and are acknowledged as significant by employees. These factors typically include job inputs (such as education, training, or experience), job requirements (e.g.,
mental effort, physical effort, decision making), job outputs (e.g., accuracy of output,
consequences of mistakes), and job conditions (e.g., nature of work environment, hazards that
may be encountered).
The variety of factors that can be used by different organizations is almost limitless, but four
main categories of factors are more or less universal: skill, effort, responsibility, and working
conditions. Every point method system of job evaluation should include representation from each of these factor categories. Under pay equity legislation, organizations are required to use
these four categories in evaluating work.
For example, “skill” might be represented by the factors of “education” and “experience.” “Effort” could be represented by “mental effort” and “physical effort.” “Responsibility” might
be represented by “consequences of errors” and “value of assets utilized.” Working conditions
might be represented by “unpleasantness of work environment” and “hazards to physical
safety.”
Compensation Notebook 8.1 lists some of the specific factors that can be used by
organizations, clustered according to the four factor categories. As the table illustrates, the four categories can include just about any characteristic that an organization might want to
measure. Many factors are generic, while others may be more specific to the firm. A customer-
oriented firm might include “amount of customer contact” as a compensable factor, thus implying that jobs with more customer contact are more important than those with less. A
firm in which innovation and the development of new products and services are important
might include a factor titled “amount of innovative behaviour.” A firm concerned with costs
might have a factor titled “responsibility for cost containment.”
How many factors should be used? There is no simple answer to this question. There must be
enough that they capture all the key aspects of work that are important to the organization,
but not so many that they start to overlap or add very little additional value to the system. In general, the broader the group of jobs to be covered with a single job evaluation system, the
greater the number of factors that will be needed. In recent years, there has been a trend
toward broadening the inclusiveness of job evaluation systems in order to ensure fairness for all employee groups and also in response to pay equity laws. For example, Ontario’s
legislation requires single plans for each union bargaining unit, regardless of whether both
blue-collar and white-collar jobs are included in the unit; if the organization is not unionized,
the law requires that the same job evaluation system cover all jobs at a given establishment.
Overall, it is difficult to see how a valid point system could operate with less than about eight
factors (with at least one from each factor category); however, systems that include more than
a dozen factors may be including marginal factors that add very little to the ability to
differentiate job values.
After the factors have been selected, it is essential to develop a clear definition of each that clearly conveys the meaning of the factor and differentiates it from other factors. If this cannot
be done for a given factor, then that factor should be dropped from the system.
One trend has been for some firms to purposely omit certain traditional factors. For example, many firms have the factor “number of subordinates,” but some firms have started to drop
that factor, for several reasons. One is that an assembly-line supervisor may have 30
subordinates, but these employees are effectively supervised by the technology, whereas the
director of a research project may have four subordinates doing highly complex work for
which constant supervision, coordination, and interaction are essential. Moreover, this factor
implies that managers who expand their staffs will be rewarded, while those who improve
efficiency and cut back their staffs will be penalized. Many firms no longer want to send that
message.
Scaling the Factors
After the compensable factors have been selected and defined, a number of “degrees”
(sometimes called “levels”) are established, resulting in a measurement scale for each factor.
These degrees represent gradations in the extent to which a certain factor is present in a
particular job being rated. For example, it may be decided that there should be five possible
“degrees” or levels for the factor of “consequences of error.” Each degree needs to be carefully
defined and arranged so that degree 2 always contains more of that factor than degree 1, and
so on. Table 8.1 provides examples of factors with their degree definitions.
COMPENSATION NOTEBOOK 8.1
Examples of Commonly Used Compensable Factors
Source: © Queen’s Printer for Ontario, 2009. Reproduced with permission. This information is
subject to change without notice. The most current version can be found at
http://www.payequity.gov.on.ca/en/resources/over_look.php.
How many degrees should be used? The number of degrees for a particular factor depends on
the range of that factor. There is no reason for all factors in a job evaluation system to have the same number of degrees. For example, if relevant education ranges from elementary school to
a university doctorate, then seven or eight degrees might be used. Where the range is from
elementary school to completion of high school, only three or four degrees might be used. But at the same time, “working conditions” might be assigned five degrees, and “experience”
might be assigned seven degrees, depending on the variation in working conditions in the
organization and the variation in experience required by different jobs in the organization.
Weighting the Factors
The compensable factors that have been selected are not likely to be equal in importance to
the firm. To recognize this variation in importance, each factor needs to be weighted according to its relative importance. For example, in one firm, “education” may be viewed as
the most important factor, followed by “experience,” then “customer contact” and “mental
complexity,” with “physical environment” considered the least important factor. If the maximum number of points that any job may receive is arbitrarily set at 1,000, then the
maximum points for education might be set at 350 points, experience at 250 points, customer
contact at 200 points, mental complexity at 150 points, and physical environment 50 points.
These points are then distributed across the degrees that were defined in the previous step.
For example, if “education” has seven degrees, then degree 1 might be assigned 50 points,
degree 2 might be assigned 100 points, and so on, all the way to degree 7, which would be assigned 350 points. However, there is no reason why the point intervals between degrees
should be identical, and it may be appropriate in many instances to vary the point intervals
between degrees.
How are the factor weights derived? There are two methods—statistical analysis and expert judgment (sometimes known as the “a priori” method). Statistical analysis uses a sample of
existing jobs that have already been rated and that are thought to be paid correctly. The
existing pay rate for each of these jobs (or the market rate for each job can be used, if it is different from company pay rates) is also fed into the equation. Multiple regression analysis is
used to determine the role that each factor plays in influencing the pay rate in this sample of
jobs. These weights are then applied to all jobs covered by the job evaluation system.
There are, however, several drawbacks to this approach. One drawback is that it is complex
and not easily understood. Another is that it assumes the current pay structure (or the market
pay structure, if used) for the sample of benchmark or criterion jobs is appropriate and that all other jobs should be aligned with this pay structure. Thus, this approach perpetuates existing
pay practices and may therefore be unacceptable for pay equity purposes.
The other alternative—expert judgment—requires forming a panel or committee of knowledgeable individuals within the organization. These individuals must have a good
understanding of the organization, its strategy, and its needs, as well as an accurate
understanding of the meanings of each factor. Each individual independently derives a set of
factor weightings and brings this set to the committee. If there are major discrepancies, the
reasons need to be identified. For example, one or more of the factor definitions may be
unclear, or different individuals may have different understandings of the types of behaviour
required. The committee members then rework their weightings and repeat this process until
the factor weightings converge.
Once the factors and degrees have been defined and weighted, the committee develops a
summary rating chart, on which they will record the points allocated for each factor for a given job. At the end of the job evaluation process, there will be a filled-in copy of this summary
chart for every job.
Figure 8.1 provides an example of a summary rating chart based on one used by a Canadian
hospital. This rating chart uses ten factors: three from the “skill” category (education,
experience, mental skill), two from the “effort” category (mental effort, physical effort), three from the “responsibility” category (importance of accuracy, patient contact, supervisory
responsibilities), and two from “working conditions” (job hazards, job/work environment).
Eight degrees have been established for education, seven for experience, and five for each of the remaining factors. The maximum total number of points that a job can receive is 1,000,
and the minimum a job can receive is 90 points. The factor weights (as indicated by the
maximum points available for a given factor) range from 210 points (education) to 55 (job/work environment). (Although this example has a round number of points (1,000) as its
maximum, there is no inherent advantage to this. A maximum could just as easily be, say,
1,140 points, and that wouldn’t affect the quality of the job evaluation system.)
Applying the Job Evaluation System
After the job evaluation system has been established, it is applied to all the jobs covered by
that system. Then a “hierarchy of jobs” is generated. A good way to summarize the results of
the job evaluation, and the resulting hierarchy of jobs, is by developing a table similar to Table
8.2. This table incorporates the results for a hypothetical set of hospital jobs, based on the job evaluation results taken from the summary rating charts shown in Figure 8.1. Of course, in
rating these jobs, evaluators are working with the actual factor and degree definitions, which
are not shown in Figure 8.1, and applying them to each job description. However, as an example, for the factor of education, the factor and degree definitions shown in Table 8.1 were
used.
What does the hierarchy of jobs in Table 8.2 tell us? First, among this sample of hospital jobs
(normally all hospital jobs would be included rather than just some of them), the most
valuable job to the organization is head of surgery, while the least valuable job is grounds
worker. According to the job evaluation system, the job of head of surgery is about 5.5 times more valuable to the hospital than the job of grounds worker. (This is determined by dividing
the point total for the job of head of surgery by the point total for the job of grounds worker.)
This also implies that the head of surgery job should be paid about 5.5 times as much as the
grounds worker job.
You will also notice that the job of ward nurse is worth more than twice as much (2.5 times) to
the hospital than the job of painter, which answers our question in the opening vignette. In
fact, in this sample of hospital jobs, only the grounds worker job is less valuable to the hospital
than the painter job.
Are there any pay relationships that surprise you? Some may be surprised that the
janitor/cleaner job is actually more valuable to the hospital than many other jobs, such as pharmacist’s assistant or accounting clerk. We can examine this unusual result by looking at
the factor scores. A relatively low level of education is required for the janitor/cleaner job, yet
it scores high on the factors of physical effort, job hazards, and job/work environment (meaning it has an undesirable work environment). Besides being exposed to infectious
patients, cleaners must deal with and properly dispose of many dangerous substances, such
as highly infectious body fluids, pus, blood, and vomit, and they must be meticulous in their
cleaning to render all surfaces sterile and germ-free. How well they succeed can directly affect
the health of patients and other staff. So we would expect the job of janitor/cleaner to be
valued more by a hospital than by, say, a corporate office.
Testing the Job Evaluation System
We should not yet assume that the relationships presented in Table 8.2, or that the underlying
job evaluation system on which they are based, are valid. A long process must be completed
before we have reasonable assurance that the job evaluation system has validity.
Testing for Reliability
How do we know that the job evaluation system we have developed is actually a true measure
of relative job values? The first test of the system is its reliability. Reliability is the extent to which a measuring instrument consistently produces the same results when repeatedly
applied to the same circumstances, whether by the same or different persons. In other words,
does the job evaluation system produce the same point scores for each factor for a given job,
for every evaluator who applies the system?
For example, if one person applies the job evaluation system to a nurse’s job and gets point
scores of 125 for mental skill, 80 for mental effort, and 40 for physical effort, while a different person who independently applies the job evaluation to the nurse’s job gets point scores of 65,
100, and 50 for the same factors, then the system may not be reliable. Using an unreliable job
evaluation system is the same as using an elastic tape measure to measure distance. This
problem must be identified and fixed before proceeding any further.
Thus, the first step in testing is for the job evaluation system to be applied independently by a
variety of raters to the same set of jobs and then to compare the results. (Incidentally, the best
way of applying the system is for each rater to evaluate all jobs on the first factor, then all on the second factor, and so on; this encourages consistent treatment of each factor.) If
discrepancies across raters are discovered, the precise nature of the problem needs to be
identified. The problem could lie in the factor definitions, which may not be sufficiently clear, or in the degree definitions, or in the job information (i.e., the job descriptions) on which the
evaluators are basing their ratings, which may not contain sufficient information for accurate
rating.
By comparing the results of the different evaluators on the different factors, it is possible to identify whether certain factors are problematic. For example, if the evaluators seem to agree
fairly closely on how most factors should be rated for most jobs but there is a lot of
discrepancy for, say, “mental effort,” then there may be a problem with this factor. If there seem to be one or two jobs where the evaluators are diverging on most factors, then there
could be a problem with the job descriptions for these jobs. Other potential pitfalls in
designing and applying a point method job evaluation system are discussed in more detail
later in the chapter.
Once the problems have been identified and corrected, the system should be applied again by
a different set of independent raters. If discrepancies remain, they must be dealt with, and the process must be repeated until consistency is achieved. There is absolutely no point in going
further in testing the system if reliability has not first been achieved.
Testing for Market Fit
Once reliability has been achieved, it is necessary to calibrate the system to the market, so
that JE points can be related to dollars. Calibrating to the market provides yet another test of
the system. The organization selects a number of “key” or “benchmark” jobs, each of which has a good match ("amarket comparator job”) in a set of valid market data. These benchmark
jobs should be selected so that there is a spread across the range of job evaluation points.
That is, some jobs with a high point total should be selected, some with a low point total, and
some that fall in between. Including at least some jobs that are strongly related to the nature of the business and that represent sizable numbers of employees is also desirable. The normal
practice is to use about 10–15 percent of the total number of jobs to be evaluated.
In the case of the hospital example in Table 8.2, a reasonable choice of benchmark jobs might
be head of surgery, director of nursing, registered nurse, medical lab technician,
janitor/cleaner, admitting clerk, and grounds worker. However, the choice of benchmark jobs
also must be made in the context of the availability of good market data for the jobs chosen. So now we need a set of compensation survey data that will include as many of our jobs as
possible. (Chapter 9 discusses how to find such a database; for now, we will assume we have
one.)
When using compensation survey data, job evaluators need to specify the geographic location
to which these data refer. In our case, let us assume that the hospital is in Toronto. We
therefore select the Toronto area as our geographic area for the compensation data. After
examining our database, we discover that there are suitable matches for the head of surgery, director of nursing, and grounds worker jobs, based on comparing the job descriptions of our
benchmark jobs to the market comparator jobs. So we still need a high-point-total and a low-
point-total job. For the high-point job, “cardiologist” is available in the data set and for the
low-point job, “painter” has a good match. Let’s assume that “cardiologist” is a reasonable comparator for our “thoracic surgeon” job, and to have a more representation from the high-
point jobs, we add “staff physician,” assuming that “family practitioner” is a good match. To
balance that, we add “nurse’s aide,” for which the “nurse assistant” seems a good match.
We now go into the database and identify the average total compensation for our market
comparator jobs. Table 8.3 summarizes the results of this process.
We now plot each benchmark job on a graph, with its job evaluation point score on the
horizontal axis and the compensation value (in dollars) for its market comparator job on the
vertical axis. A spreadsheet program (such as Microsoft Excel) is then used to calculate and
produce a straight regression line that best “fits” the pattern of plots on the graph. Figure
8.2 shows the resulting market line, including the plots for our nine benchmark jobs. If we are planning to either lead or lag the market, we need to adjust the market line upward or
downward by the percentage lead or lag to create our pay policy line, which serves as the
foundation of our base pay structure. If we are planning to match the market, then our market line simply becomes our pay policy line. In this example, let’s assume that we are planning to
match the market, so Figure 8.2 also becomes our pay policy line.
Note that a “match the market” strategy does not imply that every one of our jobs will actually match the market. Some jobs may be above the market and some may be below, but the
average results overall will approximately match the market. To determine what the average
annual compensation would be for any job under the new job evaluation system, draw a vertical line up from the horizontal axis (at the JE point score for the job you are pricing) until it
intersects the pay policy line. Draw a horizontal line from there to the vertical axis, and the
amount indicated is the pay for the job.
A more precise way to calculate proposed pay for a given job is to use the equation for the
regression (market/pay policy) line that is generated by the computer, which is in
the y = mx + b format, where “y” is the dollar value of the job, “m” is the slope of the
market/pay policy line, “x” is the JE points total for that job, and “b” is a constant (the constant “b” could be a minus or a plus, depending on where the regression line intercepts the
vertical axis). For the hospital example, the equation is y = 203.6 × x – 224,645. Therefore, the
annual pay of a job with 810 points (the thoracic surgeon) would be 203.6 × 810 – 24,645, which
equals $140,271.
As it calculates the regression (market) line, the spreadsheet program also calculates
a correlation coefficient (sometimes called a “regression coefficient”) that summarizes the
extent to which the plots on the graph approach a straight line. A correlation coefficient can
range from +1 to -1. Either +1 or -1 occur when all the plots happen to fall in a perfectly straight line (this virtually never happens); +1 indicates a positive relationship between job evaluation
points and pay rates, and -1 indicates a negative or inverse relationship between job
evaluation points and pay rates. An inverse relationship would mean that pay is lower for jobs with higher job evaluation points. Needless to say, you should never have a minus sign in front
of your coefficient!
The coefficient indicates the “goodness of fit” between the point values established by job
evaluation and the pay rates ascertained from the market. Obviously, a coefficient that
approaches zero is bad, because this says that there is little or no relationship between the
value of jobs as determined by job evaluation and the value of jobs as determined by the
market. If you were to stick with your job evaluation system with a low coefficient, you would find that you were paying far more than you need to for some jobs and not enough to attract
employees to others.
So then, the closer the coefficient is to 1, the better? Not necessarily. Some differences from the market line may well be justifiable if a job is more (or less) important to your organization
than it is to the typical organization, or if you are using a different compensation strategy from
your comparator firms. There is no hard and fast rule about exactly what the coefficient should be. But it certainly should be closer to 1 than to 0, and anything less than 0.80 needs to be
carefully examined.
Another aspect to examine is the slope of your regression line. If it is too steep then you may end up compensating jobs at the top end of your system too much and jobs at the bottom end
too little. A steep slope often means there is not enough spread in job evaluation point scores
between the lower value jobs and the higher value jobs. On the other hand, if the slope is too flat, you may be compensating jobs at the bottom too much and jobs at the top too little. One
final aspect is the average height of the pay policy line on the vertical (dollar) axis. If it is too
high, you may end up paying all jobs too much; if it is too low, you may end up paying all jobs
too little.
Exploring Solutions to Job Evaluation Problems
How do you decide what needs to be modified in your system if you have a coefficient
problem, a slope problem, or a height problem? The first thing to do is check that your benchmark jobs are equivalent to the market comparator jobs in the market you have
matched them with. (For example, the thoracic surgeon/cardiologist match may be
questionable for our hospital sample, as might the staff physician/family practitioner match.) Compare the job descriptions carefully. You should also re-examine your market sample: Are
the other organizations in your market sample really appropriate comparators? (This topic is
discussed further in the next chapter.)
If you are satisfied with these comparisons, then you could examine the “outlier jobs”—those
that have the farthest vertical distance from the market line—to determine why they are
discrepant. Have they been badly evaluated (e.g., their point total is incorrect, because the job evaluation system was applied poorly to that job), or are there problems with the job
evaluation system itself (e.g., some factors have been weighted too heavily or too lightly)?
Have the wrong factors been included in the job evaluation system, or has a key factor been omitted? There is no formula to find the right answer—it requires judgment based on studying
the pattern of results. However, you must avoid the temptation to simply adjust the JE points
of the outlier jobs so that the correlation coefficient looks better. This will not solve underlying
problems in your JE system, and will cause more problems later on.
In our hospital example, the correlation coefficient is .87, which is acceptable. Now let us
examine the outliers. You can tell which job each plot represents by looking at the JE point
totals. For example, working from the left, the first plot is the “painter” job (it has the lowest JE point total of the benchmark jobs, 195 points), the second is the “admitting clerk” job, and so
on. The extent to which a job is an outlier is indicated by the vertical distance that its plot is
from the regression line, either above or below the line. As you can see, the greatest outlier is
the “thoracic surgeon,” which has a difference of about $51,000 ($191,346 -$140,271). What this result means is that while the market is paying a thoracic surgeon an average annual total
compensation of about $191,000 (assuming the “cardiologist” job is actually a good match for
“thoracic surgeon”), we are proposing to pay thoracic surgeons about $140,000. Given that
difference, will we be able to attract the thoracic surgeons we need?
The next largest outlier is the “head ward nurse” job, which we are proposing to pay nearly
$44,000 above the market (the difference between $112,785 and $69,043). While we won’t have any trouble attracting and retaining head nurses, can we really afford to pay so much
above the market for this job? Similarly, we would pay registered nurses about $28,000 above
the market, and $8,800 above the market for nurse’s aides. The proposed pay for the staff
physician, medical lab tech, and janitor/cleaner jobs appear to be pretty close to the market,
but we are proposing to pay the admitting clerk nearly $14,000 below the market, and the
painter about $18,000 below the market, a level that might not even meet minimum wage standards. Although we didn’t include the grounds worker job as one of the benchmarks,
given that the grounds worker job has fewer JE points than the painter, we would almost
certainly be in violation of minimum wage laws for the grounds worker job.
These results suggest that we need to re-examine our job evaluation system. First, we need to
check the basics—that we have a valid market sample of comparator firms, that we have made
a good choice of benchmark jobs, and that we have valid market comparator jobs for each
benchmark job. For the market sample, the Salary Expert website unfortunately does not provide any information about the nature of its sample, nor does it allow us to structure the
market sample by including only appropriate market comparator firms. But let us assume that
the market sample is fine, as well as the benchmark job matches.
At this point, our main concern is the outliers. If we proceed from here, some jobs will be paid
much less than the market, while some will be paid much more than the market. If our
objective is to be in line with the market, then we don’t need to create a job evaluation
system—we could have just used a market pricing system.
So the relevant question is whether these discrepancies are too large. It would seem that they
are, so we need to examine our job evaluation system to see what is causing this problem. Since our system does seem to pay staff physicians at the market but thoracic surgeons
significantly less than the market, it appears that a specialization within medicine makes a big
difference in pay. Maybe we need to increase the point difference between degrees 7 and 8 on our education factor. Or maybe we need another factor that differentiates better between the
two jobs.
As for the “overpayment” of nursing staff, it may be that certain factors that they score high on are too heavily weighted, or maybe we need more degrees on these factors. As for
“underpayment” of admitting clerks and painters, what factors are pulling them down? Are
these factors weighted too heavily? Are the factors pulling them up not weighted heavily
enough, or do we need to include an additional factor that captures the nature of the work better? Or has the market simply been overcompensating these jobs relative to the value of
the work? Unfortunately, there is no formula to use in answering all of these questions; it is a
matter of judgment and trial and error. This helps explain why job evaluation systems that are
designed from the ground up can take years to develop.
Finally, any changes we make to the job evaluation system create a need to re-evaluate all
jobs in the JE system, not just those jobs appearing to cause problems for us.
Testing for Total Compensation Costs
Testing for what total compensation costs would be under the proposed compensation system is also useful. Pay policy graphs can be used to estimate the total compensation of the
proposed system. For example, the rate for each job, as established by the pay policy line, can
be multiplied by the number of people holding that job; we can then derive an estimate of the total compensation that would be payable under the proposed job evaluation. For an ongoing
organization, this can then be compared with the current compensation cost.
It can then be determined whether the organization can afford this amount. If not, changes
must be made to the pay level strategy, the job evaluation system, or other aspects of the pay structure. For example, if the JE system results in most jobs receiving high point totals,
perhaps the system may not be differentiating adequately between jobs of lower and higher
value.
It is also conceivable that the new plan will result in a reduction in the current payroll costs.
While this may seem desirable to the employer, too large a reduction can cause perceptions of
inequity among employees, which may create a higher turnover rate, particularly among the
most marketable employees. Moreover, a job evaluation system that reduces the pay of most
employees is not likely to be well accepted, especially the next time around. There may be
many appeals of the results, and many employees may devote great effort to getting their jobs
re-evaluated. Chapter 13 discusses all these issues in more detail.
// Possible Pitfalls of The Point Method of
Job Evaluation
Although point method plans have many advantages, there are also drawbacks. Besides the
complexity of developing them, perhaps the biggest drawback is that although point method plans may appear scientific, the process of selecting relevant factors and applying particular
weights is still subjective. There are many opportunities for errors to enter the system,
perhaps even destroying its validity, despite the efforts that are devoted to developing and
maintaining the system.
Four main categories of pitfalls need to be avoided in developing a point method job
evaluation plan: (1) inconsistent construct formation, (2) factor overlaps, (3) hierarchical grounding, and (4) gender bias.3 Each of these will now be examined, along with some
additional pitfalls that fall outside these categories. A thorough understanding of these pitfalls
is the best defence against them.
Inconsistent Construct Formation
In a point system of job evaluation, carefully established compensable factors are the key to
success. Each factor must be based on a separate and well-defined construct. Factors may fail
to meet this test in three areas: (1) the factor itself may be ambiguously defined, so that it is not clear to the evaluator what the factor is meant to pick up; (2) the degree or level definitions
may not be consistent with the factor definition; and (3) the definitions for each degree or level
may not all be degrees of the same construct.
Ambiguous Factor Definitions
Some factors may be designed in such a way that they are actually tapping multiple
constructs. For example, consider the following definition of “complexity of duties”:
Complexity of Duties: This factor measures the complexity of duties involved, the degree
of independent action, the extent to which the duties are circumscribed by standard practice, the exercise of judgment and the type of decisions made, the amount of resourcefulness and planning the job requires, the creative effort in devising new methods, policies, procedures or products, scientific discoveries, and original
application.4
Notice how this example contains numerous factors. If they are all important, they need to be
turned into separate factors. (And, if some of these are not important, they should be
dropped.) At least four separate factors could be extracted from this factor definition:
independent action/ circumscribed duties, resourcefulness, planning, and creative effort.
Inconsistent Factor and Degree Definitions
In some cases, the statements defining the different degrees of a given factor are actually measuring something other than the factor to which they ostensibly apply. Let’s consider the
following example for the factor of “analytical ability”:
Analytical Ability: This factor measures the extent to which analytical ability is required to
perform job duties. Analytical ability is the ability to examine information and data, to detect patterns, explanations, and causes of various phenomena, using a variety of analytical tools and procedures.
Degree 1: Little necessity for creativity in performance of job duties.
Degree 2: New ideas and approaches to job duties occasionally needed. Degree 3: Frequent need to develop new approaches to job duties. Degree 4: Continually must use creativity in performing job duties.
Notice how these degree statements focus on creativity and innovation in performing job
duties, which is not necessarily the same as analytical ability. For example, accountants may analyze financial statements to identify potential company problems, but this does not
necessarily call for creative ability. On the other hand, a graphic artist in charge of developing
new company logos may need considerable creativity but does not really use analytical tools
and procedures in performing this job.
Inconsistent Degree Statements
In a variation of the above problem, sometimes different degree statements are actually measuring different constructs, and only some of the statements are actually focusing on the
factor they are supposed to measure. Consider the following example for the factor of
“supervisory responsibility”:
Supervisory Responsibility: This factor deals with the extent of responsibility for
managing employees and overseeing their day-to-day work.
Degree 1: No supervisory responsibilities.
Degree 2: Responsible for supervision of one to three subordinates. Degree 3: Responsible for supervision of four to nine subordinates. Degree 4: Responsible for supervision of 10 or more subordinates. Degree 5: Responsible for development of all department policies.
Which one of these is not like the others? Clearly, the statement for degree 5 is focusing on a different construct than the other degrees. For example, it may be possible to be responsible
for development of department policy with very few or even no employees.
Factor Overlaps
One problem that often occurs in point systems is overlapping factors. If this does occur, then
some factors are counted twice and thus are being too heavily weighted. This sometimes occurs because factor titles sound different even though their descriptions are actually very
similar. For example, consider the factors of “judgment” and “freedom to act”:
Judgment: This factor deals with the extent to which the exercise of independent
judgment is required in the performance of job duties.
Degree 1: Prescribed directions and rules limit the scope for independent judgment.
Degree 2: Standardized work routines limit the scope for independent judgment. Degree 3: Similar procedures and methods limit the scope for independent judgment.
Freedom to Act: This factor deals with the extent to which incumbents of this job are free
to act as they see fit in performing their job duties.
Degree 1: Duties are routine and specifically delineated; work is closely controlled.
Degree 2: Duties are somewhat routine and clearly delineated; work is closely controlled. Degree 3: Characteristics of the position are such that activities and methods are clearly
defined, and/or work is frequently reviewed.5
Note how these factors are virtually indistinguishable.
Hierarchical Grounding
The purpose of the point method of job evaluation is to derive a hierarchy of jobs by
examining the individual components (“factors”) in those jobs. However, some factors in some
systems “appear to confuse the outcome with the process. That is, they say if this job is at a
high level in the [organization] hierarchy, then it should be highly rated. This is circular
reasoning.”6 For example, take the factor of “responsibility for action”:
Responsibility for Action: This factor deals with the extent to which the jobholder is
expected to take independent action in addressing and solving managerial problems, and the importance of taking this action.
Degree 1: Reports to the section supervisor.
Degree 2: Reports to the department manager. Degree 3: Reports to the division manager. Degree 4: Reports to the vice president. Degree 5: Reports to the president.
Notice how the degree definitions copy the existing organization hierarchy, by assuming that
the higher the job is in the hierarchy, the more responsibility for action it has. Thus, the job
evaluation system is not actually deriving an independent hierarchy of jobs, which is the real goal of job evaluation. There is a strong tendency for jobs higher in the organizational hier-
archy to pay more, and this example illustrates how inequity can arise as a result. What these
degree statements are really saying is that no one who reports to a section supervisor has any
responsibility to take action, when this may not be true at all for many jobs.
Gender Bias
Gender bias occurs when a job receives a higher or lower evaluation than it should because
the job incumbents are predominantly from one gender. A job evaluation system that is
thought to have gender bias can be very costly for a company, as Bell Canada and Qualcomm
Technologies found out; see Compensation Today 8.1.
So, what should you watch out for? There are at least six ways in which gender bias can arise in
job evaluation:7
• Separate job families have been delineated.
• A factor is valued when it is found in “male jobs” but not when it is
found in “female jobs.”8
• Job content is confused with stereotypes of inherent female attributes.
• Factors found in female jobs are ignored.
• There is an insufficient range of degree statements.
• The job descriptions are biased.9
Some researchers have found that insufficient training of raters can introduce unreliability and
bias into the job evaluation process if raters fall back on unconscious stereotypes that have
contributed to gender-based inequities in the past.10 Let’s examine each of these problems.
COMPENSATION TODAY 8.1
Alleged Gender Bias Costs Companies
In 1992, citing allegations of gender bias in Bell Canada’s job evaluation system, the union
representing Bell operators, the Communications, Energy, and Paperworkers’ Union of
Canada (CEP), lodged a complaint on behalf of its members with the Canadian Human Rights Commission (the body that is relevant to employers in the federal jurisdiction). The union’s
argument was that the operators (who were mostly female) were underpaid relative to the
male employees of Bell Canada.
Bell Canada vehemently disagreed, and fought the suit tenaciously, right up to the Supreme
Court of Canada, which ultimately rejected Bell’s arguments. To settle the suit, the parties
agreed to go through a mediation process, recommended by the Canadian Human Rights Commission. In 2006, after 14 years of litigation, Bell and the CEP agreed to a settlement of a
little over $104 million, to be divided among the 4,766 Bell operators included in the suit.
In a more recent case, technology giant Qualcomm Technologies agreed to settle a case for
$19.5 million brought against it by several female employees. The looming lawsuit alleged that
Qualcomm discriminated against women by paying them less and denying them the same opportunities as men. The case, settled before the lawsuit was formally filed, argued that
women in science, technology, engineering, and math (STEM) positions at Qualcomm were
not paid the same as men and had fewer promotion opportunities because of the firm’s male- dominated culture. Furthermore, the case claimed that women hold less than 15 percent of
senior management positions, and with mostly male managers doing the performance
evaluations, women were disadvantaged. According to the claims, the company also rewarded a culture of working late and being available 24/7, which made working mothers
and caregivers less competitive for promotions. As part of the agreement, Qualcomm agreed
to implement policy changes and programs, including those related to pay and promotion, for women in STEM. Qualcomm also agreed to retain two independent consultants to make policy
recommendations for an equitable workplace.
Sources: Madeline Farber, “Qualcomm Is Paying Almost $20m After Claims It Didn’t Pay Women Equally,” Fortune, July 27, 2016, at http://fortune.com/2016/07/27/qualcomm-
settlement-equal-pay, accessed September 28, 2016; Mike Freeman, “Qualcomm Enters
$19.5m Gender Bias Settlement,” San Diego Tribune, July 26, 2016, at http://www.startribune.com/qualcomm-to-pay-19-5m-to-settle-gender-discrimination-
suit/388297111, accessed September 9, 2016; Lucy Hook, “Tech Giant Pays $25M to Settle
Gender Discrimination Lawsuit,” HRM Canada, 29 July 2016, at http://www.hrmonline.ca/hr-
news/tech-giant-pays-25m-to-settle-gender-discrimination-lawsuit-211250.aspx, accessed August 2, 2016; Andree Cote and Julie Lassonde, Status Report on Pay Equity in
Canada (Ottawa: National Association of Women and the Law, 2007), at www.nawl.ca.
Separate Job Evaluation Systems for Different Job Families
In the past, each job family in an organization was evaluated under a different job evaluation
system. This can defeat the purpose of job evaluation, which is to generate a hierarchy of jobs within the organization using a common measure of job value. It can also cause gender bias.
Even when jobs are evaluated fairly within job families or classes, they may not be evaluated
fairly between job classes if separate job families are used for male and female jobs. The
opening vignette described how nurses were shortchanged by this practice. This is why the
same system of job evaluation should cover all job families that are subject to job evaluation.
In many Canadian jurisdictions, this is required by law.
Differential Valuation of Factors
One example of how factors can be valued differently is “visibility of dirt.” Jobs carried out
under dirty working conditions, such as mechanic or garbage collector, have typically been rated more highly on working conditions (i.e., they are deemed to have worse working
conditions) than jobs performed in seemingly “clean” working conditions, such as in hospitals
or hotels. However, working conditions in hospitals and hotels may not be as “clean” as they
appear, especially from the perspective of those employees, such as nurses or maids, whose
job it is to create and maintain those “clean” working conditions. Conditions may be clean by
the time nurses or maids complete their shift, but that is because of the dirt and mess they
handled during their shift!
Another example of this type of inequity comes from a municipality in the United States,
where the hazards of entering people’s homes (e.g., being bitten by a dog, or being assaulted by a resident) were factored into job evaluations for meter readers (who were male) but not
for public health nurses (who were female). Yet both had to enter people’s homes as a part of
their responsibilities.11
Confusing Job Content with Stereotypes
Certain jobs traditionally held by women are often viewed as “low-skill” jobs because the
ability to do these jobs is considered “inherent to women.” For example, in the U.S. Department of Labor’s Directory of Occupational Titles, “dog pound attendant” was once
ranked higher than “child care worker.” When this inequity was questioned, the response
given was that dog pound attendants were more highly rated because dog care skills were more difficult to acquire than child care skills.12 The argument was that any skills needed to
work with young children were inherent in women and therefore did not deserve to be highly
rated. Of course, anybody who has actually worked with small children knows that considerable skill is necessary to be effective, and that people (both female and male) vary
greatly in these skills.
COMPENSATION NOTEBOOK 8.2
Frequently Overlooked Factors in "Female Jobs"
Skill
• Analytical reasoning
• Operating and maintaining several different types of office and
manufacturing equipment
• Manual dexterity required for giving injections, typing, graphic arts
• Writing correspondence for others, proofreading and editing others’
work
• Establishing and maintaining manual and automated filing systems,
records management and disposal
• Training and orienting new staff
• Dispensing medication to patients
• Special body co-ordination or expert use of fingers and hands
• Reading forms
• Providing personal services such as arranging vacations, handling
household accounts
• Using a variety of computer software and database formats
• Creating documents
• Communicating with upset, irate, or irrational people
• Handling complaints
• Innovating—developing new procedures, solutions or products
• Coordinating a variety of responsibilities other than “other staff or
people”
• Developing or coordinating work schedules for others
• Deciding the content and format of reports and presentations
Effort—Mental and Physical
• Adjusting to rapid changes in office or plant technology
• Concentrating for prolonged periods at computer terminals, lab
benches and manufacturing equipment
• Performing complex sequences of hand-eye coordination
• Providing service to several people or departments, working under
many simultaneous deadlines
• Frequent lifting (e.g., office supplies, retail goods, lifting or turning sick
or injured adults or children)
• Heavy lifting (e.g., packing goods for shipment)
• Frequent lifting and bending (e.g., child care work)
• Long periods of travel and/or isolation
• Sitting for long periods of time at workstation, (e.g., while keyboarding)
• Irregular and/or multiple work demands
Responsibility
• Planning, problem solving, setting objectives and goals
• Caring for patients, children, institutionalized people
• Protecting confidentiality
• Acting on behalf of absent supervisors
• Representing the workplace through communications with clients and
the public
• Supervising staff
• Shouldering responsibility for consequences of error in the workplace
• Preventing possible damage to equipment or people
• Managing petty cash
• Training and orienting new employees
• Keeping public areas such as waiting rooms and offices organized
• Handling new or unexpected situations
• Contacts with others—internally, externally
Working Conditions
• Stress from open office noise, crowded conditions
• Exposure to disease and stress from caring for ill people; or physical or
verbal abuse from irrational clients or patients
• Cleaning offices, stores, machinery, hospital wards
• Exposure to and disposal of body fluids
• Exposure to communicable diseases
• Exposure to dirt from office machines and supplies
• Exposure to eye strain from computer terminals
• Adjusting to a variety of working environments continuously
Source: © Queen’s Printer for Ontario, 2009. Reproduced with permission. This information is
subject to change without notice. The most current version can be found at
http://www.payequity.gov.on.ca/en/resources/over_look.php.
Ignoring Factors Found in “Female Jobs”
In a major study of job evaluation instruments, researchers found that although hundreds of factors had been included in those systems, many factors relevant to jobs usually performed
by women had been omitted. For example, under “effort,” there were rarely factors for
“involuntary interruptions” (as many secretaries must cope with) or for “dealing with upset
people” (as complaints clerks at department stores and nurses at hospitals must do).13
Some researchers have noted that the whole area of “emotional labour” has seldom been
adequately incorporated into job evaluation plans.14 One aspect of emotional labour is dealing with people and groups who are angry, distrustful, upset, unreasonable, psychologically
impaired, or under the influence of drugs or alcohol—conditions that nurses and social
workers must contend with every day. Another aspect of emotional labour is the need to stay cheerful, courteous, friendly, and helpful, even in adverse circumstances, as is the case in
many service-oriented jobs. Compensation Notebook 8.2 lists a whole range of frequently
omitted factors in jobs typically held by women.
Insufficient Range of Degrees
Once a job evaluation system has all the factors necessary to accurately assess the full range
of jobs, the final concern is to ensure that there is sufficient range among the degrees to make
appropriate distinctions between jobs. Weiner15 cites the following example for “working
conditions”:
Working Conditions: This factor deals with the physical conditions under which the job is
normally performed.
Degree 1: Standard office conditions.
Degree 2: Inside work with possible exposure to dirt, oil, noise. Degree 3: Some exposure to disagreeable conditions, such as fumes, cold, dust. Degree 4: Constant exposure to disagreeable conditions. Continuous outside work.
This example illustrates several problems. For example, “standard office conditions” does not
distinguish between spacious private offices and offices that may be crowded, noisy, and hot,
with frequent interruptions and distractions. Also, outside work (traditionally male) is assumed to be the most onerous. Is this always true? In some occupations, workers (e.g.,
gardeners, painters) are outside only during relatively pleasant conditions. Should outside
work always be considered more onerous than working in a crowded, hot, noisy office, with
constant interruptions?
Biased Job Descriptions
Finally, even when the job evaluation system itself is fair and free of bias, one possible source of bias remains—the information on which the job evaluation is based. As discussed in Chapter
7, there is evidence that descriptions of jobs traditionally performed by women have been
subject to bias during job analysis. A dramatic case of this occurred in 2012, when the federal
government agreed to a $150 million settlement with public health nurses following an investigation by the Canadian Human Rights Tribunal.16 Here, the job descriptions had resulted
in nurses being classified as “administrative and clerical staff” rather than as “health
professionals.”
Other Pitfalls of Job Evaluation
Chapter 4 discussed the pros and cons of job evaluation systems in some depth. Job
evaluation is subject to a few other pitfalls besides the ones described there. As with job analysis, there is a tendency to evaluate the jobholder rather than the job itself.17 For example,
evaluators might think to themselves: “This is Joe’s job. Joe really doesn’t seem to work very
hard anymore. Therefore, his job does not deserve a high rating.” Joe’s performance is irrelevant when a job evaluation is being conducted; it is the importance of his job that we are
evaluating, but it is easy to lose sight of that distinction.
Another pitfall develops when job evaluation becomes an adversarial process and a source of
conflict between employees and management. But the biggest pitfall is that job evaluations
may fall out of date quickly, so that continually updating them requires a commitment of time and effort. Yet if they are not updated, they can become a source of inequity rather than a
source of employee satisfaction.
When a job does change substantially in duties, and when the revised point total for the job warrants it, there should be a prompt reclassification from one grade to the next. But even
here, it is possible for inequity to creep in. For example, a U.S. study found that more powerful
departments in an organization were more likely to have their requests for reclassifications approved than were less powerful departments.18 Obviously, such tendencies must be avoided
if the system is to be fair.
// Determining The Base Pay Structure
Whichever method of job evaluation has been used, by now the organization has created a
hierarchy of jobs. But there is still no pay structure. A base pay structure normally consists of
pay grades and pay ranges, along with the criteria for salary movement within the pay range. A pay grade is a grouping of jobs of similar value (although not necessarily of a similar nature)
to the organization, based on similar point totals.A pay grade is always defined in terms of
points (e.g., Pay Grade 1 consists of all jobs that have point totals from 100–200 points, Pay Grade 2 consists of all jobs that have point totals from 201–300 points, and so on). A pay
range provides the actual minimum and maximum pay rate, in dollar terms, for all of the jobs
that fall into a particular pay grade. The pay rates are influenced by market pay, which we will
further review in Chapter 9.
Establishing Pay Grades
In establishing a base pay structure, a fundamental question is whether to use pay grades. If
the answer is “yes,” as it is for most firms, the number of pay grades must be decided, as well
as the size of the pay grades.
Why Use Pay Grades?
Why have pay grades at all? Why not pay each job a different rate, based on what the pay policy graph indicates? There are five main reasons for clustering jobs into pay grades. First,
the use of grades recognizes that job evaluation is essentially a subjective process, no matter
which method is used, and that it makes little sense to try to make very fine distinctions between jobs. Second, pay grades make it easier to justify and explain pay rates to employees.
If employees notice someone earning more money in a job that resembles their own, they may
perceive inequity.
Third, pay grades simplify the administration of the pay system by eliminating the need for
separate rates and pay ranges for every job. Fourth, having jobs clustered within pay grades
makes it easier for employees to move across jobs in the same pay grade. Fifth, pay grades
create more stability for the pay system. For example, if a job changes, but not substantially,
there is likely no need to re-evaluate, unless the job is right at the boundary between two pay
grades.
On the downside, pay grades do create problems relating to jobs on the margins of each
grade. Employees with jobs on the borderline between two grades will naturally push to have their jobs placed in the higher grade. But if this is done, then the next-lower job becomes the
marginal job. No one wants his or her job to be the first one not included in the higher grade.
How Many Pay Grades?
How many pay grades should there be? One consideration is the total range of pay of the jobs
covered by the particular job evaluation system. If the jobs in the same pay structure range
from $20,000 to $300,000 per year, there is much greater scope for pay grades than if the jobs range from $25,000 to $75,000. Another consideration is the width of the pay ranges to be
used. If pay ranges are narrow, then the only way for an employee to significantly increase his
or her pay is through promotion to a job in the next-higher pay grade. So to provide opportunities for promotion to jobs in higher pay grades, it may be desirable to have many pay
grades. Of course, the number of pay grades will be in inverse proportion to the size of the pay
grades—the more pay grades, the smaller the size of the pay grades.
Establishing Pay Grade Sizes
A key question is how to establish the pay grade widths and boundaries. In some cases, these
are arbitrary. For example, suppose that job evaluation points in a particular pay structure can
be as low as 100 points or as high as 1,000 points and that the organization has decided to have nine pay grades. Dividing the possible range of points (which is 900) by nine yields pay
grades of 100 points in width. Thus, Pay Grade 1 is 100–200 points, Pay Grade 2 is 201–300
points, and so on. This is known as the equal interval approach.
A major problem with the equal interval approach is that it tends to bunch too many jobs
together in the lower pay grades that should not necessarily be in the same pay grade; yet at
the same time, it has too many relatively small pay grades at the top of the pay system. Two methods for addressing this issue are the equal increase approach and the equal percentage
approach. Based on the notion that jobs in higher pay grades are more complex, the width of
each pay grade increases by either a constant number of points from the previous grade or a
constant percentage from the previous grade. Compensation Notebook 8.3 gives examples
of how to calculate each of these approaches.
Another approach is to consider the possibility of error in the system. For example, what would be the point difference for a job if it were consistently evaluated one degree higher or
one degree lower than it should be? Assume that this would result in a 200-point
overevaluation or underevaluation. Then 200 points could be used as the width of the pay grades, the logic being that no job would then be more than one pay grade higher or lower
than it should be. However, one expert recommends dividing this maximum error by three, on
the assumption that in reality, two-thirds of the degree errors would cancel out.19
During the 1990s, many companies reduced the number of pay grades in their compensation
systems, thereby creating large or “fat” grades. This process, known as broadbanding, enjoyed
some popularity because of the flexibility it provided. However, the fewer the pay grades (sometimes known as “bands” under this system), the less meaning job evaluation results
have, for jobs with very different point totals may end up in the same band and thus receive
similar pay. Moreover, broad pay grades open the door to inconsistency across departments and to the possibility of pay being determined by factors such as favouritism. And, broadbands
also create a bigger distinction between the pay rate of a job that just makes it into a particular
pay band, and a job that just falls short, ending up in the next-lower pay band. As these
problems have become more apparent, the popularity of broadbanding has faded.
COMPENSATION NOTEBOOK 8.3
Calculating Pay Grade Widths Using The Equal Increase And Equal Percentage
Approaches
As an example of how you would calculate pay grade widths using the equal increase
approach, assume that you have decided to use nine pay grades (as in the text example) and that the minimum points possible in your job evaluation system is 100 and the maximum
possible is 1,000. To apply the equal increase approach, you need to first arbitrarily set the
width of your first pay grade. To give an indication of what this should be, first divide the total
range of points in your system (900) by nine, which equals 100 points. (This, of course, is the
size of the pay grades under an equal interval approach.) Since you want the pay grades to be
narrower at the bottom of your system, and wider at the top of your system, the width of your first pay grade must obviously be less than 100 points; let us say 50 points. We then have to
determine what increase in each grade width would result in our system finishing at 1,000
points, while producing nine pay grades. Although there are mathematical formulas that could
be used for working this out, trial and error also works fine.
We first try increasing each pay grade width by ten points (i.e., the width of Grade 2 becomes
60 points, the width of Grade 3 becomes 70 points, the width of Grade 4 becomes 80 points,
etc.), but this results in our ninth pay grade not reaching the 1,000 point maximum of our
system. To reach this, our pay grade widths need to add up to 900 points or so, and right now
they add up to 810 points. We have two choices now: we can either increase our first pay grade size and reapply the grade increases; or we can make the grade increases larger. Bumping up
the grade increases to 12 points raises our total to 882 points—still not quite enough—but
bumping up the grade increases to 13 points raises our total to 918 points—too much.
However, if we reduce our starting grade width to 48 points, and stick to the 13 point increase, this gives us our 900 points total that we were looking for. (Note that because each pay grade
actually starts one point higher than the end of the previous pay grade, this has the effect of
adding one point to Pay Grades 2–9. You can simply lop these 8 points off the maximum of Pay
Grade 9 to keep it to the 1,000 point maximum.)
The equal percentage increase approach can be simpler to calculate. The first part of the
process is the same as the first paragraph of this Notebook. So, let us select 50 points as our
starting grade width. We then need to select a constant percentage by which each grade width will increase from the previous grade width—a percentage that will results in grades that add
up to about 900 points. The easiest way to do this is with an “annuity calculator” (which
calculates the impact of increasing a value by particular percentage) that you can easily find online. For our example, we will use Annual Annuity Calculator. (You can still use trial and
error in coming up with the best combination of starting grade width and percentage
increases—it is just a bit more tedious to calculate.)
First, click on “rate,” because the percentage rate is what we are trying to find out. Next, in the
“total row,” put “850” (this is derived by taking the 900 point total grade width that we are
seeking, and subtracting the grade width of the first grade, which is 50 points, leaving us with
850 points we want to determine). After that, put “50” in the “annual amount” row, because
each pay grade will equal 50 points plus the percentage increase applied to that pay grade.
Finally, enter “8” in the “years” row, which reflects the number of pay grades we wish to have,
after subtracting the first pay grade, which will stay at 50 points.
Now, click “calculate” and the “rate” 16.6336 appears. That is the percentage by which each
pay grade width will increase from the previous pay grade width. For example, the width of Pay Grade 2 will be 50 times 1.166336, which equals 58.3—round to 58 points. So, Pay Grade 1
will be 50 points wide (with a minimum of 100 points and maximum of 150 points). Pay Grade
2 will be 58 points wide (with a minimum of 151 and a maximum of 209). To calculate Pay
Grade 3, multiply 58 times 1.166336, which equals 67.6 points—round to 68 points. Therefore, Pay Grade 3 will have a minimum of 210 points (one point above where Pay Grade 3 left off)
and a maximum of 278 points. Repeat this process for all nine pay grades. (Note: Because of
rounding, you will find that the maximum of Pay Grade 9 comes a little short of 1,000 points—
simply round up the maximum of Pay Grade 9 to 1,000 points.)
Finally, a thorny issue is what to do with jobs that end up near but just below grade boundaries. One solution is to do nothing and just leave jobs where they fall. But this solution
invites feelings of inequity as well as attempts by these jobholders to get their jobs re-
evaluated. Some firms attempt to deal with this problem by keeping job evaluation points
secret, which can lead to other problems such as distrust of the evaluation system. As
mentioned earlier, another method is not to use arbitrary point cutoffs but rather to look for
“natural breaks” in the job hierarchy. There is no ideal solution to this problem, which is
inherent in the use of pay grades.
Establishing Pay Ranges
Once the pay grades have been established, the next task is to decide on the pay range for
each grade in actual dollar terms. It is possible to establish a pay range of “zero”—that is, to pay all jobs in a pay grade the same flat rate. But this does not allow any room to recognize the
differential qualifications of employees as they enter a pay grade, nor does it allow for raises
based on seniority or performance. To provide latitude for this, most organizations do use pay
ranges.
There are four main questions about pay ranges. First, how are the midpoints of the ranges (in
dollar terms) determined? Second, how should the range spreads be determined (i.e., the
minimum and the maximum pay rates for each pay grade)? Third, should range overlaps be
permitted? And fourth, how should movement through the range take place?
Establishing the Range Midpoints
As an example of how to establish the midpoint of the pay range, let’s start with the graph shown in Figure 8.3, which shows a sample market line. This market line needs to be
converted to a pay policy line. If the compensation strategy for the employees in the job
evaluation system is to pay 10 percent above market, then a new line will be drawn 10 percent above the market line. This will become the pay policy line. (If the pay strategy is to match the
market, then the market line becomes the pay policy line.)
After the pay policy line has been drawn, the pay grades are marked off on the graph using vertical lines. Next, a horizontal line is drawn where the midpoint of each pay grade intersects
the pay policy line. This is illustrated by the broken lines in Figure 8.4. The horizontal line for
Pay Grade 1 (which has a grade midpoint of 190 points) intersects the pay policy line at about $32,500— which is then taken as the midpoint in the pay range for this pay grade. Similarly,
the horizontal line for Pay Grade 2 (which has a grade midpoint of 335.5 points) intersects the
pay policy line at about $36,900, so this is taken as the midpoint of the pay range for Pay Grade
2.
The differentials in range midpoints between the grades are known as the
intergrade differentials. Intergrade differentials may be expressed in dollars or in percentages.
In dollar terms, they may be constant or they may increase as one rises up through the hierarchy of jobs. The purpose of increasing intergrade differentials is to maintain the
attractiveness of promotions. In the pay structure illustrated in Figure 8.4, the intergrade
differentials stay constant at $4,400 throughout the structure, although the intergrade differential percentages actually decline. For example, the intergrade differential percentage
between Pay Grade 1 and Pay Grade 2 is about 13.5 percent, but it is only about 11.9 percent
between Pay Grades 2 and 3. Between Grades 3 and 4, the intergrade differential percentage is 10.7 percent, and between Grades 4 and 5, 9.6 percent. This means that as a proportion of pay,
promotions in the higher grades are becoming relatively less attractive than promotions in the
lower grades. One way to increase this percentage would be to widen the pay grades as the
system goes up.
Establishing the Range Spreads
Now that we have the range midpoints, we need to decide on the range spreads—that is, the dollar value of the difference between the maximum and the minimum of the pay range for
each pay grade. To maintain the integrity of the system, the dollar value differences between
the range midpoint and the range minimum, and the range midpoint and the range maximum, need to be equal. Otherwise, you are arbitrarily moving the range midpoint, after all the work
you have just devoted to establishing it!
There are no hard and fast rules for establishing range spreads, but there are several
considerations. The first is the extent to which the organization wants to use compensation to
recognize differences between employees performing the same jobs. How important is
experience? And how much can performance vary across individuals in the same job? If the
organization places no value on experience, and performance does not really vary across employees, the answer is simple—no spread! Instead, the midpoint becomes the flat pay rate
for the job, so that all jobs in Pay Grade 1 pay $32,500.
Thus, the pay range should reflect the range of performance or experience within jobs. But how do you determine this? The time it takes to become proficient at that job might be a good
indicator. For example, if a job requires a person to work for four years to become fully
proficient, then that job needs a much greater spread in pay range than a job that requires six months for proficiency. And even after four years, when that person reaches proficiency, there
may still be variations in performance that the organization wants to recognize.
Another consideration is opportunities for promotion. If the organization is growing slowly or not at all, there may be few promotional opportunities to use as a means to increase employee
pay. Or it may not be desirable to promote valued employees to management jobs just to get
them a pay raise. In these circumstances, a wider pay range can be used to accommodate and
retain high-performing employees.
Yet another consideration is how many steps or increments the organization intends to have
in the range. The more increments it wants to use, the greater the range spread needs to be. In
general, the range spread is wider for higher pay grades, the assumption being that experience makes more of a difference to performance in those grades and that there is more scope for
performance variation in jobs in higher pay grades. Another common reason for an increasing
range spread is that pay grades tend to get larger for jobs higher in the job hierarchy.
Another way to set the minimum and maximum for each pay range is by referring to the labour market. Labour market data normally provide not only the midpoints or averages for each job,
but also the ranges and quartiles. Quartiles indicate the pay for the lowest quarter of
employees, then the second quarter, and so on. One way of setting the range minimum would be to use the top of the bottom quartile for a typical job in that pay grade as the range
minimum, and the top of the third quartile as the range maximum.
Overall, the following range spread percentages seem typical in Canada—10–20 percent for production and clerical jobs, 20–30 percent for professional jobs, and 25–50 percent for
managerial jobs. In general, the range spreads increase for pay grades higher up the job
hierarchy to recognize the greater complexity of these jobs. Also, the fewer the pay grades, the
larger the pay ranges; the more the pay grades, the smaller the pay ranges.
In our example, Figure 8.4 shows the minimum and maximum of the pay range for each pay
grade. The lower line in Pay Grade 1 represents the range minimum for that pay grade (which is $30,000), while the upper line represents the range maximum (which is $35,000). Overall, the
graph shows that the pay ranges for the five pay grades are as follows:
As we develop a base pay structure, it is always useful to step back and take a hard look at
what we have done so far. So, how well does the pay structure depicted in Figure 8.4 work? It has five pay grades, covering 180 job evaluation points each. The minimum pay for any job is
$30,000, while the maximum is $55,600. The range spread for Pay Grade 1 is $5,000, and the
range spread percentage is about 17 percent, calculated by dividing the range spread by the
range minimum ($30,000) for that pay grade. The range spread for Pay Grade 5 is $11,000, or 25 percent. The intergrade differential percentages vary from 13.5 percent between Pay Grade
1 and Pay Grade 2 to 9.6 percent between Pay Grade 4 and Pay Grade 5, although they stay
constant in dollar terms at $4,400. (In fact, when we use equal point spreads to delineate pay grades, as we have in this example, the range midpoint for each grade will always be the same
dollar amount higher than the range midpoint of the previous grade.)
Given that the total pay range of jobs in this pay structure is so narrow (from $30,000 to $55,000), five pay grades may be appropriate. However, if we were developing a base pay
structure for the hospital example discussed earlier, this number of pay grades would be much
too low, given the very large dispersion in pay and jobs at the hospital. At the hospital, 10–15
pay grades would likely be necessary to adequately reflect the dispersion across jobs, depending on the method used for establishing pay grade sizes. For example, increasing the
size of the pay grades as jobs increase in value would allow use of fewer pay grades at the
hospital (possibly 10–12 grades), but using equal-sized grades would probably require at least
15 grades.
The intergrade differential percentages actually decline, so this may reduce the incentive for
promotion to a job in a higher pay grade or reduce perceptions of equity among those getting
promotions. The final potential problem is the overlaps between pay ranges.
Overlaps Between Pay Ranges
In Figure 8.4, the pay range for each pay grade overlaps with the previous one. When there is an overlap, an employee in a lower pay grade can actually earn more than an employee in a
higher pay grade. This may be seen as a threat to the integrity of the job evaluation system. So
why have overlaps?
Overlaps occur because of pay ranges. If there were very small spreads in each pay range,
there would be little or no overlap. As range spreads increase, so does overlap. One purpose
that overlap serves is to reduce the differences in pay between adjacent pay grades, thus reducing the difference in pay between jobs that fall on either side of the pay grade boundary.
Overlaps also allow the pay of top performers in a lower grade to increase without having to
promote them to a job in a higher pay grade. Finally, many people believe it would not be fair
for an inexperienced employee coming into a new job to earn more than a seasoned,
experienced, high-performing employee in a job in the next lower pay grade.
So, when should overlap be a concern? One possible rule is that it should not be possible for a
person in Pay Grade 1 to be making as much as a person in Pay Grade 3. That is, when overlap
starts to cover two pay grades, it tends to negate the job values established by the job
evaluation system and to reduce the incentive for promotion. In addition, it can also create
problems after promotion occurs. Normally, a person who has been promoted expects a raise as she or he assumes the new job. However, if that person is already earning more than the
midpoint of the next higher pay grade, then she or he has to enter that pay grade above the
midpoint. This severely limits the room for pay increases as the promoted individual gains increased experience and improves performance. As Figure 8.4 shows, if someone at the top of
the pay range for a job in Pay Grade 4 were promoted to a job in Pay Grade 5, that employee
would receive no increase unless she or he came in above the midpoint of the new pay range.
One way to avoid the problem of excessive overlap is to make sure that the top of the previous
pay range is always lower than the midpoint of the next one, perhaps halfway between the
midpoint and the minimum. Certainly, the top of a pay range should always be lower than the bottom of the range two grades up. Note that the pay structure in Figure 8.4 meets these
criteria for the lower pay grades, but not for the higher grades.
Gaps Between Pay Ranges
One final issue is the opposite problem of too much overlap—when there are gaps between
the pay ranges. In this case, not only are there no overlaps, but the ranges do not connect up.
For example, consider the following pay ranges:
As you can see, the maximum of the pay range for Pay Grade 1 is $24,000, but the minimum of the range for Pay Grade 2 is $28,000. Thus there is a $4,000 gap between the pay ranges for Pay
Grades 1 and 2. We can also see a $2,000 gap between Pay Grades 2 and 3. The problem with
gaps is that they do the opposite of overlaps—they exaggerate the pay differences between
jobs in one pay grade and jobs in the next pay grade. In general, there should be no such gaps.
If gaps do exist, this could be a sign of either an insufficient number of pay grades in the pay
system or pay ranges that are too small. Often, this problem arises when the “equal interval” approach to setting pay grade widths is used, and it can sometimes be solved by switching to
the “equal increase” or “equal percentage” approach to establishing pay grades. Sometimes
all three of the above might be needed to produce the best solution to this problem.
Movement Through The Pay Range
Once the pay range is defined for each pay grade, criteria must be established to determine
how placement and movement within the range will occur. The three most common criteria are experience, seniority, and performance. In some cases, all three are used. For example, a
person’s initial placement in the pay range may be determined by previous experience.
Seniority (in terms of years in the job) or performance—or both—can then be used to
determine future increases within the pay range.
As one example of how to combine seniority and performance, some firms allow employees to
reach the midpoint of their pay range using annual seniority increases, but to pass that point
requires meritorious performance. This is known as a split pay range, with the midpoint serving as a “control point” to prevent pay increases unless they are based on performance.
But this is just one possibility of many.
How many steps or increments should there be within a pay range? And what should the size of each increment be? Although a pay range may have as few as three or as many as fifteen
increments, most have six or seven.20 To be effective, a pay raise should constitute a “just
noticeable difference (JND).” If it doesn’t reach that level, it may have little motivational or
reward value.
In times of low inflation, a JND may be 4 percent. So let’s look back at Pay Grade 1 in Figure
8.4. The minimum is $30,000 and the maximum is $35,000. A 4 percent pay raise from the minimum would be $1,200. Since the range is $5,000, divide it by $1,200, which equals about
four. Four increments would allow four raises of about 4 percent each, so this might be a
reasonable number of steps for Pay Grade 1.
What about for the other pay grades? Let’s try another—say, Pay Grade 5. For Pay Grade 5, 4 percent of the minimum is $1,784. The range is $11,000, so dividing by $1,784 equals just over
6. Therefore, six increments might be used for this pay grade.
Some organizations do not use fixed steps or increments. Instead, they view the minimum as the entry-level pay for an employee with no experience, and the midpoint as the normal pay
that a typical employee receives. Pay raises above the midpoint are awarded only if
performance is above average, and pay reaches the maximum for the range at the discretion of the supervisor, who may vary both the timing and the amount of the raises. However, this
procedure does not fit well with motivation theory, which suggests that motivation is
maximized when the link between future performance and future pay increases is very clear.
Moreover, the flexibility of this method opens the door to inconsistency and favouritism.
Other Possible Elements of Base Pay Structure
Base pay structure can include a number of other elements. For example, for jobs with hourly
pay, overtime premiums are typically required by law when workers exceed a certain number of daily or weekly hours. However, many employers go beyond the statutory minimum,
especially unionized employers. In other cases, the organization may offer shift differentials,
where pay for an undesirable work shift (usually the night shift) is higher than for other shifts. Some employers may offer isolation premiums to boost the compensation of employees who
work in remote areas. These are just some of the possibilities that may be incorporated into a
base pay structure.
COMPENSATION TODAY 8.2
The Debate On A Living Wage
While the living wage movement in Canada can be described as being in its infancy, it has been
attracting considerable attention, especially among poverty activists. Outside Canada, the
debate has been intense, including the United Kingdom where the Living Wage campaign has gained some momentum. In 2005, the Greater London Authority established the Living Wage
Unit to calculate the London Living Wage and the issue soon generated interest throughout
the U.K. Employers started to voluntarily implement the Living Wage. In April 2016, the U.K.
government introduced a compulsory National Living Wage for workers over age of 25.
The concept of a Living Wage is very appealing. It means a wage that a person working 40
hours a week, with no additional income, will be able to provide the basics for quality of life,
such as food, shelter, utilities, transport, health care, minimal recreation, one course a year to upgrade his or her education, and child care. Advocates say that it will reduce poverty and
help businesses improve productivity. The implementation can be very complicated. Criticism
of a Living Wage can be summarized into the following four points.
• If all workers’ wage get to increase to the new Living Wage, what about
people who have longer service and better skills at the same job? For
instance, if all new hires are paid at the living wage (let us say,
$18/hour, what about a five-year service employee who is paid at
$17/hour? Should this worker also expect an increase? Should the
increase be the absolute amount of $1 or should it be proportional to
the increase in the starting pay? This is an issue that job evaluations
can help to address.
• If all workers get a subsequent increase, would the employer’s cost be
transferred to the customers for private employers or the public for
public employers? For example, 2,400 employees of Welsh National
Health Service each received an initial increase up to £470 in 2014 as a
result of implementing Living Wage. That is an extra £1 million of
payroll cost that the public will have to bear.
• Not all workers support a family and the family sizes vary. Living Wage
may benefit workers who may not be the original intended
beneficiary; for example, a young worker who recently entered the
workforce and has no dependants to support.
• The current minimum wage and wage differential encourage
employers to hire less experienced workers who are paid less while
learning the job. Living Wage will reduce employers’ incentive to hire
novice workers and provide on-job training, which may lead to more
youth unemployment.
A survey of more than 1,000 UK companies found that the forecast of the next annual salary
increase is 1.7 percent, lower than the government’s inflation forecast of 2 percent. Higher
cost as a result of the National Living Wage is cited as one reason employers cannot afford to give higher raises. Now with the new referendum result of the U.K. leaving the European
Union, the U.K. may experience tougher economic times. It will be interesting to see the
evolution of Living Wage in the next few years.
Sources: “UK ‘Jobs-Rich, Pay-Poor’ Economy to Continue,” WorldatWork, May 17, 2016, at
https://www.worldatwork.org/waw/adimLink?id=80288, accessed September 29, 2016; E.
James Brennan, “Living Wage Versus Minimum Wage,” Compensation Café, August 26, 2013, at http://www
.compensationcafe.com/2013/08/living-wage-versus-minimum-wage.html, accessed August
1, 2016; Living Wage Foundation website, http://www.livingwage.org.uk/what-living-wage, accessed August 1, 2016; Michael Babad, “The Quest for a ‘Living Wage’ Gathers Steam,” The
Globe and Mail, October 3, 2014, http://www.theglobeandmail.com/report-on-business/top-
business-stories/the-quest-for-a-living-wage-gathers-steam/article20910670, accessed
September 29, 2016; Tom Cooper and Trish Hennessey, “The Promise of the Living Wage
Movement,” Toronto Star, May 27, 2016, https://www.thestar.com/opinion/commentary/2016/05/27/the-promise-of-the-living-wage-
movement.html, accessed September 29, 2016.
Living Wage
The implementation of living wages in some jurisdictions will have additional implications for
job evaluations. A living wage is different from the minimum wage and can be described as the minimum income necessary for a worker to meet the needs of his other family in a particular
community; that is, it takes into account the basic needs of a worker to help provide for a
decent standard of living. The concept has been attracting recent attention in Canada with
dozens of communities and employers moving forward with living wage initiatives, including
the City of Cambridge, Ontario, the public school board in Hamilton, and Vancity, a credit
union in British Columbia. These organizations pay wages that are higher than the legislated
minimum wages in their jurisdictions. Compensation Today 8.2 discusses this issue further
and highlights a potential problem that has to be resolved to ensure internal equity.
// SUMMARY
This chapter has shown you how to develop a point system of job evaluation and a base pay
structure. You have learned the five main steps in developing this method (identifying
compensable factors, scaling the factors, weighting the factors, applying the system, and
testing the system), as well as the possible pitfalls in using this method.
Although the point method appears to be objective and scientific, it is still subjective and
susceptible to problems that could compromise its reliability and validity. You can avoid these pitfalls, but only if you understand them well. The four main types of pitfalls are inconsistency
within the factors, overlaps between factors, hierarchical grounding, and gender bias. All of
these have commonly afflicted job evaluation systems (and those who are subject to these
systems) in the past.
You have also learned that after establishing a hierarchy of jobs by job evaluation, you must
create a base pay structure. This includes developing pay grades and pay ranges, along with
the criteria for movement through the range.
Key Terms
• base pay structure
• benchmark job
• broadbanding
• compensable factors
• correlation coefficient
• equal increase approach
• equal interval approach
• equal percentage approach
• intergrade differential percentage
• intergrade differentials
• just noticeable difference (JND)
• living wage
• market comparator job
• market line
• pay grade
• pay policy line
• pay range
• range spread
• range spread percentage
• reliability
• validity
Discussion Questions
Discussion Question 8.1
Review
Discuss the issue of gender bias in compensation and the ways it can affect the development of a base pay
structure. In your employment experience, have you noticed possible examples of gender bias in
compensation? Your Answer
No answer submitted
Discussion Question 8.2
Review
Discuss the hierarchy of jobs for a Canadian hospital shown in Table 8.2. Does everything about this
ranking of job values make sense to you? Are there specific jobs that seem out of order to you? If so, which ones? Why do you think so?
Your Answer
No answer submitted
Discussion Question 8.3
Review
Apart from gender bias, what are the key pitfalls of job evaluations? How can you minimize their potential
problems?
Your Answer
No answer submitted
Using the Internet
Using the Internet Question 8.1
Review
In a small group or on your own, select benchmark jobs for the Canadian hospital in Table 8.2. Then use
Monster’s Salary Wizard as your market database to find appropriate market comparator jobs and price them. For the purposes of the market survey data, assume that the hospital is located in the city in which you reside. Display this information in a table similar to Table 8.3. Compare your table to Table 8.3 and
discuss why they differ. Your Answer
No answer submitted
Using the Internet Question 8.2
Review
After completing Question 1, use Microsoft Excel to prepare a market line based on data from your benchmark jobs and market comparator jobs. Examine the resulting line, and discuss all of the possible
issues surrounding its validity, including the correlation coefficient, the outliers, and the slope and height of the line. Your Answer
No answer submitted
Exercises
Exercise Question 8.1
Review
Rank the hospital jobs shown in Table 8.2 according to your own impressions of how valuable each job is to
the hospital, disregarding the hypothetical job evaluation results. Share your rankings with other classmates, and discuss any differences in your rankings. Also discuss any differences from the rankings
shown in Table 8.2. Your Answer
No answer submitted
Exercise Question 8.2
Review
In a small group or on your own, use Figure 8.2 to develop a base pay structure for a Canadian hospital, including pay grades and ranges, and criteria for salary movement within the range.
Your Answer
No answer submitted
Case Questions
Case Question 8.1
Review
Using the point method and the four basic factor categories, develop a job evaluation system for the
“Eastern Provincial University” case in the Appendix. Then apply your system to the different jobs to derive
a single hierarchy of jobs. Summarize this information in a table similar to Table 8.2. Your Answer
No answer submitted
Case Question 8.2
Review
After completing Question 1, apply the procedures required under the Ontario Pay Equity Act to determine whether pay equity exists for the female job classes at Eastern Provincial University. The following are the
annual salaries in the four job classes (as of 2012): Clerk Steno I: $36,341; II: $47,379; III: $69,057 (Job class
95 percent female) Draftsperson I: $41,179; II: $47,379; III: $58,522 (Job class 80 percent male) Grounds
Worker I: $29,721; II: $36,341; III: $41,178 (Job class 85 percent male) Medical Laboratory Technologist I: $47,379; II: $58,522 (Job class 90 percent female)
Your Answer
No answer submitted
Simulation Cross-Reference
If you are using Strategic Compensation: A Simulation in conjunction with this text, you will
find that the concepts in Chapter 8 are helpful in preparing Sections D, G, and H of the
simulation.
// Notes
1. A useful guidebook has been produced by the Ontario Pay Equity Commission that includes
the steps in the job evaluation process; see Step by Step to Pay Equity, at
http://www.payequity.gov.on.ca/en/DocsEN/minikit.pdf, accessed August 8, 2016.
2. George T. Milkovich and Jerry M. Newman, Compensation (Chicago: Irwin, 1996), 37.
3. Nan J. Weiner, “Job Evaluation Systems: A Critique,” Human Resource Management
Review 1, no. 2 (1991): 119–32.
4. Weiner, “Job Evaluation Systems,” 124.
5. Based on Ibid., 126.
6. Ibid., 127.
7. Ibid.
8. The terms “male jobs” and “female jobs” are used to denote jobs that have traditionally
been occupied mainly by males or females. These terms are used as a shorthand in pay equity
literature and carry no implications about the specific nature of these jobs, nor whether males
or females are more suited to these jobs.
9. Weiner, “Job Evaluation Systems.”
10. John Kervin and Marika Elek, “Where’s the Bias? Sources and Types of Gender Bias in Job Evaluation,” in Industrial Relations in the New Millennium: Selected Papers from the
XXXVIIth Annual CIRA Conference, ed. Y. Reshef, C. Bernier, D. Harrisson, and T.H. Wagar
(2001), 79–90.
11. Weiner, “Job Evaluation Systems.”
12. Ibid.
13. R. Steinberg and L. Haignere, Equitable Compensation: Methodological Criteria for
Comparable Worth, Working Paper #16 (Albany: Center for Women in Government, SUNY,
1985).
14. Ronnie J. Steinberg, “Emotional Labour in Job Evaluation: Redesigning Compensation
Practices,” Annals of the American Academy of Political and Social Science 561 (1999):
143–57.
15. Weiner, “Job Evaluation Systems,” 130.
16. CBC News Online, “Gender Equality Case Nets Nurses $150M,” July 3, 2012.
17. Nan J. Weiner and Morley Gunderson, Pay Equity: Issues, Options, and
Experiences (Toronto: Butterworths, 1990).
18. Theresa Welbourne and Charlie O. Trevor, “The Roles of Departmental and Position Power
in Job Evaluation,” Academy of Management Journal 43, no. 4 (2000): 761–71.
19. Roland Theriault, Mercer Compensation Manual (Boucherville: G. Morin, 1992).
20. Ibid.
Chapter 9: Evaluating the
Market CHAPTER LEARNING OBJECTIVES
After reading this chapter, you should be able to:
• Discuss the key considerations in understanding labour markets.
• Identify possible sources of compensation data.
• Describe the steps for conducting compensation surveys.
• Analyze, interpret, and apply compensation survey data.
WHERE WOULD YOU CHOOSE TO WORK?
If you had to choose an industry based strictly on how much it pays its employees, which
would you pick? The following are the average weekly earnings for different Canadian
industries for the most recent available year (2016), according to Statistics Canada:
Of course, all of these seem pretty miserly when you compare them with the average pay for
players in the National Hockey League (NHL), which is about $63,000 a week (assuming they
work 40 weeks a year). This is nice for hockey players, but is one week of an average hockey
player’s work really worth more than the combined weekly work of 72 Canadian health and social service workers, or 173 accommodation and food services workers? What scale would
you use for judging? By the way, average pay is even higher for players in the National
Basketball Association and Major League Baseball than the NHL!
// Introduction to What is Appropriate
Compensation
In 2012–13, National Hockey League (NHL) employers decided they were overpaying their
players and locked them out for half the season in order to cut their pay. This was after a season-long lockout by the owners in 2004–05 during which the average NHL player salary was
cut by about 20 percent. No employer, not even an NHL owner, can afford to ignore
product/service market and financial constraints when setting pay, as this could result in a compensation system set at a level that puts the employer out of business. After the 2004–05
lockout, average hockey salaries rose again until they exceeded pre-lockout levels by 2007–08,
and then rose again by about 30 percent over the three seasons after that, motivating the
owners to impose the 2012–13 lockout in another attempt to cut player salaries.
How do you determine the appropriate amount to pay your employees? Clearly, a key factor is
the labour market, so understanding how the labour market works is an important piece of
the puzzle. However, as discussed in Chapter 4, identifying the “going market rate” for individual jobs can be a complex process—and an elusive one, since there may be no single
market rate for many jobs.
After a brief orientation to the nature of labour markets, this chapter identifies sources of compensation data, including third-party and in-house surveys. Following that, it describes
how to conduct a compensation survey. The chapter concludes with an illustration of the
process for analyzing and interpreting compensation survey data.
// Understanding Labour Markets
Why do people get paid what they do? Surely it is based on the value or importance of the job
they do. Well, consider this. The Prime Minister of Canada earns $317,574 per year. The lowest-
paid hockey player with the Toronto Maple Leafs receives US$575,000 per year. Is being a
benchwarmer on a professional hockey team really a more important job than being Prime
Minister of Canada? What’s going on here?
In general, the price (wage) for a particular type of labour depends on the demand for that
labour relative to its supply, constrained by the ability of employers to pay. In theory,
whenever there is a surplus of a particular type of labour, the price for that labour falls. In reality, wages seldom decline in ongoing firms unless the employer is experiencing financial
difficulties and wage cutting is seen as a necessity. This is because wage cuts often have
negative consequences for the employer, such as increased turnover and reduced employee performance (see Chapter 3). However, new firms may take advantage of a labour surplus by
hiring employees at a lower rate than existing employers are paying.
In theory, when faced with a labour scarcity, firms in the private sector are willing to increase the price for labour (in terms of total compensation) until the price matches the value (in
terms of net revenue generated) that the firm receives from that labour. However, in reality,
how much an employer is willing to pay for a particular type of labour is a function of a variety
of factors, including the employer’s ability to pay. Key factors include company profitability,
the importance of that labour to the organization, and the proportion of labour costs to total
costs. For example, if labour is only a small portion of a firm’s total costs (as in the resources industry), that firm can afford to pay much more for its labour than firms in which labour is a
high proportion of total costs (as in the retail sector).
Labour scarcity helps explain why soccer player David Beckham has commanded the kinds of fees he does for endorsing various products and services (see Compensation Today 9.1).
There is only one David Beckham! Of course, you could rightfully say there is only one of you,
but nobody offers you anything to endorse their products!
COMPENSATION TODAY 9.1
Earn it Like Beckham! Lose it Like Tiger!
Soccer player and celebrity husband David Beckham may not be the soccer player he once was, but he can still rake in the cash. In 2007, it was reported that he had signed a five-year
deal with the Los Angeles Galaxy of U.S. Major League Soccer (MLS) that could be worth as
much as $250 million to him in salary and endorsements. Of this sum, $32.5 million would be
his pay as a player for the Galaxy (for which the Galaxy had to get an exemption from the
league’s maximum salary of $2.4 million per year), $20 million would come from wearing the
“Herbalife” logo on his shirt, and the rest would come from other endorsements and a share of
the profits from the merchandising of items like Beckham soccer shirts.
What makes Beckham worth so much? At that stage in his soccer career (he announced his
retirement as a professional player in 2013), it was not his soccer skills, since there are many
players who were good as or better than Beckham at that time. Instead, what the Galaxy and the other sponsors were paying for was his very famous name and his ability to attract notice
from the press and the public. If Beckham could raise soccer anywhere close to the popularity
of the other major American sports, then the value of every MLS franchise would skyrocket,
especially that of the Galaxy. Herbalife was gambling that its association with Beckham would
raise its net revenues by more than $20 million over the next five years.
Of course, whether these gambles would pay off for the Galaxy or for Beckham’s other sponsors was never certain. Indeed, in 2008 Beckham’s endorsement earnings ranked far
behind those of golfer Tiger Woods, who was dubbed the “most impactful endorser in the
history of marketing” by some experts at that time. In 2008 alone, Woods earned $23 million in winnings and $105 million in endorsements and was credited with catapulting Nike to the
fourth-largest golf retailer and with tripling the sales of sports video game producers
Electronic Arts.
But Woods turned out to be a bad bet for his sponsors after news of his various marital
infidelities came out in late 2009 and his subsequent golf performance plummeted. He was
dropped by several key sponsors, although enough of them stuck with him (most notably Nike) that he was still able to earn $55 million in endorsements in 2012, exceeding Beckham’s
$37 million that same year. However, as time passes, and if Tiger returns to his winning ways
on the links, his economic value to sponsors will no doubt rise, although it remains to be seen
whether he will ever be able to regain his “most impactful endorser” status.
For public sector organizations such as school boards, hospitals, and government departments, the ability of employees to generate revenue is obviously not a factor. Instead,
the key issue is the employer’s ability to pay. If taxpayers (through their elected
representatives on the school board) set the school district budget at $50 million, then only
this amount is available for all purposes, including teacher salaries. In Canada, public sector employees are highly unionized, so most public sector pay is determined through collective
bargaining. If the union has the right to strike, as most do, then key factors are how essential
the service is, how willing public officials (and the general public) are to endure a strike, how much budget is available for pay increases, and how easy it is to obtain a budget increase.
Higher pay levels can be granted without a budget increase, but the money must come from
somewhere, usually through a reduction in the number of persons employed by the
organization.
In general, the public sector has been experiencing wage compression. Public sector
employees at the lower end of the job hierarchy usually earn more than comparable employees in the private sector, while public sector employees at the top of the job hierarchy
usually earn less than they would in the private sector. 1 This differential at the lower end is
explained by the relative power of public sector unions due to their ability to disrupt important public services. Pay equity programs, which have been in place much longer in public sector
organizations, may also have helped increase the pay of lower-level public sector workers. 2
By contrast, pay for top-level government officials is constrained by the visibility of their
salaries as well as by a reluctance among taxpayers to pay public employees a lot more than
they themselves are earning. There are no such constraints on private sector employers
regarding their top-level employees, so the wage gap between the public and private sectors is
wide in this top employment bracket.
Several general patterns in compensation levels can be identified. Historically, unionized
employees have received considerably more compensation than comparable non-union
employees, although the so-called union wage premium has declined greatly in Canada in
recent years and may even have disappeared in some sectors.3 Male employees earn more than female employees on average (although this gap has been gradually decreasing4;
employees in large firms earn more than those in small firms; employees in Alberta, Ontario,
Saskatchewan, and Newfoundland earn more than those in other provinces; and, as the opening vignette showed, employees in the resource sector earn more than those in the
service sector.
Aside from the relative scarcity of labour and its perceived value to the employer, pay is affected by what are known as compensating differentials. For example, many of the high-
paying jobs in the resource sector are cyclical—in other words, workers in that sector often
have to endure periods of unemployment. Their higher wage levels serve in effect as compensation for this employment volatility. Similarly, the cost of living in Alberta and
Ontario is higher than in most other provinces, and the higher wage rates help compensate for
this reality.
Compensating differentials can also be triggered by negative employment features such as
poor working conditions and jobs for which failure rates are high. For example, many people
who try selling life insurance fail, but those who succeed can earn very high compensation. Another example of a negative feature is a poor industry reputation—for example, forestry is
widely perceived as environmentally unfriendly, and the tobacco industry is in social
disfavour.
However, does this theory really work? Are salaries in, say, the tobacco industry really higher
than elsewhere? Compensation Today 9.2 tries to smoke out the truth.
// Defining The Relevant Labour Market
Labour markets are complex. Luckily, an employer does not need to understand the labour
market as a whole, but only that segment of it that pertains to the specific jobs the employer
needs to fill. Essentially, what an employer needs to know is what its competitors are paying
their employees.
Two kinds of competitors are relevant: competitors in the same labour market, and
competitors in the same product/service market. Sometimes firms in many different industries compete for the same labour—for example, an insurance company, a chemical
manufacturer, and an airline all need accounting clerks. But in other cases, labour is so
specialized that certain jobs are found only within the same industry. For example, if you are a
chemical manufacturer and need chemical process control engineers, you don’t have to
compete with an insurance company or an airline to hire them.
Labour markets and product/service markets serve as constraints to employers. If an employer is paying less than its competitors in the labour market, it will not be able to attract
and retain good employees. If an employer is paying more than its competitors in the same
product/service market, it may have difficulty offering its product or service at a competitive
price.
COMPENSATION TODAY 9.2
Salaries are Really Smokin' in Tobacco!
In Chapter 3, we discussed how employees take a variety of costs and benefits into account when deciding where to seek and accept employment. We used the example of the tobacco
industry, suggesting that many people look with disfavour on the product, which makes them
reluctant to accept employment in the industry, so that higher wages are necessary to attract them. The economic theory of compensating differentials would predict exactly the same
pattern. Because of the stigma attached to the industry, salaries would have to be higher in
order to entice employees.
So both behavioural and economic theory agree: all other things being equal, salaries should be higher in the tobacco industry than industrial averages. But just what are the facts? Over
the years, total employment in Canada’s tobacco products industry (excluding growers) has
been declining, from 4,483 persons in 1990 to under 1,300 persons today, according to Statistics Canada. Over the same time, demand for the industry’s product has also been
declining, from 65 billion cigarettes in 1980 to less than 22 billion as of 2012. (But that still
amounts to more than 600 cigarettes per Canadian man, woman, and child per year.)
In 2006 (the latest available year for tobacco earnings statistics), the average wages and
salaries in the Canadian manufacturing sector were $47,044. What were they in tobacco? Try
$71,215, or more than $2,000 a month higher, on average. Interestingly, despite the decline in demand for tobacco employees and their product over the years, wage increases in the
tobacco industry actually outpaced in creases in the industrial averages between 1990 and
2006.
So if you can stand the smoke and think you will live long enough to enjoy your money, the
tobacco industry really coughs up the dough!
There are two other crucial dimensions to the labour market: occupational grouping, and the
geographic scope of the market—local, regional, national, or international. These two
dimensions overlap, depending on how specialized and industry-specific the occupational
grouping is.
For example, if you are looking for a secretary, the market is usually local. Almost every
organization of any size employs one or more secretaries, so they can be found in almost all
labour markets. But at the same time, not every organization employs a chemical process engineer, and these employees may be very scarce in some local labour markets. In general,
the more specialized the occupation, the wider the geographic scope of the market for that
occupation. For example, it may be possible to hire production and office staff locally but
necessary to seek technical staff across a larger region, senior managerial staff on a national
basis, and specialized professional staff nationally or internationally.
Thus, before setting out to collect data, the employer needs to identify the occupational groups for which it will collect data, the geographic boundaries for that group, and the
industry boundaries for the information. As discussed later in this chapter, the employer must
also identify the specific compensation data it needs to make informed decisions.
Compensation data sources sometimes allow firms to customize information on the organizations they are comparing themselves with. The selected comparator organizations
are known as market comparator firms. In putting together this sample of market comparator
firms, the trick is to maintain a broad enough sample to be representative while focusing on
firms as similar as possible to the target firm. Relevant characteristics in selecting this sample
include the type of product or service the firm provides, the geographic area over which it operates, the size of the firm, and whether the firm is union or non-union. However, depending
on the industry, even a non-union firm should include some unionized firms in its market
sample to ensure wage competitiveness. Overall, as with much in compensation, there is no precise formula for selecting a market sample. Instead, it is a balancing act, informed by
judgment and knowledge of your human resource needs.
// Sources of Compensation Data
Once an organization has defined the type of labour market information it needs, it needs to
acquire that information. All market information is based on compensation surveys, but
organizations do not all need to conduct their own compensation surveys. There are three main “third party” sources of compensation data: government agencies, industry groups, and
compensation consulting firms. Many of these organizations have websites that offer
compensation data (see Compensation Notebook 9.1), although there may be a fee for
accessing this information.
Third-Party Surveys
Government Agencies
A variety of government agencies survey employers to collect labour market information. At
the federal level, these include Statistics Canada5; Human Resources and Skills Development
Canada, which maintains information on collective agreements as well as other pay information; and the Government of Canada Labour Market Information website (shown in
Compensation Notebook 9.1). Most provincial labour departments also publish some data on
compensation levels. So do some municipal governments.
COMPENSATION NOTEBOOK 9.1
Examples of Websites with Compensation Survey Data
Government Agencies
Government of Canada: http://www.jobbank.gc.ca/wage-outlook_search-
eng.do?reportOption=wage
Toronto Region Board of Trade:
https://www.bot.com/Services/DevelopYourBusiness/CompensationSurveys.aspx
Consulting Firms
Aon Hewitt Associates: http://www.aon.com/canada/products-services/human-capital-
consulting/default.jsp
Economic Research Institute: http://www.erieri.com/salaryassessor
Hay Group: http://www.haygroup.com/ca
Willis Towers Watson: https://www.towerswatson.com/en-CA
Mercer Canada: http://www.mercer.ca/en.html
Free Websites
PayScale: http://www.payscale.com/research/CA/Country=Canada/Salary
Salary Wizard:
http://monsterca.salary.com/CanadaSalaryWizard/LayoutScripts/Swzl_NewSearch.aspx
Glassdoor: https://www.glassdoor.ca/Salaries/index.htm
Industry Groups
Most industries have industry associations, many of which collect data on pay rates within
their industries. Many professional associations also collect data on their own occupational
groups.
Compensation Consultants
There are many firms for which collecting labour market information is an important business.
These include large international firms such as Aon Hewitt Associates, Hay Group Towers Watson, and Mercer, as well as many smaller firms that operate on a local or regional basis.
One concern is that these data may come mostly from their client firms and thus do not
necessarily comprise a representative sample.
Free Compensation Data Websites
Free websites providing compensation data have come online in recent years; the most
notable of these are Salary Wizard and PayScale. There are concerns about the validity of the
data from these websites, as Compensation Today 9.3 explains.
Advantages and Disadvantages of Third-Party Surveys
Using compensation data acquired from third-party sources has both advantages and
disadvantages. The two most obvious advantages are ease and cost. Normally, when firms are asked to participate in compensation surveys, they are promised the results, so the only cost is
the cost of the time spent responding to the survey. And it is much easier to utilize third-party
data than to design and conduct an in-house survey.
However, there are several disadvantages. Third-party surveys may not cover the desired jobs,
compensation characteristics, or employers. In addition, aggregate data are often provided,
rather than company-by-company data, so that it is not possible to separate out those
employers who are the most appropriate comparators for your organization.
COMPENSATION TODAY 9.3
Traditional and New Salary Survey
Most compensation professionals are pretty clear about the salary survey process when
working with compensation data providers. They select surveys that cover their industry and
geography/locations, review the participants list to determine that they are proper comparators with whom they may compete for talent, match their benchmark jobs to the
survey benchmark jobs, submit their data, receive the report from the provider, and analyze
the data. The confidence in the survey data comes from, among other factors, knowing that the job matches are completed by trained compensation professionals and managers, who
know the jobs from both job-specific information and the talent management big picture
perspective. They know that the focus is on the job, not the person doing the job.
Now, with advances in technology, some compensation data providers are changing this
process. Take PayScale, for example. The company has revolutionized salary surveys. Instead
of doing job matches, individuals and companies can type in a job title; answer a few
questions about the skills, experience, and education required for the job, and a few questions
on the scope of the job, such as budget and numbers of people reporting to the role in the case of management positions; then type in the salary of the job; and get a report of the job profile
and how much the job is paid on the market with average, median, and percentiles. PayScale
states that the profiles are reviewed using advanced proprietary algorithms to check for outliers or illogical data sequences and compare more than 250 compensable factors to find
the ideal match for the job. PayScale claims that it will turn compensation into a true science,
rather than an art. While innovation in compensation technology helps to move the profession forward, the verdict is still pending on this methodology. One concern is the self-reported
data. Would the average worker have the skills to put in the correct data for his or her job?
How about the human nature that makes us all think highly of our own jobs and ourselves?
Take a look at the PayScale website yourself. What are your thoughts?
In-House Surveys
A final option is to carry out your own compensation survey. This can be done formally or
informally.
Informal Surveys
Informal approaches range from a quick review of help wanted ads to a question posed to a
group of colleagues at an industry function to a few telephone calls to other firms. Informal
surveys are usually simple and quick but may have poor reliability and validity.
Formal Surveys
Formal surveys can be undertaken by internal staff or can be contracted to compensation
firms. The main advantage of in-house surveys is that the employer controls the entire
process, thereby ensuring the quality and appropriateness of the data. Another advantage is that the employer avoids paying the consulting fees, which can be high, depending on the
amount of customization required. However, there are many disadvantages to conducting
your own survey. First, if the survey is to be done by internal staff, then someone with the
required expertise must be available. In addition, many employers surveyed may be reluctant
to reveal their compensation practices to their competitors in the absence of any intermediary
organization. For these reasons, most firms prefer to contract out the survey to professionals
in the field.
// Conducting Compensation Surveys
In conducting a compensation survey, there are four main steps: (1) identify the jobs that are
to be surveyed, (2) determine the information to be collected about each job, (3) identify
which employers are to be surveyed, and (4) determine the method of data collection.
Identify the Jobs to Be Surveyed
For several reasons, most organizations do not collect market data about every job they have.
First, it would be very costly to do so. Second, the organization often has unique jobs for which it is hard to find matches. Third, a full-scale survey is not necessary. The usual rule of thumb is
that surveying about 10–15 percent of jobs should be sufficient to calibrate the system.
Moreover, it is not even necessary to survey these key or benchmark jobs every year. Instead, data can be obtained on the annual increases in pay rates, and the job rates updated on this
basis.6
Essential to any compensation survey is an effective method for matching an organization’s jobs to those being surveyed. The most common approach is known as key job matching,
which involves selecting certain jobs that are well understood and numerous in the job market
and asking employers to compare their jobs with these jobs. Typically, a job title is provided,
along with a brief job summary. Employers are then asked whether they have any of these jobs, and if so, to provide compensation data about them. When selecting these jobs, it is
important to represent a variety of job families and to provide examples within each family at
both the entry level and the top level.
Determine What Information to Collect
Simply collecting information about wage and salary levels does not generally provide an
adequate basis for comparison. Information about the base pay, performance pay, and indirect pay, as well as the weekly hours of work, all need to be collected for each job in the
survey. In addition to the formal pay ranges for each job, knowing where most employees
actually are in the pay range is also useful. You can determine this by asking how many employees are in each quartile of the pay range. Compensation Notebook 9.2 provides a list
of typical questions to ask when conducting a compensation survey. Figure 9.1 provides an
actual survey form used by one human resources consulting firm.
Determine Whom to Survey
Determining which employers to survey is not a simple matter. In general, firms like to survey
other employers that they perceive as similar to themselves in industry type, geographic
location, and size. But the sample generally varies, depending on whether the jobs being
surveyed are filled by the local, regional, national, or international labour markets.
COMPENSATION NOTEBOOK 9.2
Typical Compensation Survey Questions
A. General Questions
1. Name of employer
2. Number of employees
3. Location of employees
4. Main products or services produced
B. Questions for Each Job
1. Do you have any employees performing the job described below? [The
description for the specific job being surveyed appears here.]
2. How many?
3. Are the employees in this job union members?
4. What was the average base pay, performance pay, and indirect pay
(estimate a dollar value for the benefits provided) received by
employees in this job over the last year?
5. What is the minimum, maximum, and midpoint of the pay range for this
job?
6. How many employees are in each quartile of the pay range?
7. On what basis do employees move through the pay range? (e.g.,
seniority, merit, training)
8. How long does it take a typical employee to move from the bottom to
the top of the pay range?
9. What is the standard workweek for this job, in terms of hours?
10. Are these employees eligible for overtime? At what pay rate?
Determine How to Collect the Data
There are four main ways to collect the information: personal interviews, questionnaires,
telephone interviews, and the Internet.
Personal Interviews
In general, the personal interview is thought to provide the best-quality information. In an
interview, you can ensure that the jobs being surveyed are actually similar to the job data
reported and that the questions are being interpreted properly. However, this method is very
costly to use on any significant scale.
Questionnaires
By far the cheapest method of data collection is the mail survey or questionnaire. However, it is also the least reliable method, since there is no control over who is filling out the survey and
no way of knowing whether it is being done correctly. Chores such as filling out a
questionnaire are often delegated to the most junior member of the HR department.
Telephone Interviews
A compromise method is the telephone interview. It is much cheaper than the personal
interview, yet it produces a higher quality of information than the questionnaire approach, since there is an opportunity to confirm job matches and to clarify survey questions. This
method also provides some control over who the respondent is.
Internet Surveys
Internet surveys can be faster than mail surveys and can facilitate the tabulation of data.
Moreover, Internet contact facilitates contact with respondents throughout the survey
process. Research indicates that compared to mail surveys, Internet surveys generate quicker responses and higher response rates; they also cost less and yield data of no less quality than
that produced by mail surveys.7 Compared to face-to-face interviews, response rates are
lower; however, for sensitive data where there is a social desirability aspect, Internet surveys
produce more valid results, and at a fraction of the cost.8 Internet surveys can sometimes produce more accurate information, since the time pressure of face-to-face and telephone
interviews may cause respondents to respond with guesses about data instead of taking the
time to look up the information.9 In sum, there seems to be very little downside to online
surveys.
// Analyzing And Interpreting Survey Data
After you have conducted a compensation survey, you have a set of raw data—a list of
employers surveyed and what they are paying for different jobs. It is hoped for each job you
have the minimum, maximum, and midpoints of the pay ranges, and the mean base pay,
performance pay, indirect pay, and total compensation. Now what?
Analytical Procedures
The first steps in analyzing the survey data involve assessing the central tendency of pay and
the variation across employers. There are two main ways to assess central tendency. Using
a mean average (sometimes known as a simple average), you add up the midpoints of the pay
range for a given job at each company and divide the sum by the total number of companies.
Of course, this weights all employers equally, regardless of whether they employ one or one thousand of the employees performing the target job. Therefore, some firms compute
a weighted mean (sometimes known as a weighted average) by weighting each employer
according to how many employees that employer has performing the target job. You can also calculate a simple average or weighted average of the mean base pay, performance pay, and
indirect pay across the sample of firms. A simple average mean pay gives an indication of pay
policies used by a typical firm for a given job, while a weighted average mean pay gives a
better indication of what the typical employee in a given job is earning.
One problem with a mean is that it can be distorted by extreme values. One way of avoiding
extreme values when measuring central tendency is to use the median, which is the middle
value in a ranking of pay levels, below which half of employers are paying less and above
which half are paying more.
Dispersion of pay across employers can be assessed in several ways. One way is to look at the mean total compensation for the lowest-paying employer and then determine what
percentage more the highest-paying employer is paying. For example, if the lowest-paying
employer pays its secretaries a mean total compensation of $30,000, and the highest-paying employer pays its secretaries a mean total compensation of $45,000, then the dispersion in
secretarial compensation across firms is 50 percent.
Another way of examining dispersion across employers is to look at quartiles or deciles. For
example, the mean total compensation levels at each firm for a given job are arranged from
lowest to highest, and then the list is divided into either four groups (quartiles) or ten groups
(deciles). The mean total compensation within each quartile or decile is then computed. This
method allows an assessment of detailed pay statistics, such as what the top 25 percent of
firms (using quartiles) are paying on average.
Percentiles, which indicate the amount below which a certain percentage of employers would
fall, can also be used. For example, if $60,000 is at the 90th percentile of total compensation for a given job, that means that 90 percent of firms pay less than that and 10 percent pay more.
The interquartile range is the difference between the 25th and 75th percentile values, divided
by the 25th percentile value. If this quotient is very large, it may indicate problems with the job
matching, where some of the jobs in the sample are not equivalent.10
A major issue in analyzing compensation data is determining whether to focus on range
midpoints or actual mean compensation levels. Range midpoints and pay ranges do not actually describe what the typical employee in the job earns; and pay ranges deal only with
base pay, so a lot of the compensation picture could be missing. For example, most employees
in the survey could be at the top of the pay range or the bottom. One way of assessing where employees are actually being paid in the pay range is to ask respondents to report the number
of employees in each quartile of the pay range for each job.
A statistic that can be useful in assessing the distribution of employees within their pay range
is known as the compa-ratio. The compa-ratio is calculated by taking the mean base pay of all employees holding a particular job and then dividing this amount by the midpoint of the pay
range for that job. A compa-ratio of greater than 1 means that, on average, employees are
being paid above the midpoint at that firm; a compa-ratio of less than 1 means that, on
average, employees are being paid below the midpoint.
Besides analyzing the level of compensation, analyzing survey data may also indicate the
typical structure of compensation (or pay mix) across employers. To start, you could calculate
the proportion of base pay, performance pay, and indirect pay (as a percentage of total compensation) for a given job at each firm and then average these values (either a simple
average, or a weighted average, or both). In this way, you might discover that firms in the
sample pay 70 percent of their secretaries’ total compensation in base pay, 10 percent in performance pay, and 20 percent in indirect pay, on average. You can also look at the
percentages for each firm to examine particular compensation issues, such as variation in the
use of performance pay.
Interpreting Survey Data
The best way to illustrate the issues involved in interpreting survey data is to work through a
detailed example. Table 9.1 provides an example of compensation survey results for the job of
“accounting clerk.”
In this example, we have surveyed ten companies and have data regarding the number of
accounting clerks that each firm employs; the minimum, maximum, and midpoints of the base
pay ranges; the mean amounts of base pay, performance pay, indirect pay, and total compensation paid to accounting clerks at each firm; and the distribution of accounting clerks
across the pay range in each firm by quartile.
The job summary used on the survey was based on the Human Resources and Skills Development Canada National Occupational Classification for “Accounting and Related
Clerks”:
This unit group includes clerks who calculate, prepare and process bills, invoices,
accounts payable
and receivable, budgets and other routine financial records according to established
procedures. They
are employed throughout the private and public sectors. Examples of related titles
include costing
clerk, ledger clerk, audit clerk, finance clerk, budget clerk, billing clerk, tax return
preparer, accounts
payable clerk, accounts receivable clerk, invoice clerk, deposit clerk, tax clerk, and
freight-rate clerk.
Inspecting the Data
So what can we observe from Table 9.1? Base pay range midpoints range from $24,000 (Company J) to $32,000 (Company A). The average base pay range midpoint is $28,050, and
the weighted average midpoint is $26,936. This suggests that firms that employ more
accounting clerks have a lower pay range than firms that employ fewer. The median range
midpoint is $28,500. (When there is an even number of cases, the median is the average of the
middle two cases.)
As Table 9.1 shows, mean base pay is lowest at Company J ($24,600) and highest at Company A ($33,400). Interestingly, however, when total compensation is considered, Company I pays
the least ($31,375) due to poor indirect pay and no performance pay, and Company B pays the
most ($46,340). There is quite a high dispersion (48 percent) between the lowest- and highest- paying firms, which may suggest that the job duties of accounting clerks may be different at
these firms.
Let’s examine performance pay and indirect pay. As Table 9.1 shows, three companies (G, H, I)
don’t offer any performance pay at all; otherwise, performance pay ranges from $1,377
(Company F) to $6,133 (Company C). Indirect pay ranges from $6,150 (Company J) to $12,624 (Company D). To examine the structure of the compensation mix, we have calculated below
the percentage of total compensation for each major pay component at each firm (using the
data in Table 9.1):
As this table shows, companies in this sample vary considerably in their compensation mixes,
in addition to their compensation levels. Base pay constitutes as much as 80 percent of total compensation, or as little as 67 percent. Performance pay ranges from as much as 13 percent
of total compensation down to none, and indirect pay ranges from 28 percent down to 15
percent.
Drawing Inferences from the Data
What can we make of these substantial differences in pay policies for the same job? We can
infer, from its low starting pay, that Company I may be willing to accept inexperienced and/or untrained employees and then provide them with on-the-job training. With its wide pay range,
the company can reward increased experience over time. Even so, total compensation is
constrained by low indirect pay and zero performance pay. So how will Company I keep its
accounting clerks once they are trained?
Perhaps Company I promotes these individuals rapidly to higher jobs, such as senior
accounting clerk, which may carry a considerably higher pay scale. Perhaps the jobs at
Company I have some intrinsic or extrinsic rewards that other firms do not offer, such as high job security. Or perhaps Company I cannot afford to pay any more than what it pays and has to
put up with hiring inexperienced employees who quit to take better-paying jobs once they are
trained.
What about the width of the pay ranges? They vary from $2,000 in Company C to $8,000 in
Company I. The mean width of the base pay range is $5,600. Beyond these facts, careful
examination suggests that there may be some patterns. For example, Company C, with a pay range of only $2,000, offers a high starting base pay ($29,000). Company C also has high
performance pay, which may be used to differentiate employees, since there is very little
progression through the pay range.
Perhaps Company C hires only highly experienced and well-trained accounting clerks. It
employs only six of them, yet it expects these six to handle all the clerical accounting chores
for a company of 800 employees. In comparison, Company E has nine accounting clerks for 700 employees. Many factors could explain this difference in staffing, and it may not mean that
the accounting clerks at Company C do more work than those at Company E.
Company I (along with Company E) has the widest pay range—$8,000. However, because the firm’s starting pay is so low ($21,000), it needs a wide range to keep good employees as they
become more experienced. In contrast to Company C, Company I is likely using pay range to
differentiate employees, since it has no performance pay.
This raises a question. What is the value of performance pay to employees? In our example, we
have factored it into total compensation as if it is of equivalent value to base pay (dollar for
dollar). But is a dollar of performance pay really worth a dollar of base pay? Most financial experts would say no, because performance pay is uncertain. If the performance pay is based
on individual performance and is allocated in a zero sum way, there may be a strong
possibility that an individual will not receive any performance pay in a given year. If the performance pay is based on company performance, such as a profit-sharing plan, there is no
guarantee that the necessary threshold level will be reached next year, even if it was reached
this year.
What about indirect pay? Because of the tax advantages of many types of indirect pay, some
might argue that a dollar of indirect pay is worth more than a dollar of base pay. But that
depends on the structure of the indirect pay and on the needs of the employee. Some
employees may place very little value on benefits, because they don’t use most of them. In
fact, they may not even be aware of many of the benefits for which they are eligible.
In short, some firms may be spending a lot of money on benefits that employees don’t care
about. (This is one of the problems that flexible benefits are intended to solve, by allowing employees to maximize their own cash value of benefits.) Thus, one dollar of benefits may be
worth more than one dollar of pay to some employees and less than one dollar to others.
Let’s take another angle on the data. In this survey, indirect pay averages about 21 percent of total compensation. But it is higher in larger companies than in smaller companies, which is
typical. For example, indirect pay averaged 26 percent of total compensation in companies
with 2,000 or more employees, and 19 percent in companies with fewer than 2,000 employees. On the other hand, smaller firms used performance pay more heavily: performance pay
constituted 8 percent of total compensation in firms with fewer than 2,000 employees, and
only 2 percent in firms with 2,000 or more employees. Overall, large firms paid somewhat less ($37,960) than smaller firms ($40,906). But the compensation in the larger firms was less risky,
since they had higher indirect pay and lower performance pay than smaller firms.
Examining Pay Range Distribution
Finally, we need to examine the actual distribution of employees within their pay ranges. The
last five columns in Table 9.1 present this information. They show that the distribution across
the quartiles of top-paying firms is very different from that of the lower-paying firms, with the
majority of their employees in the top (fourth) quartile.
This distribution difference is not surprising. Examine Company D, which has 84 percent of its
accounting clerks in the top quartile. Although Company D does not pay the highest maximum
base pay, it does provide some performance pay, along with the best benefits (indirect pay). Why would anyone ever quit? No one does, so eventually most employees end up in the top
pay quartile. In contrast, Companies F to J have only a minority of their employees in the top
bracket. This suggests higher turnover. In addition, let’s examine Company H, where just 35 percent of the clerks are in the top bracket. As Table 9.1 shows, 30 percent are also in the
bottom quartile. One can infer that this firm has high turnover and is continually hiring new
clerks. As these employees gain experience, they are likely able to get jobs with better paying firms, so they quit. The table also shows a sharp drop between quartiles 1 and 2, and between
quartiles 2 and 3.
In addition, Companies I and J probably cannot find acceptable employees at the low end of
their pay ranges and are bringing new clerks in at the second quartile. So the bottom end of
their pay ranges is really irrelevant. Because of low indirect pay at Company I, there is nothing
to retain their employees as they gain experience, so they appear to quit at their first
opportunity.
The compa-ratios also indicate actual base pay relative to the pay range midpoints and show
that most firms are currently paying their employees in the top half of the pay range, with the
exception of companies G, H, and I, which are paying slightly below or at the midpoints.
Applying Survey Data
This example shows that interpreting survey data is a complex process. But once interpreted,
how do you apply your results? If you are using a job evaluation system, you will use the survey data from key (benchmark) jobs to develop a market line and to calibrate the job evaluation
system against that, as described in the previous chapter. If you are using a skill-based pay
system, you will need information from jobs that match the bottom of the skill grid and the top
of the skill grid, as described in Chapter 4.
If you are using market pricing, you simply apply the market rates to your jobs, after adjusting
for compensation mix strategy and compensation level strategy. You do not need to survey each job every year; if you survey one-fifth of the jobs each year, you can update the others
based on estimates of annual increases. With this method, you will end up market-testing
every job every five years. Of course, surveys may be done more frequently for a particular job if there are indications, such as difficulty in recruiting or excessively high turnover, that the pay
level is inappropriate.
But before applying the data, you need to complete one more step. Since compensation surveys deal with historical data, they are always somewhat out of date. Furthermore, the pay
system being planned must apply to the upcoming year, so there needs to be some
consideration of the amount the market will increase in a year. So you need to adjust the
survey data through a process known as aging the data.
The application of market data can raise some thorny issues. For example, what happens
when the pay rate indicated by job evaluation differs from that indicated by market data?
Although there is not much research evidence on that question, one experimental study of
U.S. compensation managers11 found that market data tended to outweigh job evaluation
data. That is, managers’ inclination was to abandon internal equity if it conflicted with market
data. This is one reason that some argue that pay equity legislation is essential, since this
inclination tends to replicate market practices even if they are not equitable.
Limitations of Compensation Surveys
Compensation surveys have many limitations. First, they may vary dramatically in quality of
job matches and methodology. Second, they may omit important information. For example,
for most firms, adequately quantifying performance pay and indirect pay is not a simple
process, and some surveys may omit important elements. Third, unless compensation survey data are available for individual employers in the market sample (as was the case in Table
9.1 but is rare in compensation survey data), we cannot surmise anything about the
compensation strategies practised by other firms. Fourth, compensation data may not fit all of
the jobs an organization has, especially if these jobs are organized differently from the norm.
Furthermore, compensation surveys were developed when compensation systems were much
simpler than they are today. Thus, recent extensive use of indirect pay and performance pay
has complicated data gathering enormously. For example, the value of stock options is very difficult to estimate, as is that of long-term incentives. In addition, some firms may provide
other important benefits that are difficult to price out in monetary terms, such as purchase
discounts or the use of company recreational facilities. To make matters still more complicated, some firms include these items when reporting indirect pay, while others do not.
So, overall, surveys cannot capture the entire range of rewards—both extrinsic and intrinsic—
offered by organizations.
Another issue is that there may be bias in the sample of firms responding to compensation
surveys. Traditional firms with simple pay systems find it much easier to reply to
compensation surveys than nontraditional firms that have nonstandard jobs and complex pay
systems. Thus, compensation surveys may misrepresent actual pay trends.
Finally, while compensation surveys attempt to reflect the value placed on jobs by the labour
market, use of these surveys assumes that the market values jobs fairly. As discussed in previous chapters, the market may underprice certain jobs, including those dominated by
women. Underpricing puts employers in a quandary. If they wish to be fair, they may need to
pay certain jobs (such as those traditionally held by women) more than the market would
dictate. However, this practice may put them at a competitive disadvantage, especially if their
competitors do not adjust their pay rates at the same time. For this reason, many critics of
market compensation have little faith in voluntary measures to correct historic inequities and
argue that pay equity legislation is essential to create a level playing field for all employers.
// SUMMARY
This chapter has explained how to evaluate the “market rate” for a given set of jobs. It has
discussed forces affecting market rates and various sources of compensation data, including
third-party and in-house surveys. It has also presented the four main steps for conducting a compensation survey. And it has presented ways to analyze, interpret, and apply
compensation survey data.
Chapter 10 completes our discussion of how compensation values are determined by describing the processes for evaluating individual employees, known as performance
appraisal.
Key Terms
• aging the data
• compa-ratio
• compensating differential
• interquartile range
• key job matching
• market comparator firms
• mean or simple average
• median
• quartiles or deciles
• weighted mean or weighted average
Discussion Questions
Discussion Question 9.1
Review
Examine the list of industries and pay rates in the opening vignette. Discuss possible reasons each industry
has the relative pay level that it does. Your Answer
No answer submitted
Discussion Question 9.2
Review
Based on the concept of “compensating differentials,” develop a list of job/organizational characteristics
that would make you willing to work for less money. Then develop a list of job/organizational
characteristics that would cause you to want more money to accept a given job. Rank each list in order of the importance to you of each characteristic. In a small group, compare your lists and discuss possible reasons for any differences.
Your Answer
No answer submitted
Discussion Question 9.3
Review
What are the key limitations of market surveys?
Your Answer
No answer submitted
Using the Internet
Using the Internet Question 9.1
Review
Take four jobs that are of interest to you and that are included in both the PayScale and Salary Wizard
databases. Using your own geographic area as the basis for your search, identify what compensation each
of these websites indicates for each of the four jobs. How close are the two websites? What are some
possible reasons for the differences?
Your Answer
No answer submitted
Using the Internet Question 9.2
Review
How fair is the pay of NHL hockey players relative to their performance? Use the Canadian Business website for your information source on what the market is paying NHL hockey players relative to their
performances. Do you have any suggestions for developing a fairer pay system that pegs player pay to
player performance? Your Answer
No answer submitted
Exercises
Exercise Question 9.1
Review
Table 9.2 provides data from a compensation survey for the job of industrial engineer, collected from the
same employers as the compensation survey for accounting clerks discussed earlier in the chapter.
Assume you are managing a high-involvement firm that employs about 800 people and you employ ten
industrial engineers. Develop a compensation structure for this job, indicating the amount of base pay the
job will provide (including the pay ranges) and the amount and type of performance pay and indirect pay.
Assume the survey data are eight months out of date, and your new compensation structure will take
effect in four months and apply to the following 12-month period. The following job summary was used in the survey, which was based on the National Occupational
Classification for “Industrial and Manufacturing Engineers”:
Industrial and Manufacturing Engineers conduct studies and develop and supervise programs to achieve
efficient industrial production and efficient utilization of industrial human resources, machinery, and
materials. Industrial and Manufacturing Engineers are employed in consulting firms, manufacturing and processing companies, and in government, financial, health care and other institutions. Example titles include cost engineer, computer integrated manufacturing engineer, fire prevention engineer, plant engineer, work measurement engineers, methods engineer, industrial engineer, manufacturing engineer, quality
control engineer, safety engineer, production engineer, time-study engineer.
Your Answer
No answer submitted
Exercise Question 9.2
Review
After completing Question 1, develop a compensation structure for the same firm; but this time, assume it
uses the human relations managerial strategy. Then do the same for the classical managerial strategy. How
do these three compensation structures differ?
Your Answer
No answer submitted
Exercise Question 9.3
Review
In a large group, survey the hourly pay levels for all those group members who are currently employed or
were recently employed in common jobs such as salesclerk, cashier, or fast-food worker. If there are
differences in pay within the same job type, discuss why these may exist. Your Answer
No answer submitted
Case Question
Case Question 9.1
Review
You are the head of human resources at "Alliston Instruments” in the Appendix. You would like to do a compensation survey to determine whether your pay rates are in line with those in the industry. Using the
steps described in this chapter, design the process for so doing.
Your Answer
No answer submitted
Simulation Cross–Reference
If you are using Strategic Compensation: A Simulation in conjunction with this text, you will
find that the concepts in Chapter 9 are helpful in preparing Section F of the simulation.
// Notes
1. Morley Gunderson, Douglas Hyatt, and Craig Riddell, Pay Differences Between the
Government and Private Sectors: Labour Force Survey and Census Estimates,
Discussion Paper #W/10 (Ottawa: Canadian Policy Research Networks, 2000).
2. Pay Equity Task Force, Pay Equity: A New Approach to a Fundamental Right (Ottawa:
Department of Justice, 2004).
3. See S. Walsworth and R.J. Long, “Is the Union Employment Suppression Effect Diminishing?
Further Evidence from Canada,” Relations industrielles/Industrial Relations 67, no. 4 (2012):
654–80; and T. Fang and A. Verma, “Union Wage Premium,” Perspectives(Statistics Canada),
September 2002, 13–19.
4. See Kazi Stastna, “Canada’s Working Moms Still Earning Less, Doing More than Dads,” CBC
News Online, May 10, 2012, http://www.cbc.ca/news/canada/story/2012/05/10/f-mothers- day.html, accessed September 29, 2016. Also see Morley Gunderson, “Male-Female Wage
Differentials: How Can
That Be?,” Canadian Journal of Economics 39, no. 1 (2006): 1–21; and Force, Pay Equity.
5. See http://www.statcan.gc.ca/tables-tableaux/sum-som/l01/cst01/labr79-eng.htm.
6. Robert E. Sibson, Compensation(New York: American Management Association, 1990).
7. Stanley E. Griffis, Thomas J. Goldsby, and Martha Cooper, “Web-Based and Mail Surveys: A
Comparison of Response, Data, and Cost,” Journal of Business Logistics 24 (2003): 237–57.
8. Jytte Seested Nielsen, “Use of the Internet for Willingness-to-Pay Surveys:
A Comparison of Face-to-Face and Web-Based Interviews,” Resource and Energy
Economics 33 (2011): 119–29.
9. Edith D. de Leeuw, “Counting and Measuring Online: The Quality of Internet
Surveys,” Bulletin of Sociological Methodology 114 (2012): 68–78.
10. David E. Tyson, ed., Carswell’s Compensation Guide (Toronto: Thomson Carswell, 2009).
11. Carolyn L. Weber and Sara L. Rynes, “Effects of Compensation Strategy on Job Pay
Decisions,” Academy of Management Journal 34, no. 1 (1991): 86–109.
Chapter 10: Evaluating
Individuals CHAPTER LEARNING OBJECTIVES
After reading this chapter, you should be able to:
• Identify and explain the main reasons for conducting performance
appraisals.
• Explain why many performance appraisal systems fail to accurately
measure employee performance.
• Identify and describe the different methods for appraising
performance, along with their strengths and weaknesses.
• Identify the possible sources of performance appraisals, and discuss
the circumstances under which each would be appropriate.
• Explain the concept of “performance management.”
• Discuss how to link merit pay to performance appraisals.
• Identify the key design issues in developing an effective merit pay
system.
MICROSOFT CHANGES ITS PERFORMANCE MANAGEMENT
SYSTEM TO SUPPORT STRATEGY
For decades, performance management has been a core process that organizations use to
align employee behaviour with organizational goals. The annual cycle of goal setting, mid-year check-in, final review and decisions on merit increase and annual (and long-term, in some
cases) incentives has become part of the organization’s routine business. However, as we
entered the second decade of the new millennium, some organizations started to rethink and redesign their performance management processes. Microsoft is among those that did an
overhaul of its performance management system.
The change was driven by external and internal factors. External factors included the fact that
work was performed in a more collaborative way across multiple disciplines and locations; employees had different expectations as Millennials enter the workforce; and fresh
perspectives from neuroscience indicated that employees responded better to reward stimuli
than threat stimuli. Internally, Microsoft was transforming from the world’s leading software provider to a provider of software, devices and cloud-based services. To achieve this vision,
Microsoft changed its organization to drive greater cross-group dependencies by abolishing
the long-standing independent divisions with separate profit and loss statements (P&L) and
creating a new “One Microsoft” with a single P&L.
To support this business and cultural transformation, Microsoft launched the new
Performance and Development system in 2013 that focused employees’ attention on contributing to team, business or customer impact, results that build on the work, ideas and
effort of others, and contribution to the success of others. They eliminated traditional
performance ratings and the ratings distribution, increased flexibility in allocating rewards based on impact, and enabled rewards decisions to be made lower in the organization.
Instead of the old process of allocating salary increases, bonuses and stock awards based on
the rating distribution, the new system differentiates between “top rewards” for those with exceptional performance, and the rest of the workforce. The old calibration meetings were
replaced with “People Discussions for Reward Allocation,” which serves as a benchmark
opportunity for managers to understand how peer managers are considering impact and
rewards decisions.
Two years after the launch of the new Performance and Development system, employees and
managers have expressed a preference in the new approach and view the system as having a
positive impact on how teams collaborate. The new system proved to have positively influenced employee engagement and satisfaction, as well as advanced the transformation of
the company’s business and culture.
Source: J. Ritchie, “Transforming a Company: How Microsoft’s New Employee Performance System Supports Its Business and Cultural Transformation,” WorldatWork Journal (Second
Quarter 2016): 61–75.
// Introduction to Performance Appraisal and
Performance Management
As the Microsoft case shows, performance management and performance appraisals are
changing. There are many pros and cons of using “traditional” versus “new” systems. They key
goal should be “fit” (remember we discussed this concept in Chapter 2); that is, an
organization’s performance management system should support its strategy. Microsoft has
made changes to ensure that its management systems reflect its changing context and strategies. If you were an employee at Microsoft, how would you feel about the new
performance management system? Your opinion would probably depend on how it works for
you and your team.
Let’s suppose that your organization uses merit pay to reward employees who display
superior performance. How do you identify these employees in a fair and systematic way? And
how can you fairly relate these judgments to actual pay decisions?
The success of merit pay systems depends on finding the right answers to these questions,
and the purpose of this chapter is to help you find those answers. This chapter describes ways
to evaluate the overall level of job performance displayed by individual employees (a process known as performance appraisal) and ways to link the resulting appraisals to financial
rewards. We start by discussing some of the reasons for performance appraisals, and
organizations’ experiences with them, and then move on to the many pitfalls that may prevent accurate appraisal of employee performance. You’ll have a better chance of avoiding these
pitfalls if you know they are out there waiting for
the unwary!
After that, we describe some of the commonly used performance appraisal methods and
discuss who is best suited to conduct performance appraisals. We also discuss performance
management, which is a broader process for managing employee performance in which the
accurate measurement of employee performance plays an important role. Finally, we discuss how performance appraisal results can be linked to merit pay. This includes how to design a
merit pay system as well as the thorny issue of whether and how to appraise individual
performance in a team context.
// Experience With and Reasons for
Performance Appraisal
“I’d rather kick bricks with my bare feet than do appraisals!” says a manager at Digital
Equipment Corporation.1 Apparently, performance appraisal is not his favourite task—and
many managers feel the same way. But what about their employers?
It turns out that many employers are no happier than their managers about their performance
appraisal systems. For example, Pratt and Whitney, the giant manufacturer of jet engines, was
dissatisfied with its performance appraisal system and made extensive changes to it. The following year, still unhappy with the system, the firm made more changes. The year after
that, the firm abandoned its system altogether, replacing it with a completely different
one.2 Surveys have found that performance appraisal systems tend to be in constant flux as
companies search for appraisal systems they are satisfied with.3
Experience with Performance Appraisal
Despite all their efforts, companies have found it very hard to establish satisfactory appraisal
systems. At the beginning of the 21st century, about 90 percent of Canadian human resource
managers who were surveyed said that their company’s performance appraisal system
needed to be modified or abolished; even more—95 percent—of Canadian employees surveyed said the same thing.4 In a U.S. study conducted in 2012, only 3 percent of
organizations rated their systems for managing employee performance as “very
effective.”5 Yet despite the disappointing history of performance appraisal, research by one of
the authors shows that 90 percent of medium to large Canadian firms say they use performance appraisal, covering 86 percent of their nonmanagerial employees and 98 percent
of their managerial employees.6
Two findings stand out from this research. First, many companies can’t seem to find a performance appraisal system that they are happy with. Second, despite their lack of success,
they keep trying to make performance appraisal work. While performance appraisal is highly
valued as a concept, translating that concept into effective practice is very difficult.
Some observers contend that translating the concept of performance appraisal into effective
practice is virtually impossible. Based on their experience as consultants, Coens and Jenkins
argue that performance appraisal is a fundamentally flawed concept that cannot be made to work effectively.7 Other commentators agree that performance appraisal often does more
harm than good but contend that performance appraisal can work effectively if applied in the
right way and in the right circumstances.8 In this book, we adopt the latter view, although we emphasize that the right circumstances for performance appraisal (particularly for the
purposes of merit pay) are much less common than many employers think. (Those
circumstances were described in our discussion of merit pay in Chapter 5 and are summarized
in Compensation Notebook 5.1.)
Why Do Performance Appraisals?
If performance appraisals are so difficult to do effectively, why do them at all? Organizations
conduct performance appraisals for a variety of reasons, which tend to fall into four main
categories: administrative, developmental, supervisory, and symbolic.
• Administrative reasons: identify individuals who are not performing to
required standards and for whom dismissal may be necessary; identify
individuals who should be considered for promotion or merit
increases; and monitor the overall quality of performance in the firm.
A well-documented set of performance appraisals can help support
legal arguments during unjust dismissal lawsuits. Moreover, a firm
that cannot show that it attempts to manage employee performance
may find itself liable in the event of errors or accidents caused by
company employees. The key task is to measure individual perfor-
mance accurately and consistently.
• Developmental reasons: helping employees grasp the employer’s
expectations, the key performance dimensions of their jobs, the
strengths and weaknesses in their performance, and the ways they
can improve their performance. The key task is to provide useful
feedback—an essential part of any learning process—that will help
individuals change their behaviours in productive ways. This feedback
is valuable to employees even if their performance does not need
improvement, since most employees want to know how their perfor-
mance is regarded by their supervisors and the organization.
• Supervisory reasons: improving the performance of supervisors by
encouraging them to think systematically about employee
performance and by encouraging communication with employees.
• Symbolic reasons: creating the perception that management cares
about good employee performance. Performance appraisals
demonstrate this concern to employees (as long as they believe that
performance is what the appraisal system truly measures, of course).
// Pitfalls in Performance Appraisal
Performance appraisals do not always accurately reflect employee performance. Two key
aspects are crucial for accuracy. When an appraisal method has reliability, two different raters,
judging independently, will come up with similar ratings of a given individual. When a method has validity, then the individuals identified by performance appraisal as the most effective
employees are, in fact, the best performers.
Over the years, both academics and practitioners have expended an enormous amount of effort attempting to develop reliable and valid measures of employee performance. But
despite this effort, performance appraisal often fails to achieve its goals. Part of the problem
stems from the multiple objectives of most appraisal systems. Some experts have argued that there should be two separate performance appraisal processes—one for developmental
purposes and one for administrative purposes. This makes a lot of sense in some ways, since
many firms do not want to use merit pay but may still want to evaluate individual performance
to provide feedback about opportunities for performance improvement.
But for such feedback to be effective, it must be accepted by the employee as valid, it must identify specific behaviours that need to change (i.e., behaviours that are under the control of
the employee), and it must occur in an environment where the person giving the feedback is
seen as a trusted coach. However, when money is tied to appraisals, the appraiser is more
likely to be seen as a feared judge than as a trusted coach.
One advantage of linking pay to appraisals is that doing so increases the likelihood that
appraisals will be taken seriously by all parties. However, when appraisals are used for both pay and developmental purposes, the appraisal may end up focusing on judging, and the
appraisers may have to justify and defend their decisions to grant or deny merit pay. As a
result, instead of engaging in a candid discussion of their shortcomings, appraisees may attempt to portray their performance as favourably as possible (“Given the circumstances, my
performance was actually pretty good”) and to defend themselves when the appraiser does
not award high performance ratings (“My performance may have been lower than expected,
but it wasn’t my fault”).
Moreover, the most accurate systems for assessing performance may not be the best methods
for generating useful feedback for the appraisee. Yet when merit pay is denied, employees expect to be told why and what they can do to correct the situation. Most organizations
include a developmental (feedback) element in their administrative appraisals, even though
this may make it more difficult to achieve either purpose.
There are two main reasons a performance appraisal system may not produce accurate evaluations. The first has to do with the appraisal system itself, which may not allow
appraisers to accurately assess employee performance, no matter how hard they try and how
much they may want to. The second—perhaps even more important—is that accurate performance measurement may not be the appraiser’s main objective. This insight has
emerged after many years of blaming performance appraisal problems on the appraisal
systems themselves. So let’s start by considering why appraisers may not want to produce
accurate appraisals.
Intentional Inaccuracies in Appraisals
There is considerable evidence that when supervisors start the performance appraisal
process, they often have in mind certain desired outcomes or consequences.9 For example: Do
I want Sally Jones to get a raise? Do I want Mike Ouimette to be promoted? Do I want Mudira
Singh to quit? What impact will a low performance rating have on Yidari Woo? Will a high or
low appraisal be most likely to improve Joan Baum’s performance?
Supervisors may see performance appraisal as a tool to help them achieve their own goals or
as a useless or even potentially damaging exercise. In any case, they are likely to keep the
broader work context in mind when conducting appraisals, as this quote from one manager
illustrates:
As a manager, I will use the review process to do what is best for my people and the
division . . . I’ve used it to get my people better raises in lean years, to kick a [person] in the pants if [he or she] really needed it, to pick up a [person] when he [or she] was down or even to tell him [or her] that he [or she] was no longer welcome here. It is a tool that the manager should use to help [her or him] do what it takes to get the job done . . . Accurately describing an employee’s performance is not really as important as gener-
ating ratings that keep things cooking.10
Another manager expresses concern for the possible interpersonal consequences of low
performance ratings:
There is really no getting around the fact that whenever I evaluate one of my people, I
stop and think about the impact—the ramifications of my decisions on my relationship with the [person] and [his or her] future here. I’d be stupid not to. In the end I’ve got to live with [him or her], and I’m not going to rate a [person] without thinking about the fallout. There are a lot of games played in the rating process, and whether we admit it or
not we are all guilty of playing them.11
A common practice in performance appraisal is for supervisors to inflate ratings, known as the
“leniency” problem. This can happen for reasons that, to the supervisor, are consistent with or
supportive of organizational goals, or it can happen for other reasons. For example, supervisors may inflate ratings if they lack confidence in the appraisal instrument or process.
They may believe that the appraisal does not measure the right things (it is not valid), that
they have had insufficient opportunity to observe employee performance to make a valid assessment, or that they do not have the expertise to adequately appraise performance. In
these cases, it would be difficult for the appraiser to defend poor ratings, so he or she avoids
the problem by giving high ratings.
Supervisors may have other motives for giving high ratings. They may be concerned about
damaging their relations with their subordinates or about the relationships among employees.
Moreover, a supervisor may worry about damaging his or her own reputation if the
subordinates are not performing well. Furthermore, some supervisors may believe that other
supervisors are giving high ratings and that they must also do so in order to maintain a level
playing field and to protect their department’s “fair share” of the available merit money and promotional opportunities. Finally, supervisors may simply not want to put the necessary
effort into producing accurate ratings, and give high ratings in order to prevent complaints
about inaccuracy. (This tactic is not unknown in the university classroom, either, as you may
have found!)
Supervisors may have specific motives for inflating the ratings of particular employees. For
example, they may believe that an accurate rating would have a damaging effect on a
particular subordinate’s motivation and performance. Conversely, they may want to improve an employee’s eligibility for a merit raise or a promotion, perhaps on the grounds that the
employee has been unfairly treated in the past. They may want to protect a normally good
performer whose performance is suffering because of a personal problem. They may want to reward employees who show great effort despite poor measurable results or who have other
valued attributes not measured by the appraisal instrument. On a less noble plane,
supervisors may wish to get rid of poor performers by promoting them out of the department.
Finally, they may simply want to reward their friends.
Research has also found that managers sometimes (albeit much less often) deflate ratings.12 For example, they may want to “scare” better performance out of an employee
whom they believe could do much more or who is in danger of being fired. Or they may wish to
punish a difficult or rebellious employee. They may also want to create a strong case to justify planned firings or to encourage problem employees to quit. In addition, they may be following
a company order to achieve a certain distribution in ratings, and this may require deflating the
ratings of some employees. Finally, they may simply be biased against some individuals.
Unintentional Inaccuracies in Appraisals
Problems in the system itself can threaten the accuracy of appraisals. The most fundamental
requirements for an accurate appraisal are an adequate opportunity to observe employee performance and an ability to draw valid conclusions from those observations. When a
supervisor has many subordinates or when the supervisor and subordinates work separately,
supervisors may have a very limited sample of behaviour on which to base their appraisals. Or,
the supervisor may lack the expertise to accurately gauge the quality of an employee’s work,
such as highly skilled or professional workers.
There are also many perceptual errors that can affect appraisal accuracy. These include
central tendency, halo error, recency effect, contrast effect, similarity effect, and leniency/harshness. Central tendency error occurs when appraisers rate all employees as
“average” in almost everything. Less commonly, some raters have the opposite tendency—to
rate all individuals as either extremely good or extremely bad, with nobody in the middle. The halo error occurs when one characteristic for a given individual is judged to be either very
good or very bad, which then prejudices the rater to rate all characteristics of that individual at
the same level.
The recency effect refers to a tendency to place excessive weight on recent behaviour, with
earlier employee behaviour having faded from memory. The contrast effect occurs when there
is one employee who is either exceedingly good or exceedingly bad, which causes the appraiser to rate other employees either worse (or better) than they really deserve.
The similarity effect describes a tendency for appraisers to rate individuals who are similar to
themselves more highly than those who are different. Finally, some evaluators tend to be
more lenient and rate all subordinates highly (the leniency effect), while others may be
inherently harsh (the harshness effect), rating all subordinates poorly.
Finally, one rating error that has become increasingly apparent is the “beauty effect.” This is
the finding that performance appraisals can be biased by the perceived physical attractiveness of the appraisee. For example, attractive appraisees tend to receive higher performance
ratings than their performance may justify, while unattractive appraisees tend to receive lower
performance appraisals than their actual performance would warrant.13 Taller appraisees are more likely to get promotions and raises than other employees.14 Obese employees tend to
receive lower performance ratings than they may deserve.15 Compensation Today
10.1 explores this phenomenon in more depth.
COMPENSATION TODAY 10.1
The Beauty Effect: Does “hotness” Pay?
Recent research has shown that people rated as “above average” in physical attractiveness
earn $230,000 more over the course of their careers than people rated as “below
average.”a Interestingly, although people tend to think of “beauty” as a female characteristic, and therefore might assume that women benefit more from good looks—and suffer more from
bad looks—than do men, research suggests that men can actually be more affected by a deficit
or a surplus in physical attractiveness. For example, in the study cited above, men who were rated as “above average” in looks earned 17 percent more than men rated as “below average”;
women rated “above average” earned 12 percent more than women rated “below average.”
Well, you might say, you can see how people in professions such as acting and modelling might benefit from an attractiveness surplus, but surely this doesn’t apply everywhere,
especially not in the academic environment, where brains should be valued above all else. In
fact, studies show that student evaluations of their professors are significantly affected by the
perceived physical attractiveness of the professor b What’s more, so is professor pay.
But again, the findings regarding men and women are a bit counterintuitive. It turns out that,
in a study of economics professors in Canadian universities, male professors who were rated
as “hot” (those who received a hot chili pepper on the “RateMyProfessor” website) by students earned significantly more than male professors who were not rated as “hot”—with “hot” male
professors about 20 percent more likely to earn more than $100,000 per year than were male
professors not deemed “hot.”c However, there was apparently no salary payoff at all for female economics professors rated as “hot.” The study authors do note one caveat to these findings—
very few female economics professors, especially those at senior levels (none at the full
professor level) were rated as “hot” by students, so it is not clear how this may have affected
results.
A more recent U.S. study, published in 2016, found similar results.d First, attractive individuals
earn roughly 20 percent more than people of average attractiveness. Second, contrary to the research findings in previous studies, there are no significant gender differences in the returns
to attractiveness. Attractiveness is no more or less important for women than for men when it
comes to income earning. Third, grooming contributes significantly to higher income, especially for women. Good news for most of us who are not lucky to be born beautiful or
handsome!
On a serious note, discrimination based on looks is not only unfair, but can also be a drag on
productivity, if less competent employees are given raises or promotions over more competent (but less attractive) employees. As discussed in Chapter 3, we know that an unfair
pay system has many negative consequences for the organization and can hurt productivity.
For example, in the United States, it is estimated that discrimination against the unattractive
costs the economy $20 billion per year.e
a Daniel Hamermesh, Beauty Pays: Why Attractive People Are More Successful (Princeton: Princeton University Press, 2011). b Gabriella Montell, “Do Good Looks Equal Good Evaluations?” Chronicle of Higher
Education, October 15, 2003, 1–4.
c Frances Woolley, “The Hottie Factor: Why Some Profs Out-Earn Others,” The Globe and Mail
Online, October 28, 2010; see also Anindya Sen, Marcel Voia, and Frances Woolley, “The Effect
of Hotness on Pay and Productivity,” Department of Economics, Carleton University, unpublished paper, 2010.
d Jaclyn Wong and Andrew Penner, “Gender and the Returns to Attractiveness,” Research in
Social Stratification and Mobility 44 (2016): 113–23.
e Daniel Hamermesh, Beauty Pays: Why Attractive People Are More Successful (Princeton:
Princeton University Press, 2011).
These perceptual errors and inconsistencies across raters can be magnified by poor rating
instruments, which provide insufficient definition of the characteristics being evaluated and of
the scales used to rate these characteristics. Some rating instruments are better than others at controlling these errors. But despite 50 years of effort to develop valid appraisal processes,
rater bias still has about twice the weight in determining performance ratings as does actual
appraisee performance.16
A final problem with appraisals arises when they take place under inappropriate
circumstances. For example, when work is highly interdependent, separating out individual
behaviour may be virtually impossible, and it makes no sense to attempt to do so. Moreover,
in some jobs, there is simply not much scope for individual performance to vary. Remember our chicken plant workers in Chapter 2 (Compensation Today 2.4)? It doesn’t make sense to
waste time attempting individual appraisals when so little performance variation is possible.
// Methods and Instruments for Appraisal
A number of appraisal systems have been developed over the years, but there is no
widespread consensus that any of them work in every situation. As discussed in Chapter 5, this
is partly because performance appraisals are often applied in circumstances where they do
not fit and where no performance appraisal instrument would be effective.
However, depending on the setting and the objectives, some appraisal methods are more appropriate than others. This section discusses the relative merits of the best-known
methods, in roughly the order in which they were developed:
• ranking and forced distribution graphic rating scale,
• behaviourally anchored rating scales,
• behavioural observation scales,
• objectives and results based systems,
• field review,
• combination approaches.
Ranking and Forced Distribution
Perhaps the simplest method of performance appraisal is just to rank the performance of all
individuals engaged in similar jobs, from most effective to least effective. This method has the
advantage that it does not require complicated forms and procedures. Furthermore, most
supervisors generally have little difficulty in determining their best and worst performers. This approach also eliminates the problems of central tendency and leniency/harshness. In
addition, it fits well with a system in which management decrees that only the top performers,
say, 10 percent of employees, will receive merit pay.
However, this system has many drawbacks. It is highly subjective, does not allow for
comparisons across departments, and provides little useful feedback to the individuals being
rated. It is also subject to numerous perceptual errors, such as recency, halo, contrast, similarity, and bias, as well as inconsistency in application across supervisors, since the bases
for evaluating performance are usually not made explicit. The system also implies that the
distances between the ranks are the same, when in fact there may be large gaps between, say,
the third- and fourth-best performers.
It is also a win–lose system, in that the only way a person can improve her or his or ranking is
to displace someone else. This may create conflict and lack of cooperation among employees.
It is also highly unfair across departments, because it does not recognize that some departments may be loaded with high performers, while other departments may have very
few.
Finally, this kind of ranking is difficult to carry out. That is, it may be easy to pick out the best and worst performers but very difficult to rank the large middle group. For example, should an
employee be ranked 10th or 11th out of 20 employees? It may also be very difficult to justify
these fine differences to appraisees, and these fine differences are seldom needed for
administrative purposes anyway.
One method for facilitating this ranking process is the paired comparison method. Each
individual is compared with every other individual, one at a time. Then, the number of times each individual is judged the superior of the pair determines the rank of that employee. This
method does simplify the ranking process; however, the number of comparisons that must be
made increases geometrically with the number of employees being ranked.
A variation of the ranking method is the forced distribution method. This approach was
popularized by Jack Welch, the highly successful former CEO of General Electric, who adopted
it at GE. See Compensation Today 10.2 for a related discussion. Under this approach, the rater is presented with a number of categories and is required to place a certain percentage of
the appraisees in each category. For example, Merck & Co. Inc., the large pharmaceuticals firm,
adopted an approach that required supervisors to place 5 percent of employees in the top
category (“exceptional”); 15 percent in the next (“with distinction”); 70 percent in the middle
(“high Merck standard”); 8 percent in the next to lowest (“room for improvement”); and 2
percent in the lowest (“not acceptable”).17 The company began using the system after it found that its previous rating scale was not discriminating between performance levels (almost
everyone was rated at the highest level). For the same reason, IBM tried a similar approach in
the 1990s, requiring each supervisor to place 10 percent of employees in the highest category and 10 percent in the lowest. Forced distribution is enjoying a surge in popularity even though
it still has almost all the deficiencies and problems of the ranking method. However, it does
have this major advantage: it is not necessary to generate a specific rank for each employee, which can simplify the appraisal process greatly. This method, though, does not fit well with
either human relations or high-involvement firms.
COMPENSATION TODAY 10.2
Changing With the Times
Jack Welch introduced the famous Vitality Curve to General Electric and led many of the
Session C meetings where executives were ranked into A, B, and C players in a distribution of 20-70-10; that is, 20 percent were ranked as A players, 70 percent as B, and 10 percent as C.
The C players were often terminated from the company. The process cascaded down the
whole organization. Welch’s tough management style turned GE from a bloated industrial
conglomerate, struggling to compete with manufacturers globally, to an efficient and even
more successful business. The company’s value increased by more than $300 billion during
Welch’s tenure and Fortune Magazine named him the “manager of the century” in 1999. Vitality Curve, also called forced distribution, or stacked ranking, became a popular
management process across industries.
Since Jack Welch left the helms of GE in 2001, a lot has changed at GE and in the world. According to a 2013 survey by WorldatWork, the forced distribution method is still used by
about 12 percent of US corporations; however, many organizations are changing their
performance management systems to focus on employee development. At GE not only is the
forced distribution discontinued, but also further changes to the performance management
system are being piloted and implemented. While it is acknowledged that the forced
distribution process made some sense in the 1980s and 1990s when managing cost and increasing efficiency were vital to the business, this management practice had become more a
ritual than moving the company upward and forward, according to GE’s current head of
human resources.
A new app called “PD@GE” for “performance development at GE” was piloted to 80,000 employees in 2015 and 2016. The app enables employees set near-term goals, or priorities and
have frequent discussions called “touchpoints” with the managers. The app can provide
summaries on demand, through typed notes, photographs, or even voice recordings. The focus is not on rating, but on how employees can improve. Managers and employees will still
have an annual conversation about their performance where they look back at the year and
set goals.
Sources: Jack Welch, Straight from Gut(New York: Warner Books, 2001); Max Nisen, “Why GE had to kill its annual performance reviews,” Quartz,August 13, 2015, at
http://qz.com/428813/ge-performance-review-strategy-shift/; Kate Linebaugh, “The New GE
Way: Go Deep, Not Wide,” The Wall Street Journal,March 7, 2012; Vitality Curve, Wikipedia,at
https://en.wikipedia.org/wiki/Vitality_curve. Accessed August 13, 2016.
Graphic Rating Scale
For many decades, the graphic rating scale has been one of the most widely used performance
appraisal methods. It is still, probably, the single most popular rating method, mainly because
of its simplicity. First, the organization selects a number of traits judged relevant to job performance. These typically include things such as quantity and quality of work performed,
initiative, responsibility, and cooperation with others. Then, immediate supervisors rate
employees on the extent to which they possess each characteristic. In many cases, raters are
required to make written comments in support of their ratings. These narrative comments are
especially useful for feedback purposes and for justifying the ratings.
Figure 10.1 shows a graphic rating scale that has been used by a police service in a western
Canadian city. Seven characteristics are each rated in terms of six levels of performance. In this example, raters must depend on their own judgment to define both the characteristic being
rated and the performance level. A more effective appraisal form would include brief
descriptions of the traits and definitions of the performance levels; this would improve
consistency of application. Some rating scales also weight the characteristics differentially.
Graphic rating scales have many shortcomings. First, the traits or characteristics are too often
defined vaguely or not at all, as in Figure 10.1. As a result, different supervisors define and measure these traits differently. Second, some characteristics are very difficult for a supervisor
to directly observe, which results in guesswork. Third, the traits being assessed are often
simply someone’s opinion of what is related to job performance and may not reflect actual job
performance. Fourth, performance levels are usually defined in general terms, such as
“excellent,” “good,” “satisfactory,” or “unsatisfactory,” and appraisers may differ significantly
in their standards for each of these rating levels. Fifth, this method often fails to provide useful
feedback to appraisees.
Moreover, the graphic rating scale is vulnerable to virtually all of the perceptual errors in the
rating process discussed earlier, especially leniency. Although some of these problems can be
reduced by rater training and by careful definitions of rated characteristics and response scales, this method is generally considered one of the least reliable or valid approaches to
performance evaluation. Indeed, many supervisors who are required to use this method are
reluctant to put much effort into it or to place much reliance on it because of doubts about its
validity.
Yet many organizations use this method because of its ease, low cost, and “face” validity—that is, it looks as if it should be a valid system. Since it is an absolute system (rather than a relative
system, as in the case of ranking), it does avoid certain problems of ranking systems, such as
the inability to make comparisons across departments. In some cases, it may be better than no system at all, especially if it is not used for pay purposes. Use of multiple raters may also
improve the utility of this method.
Behaviourally Anchored Rating Scales
Behaviourally anchored rating scales (BARS)are an attempt to improve on the graphic rating
scale by providing specific descriptions of behaviours for each point on the rating scale for
each job aspect. For example, take the job of “recruiting officer.” This job has a number of
different job aspects, such as identifying sources of good candidates, encouraging them to
apply for vacancies, gathering necessary information on each candidate, interviewing them, and recommending the best candidates. One aspect of the job involves soliciting and
answering questions from applicants during the interview process. So the following scale
might be developed for appraising this aspect:
Position: Recruiting Officer.
Name of Appraisee: ___________________________________
Job Aspect: Soliciting and addressing questions from interviewees.
Instructions: Choose the statement below that is most typical of this individual:
1. Often fails to solicit questions from interviewee.
2. Attempts to solicit questions, but not very successful in generating
questions.
3. Successfully generates questions, but often does not address them
effectively.
4. Successfully generates questions, and addresses most of them
effectively.
5. Successfully generates questions, and addresses virtually all
effectively.
Similar scales would need to be developed for each aspect of the “recruiting officer” job.
Evidence that BARS results in an appreciable improvement in the reliability and validity of ratings is mixed, although there is some evidence that BARS provides better guidance to raters
in defining degrees of effectiveness. BARS have the advantage of yielding a total score for
purposes of pay decisions and an evaluation in specific behavioural terms that is useful in providing meaningful feedback for developmental purposes. The major disadvantage is that
different scales need to be developed for each job aspect for each job in the organization,
which can be both expensive and time consuming. Another problem is that supervisors may disagree with the ordering on the scale, or there may be two items that could be selected for a
given scale.
Behavioural Observation Scales
Behavioural observation scales (BOS)were developed to try to improve upon the BARS.18 This
method entails developing behavioural statements that reflect examples of positive behaviour
for each job; each employee is then rated on the frequency with which each behaviour occurs
(on a “1” to “5” scale from “almost never” to “almost always”). Overall ratings are developed
by summing the individual scores. Figure 10.2 illustrates some sample items in a BOS.
Proponents argue that this method preserves the advantages of BARS by specifically
identifying the behaviours that will be rated, while eliminating some of their disadvantages. The major advantage of BOS over BARS is that once an item has been selected, there is no
need to develop detailed definitions for each scale point. Furthermore, using frequency of
behaviour as the rating scale ensures that two or more responses cannot be selected, as is
possible for BARS.
Of course, this method also has its drawbacks. For example, the frequency of a given
behaviour can be hard to judge, because most supervisors have only a limited number of observations on which to base this judgment. Furthermore, some research indicates that
raters generalize from a global evaluation of the individual, instead of first determining
frequencies for each item.19 In fact, these researchers conclude that BOS may actually be more
subjective than other scales, such as BARS.
Objectives-based and Results-based Systems
An approach that first gained prominence more than three decades ago involves establishing
goals and objectives for each employee, usually on a joint basis, and then measuring actual performance against those objectives. This approach is known as management by objectives
(MBO) or sometimes “management by results.” MBO is regarded by many as a highly effective
approach to employee motivation because of two key elements: participation by the employee in setting the goals, and frequent feedback on goal accomplishment. Research has
consistently shown that setting goals and providing feedback on progress improves employee
performance.20 To be effective, goals must be significant yet realistic, and there must be a
means of measuring the extent to which they have been achieved.
According to research conducted by one of the authors, most Canadian organizations use
performance appraisals based on goal setting for their employees, and an even larger
proportion use it for their managers. As will be discussed shortly, this change is likely due to a
surge of interest in “performance management,” which incorporates goal setting as a central
feature.
Although the motivational advantages of MBO systems can be significant, using them for determining pay levels can be difficult. One major difficulty is that not all significant goals can
be easily measured in a concrete way, and goals that cannot be measured are often
neglected.21 Another problem is that different employees set different goal levels. Should an individual who sets high goals but falls slightly short be penalized, while an individual who
achieves low goals is rewarded? The following example illustrates this problem:
A high-level manager in the start-up operations of a paper products company set
stringent goals to “shoot for” regarding start-up costs. Due to the inefficiencies of outside contractors, the targets were not attained. The manager was severely penalized at Christmas bonus time and again the following February at his annual performance
review. He vowed that he would not repeat the same mistake.22
Overall, the lesson this manager (and his subordinates) learned from this experience was to
set specific, relatively easy goals. The manager subsequently became a senior vice president in
his organization.
Field Review
The field review method involves a short period of direct observation of the job performance
of the individual being rated, often by an individual from outside the department who is
specially trained to conduct such reviews. This method is often used for jobs that are not
normally under direct observation by the supervisor. Truck drivers and airline pilots are often
appraised in this way. In the service sector, “mystery shoppers” are often used to assess the
work performance of sales personnel and other service staff.
A major advantage of this method is that a small number of specially trained raters may be
able to rate many employees, thus increasing the consistency and reliability of the appraisals. This method also provides the supervisor with a “second opinion” on the employee’s
performance and may reduce bias and other rating errors. Normally, this method is used in
conjunction with other methods and provides supervisors with additional data for their appraisals. Its main disadvantages relate to the cost of training and using specialized raters
and its limited application: field reviews are appropriate only in circumstances where the
behaviour can be evaluated relatively quickly.
Combination Approaches
Of course, some of the methods described above can be used in combination with other
methods. For example, at JPMorgan Chase, the financial services giant, the appraisal process
has three components: core competencies important to the firm (as measured by behavioural observation scales), contribution to key business success criteria, and achievement of
individual performance objectives.23
// Sources of Appraisals
Who should conduct performance appraisals? In the past, the answer was obvious: the
employee’s immediate supervisor, often augmented by an overall review of appraisals by the next-higher level of management. Recent research, though, has shown that there may be
value in including others in the appraisal process, including peers, subordinates, and even
customers, and that use of these alternative sources of appraisal information has expanded. However, research by one of the authors indicates that supervisory appraisals are still the
mainstay of the appraisal process; about three-quarters of Canadian employers use only
supervisory appraisals.
Appraisal by Superiors
The traditional approach to performance appraisal involves appraisals by the immediate
superior. In a classical organization, supervisors are responsible for the performance of their
units, so it seems logical to give them the responsibility for appraising the performance of the people within their units. Besides, this approach reinforces the authority of the supervisor—
something that is important in classical organizations.
But relying on the supervisor as the sole source for performance appraisals can generate a number of problems. For example, supervisors may not have had sufficient opportunities to
observe behaviour, or employees may skew their behaviour when they know a supervisor is
observing. And as has been discussed, supervisors may distort ratings, intentionally or not.
The “solution” to these problems has traditionally been for the next-higher level of
management to review the appraisals prepared by their subordinate managers. But while this
practice may have some advantages, such as demonstrating that appraisers are accountable for their ratings, it does not solve all of the performance appraisal problems noted earlier.
Since the superior generally has even less knowledge about specific employee behaviour than
the appraiser, the superior may be reluctant to question the results. For the same reason, the
superior has to resist the temptation to tinker with individual ratings.
Peer Appraisals
To augment the information available to the manager, information is sometimes collected
from employees who work at the same level as the appraisee. The rationale is that peers usually have much more contact with their coworkers than a supervisor does and thus are
more likely in a position to observe typical behaviour (i.e., behaviour that is not skewed). Also,
research has shown that rating errors are usually reduced when multiple raters are used.24
However, when appraisals are used for pay purposes, peers may be reluctant to “grade down”
their colleagues, and the appraisal system may informally gravitate toward a mutual
admiration society, in which all will benefit provided that they rate each other highly. Of course, the opposite may occur if there is only a limited amount of merit pay that can be
awarded; that is, peers may give one another low ratings in an attempt to make their own
performance look better, resulting in conflict and ill will among peers.
In general, research suggests that, if anything, peers are more lenient than superiors in making
their ratings. As one observer put it: “In more than one team I studied, participants in peer
appraisal routinely gave all their colleagues the highest rating on all dimensions. When I questioned this practice, the responses revealed just how perplexing and risky, both
personally and professionally, evaluating peers can be.”25 Some employees in this example
feared that providing negative feedback would damage their relationships with their peers and possibly hinder their own careers. Others felt that negative peer feedback was not in
keeping with the supportive work environment in which they preferred to work.
Subordinate Appraisals
Appraisal of managers by their subordinates is playing an increasing role in the performance
appraisal process. The logic is that subordinates can provide valid input regarding the
effectiveness of a manager that may not be available from a different vantage point. For example, at Ernst & Young Canada, a professional services firm, all employees are asked to
respond (anonymously) to this e-survey question: “How well does [your manager] foster a
positive work environment and help our people grow?”26 The company believes that only
employees can tell them what the atmosphere is really like “down in the trenches.”
However, supervisors often have serious concerns about subordinate appraisals. They may
worry that their subordinates do not understand all of the job demands placed on them or the
constraints they are operating under. They may also fear that employees will downgrade them
if they have to make unpopular decisions.
For their part, employees may be reluctant to criticize their supervisor for fear of
repercussions. In fact, a perverse situation can arise in which supervisors with good relationships with their subordinates—whose subordinates believe they are free to be candid
in their comments—may actually receive less favourable evaluations than supervisors who are
perceived as vindictive tyrants, since in the latter situation, employees may be afraid that any
criticism could have negative repercussions.
In fact, recent research has shown that subordinate appraisals are actually much less accurate
in assessing managerial performance than peer or supervisory appraisals (supervisory appraisals turned out to be the most accurate of the three, despite the finding that supervisory
bias was twice as strong as employee performance as a determinant of appraisee ratings).27 In
addition, subordinate appraisals clearly do not fit well with classical organizations. Nor do
they fit well with human relations organizations, since nobody will want to provide any nega-
tive feedback about their well-liked supervisors. In short, subordinate appraisals can be
expected to work well only in high-involvement organizations, where trust and open
communication are key values.
Self-Appraisals
Including a self-appraisal component in the appraisal process may have several advantages—
such as encouraging employees to critically examine their own performance and facilitating communication with superiors. However, self-appraisals are of very little value for pay
purposes, since they tend to be inflated. Not surprisingly, the poorest employees tend to
inflate their performance the most (see Compensation Today 10.3), while some high
performers may be overly self-critical.
Studies have also shown that self-appraisals are especially poor at identifying specific
employee behaviours that impede productivity. In assessing these kinds of behaviours, peer
appraisals were far superior to self-appraisals.28 Indeed, rather than being used for assessing job performance in general, peer appraisals may be most helpful in identifying
counterproductive employee behaviours.
Customer Appraisals
Customers are sometimes included in the feedback process. This can be highly useful when
customer satisfaction is a key factor in the organization’s success. At Avis Rent A Car, for
example, customers can evaluate employees on a “customer care balance sheet.”29 But this approach has limitations: not all employees come into contact with customers, and customers
may not be able to single out the performance of individual employees.
Other Appraisers
As with field reviews, professional raters may be useful for some organizations. Many firms in
the service industry, including Burger King, McDonald’s, Domino’s Pizza, and Taco Bell—as
well as banks, gasoline stations, hotels, retailers, and many other businesses—have full-time
raters (known as “mystery shoppers” when they are not identified in advance) who visit
specific sites and conduct detailed appraisals, which are then used to evaluate employee and
managerial performance.30
COMPENSATION TODAY 10.3
“But I’m Still Better Than Average, Right”
One reason for employee dissatisfaction with performance appraisals (but not the only one!) is
that most people tend to rate their performance as “above average” (even though this can be true for no more than half of all employees), and they don’t like to be told otherwise. What
heightens this problem is that not only are individuals who are performing below the norm
often blissfully unaware of this fact, but they also tend to be oblivious to feedback that would help them recognize their true performance level. Research conducted by Kruger and Dunning
used a series of experiments with university students to illustrate this tendency.
In one experiment, subjects were given a test of grammatical ability. Before knowing their test scores, students were asked to rate their grammatical ability and estimate their test scores.
Students who performed in the bottom quartile on the test estimated that they had performed
at the 61st percentile, and that their overall grammatical ability was at the 67th percentile.
Their actual result: the 10th percentile. Students who had performed at the second quartile
also had inflated perceptions of their grammatical ability, estimating it at the 72nd percentile, when in reality it was in the 32nd percentile. Students in the third quartile (and thus actually
having better-than-average grammatical ability) estimated their performance at the 70th
percentile, just a few points above their actual ability, while those who were in the top quartile actually underestimated their performance, estimating it at the 72nd percentile when it was
really at the 89th percentile.
Interestingly, however, not only were the students with poor grammatical skills apparently unaware of their lack of grammatical ability, but they also failed to learn from the feedback
provided. After their test scores and percentile rankings were revealed to them, they were
again asked to estimate their level of grammatical ability. Despite the feedback they had
received, they estimated their grammatical ability at almost precisely the same inflated level
they did before receiving the feedback, somehow still believing themselves “above average.”
Source: Justin Kruger and David Dunning, “Unskilled and Unaware of It: Difficulties in Recognizing One’s Own Incompetence Lead to Inflated Self-Assessments,” Journal of
Personality and Social Psychology 77, no. 6 (1999): 1121–34.
Multisource Systems/360-Degree Feedback
But any combination of these sources is also possible. A relatively new method, the 360-
degree feedback method, combines peer and subordinate appraisals (and sometimes even
customer appraisals) with supervisory appraisals.31 Because of dissatisfaction with existing
appraisal systems, 360-degree feedback expanded rapidly in the 1990s, although this expansion appears to have slowed as some of its shortcomings have become more apparent.
Originally intended as a tool for providing developmental feedback, this system has since
been used by many organizations for pay and promotion purposes.32 According to research by one of the authors, perhaps one-fifth of Canadian firms are currently using 360-degree
feedback for appraising their managers and employees (of course, for nonmanagers, it is really
270-degree feedback, since they generally have no subordinates).
Multisource systems use standardized forms that provide numerical ratings of the appraisee along numerous dimensions. Individual raters (except the superior) are assured of anonymity
so that they can feel free to be candid in their ratings. Importantly, the system employs several
procedures to screen out invalid data. For example, in a set of ratings for a given appraisee, the extreme scores (i.e., the lowest and the highest) are dropped before the scores are
averaged. And if a rater is more than 40 percent discrepant from other raters, that person’s
ratings may be eliminated entirely.
Advocates of this approach suggest that 360-degree systems have many advantages over
traditional superior-only ratings:
1. They are fair, in that they have more safeguards to prevent bias, which
results in less rating inflation.
2. They are more accurate, because they encompass the perspectives of
many raters, who have different viewpoints from which to observe
performance.
3. They are more credible to the recipient. Appraisees may believe a
single rater to be wrong or biased, but could all of these raters be
wrong?
4. They may be more valuable for bringing about behaviour change, since
work associates are likely to be more specific in their behavioural
feedback.
5. They may be more motivational, since peer pressure may motivate
constructive behaviour changes.33
However, multisource plans also have drawbacks. They are subject to most of the same
problems faced by peer and subordinate ratings discussed earlier. Also, multisource systems can be complicated to set up. Forms (whether paper or electronic) must be developed that ask
the right questions, and different forms may be necessary for different jobs.
Employees must be willing to fill out the forms voluntarily, and it may be difficult to track those who do not submit forms because the forms are submitted anonymously. To ensure
anonymity, there must be at least four persons in each rating group (peers or subordinates),
but this number of raters may not be available for all appraisees. Moreover, training needs to be provided to all raters, which is generally not practical given the number of potential raters
in this system (i.e., virtually everybody!).
Are 360-degree systems effective? Unfortunately, there is very little evidence on this question, probably because of the relative newness of these systems. One early study indicated that
360-degree systems were somewhat more effective in fostering employee performance than
other types of systems (68 percent of 360-degree users reported that their appraisal system had led to better employee performance, compared to 55 percent of users of traditional
systems).34 Moreover, 65 percent of 360-degree users believed that their systems produced
valid information for promotions, compared to 55 percent of users of traditional systems.
However, 360-degree systems had no real advantage over traditional systems in producing
valid information for merit increases: 69 percent of 360-degree firms believed their systems
produced valid information for merit raises, compared to 65 percent of other firms.
In a more recent but small-scale study, researchers found that “more than half” of the 360- degree systems they examined were successful.35 Overall, current thinking is that 360-degree
appraisal works better for feedback purposes than as a basis for merit pay.36 It is also
important, if employee behaviour is to actually change, that managers follow up the results of 360 degree feedback by discussing the results with appraisees and jointly developing plans for
behaviour change.37 It seems probable that, like subordinate appraisals, 360-degree systems
are more likely to succeed in high-involvement organizations than in classical or human
relations organizations.
// Performance Management
Although most practitioners and academics agreed that management by objectives (MBO) was
a good concept, its use waned in the 1980s as the practical problems of making MBO work became more apparent. This decline in popularity was hastened by the emergence of the total
quality management (TQM) movement in the 1980s, which eschewed the use of numerical
goals, believing them to be counterproductive. However, in recent years, the concept of MBO
has been resurrected under a new name—performance management—as part of the con-
tinuing quest to find a performance
appraisal system that really works.38
Under performance management, the organization sets goals for individuals and groups,
develops measures for goal achievement, provides feedback on progress, offers
encouragement and support, and provides rewards for success.39 When applied at the team
level, performance management is really a type of goal-sharing plan (see Chapter 5). Overall, 95 percent of large Canadian employers claim to use “performance management,” although
only 31 percent rate it as “effective” or “very effective.”40 About 30 percent were lukewarm
about the program, and 34 percent indicated that it “required improvement.”
Because it has become such a widely adopted program, and because some companies do
believe it to be effective, you need to understand its key elements, as listed in Compensation
Notebook 10.1.41 Although performance appraisal is an important aspect, when used properly, performance management is really more of a management system than an appraisal
system.42
The first element of performance management is goals. These need to be “SMART”—that is, Specific, Measurable, Achievable, Relevant, and specified in Time. Goals need to be tied to key
success factors for the firm, such as customer satisfaction or product quality. However,
coming up with goals that apply to individual employees can be very difficult, since results may depend on the collective efforts of a number of different employees. If this is the case,
some type of group goal-sharing system may be preferable.
Organizations that use SMART goals need to develop measures that are both reliable and valid—which is not always easy to do. During the course of the year, employees need feedback
on their progress toward goal accomplishment as well as specific guidance on ways to
improve performance. They also need to be encouraged and reinforced as they make progress
toward achieving their goals; and they must be appropriately rewarded when goal
achievement occurs. Of course, all of this is easier said than done!
Recent research suggests that getting performance management right is neither easy nor
common, that performance management is often used in circumstances where it does not fit, and that successful implementation of performance management is dependent on several key
circumstances.43 These include the quality of the employee–manager relationship, trust
between the employee and the supervisor, and provision of both formal and informal
feedback on performance and progress toward goal achievement.
COMPENSATION NOTEBOOK 10.1
Key Elements of Performance Management
1. Goals are tied to the strategy and key success factors of the business.
2. Measures are the primary indicators of success.
3. Feedback is the data used to determine progress toward goals.
4. Reinforcement is the active encouragement and support for action.
5. Rewards are what the individual or team receives for achieving desired
results.
// Linking Pay to Performance Appraisals
Besides accurate measurement of performance, the other crucial aspect of merit pay is having
an effective way of linking performance to pay.44 There are several issues to consider here.
First, should the link between performance appraisal and awarding a merit raise or bonus be fixed or discretionary? Second, should the amount of merit money each employee receives be
fixed or discretionary? Third, how should the total amount of money available for merit pay be
determined?
Regarding the first issue, whether or not an employee receives a merit increase can simply be
left up to the supervisor, based on examination and comparison of performance appraisal
results. However, this leaves the door open to supervisor bias and inconsistency, so most firms
have a fixed link between performance appraisal results and whether a merit increase is granted.45 For example, the firm may decide that nobody receiving less than a “very good”
rating or a particular cutoff score will receive any merit increase. Or it may decide that merit
pay will be restricted to the top 10 percent of employees in a department, based on their
appraisal scores.
A second issue is whether the amount of the merit pay to be provided to each meritorious
employee will be fixed or discretionary. In some cases, a supervisor simply receives a block of merit money to be allocated as he or she sees fit to the employees designated as meritorious,
as long as pay ranges are not violated. However, research shows that this approach can lead to
unfair allocation of merit money. For example, a recent study found that even when
performance appraisals are fairly done, and even when there is no bias regarding which
employees are selected to receive merit money, women and racial minority employees receive
smaller raises than they deserve, relative to other meritorious employees.46
So it makes sense to stipulate a fixed formula for the amount of merit money that meritorious
employees will receive. In some instances, a forced distribution is stipulated. For example, the top one-quarter of employees in a department receive, say, a merit raise of 10 percent, the
next quarter receive 5 percent, and the third and bottom quarters receive no merit increase at
all.
One approach to linking merit pay to performance appraisal is the merit pay grid (sometimes
referred to as a “merit pay matrix”). As Table 10.1 shows, this grid has two dimensions. Across
the top are employee performance ratings. Along the vertical axis are quartiles of the pay range for a particular set of employees. The numbers in each cell indicate the percentage
increase employees in that cell receive as a merit raise. For example, an employee in the
second quartile of the pay range with a “good” performance rating receives a 5 percent merit
increase.
As in this example, a common practice is for employees in the lower quartiles of their pay
range to receive a higher percentage increase in order to bring them up to the midpoint of the
range quite quickly. (Of course, increments expressed in fixed dollar amounts also amount to a
higher percentage increase for employees in the lower part of the range.) The example is also
designed so that employees in the third and fourth quartiles receive no merit increase for
simply doing satisfactory work, although employees in the first and second pay quartiles
receive 3 or 4 percent. The logic of this is that employees paid above the midpoint in their pay are already being rewarded for “satisfactory” work, and that a higher rating is necessary to
trigger a merit raise for them.
An alternative to the percentage approach to determining the amount of merit pay is to use a fixed increment method. Within every pay range, a fixed number of increments (with each
increment normally having the same value) are made available for merit pay. For example, a
job in a pay range of $50,000–$60,000 may have five “merit increments” of $2,000 available,
and if an employee proves meritorious in given year, that employee receives one increment.
(Development of these increments was discussed in Chapter 8, in connection with developing
a base pay structure.)
Note that individuals at the top of the pay range for their pay grade are not generally eligible
for further merit raises, no matter how superior their performance. Motivational problems
resulting from this situation can be eliminated by making merit bonuses available for those at the top of their range. So instead of providing a merit raise of $2,000, a merit bonus of $2,000
could be provided to meritorious performers who are at the top of their pay range.
A third issue is deciding how much money to make available for merit raises in a given year. There are two main approaches. A “bottom-up approach” does not set any arbitrary amount
but simply adds up all the merit increments and pays them. The major disadvantage of this
method is that the organization has no control over labour cost increases. Many organizations are not comfortable with that lack of control, so they set a maximum amount available for
merit pay (the “top-down approach”) and allocate it across departments. When this approach
is used, the firm should ensure that it is making available sufficient funds to allow a reasonable
number of merit increases.
Some firms gear the total amount of merit money available in a given year to the achievement
of certain financial goals of the organization. Compensation Today 10.4 describes a system used by RBC Financial to determine how much money will be available for annual merit
bonuses based on organizational performance. A problem here is that the entire merit pay
system may become irrelevant when the firm is not meeting its financial goals. Is this really a
time to signal to your top performers that merit will no longer be rewarded?
Organizations must also decide whether persons performing at simply an adequate level
should receive any merit increase. In general, the answer is “no.” Some firms lump all their
increases together, for cost of living, experience/seniority, and merit; in this way, everyone appears to get something. But this obscures the relationship between performance and merit
pay.47
Instead, if cost of living increases are justified or if the labour market becomes highly competitive, increases should be provided across the board to all employees by raising base
pay ranges or commission rates. If the organization wishes to reward seniority, seniority
increases should also be kept separate from merit increases. One option is to provide inflation/market increases to all employees, seniority increases to all employees who are
performing at a satisfactory or higher level, and an additional merit increase only to those
persons who are clearly performing at a higher-than-satisfactory level. As discussed in Chapter 8, it is important for the amount of a merit increase to constitute a “just noticeable difference”
in order for it to have impact.
Interestingly, conditions in public sector organizations may be more amenable to merit pay than they are in the private sector, where business environments are rapidly changing and
where alternatives, such as gain sharing and profit sharing, are available. In contrast, jobs in
public sector organizations tend to be more stable and less subject to dramatic change. One
occupational group that appears to fit many of the conditions for merit pay is university
professors, as Compensation Today 10.5 illustrates.
COMPENSATION TODAY 10.4
Tying Bonuses to Performance Ratings at RBC Financial
Several years ago, RBC Financial introduced a new merit bonus system—called the “quality performance incentive” or “QPI”—that it applied to virtually every employee. Under this
system, the total amount of the annual bonus pool is determined by the extent to which the
bank achieves certain financial objectives in each year. The specific amount received by each
employee depends on his or her annual performance rating.
The system works like this: If the company meets financial performance goals for the next year
(in terms of return on equity and revenue growth), a specific sum—say $100 million—is placed in a bonus pool. This amount is increased by 25 percent if three other goals are met: if revenue
growth, customer satisfaction, and employee commitment all exceed that of the competitors.
The amount each employee actually receives depends on the employee’s individual performance rating. An employee who achieves less than a “satisfactory” performance rating
normally receives none of the bonus. An employee who achieves a “satisfactory” rating
receives 100 percent of the basic bonus amount available for that employee’s salary band. If
an employee achieves higher ratings, this amount goes to 130, 170, or 200 percent. For an employee in the lowest salary band, a standard payout could be $750, compared to $15,350
for an employee in the highest pay band.
If you were an employee at RBC Financial, how would you feel about the “QPI” plan? Your opinion would probably depend on two considerations. First, is it likely that the bank will meet
its performance criteria, thus creating a bonus pool? And second, will the performance ratings
measure your performance fairly, so that you receive a merit bonus consistent with your performance? Without confidence that both of these are likely, you would find this
combination individual and organizational performance pay plan irrelevant or even
demotivating.
// Issues in Designing an Effective Merit
System
If the circumstances in an organization are judged to be right for an individual merit pay
system, the next step is to design an effective system. This means addressing the following
issues:
1. What should be the objectives of the system?
2. What is the most appropriate measurement system?
3. How frequently should appraisals be conducted?
4. How are appraisals to be linked to pay?
5. How should feedback be provided?
6. How is procedural justice to be achieved?
7. How are raters to be trained and evaluated?
8. How is the system to be evaluated?
We will discuss each of these issues in turn. We will conclude this section (and this chapter)
with a discussion of the thorny issue of whether and how to evaluate the individual
performance of employees who work in teams.
COMPENSATION TODAY 10.5
How Would You Grade Your Professor?
Merit pay seems to be appropriate only in limited circumstances. However, university
professors appear to meet many of the criteria. For the most part, they work independently
and have control over their performance, and their accomplishments can usually be separated
from those of others.
So how do you evaluate the performance of professors? In general, university professors are expected to perform in three main areas: teaching, research, and university and public service.
Therefore, performance in each of these areas needs to be evaluated in some way.
The usual measure of research performance is the number of publications in high-quality academic journals. Why is this such a popular measure? Because it avoids virtually all of the
problems inherent in more subjective appraisal systems. When a professor believes that he or
she has made a useful contribution to the state of knowledge in a particular field, that professor prepares a paper describing the research results and submits it to a journal that
specializes in that type of research. This journal then has the article reviewed by two or more
experts in the field, using what is known as a double-blind process. That is, the reviewers do not know whose work they are reviewing, and the researchers do not know who is reviewing
their work. Thus, bias, halo, and the other major rating problems are avoided. Certainly,
leniency is avoided, since most reputable journals accept for publication only a small percentage of the work submitted to them—often as low as 5 to 10 percent of submissions.
One could therefore argue that if there is any problem with this system, it is harshness.
Compare this practice with the evaluation of teaching. The usual process is to use feedback from superiors (e.g., the department head), peers (other professors), and customers
(students). But superior and peer appraisals take place for only a small sample of teaching
behaviour, perhaps one class per term, and it is usual practice to inform the professor well in
advance of the appraisal. This, of course, allows the faculty member to alter behaviour to
impress the appraisers. On the other hand, the presence of these appraisers could make the
professor nervous and detract from her or his performance. But in any case, colleagues
(department heads are normally considered as colleagues) are usually reluctant to be too
critical of a colleague.
In addition, since no standardized rating form is usually used, the appraisals from peers are
subject to all of the errors discussed earlier in the chapter.
Students have the opportunity to attend all classes and so are in a better position to judge
overall behaviour. But while they are qualified to judge things like preparation and
organization of material, they are not well equipped to judge the rigour and academic validity of what is being taught, because they are (by definition) not experts in the subject matter. In
addition, some faculty members attempt to influence student evaluations by combining
lightweight material with easy tests and few assignments, in the hope of leading students to believe that they are learning a lot (as evidenced by their high grades), or simply to curry
favour by making life as easy as possible for them.
With all of these problems, it is difficult to place a high degree of confidence in evaluations of teaching. But evaluations of university and public service accomplishments are even less
systematic and just as subjective. For example, what value should be placed on serving on the
university budget committee or delivering a public lecture to the Rotary Club? Given the
problems of accurately measuring teaching and university/public service, is it any wonder that
research performance often carries the most weight in university appraisal processes?
Define the Objectives for Merit Pay
The first issue is to define what the merit pay/performance appraisal system is supposed to
accomplish. Is it intended primarily to stimulate performance, promote reward equity, retain
valued performers, promote development/learning, or foster other desired behaviours? Is the
focus to be on task behaviour membership behaviour, or citizenship behaviour?
Determine the Most Appropriate Performance Measurement
System
The second issue is to determine the most appropriate performance measurement system.
The appraisal method or process chosen should depend largely on the nature of the
organization and of the jobs being appraised. For example, in jobs where employees do not work under close supervision, objectives-based and/or field review methods may be
necessary. A 360-degree feedback system may also be useful.
As a general rule, ranking and forced distribution systems should not be used (since they foster a win–lose competitive environment among employees), except possibly when there is
little or no interdependence among employees. These methods do not suit high-involvement
or human relations organizations. Job-based systems, such as BARS, are probably not appropriate in organizations where jobs change rapidly. Ideally, whatever method is used, it
should be systematic in approach, promote consistency across various raters, and be
validated in some fashion.
Determine the Frequency of Appraisals
Third, how often should appraisals be done? For accuracy and feedback, the more frequent,
the better. From a practical point of view, an annual basis is usually best, since merit raises are
normally awarded once a year. One system that might be effective is to have two appraisals a year, with the intermediate appraisal used for feedback and development only, to give an
indication of progress toward receiving a merit award.
Determine How to Link Appraisals to Pay
Fourth, how should the appraisals be linked to pay? Several options were discussed in the
previous section of this chapter. Overall, to be effective, merit pay systems need to provide
some assurance that top-rated performance will be recognized in a significant way. The issue of whether and how to recognize employees at the top of their pay ranges needs to be dealt
with here.
Determine How to Provide Feedback
Fifth, how is feedback to be provided? To be useful, appraisal results should be fully
communicated to employees, with concrete feedback on what can be done to improve individual performance. Also, employees should be encouraged to identify their own strengths
and weaknesses and to communicate to the supervisor their view of the appraisal results and
process. While appraisal interviews held at the time of each formal appraisal usually cover basic communication, the supervisor must also provide informal performance feedback on an
ongoing basis to each subordinate.
For an appraisal interview to be effective, the supervisor must be highly familiar with the subordinate’s job and performance, must take a supportive approach, and must encourage
subordinates to present their views and perceptions. In general, a friendly approach that
stresses strengths as well as weaknesses, and that enables subordinates to realize for themselves where their behaviour needs improvement, is most effective. The supervisor
should focus on specific behaviours that are undesirable instead of simply making a general
statement, such as “You have a bad attitude.” A statement like that is guaranteed to generate
defensiveness and resistance on the subordinate’s part; furthermore, it provides no real guidance regarding exactly what behaviour needs to change. The appraisee should leave the
interview with a description of specific, concrete steps that can be taken to improve
performance.
Although it is important to use a systematic and valid appraisal method, effective performance
appraisal goes far beyond the method used. The real key is the quality of the relationship
between the supervisor and his or her subordinates. If a climate of trust and open communication does not exist between superior and subordinate, then the effectiveness of
the appraisal process will be severely hampered, no matter how good the tools. A recent study
found that a positive and supportive relationship with the supervisor was just as important as the performance score itself in determining appraisee satisfaction with the appraisal inter-
view.48 Dissatisfaction with the appraisal interview led to lower job satisfaction and lower
organizational commitment.
Determine Mechanisms for Procedural Justice
Sixth, there need to be mechanisms for ensuring procedural justice. Two key aspects are
transparency (i.e., pay decisions are openly communicated to employees) and accountability
(i.e., supervisors are held accountable for applying the merit pay system in a fair way).49 One way of achieving transparency and greater employee confidence in the merit process is
participation by employees in that process, although this may be viable only in high-
involvement organizations. Another aspect of procedural justice is some type of review or appeals system. A highly developed process used by a Canadian university is illustrated
in Compensation Today 10.6.
Determine Procedures for Rater Training and Evaluation
Seventh, there need to be procedures for rater training, as well as for rater accountability.
Raters need to be carefully trained to use the system, to make observations of employee behaviour, to relate these observations to the measurement system, and to provide effective
feedback. In addition, a system needs to be in place for recognizing and rewarding those
supervisors who take the appraisal process seriously and do it well. Supervisors need to know that appraisals of their own performance are partly based on how well they conduct
performance appraisals for their subordinates.
COMPENSATION TODAY 10.6
Does This System Have Any Merit?
A major western Canadian university has used a complex system for merit increases. Each fall,
faculty members in each academic department vote on whether to have an elected merit pay committee or to delegate this function to the department head. Then, faculty who wish to be
considered for a merit increment (raise) are asked to submit evidence substantiating their
case. The department committee or head then reviews these submissions, ranks them, and chooses which to submit to the College Review Committee, an elected body of faculty chaired
by the dean of the college.
The College Review Committee reviews all submissions from the departments in the college and ranks them. The committee then awards merit increments (usually a half-increment, but
occasionally a full increment) down the list until the available funds are exhausted. The funds
available for merit increases are established through negotiations between the university and the faculty union, and they are usually sufficient to provide half-increments (which currently
amount to about $1,250) to approximately one-third of the faculty. There is also a special
university-wide pool from which additional increments can be awarded to deserving faculty members. These funds are allocated by another elected faculty committee, the University
Review Committee.
To ensure that teaching and university/public-service performance are not neglected because they are difficult to measure, most committees make a special effort to ensure that some
awards are made on these bases. Once the awards are official, a report listing the faculty
members who have received merit awards is provided to all faculty, along with a brief
explanation of the basis for each award.
If an individual does not receive a merit increase, he or she has several avenues of appeal. If
the department committee or head did not recommend an increase, that faculty member may
appeal to the College Review Committee. If the College Review Committee does not grant an
increment, the individual may then appeal to the University Review Committee.
It should also be noted that unless faculty members are at the top of the pay range for their
rank, they will receive a full increment for each additional year of service, aside from whatever
cost of living increase the faculty union is able to negotiate (which is not much these days). Thus, seniority usually counts about double the value of merit, even if one is among the
fortunate one-third who receive merit increases.
You will recognize many elements of procedural justice in this system, including openness, the election of salary committees, the opportunity to make one’s own case, and the two sets of
appeal processes. Interestingly, despite all of these elements of procedural justice, many
faculty still feel slighted if they do not receive a merit increment and blame the system for
“unfairness.”
This system illustrates the difficulty inherent in developing a merit pay system that is
perceived as fair by all employees. Part of the problem may be incomplete information: the brief report on merit awards that is provided to faculty typically does not portray the full
spectrum of accomplishments on which the award is based, and many faculty members not
receiving an award are able to point to somebody who appears to have done less than they
have but were awarded a merit increment.
So is this merit system worthwhile? There is no clear answer, but it does accomplish several
goals. It signals the behaviours that are important to the university, it attempts to provide some connection between contributions and rewards, it recognizes noteworthy accom-
plishments, and it serves as a mechanism for raising the pay of faculty members who might
otherwise be lured to other universities.
Develop Procedures for Evaluating the Merit System
Finally, how should the merit system be evaluated? Organizations need to develop a process
for determining whether the system is achieving its objectives and whether it is causing any undesirable side effects. Rater and appraisee acceptance of the system can easily be
evaluated through the use of surveys. If both raters and appraisees do not accept and believe
in the system, then it doesn’t stand a chance. However, even if both groups accept a particular
appraisal system, its weaknesses may render it ineffective or dysfunctional. Employee
satisfaction with the system and its results is a key check on how it is performing.
Evaluating Individuals in Teams
One final topic in performance appraisal is the issue of how (and whether) to evaluate the
performance of individuals in teams. As tasks in organizations have become more complex
and interrelated, and as the business environment has come to demand more speed and
customer responsiveness, many organizations have come to depend on work teams. Research by one of the authors suggests that at least one-fifth of Canadian firms use work teams or
project teams for their employees, although not every employee at these firms is necessarily
included in a team.
When Should Individuals in Teams Be Evaluated?
The topic of teamwork raises two questions: (1) Should you attempt to recognize individual
performance when that individual spends most or all of his or her time in a team? And (2) if so,
how can this be done? There are two schools of thought on the first question. One is that any attempt to single out individuals in a team context (except possibly on the basis of pay for
knowledge) will likely do more harm than good. The argument here is that teams are so
interdependent in accomplishing their goals that singling out individuals is inherently unfair. Singling out particular team members may lead to resentment and a less cohesive and
cooperative team. There is also a risk that some members will devote more energy to looking
good according to the appraisal system than to being effective team players. Thus, critics of individual pay believe that team-based reward systems—such as gain sharing or goal
sharing—are the best means of rewarding performance in teams.
The second school of thought argues that it is inevitable that some team members will contribute more to team success than others, so it is unfair (and possibly demotivating) to
high contributors not to have their contributions recognized financially. If the right behaviours
are rewarded, if individual contribution levels are fairly determined, and if the system is used in conjunction with group-based and organization-based performance pay, then individual
performance pay may play a useful role even in a team context.50
Which school is correct? Unfortunately, there is no definitive evidence on this issue. However,
it is clear that work teams can be highly effective without the use of individual performance pay, as Toyota and Shell Sarnia have demonstrated. Whether teams at these companies would
be even more successful with an element of individual performance pay is not clear. However,
it is conceivable that if done right, individual performance pay might help a firm encourage and retain high contributors without negative repercussions for the team as a whole. But given
the risks and possible pitfalls involved, it may well be that the risks usually outweigh the
possible returns.
In some circumstances, identifying and rewarding individual contributions may be
appropriate and even necessary for team success. For example:
1. when the members do not have strong intrinsic motivation,
2. when strong positive group norms do not exist,
3. when group sanctions against poor contributors are ineffective,
4. when little member commitment to overall team or organizational
goals is evident, and/or
5. when teams are temporary and membership is part-time.
Under these conditions, recognizing individual contribution levels may be essential, not only
to discourage free riding, but also to assure team members who are contributing that their
rewards will be higher than those of the free riders. There is nothing more demoralizing to
conscientious team members than the presence of free riders who benefit equally from the
team’s accomplishments. This can result in a downward performance spiral as all members
“cut their losses” by competing to see who can get away with contributing the least.
How Can Individuals in Teams Be Evaluated?
One way of avoiding a downward performance spiral by team members is through the use of
an individual/team merit grid that recognizes individual contributions while providing incentives for team-oriented behaviour.51 Table 10.2 provides an example. The table shows
three levels of team performance and four levels of individual performance (defined in terms
of contribution to team success) to measure total performance. If the team does not meet its performance goals, there is no merit pay for anyone, regardless of individual performance. The
message is that there can be no individual success without team success. However, even if the
team does meet its performance goals, there will be no merit pay for individuals who did not make at least an “effective” contribution to team success. If the team meets its goals,
“effective contributors” (the norm) will receive a 4 percent raise or bonus, “high contributors”
will receive a 6 percent raise or bonus, and “exceptional contributors” (these will generally be
quite rare) will receive 8 percent. If the team exceeds its goals, these amounts will be doubled. Overall, this system creates a common goal for team members while recognizing individual
contribution levels. Of course, the key to success for this system is to have some way of
identifying individual contribution levels that is both accurate and accepted as fair.
If an organization cannot devise an appraisal system that the team accepts, it should not
attempt to force the use of an unacceptable system, since this will likely do more harm than
good. However, a peer appraisal system could well be used to identify the performance of
team members, so that weak members could take steps to improve their performance (or be
removed from the team). Nothing is more damaging to team morale (and, ultimately, to team performance) than carrying a member who makes little or no contribution to team success
(especially if that member will receive the same rewards as everyone else, or who could affect
other team members’ rewards!).
Figure 10.3 provides a peer evaluation tool that has been tested for reliability and validity. It utilizes a behaviourally anchored rating scale format for assessing individual contribution to
team success.52
// SUMMARY
The pay for a given employee is a function of the internal value of the employee’s job (i.e., as
determined by job evaluation), the external value of the job (i.e., as determined by market
surveys), and the individual’s contribution to the job (i.e., as determined by performance
appraisal). This chapter focused on the third element in determining compensation values. While performance management systems are changing, organizations still evaluate
individuals, by themselves and/or in teams. The chapter explained how to develop processes
for evaluating the performance level of individual employees so that they can then be compensated accordingly, and emphasized that accurate evaluation of individual
performance is essential for a successful merit pay system.
You have learned how creating a reliable and valid performance appraisal system is fraught
with difficulties and that many firms are dissatisfied with their current appraisal processes. Part of the problem is that linking individual merit pay to performance appraisal (or even use
of individual merit pay itself) is not appropriate in many circumstances. Performance appraisal
can be applied effectively only where performance has scope to vary, where employees can control their performance levels, and where individual performance can be separated out and
accurately assessed. In addition, you have learned that evaluating individual performance in a
team context is an especially thorny matter, although sometimes necessary.
You now understand the many threats to the accuracy of performance appraisal, some of
them intentional. Managers usually view performance appraisal in the context of their overall
task objectives, and the accuracy of performance appraisal is often secondary to the
achievement of managerial goals.
Another potential source of appraisal problems is the appraisal method itself, of which there
are many. Although no method is perfect, some methods are more reliable and valid than others. The key is to select the method that fits best with the purpose of the appraisal system,
the nature of the behaviour being evaluated, and the organizational context in which it is
applied. The same is true for selecting the most appropriate persons to actually conduct the appraisals, which may include not only superiors, but also peers, subordinates, and even
customers.
When pay is to be based on performance appraisal, you must develop a method for effectively linking pay to the appraisal results. But you will still have to deal with other issues before
completing the design of the merit system, including the frequency of appraisals, feedback,
mechanisms for procedural justice, procedures for rater training, and how to evaluate the
merit system itself.
Key Terms
• 360-degree feedback
• beauty effect
• behaviourally anchored rating scales (BARS)
• behavioural observation scales (BOS)
• central tendency error
• contrast effect
• forced distribution method
• graphic rating scale
• halo error
• harshness effect
• individual/team merit grid
• leniency effect
• management by objectives (MBO)
• merit pay grid (merit pay matrix)
• paired comparison method
• performance appraisal
• performance appraisal reliability
• performance appraisal validity
• performance management
• recency effect
• similarity effect
Discussion Questions
Discussion Question 10.1
Review
Take several jobs that you or other members of your class have held or are currently holding and discuss
whether and how you would go about designing a useful performance appraisal and merit system for them.
Your Answer
No answer submitted
Discussion Question 10.2
Review
One alleged problem with performance appraisal is that most employees seem to think they are above
average and do not like to be told otherwise. Do you think this is true, and, if so, how could you design an appraisal system that might avoid this problem?
Your Answer
No answer submitted
Discussion Question 10.3
Review
What are the key issues related to merit pay for individuals in teams?
Your Answer
No answer submitted
Using the Internet
Using the Internet 10.1
Review
On the website http://www.buisenessballs.com you will find a template for a performance appraisal form.
Using the material in this chapter, assess the pros and cons of this form. Which type of performance
appraisal method do you think it represents?
Your Answer
No answer submitted
Exercises
Exercise Question 10.1
Review
In groups of six to eight, share your experiences with performance appraisal. Group members who have
been subject to a performance appraisal system should indicate whether they believe their performance was fairly evaluated and, if not, why not. After that, the groups should come together and discuss the
overall experience of class members with performance appraisal. How many members believe they were
fairly appraised, and how many believe they were not, and what were the differences between fair and unfair appraisal systems?
Your Answer
No answer submitted
Exercise Question 10.2
Review
Assume you are the HR manager in a small firm with ten employees; all the employees are eligible for merit pay. You have been allocated $10,000 to reward these employees. Design a performance management system to first evaluate the employees and then a system to link their performance with pay. Discuss your
approach with members in the class. What are the pros and cons in the various approaches?
Your Answer
No answer submitted
Case Questions
Case Question 10.1
Review
“Henderson Printing" in the Appendix currently has no formal performance appraisal system. The CEO, Georgette Henderson, thinks that a performance appraisal system might be useful, and she has hired you
to assess the company and recommend whether to implement one. She also wants to know whether she
should link pay to the appraisals. She expects your report to include the pros and cons of each idea, along
with a detailed justification for your recommendations.
Your Answer
No answer submitted
Case Question 10.2
Review
CEO Henderson has decided to go ahead with a performance appraisal system, and she has decided to link
it to merit pay. Impressed with your earlier work for the company (see Question 1), she has hired you to
design the performance appraisal system and a merit pay system that will be linked to it. She expects your report to be sufficiently comprehensive that it can serve as the blueprint for implementing these systems.
Your Answer
No answer submitted
Simulation Cross-Reference
If you are using Strategic Compensation: A Simulation in conjunction with this text, you will
find that the concepts in Chapter 10 are helpful in preparing Section K of the simulation.
// Notes
1. Jeffrey S. Kane and Kimberly F. Kane, “Performance Appraisal,” in Human Resource
Management: An Experimental Approach, ed. H.J. Bernardin and J.E.A. Russell (New York:
McGraw-Hill, 1993), 378.
2. Kane and Kane, “Performance Appraisal,” 377–404.
3. Don L. Bohl, “Minisurvey: 360-Degree Appraisals Yield Superior Results,” Compensation
and Benefits Review28, no. 5 (1996).
4. “Performance Appraisals Get Thumbs Down,” Human Resources Management in
Canada, Report Bulletin #208 (2004), 4.
5. Edward E. Lawler, George S. Benson, and Michael mcDermott, Performance Management
and Rewards Systems (Los Angeles: Center for Organizational Effectiveness, Marshall School
of Business, University of Southern California, 2012).
6. Not surprisingly, use of formal performance appraisal is much lower in small firms; only 38
percent of firms with fewer than 100 employees reported having formal performance
appraisal. See Terry H. Wagar and Lynn Langrock, “Performance Appraisal and Compensation
in Small Firms,” Canadian HR Reporter17, no. 14 (2004): 10.
7. Tom Coens and Mary Jenkins, Abolishing Performance Appraisals: Why They Backfire
and What to Do Instead(San Francisco: Berrett-Koehler, 2000).
8. Edward E. Lawler, Rewarding Excellence: Pay Strategies for the New Economy
(San Francisco: Jossey-Bass, 2000).
9. Clinton O. Longenecker, H.P. Sims, and D.A. Gioia, “Behind the Mask: The Politics of
Employee Appraisal,”Academy of Management Executive1 (1987): 183–93.
10. Ibid., 185.
11. Ibid., 183.
12. Clinton Longenecker and Dean Ludwig, “Ethical Dilemmas in Performance Appraisal
Revisited,” in Performance Measurement and Evaluation, ed. Jacky Holloway, Jenny Lewis,
and Geoff Mallory (London: Sage, 1985), 66–77.
13. Daniel Hamermesh, Beauty Pays: Why Attractive People Are More
Successful(Princeton: Princeton University Press, 2011).
14. Daniel Hamermesh, Tall or Taller, Pretty or Prettier: Is Discrimination Absolute or
Relative?(Cambridge, MA: National Bureau of Economic Research, 2012).
15. Rebecca Puhl and Kelly D. Brownell, “Bias, Discrimination, and Obesity,” Obesity
Research9, no. 12 (2001): 788–805.
16. Steven E. Scullen, Michael K. Mount, and Maynard Goff, “Understanding the Latent Structure of Job Performance Ratings,” Journal of Applied Psychology 85, no. 6 (2000): 956–
70.
17. Kane and Kane, “Performance Appraisal.”
18. Gary P. Latham and Kenneth N. Wexley, Increasing Productivity Through Performance
Appraisal(Reading: Addison-Wesley, 1994), 51.
19. Kevin R. Murphy and Jeanette N. Cleveland, Understanding Performance
Appraisal(Thousand Oaks: Sage, 1995).
20. Edwin A. Locke and Gary P. Latham, “Has Goal Setting Gone Wild, or Have Its Attackers
Abandoned Good Scholarship?,” Academy of Management Perspectives23, no. 1 (2009):
17–23.
21. Lisa D. Ordonez, Maurice E. Schweitzer, Adam D. Galinsky, and Max H. Bazerman, “Goals
Gone Wild: The Systematic Side Effects of Overprescribing Goal Setting,” Academy of
Management Perspectives23, no. 1 (2009): 6–16.
22. Latham and Wexley, Increasing Productivity, 51.
23. Gary P. Latham and Soosan D. Latham, “The Importance of Performance Management to
Productivity,” HR.com eBulletin, June 11, 2001, http://www.hr.com.
24. Scullen et al., “Understanding the Latent Structure.”
25. Maury A. Peiperl, “Getting 360° Feedback Right,” Harvard Business Review 79, no. 1
(2001): 143.
26. Natalie Southworth, “Managers Crucial to Curbing Turnover,” Globe and Mail, May 30,
2001, M1.
27. Scullen et al., “Understanding the Latent Structure.”
28. Sara L. Mann, Marie-Helene Budworth, and Afisi S. Ismaila, “Ratings of Counterproductive
Performance: The Effect of Source and Rater Behavior,” International Journal of Productivity
and Performance Management 61, no. 2 (2012): 142–56.
29. Kane and Kane, “Performance Appraisal.”
30. Kane and Kane, “Performance Appraisal.”
31. Mark R. Edwards and Ann J. Ewen, 360° Feedback (New York: Amacom, 1996).
32. Bohl, “Minisurvey.”
33. Edwards and Ewen, 360° Feedback.
34. Bohl, “Minisurvey.”
35. David W. Bracken, Carol W. Timmreck, John W. Fleenor, and Lynn Summers, “360 Degree
Feedback from Another Angle,” Human Resource Management 40, no. 1 (2001): 3–20.
36. Angelo S. DeNisi, “360-Degree Feedback,” in Encyclopedia of Industrial and
Organizational Psychology, ed. Steven G. Rogelberg (Thousand Oaks: Sage, 2007), 809–12.
37. David W. Bracken and Dale S. Rose, “When Does 360-Degree Feedback Create Behavior
Change? And How Would We Know When It Does?,” Journal of Business Psychology26
(2011): 183–92.
38. Tracey B. Weiss, “Performance Management,” in The Compensation Handbook, ed.
Lance Berger and Dorothy R. Berger (New York: McGraw-Hill, 2000), 429–42.
39. David E. Tyson, Carswell’s Compensation Guide(Toronto: Thomson Carswell, 2009).
40. Carolyn Baarda, Compensation Planning Outlook 2001(Ottawa: Conference Board of
Canada, 2000).
41. Tyson, Carswell’s Compensation Guide, 19–3.
42. John Shields, Managing Employee Performance and Reward: Concepts, Practices,
Strategies (Cambridge: Cambridge University Press, 2007).
43. Elaine Pulakos and Ryan S. O’Leary, “Why Is Performance Management
Broken?,” Industrial and Organizational Psychology 4 (2011): 146–64; Marie-Helene
Budworth, Garuy Latham and Laxmikant Manroop, “Looking Forward to Performance
Improvement: A Field Test of the Feedforward Interview for Performance,” Management,
Human Resource Management 54, no. 1 (2015): 45–54.
44. Mary Jo Ducharme, Mark Podolsky and Parbudyal Singh, “Exploring the Links Between Performance Appraisal and Pay Satisfaction,” Compensation and Benefits Review37 (2005):
46–52.
45. Robert L. Heneman and Jon M. Werner, Merit Pay: Linking Pay to Performance in a
Changing World(Greenwich: Information Age, 2005).
46. Emilio J. Castilla, “Gender, Race, and Meritocracy in Organizational Careers,” American
Journal of Sociology113, no. 6 (2008): 1479–526.
47. Lawler,Rewarding Excellence.
48. I. .M. Jawahar, “Antecedents and Potential Consequences of Satisfaction with Performance
Appraisal Interview,” Proceedings of the Annual Conference of the Administrative
Sciences Association of Canada, Human Resources Division22, no. 9 (2001): 45–54.
49. Castilla, “Gender, Race, and Meritocracy.”
50. Jack Zigon, “Measuring the Hard Stuff: Teams and Other Hard-to-Measure Work,” in The
Compensation Handbook, ed. Lance A. Berger and Dorothy R. Berger (New York: McGraw-Hill,
2000), 443–66.
51. Tyson, Carswell’s Compensation Guide.
52. Matthew Ohland, Misty L. Loughry, David J. Woehr, Lisa G. Bullard, Richard M. Felder, Cynthia J. Finelli, Richard A. Layton, Hal R. Pomeranz, and Douglas G. Schmucker, “The
Comprehensive Assessment of Team Member Effectiveness: Development of a Behaviorally
Anchored Rating Scale for Self- and Peer Evaluation,” Academy of Management Learning
and Education 11, no. 4 (2012): 609–30.
Chapter 11: Designing
Performance Pay Plans CHAPTER LEARNING OBJECTIVES
After reading this chapter, you should be able to:
• Identify the main types of gain-sharing plans and key issues in their
design.
• Identify the main types of goal-sharing plans and key issues in their
design.
• Identify the main types of profit-sharing plans and key issues in their
design.
• Identify the main types of employee stock plans and key issues in their
design.
• Discuss the considerations in designing a nonmonetary rewards
program.
WHO WANTS TO BE A MILLIONAIRE?
In the 1980s, a young, aggressive software company wanted a tool to help it attract and
motivate young, dedicated employees who would be willing to stick with the firm and do
whatever it took to make the company successful. As part of its compensation strategy, the
firm offered generous employee share plans, where employees would acquire significant
holdings in the company. At the time, no one knew whether this would end up being a
bonanza or a bust for the employees. In many cases like this, the company doesn’t make it and
the shares become virtually worthless.
In this case, the story had a very happy ending for the employees. The company was Microsoft, and by 1996 virtually all of the company’s original employees (and many of the later ones) had
become millionaires. By 2015, it was estimated that Microsoft had created three billionaires
and more than 12,000 millionaires through its employee share plans! Ironically, now that they are independently wealthy, many of these employees have left Microsoft to pursue a variety of
life goals, ranging from philanthropy to starting their own businesses. However, many others
have stayed, because Microsoft pays a lot of attention to providing jobs and a work
environment that are intrinsically motivating. Microsoft has always understood that there is
more to motivation than money.
Sources: Julie Bick, “Microsoft Millionaires Branch Out,” Star Phoenix [Saskatoon], June 3, 2003, C10; Matt Weinberger, “Microsoft Millionaires Unleashed,” Business Insider, August 8,
2015, at http://www.businessinsider.com/microsoft-millionaires-who-spent-their-money-
magnificently-2015-8, accessed October 2, 2016.
// Introduction To Types Of Plans And Design
Issues
Suppose that, based on all the considerations in the first half of this book, you have decided
that an employee stock plan should be part of your compensation strategy. As you will see later in this chapter, not every employee stock plan works out as well as Microsoft’s did. How
can we design an employee stock plan that is likely to succeed, so that it benefits both the
company and its employees? What are the key issues to consider in actually designing a successful plan? Employee stock ownership may be a good fit for your firm, but many design
issues will need to be dealt with effectively before such a plan can be launched, and you need
to understand them.
The purpose of this chapter is to address these design issues, not only for employee stock
plans but also for three other important types of performance pay plans. Previous chapters
discussed plans geared to the performance of individual employees; this chapter focuses on plans geared to the performance of work groups—notably gain-sharing and goal-sharing
plans—and on plans geared to the performance of the organization as a whole—notably profit-
sharing and employee stock plans. We end this chapter with a discussion of employee recognition programs that don’t involve cash payments. As you understand by now, money is
not the only valued reward an organization can offer!
// Gain-Sharing Plans
We’ll start with gain-sharing plans. As you will recall, the defining feature of gain-sharing plans
is that whenever employees in a particular work group are able to reduce costs or increase
productivity, a portion of the resulting gains are shared in a systematic way among all of the members of the work group. Cost savings can be brought about in a variety of ways, such as
through improved quality, decreased waste, improved methods of working, and, of course,
increased output per unit of labour.
Types of Gain-Sharing Plans
There are four main types of gain-sharing plans: the Scanlon plan, the Rucker plan,
Improshare, and the family of measures plan. And there are countless permutations of these.
The Scanlon Plan
The Scanlon plan was developed by Joseph Scanlon, a United Steelworkers local president, at
a financially troubled steel mill during the Great Depression. In a Scanlon plan, the
organization first computes a “normal” labour cost, based on past experience and expressed as a percentage of the sales value of production. For example, labour costs may be 50 percent
of the sales value of production. If workers lower this cost to 47 percent, they share this
productivity gain (3 percent of sales value) with the company according to a prearranged formula. For Scanlon plans, the share traditionally has been 25 percent for the company and
75 percent for employees, based on the notion that the workers are primarily responsible for
the productivity gain; however, many gain-sharing plans use a 50/50 share.
The Scanlon plan is much more than a financial incentive plan. According to proponents, the
key to its success is the development of a cooperative relationship among workers, union, and
management, along with the establishment of a process through which workers can contribute to problem solving. Within each work unit, gain-sharing committees composed of
management and worker representatives solicit and examine employees’ suggestions for
improvements and recommend either approval or rejection. If the proposal is outside the department’s jurisdiction or involves large expenditures for implementation, the committee
passes it on to a plant-wide committee, where top management and union officials (if the firm
is unionized) discuss it. Typically, all members of the gain-sharing plan share in savings from
any resulting improvements.
The Scanlon plan has been modified over time. A major modification has been the inclusion of
additional costs besides labour.1 There are two reasons for this change. First, many possible
cost savings do not show up in labour costs, such as reductions in raw materials waste.
Second, because it is usually possible to decrease labour costs by increasing other costs, a
singular focus on reducing labour costs could spur a rise in other costs. For example, a worker may scrap slightly defective raw material instead of trying to work with it, since using the
poorer quality raw material would slow production and increase labour costs. As another
example, a worker may discard tools that become somewhat dull because they slow down the work, even though replacements may be expensive. With the “multicost” approach, the share
for employees is usually lower, perhaps by 50 percent, because potential savings are much
higher with a broader cost base.
The Rucker Plan
Another type of gain-sharing plan was developed in the 1930s by Alan Rucker, who modified
the Scanlon plan in a small but very significant way by expressing labour costs as a percentage
of value added (sales value of production less purchased inputs), rather than the sales value of production. The effect is that employees benefit from reductions in raw materials or any other
purchased inputs and are therefore motivated to find ways to reduce these costs; like the
Scanlon plan, the Rucker plan typically has a worker participation component.
Improshare
A third type of gain-sharing plan, known as Improshare, was developed by industrial engineer
Mitchell Fein in the 1970s.2 This plan does not use dollar values of production but rather labour hours per unit of output, usually based on the previous year’s output. The plan also takes into
account indirect labour hours and includes them in the base productivity factor. When
productivity exceeds the base productivity factor, a bonus is paid, usually 50 percent of the
labour savings.
A disadvantage of Improshare is that it does not take other cost savings into account. Also, it
does not make employee involvement integral to the system (something that classical firms might in fact regard as an advantage). Most experts believe that the participation element is
vital to successful gain sharing; research has shown, however, that gain sharing can succeed
even without mechanisms for employee participation.3
Family of Measures Plan
A family of measures plan describes any gain-sharing formula that uses multiple, independent
measures. A gain (or loss) is calculated for each measure separately; the results are then
aggregated to determine the size of the bonus pool.4 The key attractions of this method are flexibility and focus. Flexibility comes from the ability to include performance measures that
are especially important to the success of the business. Focus comes from the ability to specify
the types of performance that lead to bonus payouts.
For example, the performance measures might include not only labour and materials
efficiency but also production schedule attainment, quality levels, customer satisfaction
measures, and even accident rates. Some of these additional measures can be based on historical records; others can be based on the achievement of targets or goals set by
management. In addition, some measures (known as “modifiers”) may subtract from rather
than add to the bonus. For example, some firms subtract from labour savings if there are
excessive accident levels. The logic here is that labour productivity should not increase at the
expense of safety. Compensation Today 11.1 provides an example of a longstanding family of
measures approach used at a service enterprise.
Family of measures plans have some disadvantages compared to the other types of plans. A
major one is that some of the payouts are not based on calculated cost savings but rather on
the achievement of certain goals. Thus, the payout for achieving these goals may bear little relation to actual cost savings, since these cost savings are often hard to quantify.
Consequently, employees may see the payouts as arbitrary (since there is no solid basis for
them) and the goals as unrealistic. Where goals are seen as unrealistic, little effort will be
made to attain them.
Issues in Designing Gain-Sharing Plans
The key steps in establishing gain-sharing plans are as follows:
1. Defining the group or work unit to be included in the plan.
2. Establishing the bonus formula.
3. Defining the baseline against which to measure improvement.
4. Deciding on the share between the company and the employees.
5. Deciding on the split among employees.
6. Deciding on the frequency of payout.
7. Developing procedures for communicating results.
8. Deciding whether and how to incorporate employee participation.
Each of these issues, if not resolved appropriately, could cause the gain-sharing plan to fail.
COMPENSATION TODAY 11.1
Gain Sharing at Ceridian Corporation
In the late 1980s, at the Ceridian Corporation, management of the Business Management Services Division—which provided computerized human resource, payroll, and related
services to external clients through 40 branch offices—wanted to establish a new business
strategy with more focus on the customer. They believed that a gain-sharing plan might help
support this new strategy.
To develop the gain-sharing plan, management selected one branch office (one of the
company’s highest performing offices) and set up an employee team there to design the plan. The design team was aware they were breaking new ground, since no existing examples of
gain sharing could be found in this industry.
The plan, which was launched in 1990, had five performance measures and two modifiers. The performance measures were the cost of processing each customer order, controllable
expenses as a percentage of revenues, the number of customer credits issued, retention of
customers, and number of suggestions submitted. The first two items were standard cost
measures, and a historical baseline was established for each. The third item—number of credits issued—was taken as an indicator of quality of customer service, using the reasoning
that each credit represented some type of error committed by the office. An analysis showed
that each credit cost $80 to process, so for each credit less than the baseline, $80 was added to
the bonus pool.
The fourth performance measure, customer retention, was the proportion of customers lost to
competitors, and the gains from increasing this retention rate were added to the bonus pool. Finally, for each plausible suggestion made by the team at each office, $100 would be added to
the bonus pool, along with another $100 if the suggestion was accepted.
The team also suggested two modifiers. The total bonus pool would be adjusted depending on (1) the level of gross profits realized at the office, and (2) the results of customer satisfaction
surveys. The first modifier acknowledged that without profit, there would be no money to fund
a bonus plan; the second modifier signified that customer satisfaction was the means by which profitability would be achieved. This last modifier was important in preventing the
office from cutting costs at the expense of customer satisfaction. For example, one way of
reducing customer credits would have been to refuse to issue them in all but the most extreme
cases. This might have been tempting, if not for the customer satisfaction modifier.
Source: John G. Belcher, Gain Sharing (Houston: Gulf 1991).
Defining the Group
Defining the group or unit for a particular gain-sharing plan is not as easy as it sounds. In
general, all employees who are in a position to significantly affect the results of the plan
should be included.
For example, a company that distributed building materials (such as drywall) wanted to
improve the productivity of its warehousing and delivery operations. It wanted to improve the
efficiency of delivery and reduce wastage resulting from improperly loaded or carelessly handled material. It had warehouses in various cities across western Canada. At first, the
company included just the warehouse staff and delivery drivers at each location in gain
sharing. Thus, one gain-sharing group was the Winnipeg warehouse and delivery staff, another
was the Regina warehouse and delivery staff, and so on.
In the beginning, the office staff at each location were not included in the gain-sharing groups.
However, the company soon realized that these people had a significant impact on warehouse and delivery efficiency, depending on how quickly they responded to customers and passed
the information on to the warehouse, whether they were precise about delivery locations, and
how effectively they sorted out problems. Moreover, leaving office employees out caused them to think that the company did not consider them important. So the plan was revised to
include them in the gain-sharing groups, along with the warehouse managers, who had also
been left out on the argument that they received other types of bonuses.
Establishing the Bonus Formula
Since each gain-sharing program uses different criteria to establish its bonus formula, a
company must determine which criteria are appropriate for its situation. In general, the
simpler the formula, the better. But at the same time, the plan must capture all of the factors that affect performance. Thus, most plans typically include a number of performance
measures, along with some modifiers to constrain undesirable behaviour. For example, the
performance measure for a mining team might be tonnes produced per person-hour. To avoid abuse of equipment (e.g., the changing of cutting bits more often than necessary in order to
maximize production), any excess equipment replacement costs could be factored into the
formula. And to avoid unsafe practices, a modifier stipulating no bonus for periods in which
lost-time accidents occurred could be included.
Defining the Baseline
Vital to a gain-sharing plan is a historical baseline against which to compare productivity, in
order to determine whether real productivity gains have actually taken place. Typically, a
company can use its past two to three years of productivity results and compute an average.
However, this procedure is valid only when the baseline over this period does not show a markedly upward or downward trend. In some cases, stable historical baselines don’t exist,
especially if the product/ service mix is continually changing, if raw materials are improving (or
declining) in quality or ease of use, or if the production/service technology frequently changes. If no valid historical benchmark can be set, then a gain-sharing plan is not viable and some
other option (such as goal sharing) needs to be considered.
A key question is whether to change the baseline over time. A baseline that stays constant is
known as a “fixed baseline,” while baselines that change are known as “ratcheting” or
“rolling” baselines. A ratcheting baseline goes up each year there is a productivity gain, so that
last year’s productivity becomes the new baseline. A rolling baseline uses a fixed period (say, a
three-year period), dropping the oldest year off and adding the newest one. The result is
similar to a ratcheting baseline, but it develops more slowly.
Management’s rationale for ratcheting or rolling baselines is to keep pushing productivity up.
However, employees may find that this kind of baseline just means working harder to maintain the same reward level. Moreover, depending on the measure, at some point it
becomes very unrealistic to push the baseline up any further, unless the goal is to wipe out the
gain-sharing plan without formally ending it. For example, if the measure is a reduction in defect rates, what happens when defect rates approach zero? Overall, ratcheting or rolling
baselines are likely to be demotivational if employees start to see them as causing “long-term
pain” for a “short-term gain.”
This is not to say that baselines should never change. Changing them is reasonable if new
capital equipment speeds up the production process without any increased worker effort, or if
products are redesigned for easier production. However, in these cases, management must resist the temptation to take advantage of these changes to unduly raise the baseline. If
workers are to have any trust in the plan, reasons for changes to the baseline must be clearly
explained to them.
Deciding the Share
The “share” is the formula for dividing the bonus pool generated by productivity gains
between the employees and the company. Typically, the employee share ranges from 25
percent to 50 percent, although it can range as high as 75 percent in Scanlon plans, which
defines productivity gains on a relatively small base.5
Three criteria must be considered when setting the share. First, the broader the bonus
formula, the lower the share, since there are more opportunities for productivity gains or cost
savings with a broader formula. Second, the higher the capital intensity, the lower the share.
Since there are relatively fewer employees in a capital-intensive firm, a lower share can still
produce high bonuses for individual employees. Third, the more demanding the baseline (i.e., the greater the extent to which it increases), the higher the share needs to be to compensate
for the increasing difficulty of achieving productivity gains.
Deciding the Split
How should the bonus pool be split across the eligible employees? Should everyone receive an
equal share? That sounds fair—but is it? What about employees who have been employed by
the firm for only a few days during the bonus period? What about employees who are only part-time? What about employees who have performed exceptionally well during the bonus
period? What about senior employees—do they deserve more of the pool?
The answers to these questions depend on the organization’s goals for the gain-sharing plan. Some firms distribute the bonus according to the salary levels of employees, with those who
have higher salaries receiving a greater share of the gain-sharing bonus, based on the
assumption that the more highly paid employees have probably contributed more to the cost
reductions. A major advantage of salary-based allocation is that it maintains the same
proportion of goal-sharing compensation in the compensation mix for all employees.
However, the bonus allocation method that is most in keeping with the underlying philosophy of gain sharing is equal allocation across employees after adjusting for time worked during the
bonus period. Gain sharing is intended to create cooperation and teamwork, and equality is an
underlying condition of both. If singling out individuals for special treatment is necessary, companies should use other elements of the compensation system, rather than the gain-
sharing plan.
Deciding the Payout Frequency
On what period should the bonus calculations be based? Both technical and behavioural
issues must be considered here. For example, if productivity results fluctuate widely on a
weekly, monthly, or seasonal basis, longer payout periods will be required. But from a behavioural point of view, for maximum motivation, the receipt of rewards should closely
follow the event that triggers the rewards. Also, the size of the reward should be at least
enough to provide a “just noticeable difference.” This suggests longer bonus periods, which would also reduce administrative costs. Overall, quarterly bonuses are often the best
compromise.
Communication
A compensation system will not have any impact if employees do not understand how it works
and how their behaviour relates to rewards. Employees need to see whether they are making
progress toward meeting the bonus criteria that have been set out, so frequent feedback
about productivity results and cost savings is essential. However, communication does not happen without effort and planning, so procedures for communicating this information need
to be planned and implemented carefully.
Participatory Mechanisms
Some gain-sharing plans, such as Scanlon and Rucker, specifically incorporate a mechanism
through which employees can participate in making productivity improvements. Participation
is often achieved through an employee–management gain-sharing committee, which meets on a regular basis to solicit employee suggestions and feedback. Other plans, such as
Improshare, carry no such requirements.
Research shows that Improshare systems can be effective even though they lack a participative element.6 Research on group pay in general (including various types of group
pay) indicates that such plans can be very successful in the absence of participatory
mechanisms, although their success increases if they are accompanied by an employee suggestion program, which most gain-sharing plans include.7 It is interesting, though, that the
favourable results were not found in firms that pursued an innovator business strategy, only in
firms that did not. Group pay had no impact—positive or negative—in innovator firms. This suggests that conditions in innovator firms are too unstable to provide the stable historical
baselines necessary for successful gain sharing.
Considerable research has been conducted on the conditions necessary for gain-sharing plans
to succeed.8 First, employees must regard the gain-sharing system as fair and equitable in
terms of both procedural and distributive justice. Employee participation in the development of the gain-sharing system can help achieve this goal. Because an organization needs to adjust
these plans over time, it also needs a certain level of trust between management and
employees, as well as a history of job security. Employees must have some assurance that they will not “work themselves out of a job.” For example, when John Deere Corporation
abandoned individual production bonuses for its employees and moved to gain sharing
(see Compensation Today 11.2), it guaranteed that the only jobs that could be eliminated if
productivity increased were those of retiring employees.
COMPENSATION TODAY 11.2
Nothing Runs Like a Deere! Especially a Deere with Gain Sharing!
In the 1980s, John Deere Corporation was in trouble. The long-time maker of agricultural
equipment, including tractors and combines—as well as construction equipment and
consumer products like riding lawnmowers—found sales in a deep slump due to economic circumstances. To survive, management had to come up with some way to increase
productivity and cut costs. Previously, to motivate production employees, they had relied on a
system of base pay plus an individual incentive based on whether the employee exceeded the
production standard for his or her job.
However, while this system was believed to be effective in eliciting individual effort from the
production employees, the company felt that it didn’t promote teamwork or innovative production ideas. They saw three main problems with the current system. First, individual
employees were not willing to spend any time training or helping new employees, since this
would cut into their own productivity. Second, the system led employees to conceal any methods for faster production from the industrial engineers, since employees were concerned
that revealing these methods would result in a higher production standard, and less bonus for
them (which is actually what would have happened). Third, the standard hours plan was very
difficult and expensive to maintain—to maintain and update the production standards
required more than 600 industrial engineers at a cost of over $30 million per year.
The company felt that replacing the standard hours system with gain sharing might alleviate these problems, and sought union approval to do so. After extensive consultation with the
United Auto Workers, and having made a pledge that no existing employees would be laid off
as a result of this change (the only jobs that could be eliminated were those of retiring
employees), the union approved the change. First, all manufacturing employees were grouped into work teams, each of which was responsible for a particular part of the production process.
This resulted in 240 work teams. Rather than individual performance, team performance was
measured and rewarded. In addition to their hourly pay, each team was rewarded according to whether they had cut labour costs relative to standard costs, which were themselves based
on historical costs. Team members would share equally whatever gain-sharing bonus the
team had earned. John Deere has since found this system—which is really based on a
transition from classical to high-involvement managerial strategy—to have substantially
improved productivity.
Source: Geoffrey B. Sprinkle and Michael G. Williamson, “The Evolution from Taylorism to
Employee Gainsharing: A Case Study Examining John Deere’s Continuous Improvement Pay
Plan,” Issues in Accounting Education 19, no. 4 (2004): 487–503.
// Goal-Sharing Plans
Goal sharing rapidly gained popularity in the 1990s. However, like gain sharing and other
group pay plans, it appears to have lost popularity in recent years. This is a bit surprising,
given that research shows that group-based plans can dramatically improve company profitability when adopted by firms that are not pursuing an innovator strategy.9 Moreover,
even in firms that do pursue an innovator strategy, these plans broke even on average, so
there doesn’t seem to be much to lose in trying them, especially when conditions are right.
The essence of goal sharing is that work groups or teams receive a bonus when certain
prespecified performance goals are met. Goal-sharing plans differ from gain-sharing plans in
several fundamental ways. In gain sharing, cost savings are quantified and then shared
between the company and the group, whereas under goal sharing there is typically no
systematic link between performance improvements and the goal-sharing bonus pool. How,
for example, do you place a monetary value on achieving the goal of increased customer
satisfaction?
There are no set goals with gain sharing other than to improve as much as possible relative to
the historical baseline. In contrast, under goal sharing, goals on one or more performance indicators are set for each group or team, to be met within a specified time period, and a
bonus is paid to all team members if the goal is achieved.
In gain sharing, there is an expectation of continuity—the gain-sharing system will not be
changed arbitrarily, because procedures for calculating and sharing gains are so well spelled
out. While goal-sharing plans are more flexible, the flip side of that is that continuity of goal-
sharing plans is less assured than with gain sharing.
Finally, in most gain-sharing plans, there is usually an explicit expectation of employee involvement in suggesting ideas for productivity gains. Under goal sharing, employee
participation is not necessarily a component, although it can be.
Types of Goal-Sharing Plans
Because goal-sharing plans are so new and varied, they have not really evolved to the point
where distinct types can be identified. However, one important distinction is whether they are single-goal plans, multigoal plans, or financially funded plans. Single-goal plans are the
simplest and focus attention on one key goal, such as customer satisfaction. These plans may
cause other important behaviours to be neglected,10 so most firms typically use multigoal
plans to better cover the range of desired behaviour.11
Financially funded plans combine two sets of criteria. The total amount of the goal-sharing
bonus available is typically based on some indicator such as company profit, while the actual amount of the payout is based on the achievement of specified goals. This combination of
criteria has the benefit of not paying out goal-sharing bonuses when the company is not
profitable, but it also makes the performance-reward contingency less certain, which
generally diminishes employees’ motivation to meet goals.
Issues in Designing Goal-Sharing Plans
Many issues need to be dealt with when designing a goal-sharing plan:
1. Define the group to which goal sharing applies.
2. Decide on the nature of the goals to be sought.
3. Determine levels and time frames for goal achievement.
4. Establish the bonus amounts.
5. Decide on the split of the bonus among employees.
The first issue in goal sharing is to define the group to which a given goal-sharing plan will
apply. In general, the smaller the group, the stronger the motivation; however, the group must
include all employees who can play a significant role in goal achievement.
A critical variable is the nature of the goals to be set. They must be important to the
organization and controllable by the work group, and they encompass the full range of desired
behaviour. Care must be taken to ensure that the goals do not conflict. For example, Continental Airlines was suffering from a very poor on-time performance record. So the
company established a goal-sharing plan in which all employees who affected on-time
performance, such as baggage handlers, would receive a bonus if on-time performance improved to the point that Continental was among the five top airlines in this performance
category. The plan worked: on-time performance improved and bonuses were paid out.
Unfortunately, at the same time, customer complaints increased, as passenger baggage was
often left behind in order to get flights out on time.12
Once the goals to be rewarded have been identified, the organization needs to determine the
levels of achievement necessary to trigger a bonus payout. This is probably the single most
important factor in the success of a goal-sharing plan. Goals that are seen as too difficult do not motivate behaviour. Goals that are too easy also do not motivate; such goals also carry the
additional penalty of paying out bonuses for no real performance gain and may cause
employees to ease off once the goal is achieved. When there is a single goal achievement level,
there is no employee motivation to surpass the target goal; in fact, it may well be seen as undesirable to surpass the goal if so doing might result in a higher target goal the following
year.
So, many firms have now established several levels of achievement for each goal. At one firm, a goal level that exceeds current performance, but not by much, is called the “standard plus”
goal; the next level is called the “goal level,” which is viewed as realistic but not a sure thing;
and the highest level, which employees have less than a 50 percent likelihood of achieving, is called the “goal plus” level. The “goal plus” level is an example of what is commonly known as
a “stretch goal.” Of course, bonus amounts increase substantially for each goal level that is
met.
In order to establish goal levels that employees will commit to, many organizations involve
employees in the goal-setting process. Research has shown that employees are more
motivated to attempt goals they have played a role in developing.13
Goals also need to be bounded by some time period. Within what time frame does the goal
need to be accomplished? For most goals, a year would seem a reasonable time period. At the
end of the year, new goals can be established, depending on whether or not the goal was met.
Once an organization has established the target goal levels, it must set the dollar amount of
bonus for each level of accomplishment. Sometimes it can find a cost basis for so doing. For
example, if a company knows how much it costs to correct a particular type of error, it can use
this number to calculate a reasonable bonus for achieving a particular reduction in the error rate. But in other cases, there may be no good basis for calculating the value of goal
achievement—for example, the value of improved “on-time performance.”
Another key issue is the basis for allocating the goal-sharing bonus among employees. The
basis can be salary, seniority, individual performance, some combination of these, or equal
distribution. Equal distribution is the most egalitarian, but is it really fair to more senior
employees, who may feel that they have contributed more to company success and who have shown long-term commitment to the firm? The advantage of salary-based allocation is that it
maintains the same proportion of goal-sharing compensation in the compensation mix for all
employees. One advantage of allocating the bonus on individual performance is that it addresses the free-riding problem. But the challenge here is to create an individual
performance appraisal system that employees accept as fair. Finally, even where equal
allocation is used, adjustments typically have to be made based on the number of days or
hours actually worked during the period in which goal accomplishment took place.
// Profit-sharing Plans
Research by one of the authors indicates that about one-quarter of medium to large Canadian
firms use broad-based profit sharing. Profit-sharing plans are just as likely to be found in
publicly traded as in privately held corporations. Studies have found that profit sharing is
applicable to a wide variety of industries; the only commonality among profit-sharing firms is
that they tend to be high-involvement organizations.14
Types of Profit-Sharing Plans
As discussed in Chapter 5, there are three main types of profit-sharing plans: current
distribution, deferred profit sharing, and combination. Research indicates that the majority of Canadian profit-sharing plans are current distribution (cash-based) plans and that most of the
remainder are deferred plans. About 5 percent are combination cash/deferred plans. About 2
percent of firms pay the profit-sharing bonus in a mix of cash and company stock, and 1
percent pay out the bonus only in company stock.15
Establishing a current distribution plan does not require any approvals by government, unless
the firm wants to register it as an employee profit-sharing plan (EPSP) under the federal Income Tax Act. The EPSP is not a tax-deferred plan, and these plans are really a type of
unsheltered company-supported savings/investment plan. Their main purpose is to provide a
vehicle for accumulating savings after the tax-deferred approaches have been exhausted.
Registered EPSPs are rarely used, since there are no real advantages to registering them with the federal government, and current distribution plans can be set up without government
registration.
Because the deferred profit-sharing plan (DPSP) is a tax-deferred plan, registration with the federal government is required. A DPSP trust is set up, and both the employer contributions
and the annual earnings of the trust are exempt from taxation until the employee actually
cashes in the plan, usually at termination or retirement. Because of this feature, DPSPs are often used as a form of pension plan, especially in small to medium-sized companies where no
other pension plan exists. The maximum tax deduction for the DPSP is tied to the unused
portion of the employee’s registered retirement savings plan (RRSP) contribution. “Top hat” plans (those in which only senior management is eligible) are not eligible for registration as a
DPSP, as DPSPs require wide employee eligibility.
Another taxation feature makes the DPSP even more attractive, if shares (rather than cash) are deposited in the trust. Instead of being taxed on the full market value of the shares at the time
of withdrawal from the DPSP, the employee is taxed on “employment income” only on the
original value of the shares when they were placed in the DPSP trust on behalf of the
employee. When the shares are sold, the difference between the original value and the selling
price is considered a capital gain rather than employment income. (Note that only publicly
traded shares—including those of the employer—are eligible for purchase by a DPSP.)
Although there are some tax advantages, there is some risk to the employees, in that even if their shares have declined in value at the time of sale, they still have to pay income tax on the
original amount of the profit-sharing bonus. However, the decline in share value is partially
offset by the capital loss this creates, which can be used to offset any capital gains the
employee may have.
To provide some idea of the diversity of profit-sharing plans, Compensation Today 11.3 gives
examples of profit sharing that have been used at two prominent Canadian companies.
COMPENSATION TODAY 11.3
Profit Sharing at Two Prominent Canadian Companies
A company with one of the longest histories of profit sharing in Canada is Dofasco Steel of Hamilton, Ontario (now known as ArcelorMittal Dofasco). A non-union firm in a unionized
industry, Dofasco has always seen profit sharing as a major part of its renowned human
relations managerial philosophy. To this day, its employee profit-sharing plan is featured prominently on the company’s website. The plan was started in 1938 as a pension plan and
continues as a DPSP and group-registered retirement savings plan.a Any amounts that exceed
the government limits on these plans may be received in cash. The bonus pool is 14 percent of pre-tax profits from operations, and it is allocated equally to eligible employees in its 7,400-
person workforce. All employees with at least two years of service are included in the plan. In
2000, the company made headlines when it split a bonus pool of $53.3 million—the highest
payout ever—among employees, who each received $7,906.b Ten years after becoming a subsidiary of ArcelorMittal, the employee profit-sharing plan is still going strong. ArcelorMittal
Dofasco now employs 10,000 full-time employees in Canada and ships 4.5 million tons of high
quality steel every year. It won the Canada’s Top 100 Employers 2016 Award.c
Another company with a long-standing commitment to profit sharing is Canadian Tire. The
founder of the chain, A.J. Billes, always believed in profit sharing in both a philosophical and a
practical way. He believed that it was morally just that employees receive a portion of the profits they helped generate and that this would create employee commitment to the firm.
The company has always had a profit-sharing plan that applies to the employees of the parent
firm, and it strongly encourages profit sharing at its independently owned associate stores. The average Canadian Tire profit sharing awards over the past five years have been over 10
percent of employee earnings.d
At the Canadian Tire associate store in Barrie, Ontario, the profit-sharing bonus allocation is based on salary level (40 percent), merit rating (40 percent), and seniority (20 percent). The
plan is a DPSP that invests in Canadian Tire Class A shares, so it is a share plan as well as a
profit-sharing plan. The vesting schedule is 20 percent after the first year and 80% after the
second year. Amounts that exceed the allowable government limits on DPSPs are placed in an
EPSP, which pays interest at the prime rate.
aDavid E. Tyson, HR Manager’s Guide to Profit Sharing in Canada (Toronto: Thomson Carswell, 2006). bKen Kilpatrick and Dawn Walton, “What a Joy to Work for Dofasco,” The Globe and Mail,
February 12, 2000, B1. cCanada’s Top 100 Employers website, http://www.canadastop100.com/national, accessed
October 19, 2016; Richard Yerema and Kristina Leung, Mediacorp Canada Inc. staff editors
(November 8, 2015), http://content.eluta.ca/top-employer-arcelormittal-dofasco, accessed
October 2, 2016; ArcelorMittal Dofasco website, http://dofasco.arcelormittal.com/who-we- are/at-a-glance/about-dofasco.aspx, accessed October 2, 2016. dCanadian Tire website,
http://corp.canadiantire.ca/EN/ctyourwealth/savings/Pages/CTProfitSharing.aspx, accessed October 2, 2016; Marg Bruineman, “How Canadian Tire Connects Retirement to Profits,”
Benefits Canada, April 15, 2015; http://www.benefitscanada.com/pensions/other -
pensions/how-canadian-tire-connects-retirement-to-profits-79537, accessed October 2, 2016.
Issues in Designing Profit-Sharing Plans
Besides the form of the bonus payout (deferred, cash, stock, or a combination of these), profit-
sharing plans have numerous other design issues:
• the formula for bonus determination (fixed or discretionary),
• employee eligibility,
• the basis for allocating the profit-sharing bonus across employees,
• payout frequency, and
• communicating financial results and profit sharing.
Formula for Bonus Determination
Under a discretionary approach to bonus determination, management simply looks at the
profitability at the end of the year and decides on an amount. The problem with discretionary plans is that the link between performance and reward becomes even more tenuous than
otherwise, since employees do not really know to what extent (if at all) better performance will
be rewarded.
For motivational reasons, fixed formula plans are strongly recommended. There are many
possibilities. The simplest is to declare that a portion of pre-tax profit (say, 10 percent) goes
into the profit-sharing bonus pool at the end of the year. Alternatively, there can be a threshold (say, a return on investment of 5 percent), and no profit-sharing bonus is paid until
this threshold is exceeded. The formula may also incorporate a step function, such that the
percentage of profits going to the profit-sharing bonus increases as various thresholds or “steps” are exceeded. Overall, research indicates that more than half of Canadian firms (55
percent) use a fixed percentage of annual pre-tax profits—ranging from 1 percent to 33
percent of profits—to determine the profit-sharing bonus, with the median percentage being
10 percent.16
Employee Eligibility
Another key issue is employee eligibility. In general, the more inclusive the better, although casual and contract employees are often excluded, as are unionized employees if the union
does not agree to profit sharing. In most cases, there is a time period for eligibility (usually one
year). Research on Canadian firms indicates that in most cases, all full-time employees are
included in the plan, while a few firms exclude unionized employees, and some firms (less than one-fifth) restrict profit sharing to designated employees only. In a substantial number of
firms, although not the majority, part-time employees are included.17
Basis for Allocating the Profit-Sharing Bonus
Allocation of the profit-sharing bonus can be based on salary, seniority, individual
performance, some combination of these, or equal distribution. The advantage of salary-
based allocation is that it maintains the same proportion of profit-sharing pay in the compensation mix for each employee. It also tends to provide a greater reward to those
employees who are more able to influence profits. The advantage of allocating the bonus on
individual performance is that it addresses the free-riding problem. But the key here is the
availability of an individual performance appraisal system that employees accept as fair.
Finally, even where equal allocation is used, adjustments have to be made based on the
number of days or hours actually worked during the year in which the profit-sharing bonus
was earned.
The most common bases for allocating the profit-sharing bonus across employees in Canadian
firms are salary level and individual performance (each used by about one-third of firms).18 Seniority is used by 10–15 percent of firms, while about the same proportion use a
combination of salary and seniority. Only a few firms (less than 5 percent) allocate the bonus
equally to all employees; some firms use a combination of equality and other bases. Many
firms use multiple bases.
Payout Frequency
Payout frequency is another issue. Results must be based on financial statements, which
suggests that payouts should occur no more often than quarterly. In addition, where profits fluctuate by season, an annual basis is probably best in order to smooth out these fluctuations
and to avoid paying profit sharing in an unprofitable year.
Communicating Profit Sharing
As with other performance pay plans, communication is important to the success of profit
sharing. Most profit-sharing firms distribute financial statements and profit-sharing
newsletters on a regular basis, but some firms go beyond this. For example, WestJet holds a profit-sharing party every six months, at which employees receive their profit-sharing cheques
and are treated to a company celebration.19
Research reveals that besides communications, two other factors significantly affect the success of profit sharing, as perceived by Canadian CEOs.20 CEOs reported better results in
firms that use high-involvement management and that allocate the bonus according to
measures of individual performance. Note, however, that the measure of success used in this
study is the CEO’s perception of success, not financial data, so these are not definitive results.
Rather surprisingly, none of the other company characteristics or plan characteristics were
very important influences on the results of profit sharing. It follows that profit sharing can be
effective for most types of companies and that various plan designs can be effective as well.
One interesting caveat to this finding, however, is that while there was no major difference in
results between firms that used a fixed percentage for bonus determination and those that did
not (except that industrial relations were more favourable in firms with a fixed percentage), for those with fixed percentage plans, success increased with the size of the bonus percentage.
Overall, performance of the plan appears to improve when the bonus percentage exceeds 10
percent of profits.
// Employee Stock Plans
As discussed in Chapter 5, an employee stock plan is any type of plan through which
employees acquire shares in the firm that employs them. In some plans, employees receive
shares at no cost, while in other plans, employees are given the opportunity to purchase stock
on favourable terms. This section describes the three main types of stock plans (stock bonus,
stock purchase, stock option), along with related plans that tie employee rewards to company stock performance but do not actually provide employees with the opportunity to acquire
shares (phantom stock plans), as well as the issues to be addressed when designing these
plans.
Employee Stock Bonus Plans
The essence of stock bonus plans is that employees receive company stock at no cost to
themselves, through one of several methods. One approach is simply to make stock grants to
employees at periodic intervals, often annually. Another approach is to tie stock grants to the
profit-sharing plan, paying out in company stock instead of paying out in cash. The employee
could then put this stock into a deferred profit-sharing plan, if desired. In some cases, stock bonuses are tied to certain company or individual performance criteria. As Compensation
Today 11.4 shows, stock bonuses can be linked to almost any kind of criteria.
COMPENSATION TODAY 11.4
It Pays to be Green at Husky Injection Molding Systems
At Husky Injection Molding Systems, based in Bolton, Ontario, founder Robert Schad believes
that capitalism can’t survive without environmental protection. So he devised a plan to tie the two concepts together. Under his “GreenShares” program launched in 2000, employees
receive points that can be redeemed for company shares whenever the employees can show
community or environmental activism. For example, an hour of volunteer work in the community is worth one-tenth of a share. Carpooling for a month gets you one share. And if
you buy a new car that runs partly on electricity, natural gas, or fuel cells, you receive 100
shares. This program has proved so successful that it remains in place more than 13 years
later.
Sources: Keith McArthur, “Husky Boss Offers Equity for Activism,” The Globe and Mail, January 21, 2000. Husky Injection Molding website:
http://www.husky.ca/newdynamic.aspx?id=3453.
Stock bonus plans have experienced a decline in popularity in recent years, starting with the
stock market downturn of 2001, which diminished interest in employee share ownership, and
then due to the financial meltdown of 2008–09, which further reduced employee interest in share ownership. Of the three major stock plans, broad-based (i.e., not confined to just senior
executives) employee stock bonus plans are the least common, with perhaps 2 percent of
medium to large Canadian firms offering such plans to their employees. (By contrast, these plans are extremely common for executives.) Unlike other employee stock plans, these plans
are equally common in publicly traded and privately held corporations.
A variation that merges the stock bonus plan with the stock option concept is share appreciation rights. Employees are first “allocated” a number of shares of company stock,
although they do not actually receive any shares. If these “shares” appreciate within a fixed
time period, employees receive as a bonus the number of actual company shares that this appreciation can purchase (although in some plans, they can opt to take the cash). For
example, an employee is “allocated” 1,000 company shares. If the share price is $20 at the
outset and if the shares rise to the value of $25 each by the end of the specified period, then
the employee will receive a bonus of 200 actual company shares (the $5,000 appreciation will
buy 200 shares at $25 each), at no cost to the employee.
Taxation is a major issue with employee stock plans and can be either a huge advantage (in an
up market) or a huge disadvantage (in a down market). Employees who receive stock bonuses are deemed to have received employment income in the amount of whatever the value of the
stock is when it is vested (which occurs when the employee receives full legal ownership of the
shares), but it is taxed at the capital gains rate (which is half of the rate that applies to employment income). However, the income tax is not actually payable until such time as the
employee sells the shares or the employer goes out of business. Any appreciation in share
value (the difference between the initial value of the shares and the actual selling price of the shares, if positive) is taxed at the capital gains rate (which is half the normal rate that applies
to employment income). So, things are very rosy tax-wise for employee-owners in an up
market.
However, things may not be so rosy in a down market. The problem in a down market is that
the employee is liable to pay taxes (at the capital gains tax rate) on the value of the initial stock
grant, regardless of the price the employee actually realizes from selling the shares. For example, let’s suppose that an employee receives a stock grant of 1,000 shares in 2010 and
that those shares are selling at $10 per share when vested to the employee. That employee
now has a tax liability based on $10,000 of deemed employment income (so, let’s say a tax bill
of about $2,200, based on an average marginal tax rate of 44 percent); however, this tax does
not need to be paid until the employee sells the shares or the company is wound up or sold.
Let’s suppose the down market causes the shares to fall and that the employee eventually sells at $1 per share. The employee realizes $1,000 but faces a tax bill of $2,200 on shares
provided “free” to her or him by a seemingly benevolent employer! As Compensation Today
11.5 shows, this issue can even bankrupt employee-owners!
COMPENSATION TODAY 11.5
“Bargain Shares” Bankrupt Unlucky Employee-Owners
Shannon McLeod, a marketing manager at B.C.-based Creo—a digital imaging company—
thought she knew a bargain when she saw one. Several years after the company had given her
stock options—which confer the right to purchase a specified number of company shares at some point in the future at a fixed price—the value of those shares had risen dramatically.
When they were trading at $53, McLeod borrowed money to purchase 10,000 shares at $17,
which to her sounded like a
terrific deal.
In purchasing those shares, she was deemed to have received employment income of
$360,000—the difference between what she paid for them and what their market value was
when she purchased them. At that time, she incurred a tax liability of $100,000 (taxed at the capital gains rate), which would not actually need to be paid to the Canada Revenue Agency
until she sold the shares or the company was wound up or sold.
As it turned out, Creo was sold, and at the time of sale, her shares were actually worth slightly less than she had paid for them. She used the proceeds from the sale to repay the loan she had
taken out to purchase the shares, but she was still left with the $100,000 tax bill, which was
now due. She then had to take out another loan to pay her taxes. So, all in all, she ended up
paying taxes of $100,000 on an investment that yielded her nothing.
Although McLeod may not see it that way, she was actually luckier than some employees at
other firms, who saw their shares plummet to almost zero. For example, a former Nortel
manager, who was laid off in 1999, faces a tax bill of $204,000 on 1,000 shares now worth 25
cents each.
A number of employees who have encountered this problem have banded together to form Canadians for Fair and Equitable Taxation, which is lobbying the federal government for
changes to the tax rules that put them in this situation. They are hoping for changes in line
with those made to U.S. taxation rules in 2008 to deal with this problem. Changing the status
of the initial share gain from employment income to capital gains income would allow
employees to offset their capital gains with capital losses from the decline in share prices.
As of 2013, the federal government has provided some taxation relief to employee-owners
who have been affected in the taxation years 2000 and later, with regard to shares that were
included in elections for deferral of taxable benefit income. However, other employee-owners
remain out in the cold.
Sources: Kathy Tomlinson, “Thousands of Canadians Taxed on ‘Phantom Income,’” CBC
News Online, May 25, 2009; Canadians for Fair and Equitable Taxation, personal
communication, January 2013.
Employee Share Purchase Plans
In an employee share purchase plan, employees provide some kind of direct payment in
return for company shares. But they often do not have to pay full market price for these
shares, and firms offer many incentives to promote these purchases. Promotions include subsidized or discounted prices or matching programs in which the firm provides an
additional share for each share purchased by an employee. In some cases, the company pays
the brokerage fees, while in others, it provides low- or no-interest loans for stock purchase. In
many cases, the company offers the convenience of payroll deduction.
Research by one of the authors suggests that employee stock purchase plans have apparently
maintained their popularity—at least until mid-decade, the most recent period for which data
are available. About one-fifth of medium to large Canadian firms have employee stock plans,
with the proportion being higher in publicly traded corporations and lower in privately held
corporations. Reasons for lower use in private corporations include more complicated
mechanics (discussed shortly) and owners’ reluctance to share ownership.
As for the tax status of employee stock purchase plans, the amount of the purchase discount
(if any) is deemed to be employment income (but is taxed at the capital gains rate) and must
be paid when the employee sells the shares or when the firm is wound up or sold. The tax rules
for share appreciation also apply to stock bonus plans.
Employee Stock Option Plans
Under an employee stock option plan, employees receive options to purchase company stock at a future time at a fixed price. For example, if company stock is now trading at $10 a share,
then 1,000 options with an exercise price of $11 a share might be issued to each employee.
Half of the options might be exercisable (when options become exercisable, they are considered “vested” in the hands of the employees) a year after they are granted, and the
other half in two years, with an exercise deadline (option expiry) of five years. What this means
is that one year from now, the employee has the option of purchasing up to 500 shares of company stock at a price of $11 each. Obviously, if the stock is trading at that time at, say, $9 a
share, there will be no reason to exercise the options. An employee who wants the stock could
just purchase it through a stockbroker for $9 a share.
But if the stock is trading at, say, $12 a share, employees have a decision to make. They can
exercise their options and purchase 500 shares at $11. But if they do purchase the shares,
there is the possibility that these shares will go down in price. Of course, they might also go up in price. It’s a gamble. But employees who don’t want to gamble or who don’t have the money
with which to purchase the shares can simply cash out by purchasing the shares and then
selling them immediately at $12, thus realizing a net gain of $500 (less any brokerage costs).
The $500 would be deemed employment income (but taxed at the capital gains rate).
But they need not exercise their options at this time either. They could just continue to hold
their options (for up to another four years, since that is the expiry date) in the expectation that stock prices will go up over the next four years. But if the stock price sinks below the exercise
price of $11 (when the stock price is below the exercise price, the stock options are said to be
“under water”) and never again rises above that price (during the next four years), employees
will not realize any value from their options. On the other hand, they are not out of pocket any
money, either, as they would be if they had purchased and held the shares as they dropped
below the $11 mark.
Although stock options are not a new concept, prior to 1990, they were provided almost
exclusively to top executives. What is radically new is the idea of extending stock options
throughout the organization. Soft drink maker PepsiCo Inc. started this trend in 1989, when it granted every employee bonus stock options worth 10 percent of their salary. By the year
2004, it was estimated that at least 10 million American workers in 4,000 firms had received
stock options.21
Until 2000, the growth of employee stock option programs in Canada had been slower than in
the United States because Canadian tax laws did not favour stock options the way that U.S. tax
law does. However, recognizing the increasing importance of employee stock option plans in
competing for and retaining employees, the Canadian federal government amended its income tax legislation in 2000 to make capital gains on options taxable at the time company
shares are sold, not at the time the options are exercised. The same legislation allowed 50
percent of the capital gain to be excluded entirely from taxation. Besides making options more attractive, these changes also encourage retention of shares after the exercise of the options—
something that the former tax system had discouraged.
These changes have brought Canadian tax treatment of options in line with U.S. treatment and have made options much more attractive to employees as a form of compensation as well
as much more valuable to companies as a compensation instrument. At the same time, the
Canadian federal government has made the overall tax treatment of capital gains more favourable, which has also increased the relative attractiveness of stock plans as
compensation instruments.
Despite the less favourable tax treatment until 2000, Canada experienced a dramatic increase in the use of broad-based employee stock options during the 1990s. In 1995, about 4.4 percent
of medium to large Canadian companies provided stock options to nonmanagerial
employees22; by 2000, this proportion had approximately doubled, according to research by
one of the authors. By 2005, this proportion was holding at around 10 percent, despite the
considerable bad press that options suffered in the first part of the decade.
In the early 2000s, excessive executive stock options were cited as a factor in the collapse of
some major U.S. corporations and in the exorbitant increases in executive compensation that
have been taking place for a number of years. Part of the problem was that due to a quirk in financial reporting systems, stock options appeared to be a virtually “costless” way of
providing compensation to executives. However, when exercised, stock options can exert a
very real cost to shareholders in terms of dilution of their share values. Recognizing this problem, the United States and Canada developed new accounting rules that require
expensing of stock option grants.
When the Sarbanes-Oxley Act of 2002 was signed into law in the United States, one of its requirements was to explore the implications of moving from a rule-oriented system of GAAP
to one that was more principle based.23 The Sarbanes-Oxley Act was aimed at ensuring the
accuracy of financial information submitted by firms, with more punitive penalties for firms
that violate the Act. As mentioned above, stock options were not properly reported. Canada
became the first major jurisdiction to require that all public companies must expense
employee stock-based compensation awards as of January 1, 2004. The U.S. Financial Accounting Standards Board (FASB) subsequently issued the Revised Financial Accounting
Standard 123 requiring companies to expense stock options.24 The Sarbanes-Oxley Act also
required companies to report all options grants within two days of the date of the grant, effectively eliminating options backdating. As a result of all these legislative and accounting
requirements, companies are now using fewer stock options, and replacing them with
incentives that are more closely tied to firm and individual performance. A Hay Group study
shows that performance awards made up over half of the granted long-term incentive value
provided to CEOs in 2012 while stock options dropped to about a quarter.25
As with stock purchase plans, stock option plans are more common in publicly traded
corporations than in privately held corporations: according to research by one of the authors, about 15 percent of public corporations were providing broad-based employee stock option
plans at mid-decade, compared to about 5 percent of private corporations.
Phantom Share Plans
A phantom share plan ties an employee’s bonus to the performance of company stock, but
that employee never actually receives any stock. The employee is granted a certain number of
“units,” each corresponding to a share of stock. The employee is entitled to the same dividends that accrue to the actual stock and also to the appreciation in share value; both,
however, are paid in cash at periodic intervals. Any payouts are considered employment
income and are taxed at the full employment income rate.
One relatively new and interesting variation on a phantom stock plan is a phantom equity
plan.26 Professional service firms—including firms such as management consulting giants
McKinsey & Company and Accenture—developed this compensation method to help them retain staff who might otherwise be drawn to high-tech companies better able to offer stock
options or equity shares (which professional services firms generally cannot do, since they
usually do not have a corporate ownership structure). The plan is not in fact an employee
stock plan, since the shares in question are not those of the employer; rather, it is a plan in which employees are granted participation units in a pool of equities of client firms. The value
of the units varies with the value of the fund. Employees are allowed to cash out only at
specified intervals and on termination, when they must do so.
Compensation Notebook 11.1 summarizes the main types of stock plans available as well as
the other main types of group and organizational performance pay plans.
COMPENSATION NOTEBOOK 11.1
Types of Group and Organizational Pay Plans
Gain-Sharing Plans
• Scanlon Plan
• Rucker Plan
• Improshare
• Family of Measures
Goal-Sharing Plans
• Single-Goal Plan
• Multigoal Plan
• Financially Funded Plan
Profit-Sharing Plans
• Deferred Profit-Sharing Plan (DPSP)
• Current Distribution Plan
• Combination Plan
Employee Stock Plans
• Share Bonus Plan
• Share Purchase Plan
• Stock Option Plan
• Phantom Share Plan
Issues in Designing Stock Plans
The issues in designing an employee stock plan vary somewhat according to whether the
employer is a publicly traded or a privately held corporation. However, for all companies, several factors differentiate more successful employee stock plans from less successful ones.
The effectiveness of employee share ownership increases with the proportion of the
employees who hold shares, the proportion of the firm owned by employees, and the degree of employee consultation in the development of the share plan.27 Employees must feel that
they own enough shares to make a difference to their financial well-being and must also feel a
sense of real ownership in a corporate context where effective mechanisms for employee participation in decision making are in place.28 Also essential are effective procedures for
educating employees about the nature of the stock plan and communicating about company
results.
Design Issues for Stock Plans in Public Corporations
Employee stock plans are simpler to implement in publicly traded corporations than in
privately held corporations because the public stock market provides a well-understood
mechanism for the purchase and sale of company stock. However, organizations still have to
decide on a number of issues before implementing the plan:
• eligibility for inclusion,
• criteria for allocating stock among employees, and
• the type of holding period.
The first issue is eligibility for inclusion in the stock plan. In general, the more inclusive, the better, although temporary employees and contract employees are usually excluded. Often
some minimal length of service is required, usually not exceeding one year.
Next, the criteria for allocating stock among employees must be decided. This allocation can be based on salary (probably the most common approach), seniority, employee performance,
equal distribution, or some combination of these. Equal distribution is the most egalitarian,
but is it really fair to more senior employees, who may feel that they are contributing more to the company’s success or who have shown long-term commitment to the firm? Salary-based
allocation has the advantage of maintaining the same proportion of stock in the
compensation mix for all employees. Equal allocation is the simplest method, but adjustments typically still need to be made based on the number of days or hours each employee worked in
the preceding year.
The holding period is another critical issue. If the objective is to create employee-owners, then some type of holding period should be imposed. Otherwise, it is very tempting to sell the
shares immediately to realize the profit in so doing. In general, the more generous the stock
plan, the longer the holding period. For example, if employees are purchasing the shares at only a small discount from the market price, then only a short holding period is justified, if any.
But if employees are receiving the shares at no cost to themselves, they may be required to
hold the shares for up to five years.
Design Issues for Stock Plans in Private Corporations
Stock plans in private corporations must deal with the same issues as public corporations, and
some others besides.29 One key difference is that there is no external market to place a value on company shares and to serve as a mechanism for purchasing or selling the shares. Another
difference is that the existing owners likely wish to prevent the unfettered sale of the shares in
order to maintain control of the firm. Still another difference is that as minority shareholders in private corporations, employees may have very little control or influence over what goes on
in the organization and no easy way to liquidate their shares if they are not happy with
management or if they feel their interests are not being well represented. Employee-owners in public corporations may also have very little control, but at least they have the option of easily
liquidating their holdings.
To deal with these issues, an artificial “market” is often set up. At regular intervals (usually quarterly or annually), company shares are priced by an outside auditor, and employees are
allowed to purchase from or sell shares to other employees at these times. If the available
shares exceed the demand, the company will often agree to buy back any shares up for sale. In general, when shares are issued, the company is given “right of first refusal” so that employees
must offer their shares to the company before offering them to an outside buyer. In some
cases, the board of directors is required to approve the sale of any of the employee shares to outside investors. In some cases, employees are not permitted to sell their shares except on
termination or retirement from the firm. In many cases, employees are required to sell if they
terminate their employment.
To help protect minority rights, employee shares should carry full rights to voting and
information. There should be guaranteed board representation for employee shareholders
and some legal protection for minority interests. For example, there could be a clause
requiring a majority of employee-owners to agree to major changes that might materially affect their share value, such as sale or purchase of a plant or major asset, or issuance of new
classes of stock to existing owners. These types of provisions are particularly important for
share purchase plans, where employees must make a significant investment to purchase the
shares.30
// Nonmonetary Reward Plans
“Dump the cash, load on the praise!” This is the advice of a well-known consultant who has
come up with “1001 Ways to Reward Employees,” many of which do not involve money.31 He
argues that what employees really want is recognition for their achievements and affirmation
that they are valuable members of the organization. This recognition can take a variety of
forms, ranging from simple praise to substantial prizes, such as an all-expenses-paid holiday.
Certainly, many employers find this attractive advice, since not spending money is usually
popular with employers. And as we have seen, there are many problems and difficulties with individually based financial incentive plans. So it is not surprising that over half of medium to
large Canadian firms now use formal noncash rewards to recognize individual employee
performance. About one-fifth of firms have group-based recognition systems—in which all
members of a team are recognized for the team’s success—in addition to individual
recognition. Some firms have noncash recognition programs that recognize only group
performance, but this is quite rare.
However, while firms may be loading on the praise, they are certainly not “dumping the cash”;
research shows that firms with noncash recognition plans actually have more performance
pay plans than do firms without noncash recognition.32
What exactly is a nonmonetary recognition award? Perhaps one of the most famous examples
is the “Golden Banana Award”: “When a senior manager in one organization was trying to figure out a way to recognize an employee who had just done a great job, he spontaneously
picked up a banana [which had been packed in his lunch], and handed it to the astonished
employee with hearty congratulations. Now, one of the highest honours in that company has been dubbed the ‘Golden Banana Award.’”33 Although some recognition rewards may have
financial value (as in the case of a restaurant voucher or expenses-paid holiday), they are
never provided as cash, since the key to their importance is their symbolic value, as this
example illustrates.
There are some important caveats regarding the use of nonmonetary rewards. First, such
rewards are not a substitute for a fair and equitable pay system. Indeed, without an adequate pay system and a collaborative and trusting relationship between workers and management,
employees will not likely attach much value to nonmonetary rewards. They will likely see such
rewards as an attempt to manipulate them into working harder while withholding “real”
(financial) rewards. And they will not value praise or recognition from managers whom they
don’t respect or trust.
But where there is equitable pay and employee–management trust, nonmonetary rewards can
be effective, as the Toyota case illustrated (see Compensation Today 3.1). Overall, the arguments made by proponents of these reward systems are consistent with Maslow’s theory:
once lower-order needs are satisfied, then the needs for achievement and recognition for this
achievement can come to the fore. But to be effective, praise must be grounded in actual
achievement, follow accomplishment closely, and come from a credible and respected source.
Given all this, nonmonetary rewards seem most suited to high-involvement organizations,
although they may also have applications in human relations organizations. Because the foundations for success do not exist in classical organizations, nonmonetary rewards will
likely be of relatively little value there.
Types of Nonmonetary Reward Plans
Two important dimensions on which noncash recognition programs can vary is whether they
are formal or informal, and whether they recognize individual or group
performance.34 Informal programs, in which supervisors are encouraged to recognize
employee performance as part of their day-to-day management approach, will not likely be effective without extensive managerial training and reinforcement by their superiors, and may
end up being rather hit or miss across different supervisors. To be effective, an informal
approach needs a supportive culture, such as a high-involvement managerial strategy would
provide.
Formal programs can be more systematic and consistent across organizational units, but even
a formal program depends on the cooperation of supervisors for its success.
Regarding individual versus group recognition, if the organization depends on extensive
cooperation within teams or units, then it is probably best to develop a program that provides
recognition on both an individual and a group basis.
According to one expert, there are five types of nonmonetary awards—social reinforcers,
merchandise awards, travel awards, symbolic awards, and earned time off.35 Social reinforcers may range from a simple pat on the back to a valued training opportunity or a company picnic.
The general purpose is to demonstrate the value the firm places on its employees.
Merchandise awards are given to individual employees to recognize performance accomplishments. Travel awards can be provided to recognize individuals or, more
commonly, groups or teams for outstanding accomplishments. Symbolic awards are
exemplified by the “Golden Banana” award. Earned time off can be used to recognize individuals or teams that have gone “above and beyond” the call of duty in finishing a project
or assignment.
Issues in Designing Nonmonetary Reward Plans
In any recognition system, the recognition must be truly deserved, and awards must not be
handed out because they are relatively cheap. In general, the more inexpensive the reward,
the more judiciously it must be provided if it is to be seen as having any value at all. In
addition, it is important to avoid singling out individuals for recognition if their accomplishments have been achieved in a team context or with the help of other employees.
This would lead to only divisiveness and discord.
In general, it is best to structure these programs so that it is possible to recognize all deserving employees. For example, instead of saying that the employee with the highest sales will
receive a recognition award, say that “all employees who achieve a 10 percent increase in
sales” will receive a recognition award. Artificially “rationing” recognition goes against the principle of these programs, which is that any employee with a significant accomplishment
should be recognized.
Another major issue is determining how to identify those individuals and teams deserving of formal recognition. Of course, any manager is free to provide recognition through praise and
other informal means whenever he or she wishes. But for major recognition awards, many
organizations use an elected committee of employees and managers.
At RBC Financial, employees who wish to nominate a coworker can go online to do so. Then the nominee’s immediate manager reviews the nomination. That manager may award a small
recognition on the spot or may make a recommendation to the recognition committee.36
While a recognition program must focus at the grassroots level and become part of the
corporate culture, keeping it alive and vibrant usually requires a champion who will take the
lead in promoting the program. At RBC, a five-person unit is in charge of the recognition program, constantly monitoring its health and coordinating the recognition budget. To help
promote and publicize the program, the bank uses a recognition intranet page. It also has 30
“recognition counterparts” scattered throughout the organization, from all functions and departments, who act as point persons for recognition in that part of the organization and
who answer questions about the program. The recognition budgets for each area of the
organization are funnelled through these people.
In terms of the awards themselves, the bank’s recognition is in the form of “recognition
points.” Employees can redeem these points for a variety of awards (except cash), which
enables them to select an award that is valuable to them. Employees can also accumulate
recognition points in order to garner a larger recognition award.
Through this program, RBC is showing the importance it places on its employees as the key
driver of business success. As earlier RBC examples interspersed throughout the book have shown, nonmonetary rewards are just part of the total reward program at the bank. The
program as a whole is designed to help create a culture of employee commitment to the
organization and its goals.
// SUMMARY
This chapter identified the key issues in designing the four main types of group and
organizational performance pay plans—gain-sharing, goal-sharing, profit-sharing, and employee stock plans—as well as some of the key issues in designing noncash employee
recognition plans.
You have read about the four main types of gain-sharing plans—Scanlon, Rucker, Improshare, and family of measures—each of which uses a different formula for calculating productivity
increases. You now understand the key issues in designing gain-sharing plans and recognize
that these plans suit stable organizations much better than more dynamic organizations.
Goal sharing is a much more flexible system than gain sharing. It also has the potential to be
more arbitrary, both in the criteria for goal achievement and in the amount of the bonus for
goal achievement. When designing these programs, you need to create challenging but
attainable goals; this may be more difficult in dynamic organizations.
Although simpler to develop than gain sharing or goal sharing, profit-sharing plans present
you with a multitude of design choices. To succeed, these plans need extensive
communications, implementation in a high-involvement setting, and allocation of the profit- sharing bonus by individual performance, where permitted by circumstances (i.e., availability
of fair, accurate, and accepted individual performance measures).
You also now know about the four main types of employee stock plans—stock bonus plans,
stock purchase plans, stock option plans, and phantom stock plans—and have learned that
although the design issues are more complex for privately held than for publicly traded corporations, many private corporations do implement employee stock plans. For an
employee stock plan to succeed, it needs to incorporate widespread implementation
throughout the organization, significant ownership for employees, and mechanisms for
extensive employee participation within the enterprise.
Finally, you have learned about nonmonetary employee recognition programs, noting that
there is more to motivation than money. To develop an effective noncash employee recognition program, you need to ensure that all deserving employees receive recognition,
that the process for determining recognition is fair, that team-based recognition is provided
when warranted, and that nonmonetary rewards are not used a substitute for equitable
monetary rewards.
Key Terms
• family of measures plan
• Improshare
• phantom equity plan
• phantom share plan
• Rucker plan
• Scanlon plan
• share appreciation rights
Discussion Questions
Discussion Question 11.1
Review
Gain-sharing and goal-sharing programs have high discontinuation rates. Why do you think that may be?
Your Answer
No answer submitted
Discussion Question 11.2
Review
When designing a profit-sharing plan, what design issues do you think would prove to be the most difficult
to decide?
Your Answer
No answer submitted
Discussion Question 11.3
Review
Of the various types of employee share plans, which do you think would best fit a privately held
corporation?
Your Answer
No answer submitted
Discussion Question 11.4
Review
Discuss the pros and cons of nonmonetary reward programs.
Your Answer
No answer submitted
Discussion Question 11.5
Review
Review expectancy theory from Chapter 3. Now, using expectancy theory, discuss the potential
motivational impact of profit-sharing pay systems on employees.
Your Answer
No answer submitted
Using the Internet
Using the Internet Question 11.1
Review
Go to the National Center for Employee Ownership website, and identify the factors the Center suggests
are important to the success of employee share ownership plans.
Your Answer
No answer submitted
Exercises
Exercise Question 11.1
Review
Examine the two profit-sharing plans described in Compensation Today 11.3. Evaluate the possible impact
of each. Which do you think will be most effective, and why do you think so? What additional information would be useful in order to draw firm conclusions?
Your Answer
No answer submitted
Exercise Question 11.2
Review
Assume you are an employee in a firm that is planning to implement profit sharing. As an employee,
identify the design features you would like to see included. Then, in a small group, compare your desired plans. How do they differ, and what do you think are the reasons for the differences?
Your Answer
No answer submitted
Case Questions
Case Question 11.1
Review
You are a team of top-notch compensation consultants hired by Alliston Instruments, the manufacturer in
the case study in the Appendix. After analyzing the various options available, you have decided that a
group pay plan would be beneficial to this organization. Select the specific group plan that would seem to
work best; then design it, describing specifically how you would deal with the various design issues. When
you are done, the plan should be ready for implementation.
Your Answer
No answer submitted
Case Question 11.2
Review
You have decided that The Fit Stop in the Appendix would be well suited to an organizational performance
pay plan. Select the specific organization pay plan that would seem to work best; then design it, describing
specifically how you would deal with the various design issues. When you are done, the plan should be ready for implementation.
Your Answer
No answer submitted
Simulation Cross-Reference
If you are using Strategic Compensation: A Simulation in conjunction with this text, you will
find that the concepts in Chapter 11 are helpful in preparing Section K of the simulation.
// Notes
1. John G. Belcher, Gain Sharing(Houston: Gulf, 1991).
2. Mitchell Fein, IMPROSHARE: An Alternative to Traditional Managing (Hillsdale: Mitchell
Fein, 1981).
3. R.T. Kaufman, “The Effects of IMPROSHARE on Productivity,” Industrial
and Labor Relations Review 45 (1992): 311–22.
4. Belcher, Gain Sharing.
5. Ibid.
6. Kaufman, “The Effects of IMPROSHARE.”
7. Richard J. Long, “Group-based Pay, Participatory Practices, and Workplace Performance,”
paper presented at the Conference on the Evolving Workplace, Ottawa, September 2005, 28–
29.
8. For example, see Kenneth Mericle and Dong–One Kim, Gainsharing and Goalsharing:
Aligning Pay and Strategic Goals (Westport: Praeger, 2004).
See also Christine Cooper, Bruno Dyck, and Norman Frohlich, “Improving the Effectiveness of
Gainsharing: The Role of Fairness and Participation,” Administrative Science Quarterly 37,
no. 3 (1992), 471–90. See also Theresa M. Welbourne, David B. Balkin, and Luis Gomez–Mejia,
“Gain Sharing and Mutual Monitoring: A Combined Agency–Organizational Justice Interpretation,” Academy of Management Journal 38, no. 3 (1995): 881–99.
See also Theresa M. Welbourne and Daniel M. Cable, “Group Incentives and Pay Satisfaction:
Understanding the Relationship Through an Identity Theory Perspective,” Human
Relations 48, no. 6 (1995): 711–26. See also Dong-One Kim, “Factors Influencing
Organizational Performance in Gainsharing Programs,” Industrial Relations 35, no. 2 (1996):
227–44.
9. Long, “Group-based Pay.”
10. Lisa D. Ordonez, Maurice E. Schweitzer, Adam D. Galinsky, and Max H. Bazerman, “Goals
Gone Wild: The Systematic Side Effects of Overprescribing Goal Setting,” Academy of
Management Perspectives 23, no. 1 (2009): 6–16.
11. Mericle and Kim, Gainsharing and Goalsharing.
12. Edward E. Lawler, Rewarding Excellence: Pay Strategies for the New Economy (San
Francisco: Jossey–Bass, 2000), 228.
13. K.M. Bartol and E.A. Locke, “Incentives and Motivation,” in Compensation in
Organizations: Current Research and Practice, ed. S.L. Rynes and B. Gerhart (San
Francisco: Jossey–Bass, 2000), 104–50.
14. Three Canadian studies found that profit sharing was more likely in high-involvement
organizations than in classical and human relations organizations. See Terry H. Wagar and
Richard J. Long, “Profit Sharing in Canada: Incidence and Predictors,” Proceedings of the
Administrative Sciences Association of Canada, Human Resources Division 16, no. 9
(1995): 97–105.
See also Richard J. Long, “Motives for Profit Sharing: A Study of Canadian Chief Executive Officers,” Relations industrielles/Industrial Relations52,
no. 4 (1997): 712–733. See also Richard J. Long, “Performance Pay in Canada,” in Paying for
Performance: An International Comparison, ed. Michelle Brown and John S. Heywood
(Armonk: M.E. Sharpe, 2002).
15. Long, “Motives for Profit Sharing.”
16. Ibid.
17. Ibid.
18. Ibid.
19. Richard Yerema, Canada’s Top 100 Employers (Toronto: Mediacorp, 2005)
20. Richard J. Long, “Employee Profit Sharing: Consequences and Moderators,” Relations
industrielles/Industrial Relations 55, no. 3 (2000): 477–504.
21. Corey Rosen, John Case, and Martin Staubus, “Every Employee an Owner. Really,” Harvard
Business Review, June 2005, 1–8.
22. Kerry Isaac, Compensation Planning Outlook 1996 (Ottawa: Conference Board of
Canada, 1995).
23. Stephen Spector, “Expensing Stock Options.” CGA Magazine, March–April 2004, at
http://www.cga-canada.org/en-ca/AboutCGACanada/CGAMagazine/2004/Mar-
Apr/Pagesca_2004_03-04_dp_standards.aspx.
24. Summary of Statement No. 123 (revised 2004), Financial Accounting Standards Board, at
http://www.fasb.org/summary/stsum123r.shtml, accessed October 2, 2016.
25. Executive compensation 2013: Data, trends and strategies. © 2014 Hay Group.
26. Helen H. Morrison and Joseph S. Adams, “New Type of Phantom Equity Plan Used to
Combat Employee Defections,” Journal of Employee Ownership Law
and Finance 13, no. 1 (2001): 109–26.
27. Long, “Employee Profit Sharing.”
28. Rosen et al., “Every Employee an Owner.”
29. For examples of employee ownership systems in private Canadian corporations, see Carol Beatty and Harvey Schacter, Employee Ownership: The New Source of Competitive
Advantage(Toronto: John Wiley and Sons, 2002).
30. An excellent source of information on the technical aspects of designing employee share plans in Canada is Perry Phillips, Employee Share Ownership Plans (Toronto: John Wiley
and Sons, 2001).
31. Bob Nelson, “Dump the Cash, Load on the Praise,” Personnel Journal 75, no. 7 (1996): 65–
70. See also Bob Nelson, 1001 Ways to Reward Employees (New York: Workman, 1994); or
Bob Nelson, 1001 Ways to Reward Employees: 100s of New Ways to Praise (New York:
Workman, 2005).
32. Richard J. Long and John L. Shields, “From Pay to Praise? Non–Cash Employee Recognition
in Canadian and Australian Firms,” International Journal of Human Resource
Management 21, no. 8 (2010): 1145–72.
33. Dean R. Spitzer, “Power Rewards: Rewards That Really Motivate,” Management
Review 85, no. 5 (1996): 48–49.
34. J.–P. Brun and N. Dugas, “An Analysis of Employee Recognition: Perspectives on Human
Resources Practices,” International Journal of Human Resource Management 19, no. 4
(2008): 716–30.
35. Jerry L. McAdams, “Nonmonetary Rewards: Cash Equivalents and Tangible Awards,” in The
Compensation Handbook: A State-of-the-Art Guide to Compensation Strategy and
Design, ed. Lance A. Berger and Dorothy R. Berger (New York: McGraw–Hill, 2000), 241–59.
36. David Brown, “RBC’s Recognition Department Oversees Rewarding Culture,” Canadian
HR Reporter18, no. 5 (2005): 7–9.
Chapter 12: Designing
Indirect Pay Plans CHAPTER LEARNING OBJECTIVES
After reading this chapter, you should be able to:
• Identify the six major categories of employee benefits and the specific
types of benefits included in each category.
• Discuss the advantages and disadvantages of fixed versus flexible
benefits plans and the circumstances in which each would be most
appropriate.
• Describe the issues that must be addressed in designing a benefits
system.
BENEFITS ARE EXTREME HERE!
Something’s always percolating at Digital Extremes. If not the free coffee (along with free
meals—breakfast, lunch, and supper—prepared by full-time chefs employed by the firm), it’s
the interplay between employees as they work together to produce video games such as Bioshock, Dark Sector, Warframe, and the Unreal Tournament series. To keep things light in
what can be a high-intensity work environment, the company has a “Fun Brigade” that
organizes everything from ping-pong tournaments, to paintball and paper airplane contests,
to pumpkin-carving competitions.
At this video games maker, based in London, Ontario, President Mike Schmalz believes it is
important to keep things fun so that employees don’t burn out. As Schmalz puts it, “As fun as it looks, it’s a lot of hard work. There are big deadlines. We try to work hard, play hard, and
ultimately we want to create something that everyone can be proud of.” In addition to the
food, fun, and stimulating work, the company offers a wide array of benefits to its employees,
which include an in-house theatre, nap room, free parking, and free snacks. The firm also subsidizes tuition and professional accreditation and online training programs, tops up
parental leave programs, offers matching RSP contributions, and has a company-paid health
plan that covers everything from medicine and prescription coverage to eye and dental care for its employees and their families. All in all, it is no surprise that the firm has been named one
of “Canada’s Top 100 Employers” from 2010 to 2013 and again in 2015 and 2016.
Sources: Kira Vermond, “At Digital Extremes, Free Lunch Connects Workers,” The Globe and
Mail Online, October 10, 2012, http://www.theglobeandmail.com/report-on-
business/careers/top-employers/at-digital-extremes-free-lunch-connects-
workers/article4598583, accessed October 18, 2016; Richard Yerema and Kristina Leung, Canada’s Top 100 Employers (Toronto: Mediacorp, 2012), http://www
.canadastop100.com/national, accessed October 3, 2016.
// TYPES OF EMPLOYEE BENEFITS AND
SERVICES
Vancity Credit Union in Vancouver (another long-standing member of the “Canada’s Top 100
Employers” club) also offers an impressive array of benefits. The company has a defined
benefit pension plan and an employer-matched RSP plan; as well, it offers low-interest home
loans, subsidized home insurance, subsidized child care, an employee assistance program,
and discounts on all the financial services it offers. It has a very generous parental leave plan as well as an extensive program to subsidize tuition and education programs. It also has a
health plan for which the employer pays 70 percent of the premiums and that allows
employees great flexibility regarding features and coverage levels.1
As discussed in Chapter 4, indirect pay is an important component of a firm’s compensation
strategy and can serve a variety of purposes. However, many issues affect the design of
indirect pay, which is technically the most complex of the compensation components, not least because of all the legal and tax issues surrounding it. This chapter begins by discussing
the six main categories of indirect pay and the specific employee benefits included in each. It
then discusses fixed versus flexible benefits systems and concludes by outlining how to
develop an effective employee benefits system.
There are six main categories of indirect pay:
• mandatory benefits,
• retirement income,
• health benefits,
• pay for time not worked,
• employee services, and
• miscellaneous benefits.
Within each of these categories, a multitude of specific benefits can be
included. Compensation Notebook 12.1 provides an overview of the benefits that will be
covered in this chapter.
Statistics Canada data2 suggest that the most common nonmandatory benefits offered by
Canadian private sector establishments with at least 10 employees are life insurance,
supplemental medical benefits, and dental benefits (each of these is offered by about two-
thirds of employers). About one-third of these employers offer group RRSPs, and about one- quarter offer a formal pension plan. About one in eight firms offer supplemental employment
insurance. Most public sector employers, as well as unionized employers, offer all of these
benefits.
COMPENSATION NOTEBOOK 12.1
Benefits
Mandatory Benefits
• Canada/Quebec Pension Plan
• Employment Insurance
• Workers’ Compensation
Retirement Income
• Defined benefit plans
• Defined contribution plans
• Hybrid pension plans
Health Benefits
• Supplemental health insurance
• Disability insurance
• Life and accident insurance
• Dental insurance
• Health care spending accounts
Pay for Time Not Worked
• Vacations, holidays, breaks
• Sickness, compassionate, and personal absences
• Supplemental unemployment benefits
• Parental leaves
• Educational and sabbatical leaves
• Severance pay
Employee Services
• Employee assistance programs
• Wellness and recreational services
• Child care/elder care
• Work/life balance
• Financial or legal services
• Food services
• Outplacement services
Miscellaneous Benefits
• Use of company vehicle
• Product/service discounts
• Housing/mortgage subsidies
• Employee savings plans
• Tuition reimbursements
• Work clothing/equipment
Mandatory Benefits
The federal and provincial governments require employers to contribute toward a number of
government-provided employee benefits. That is, employers must participate in the
following mandatory benefits on behalf of their employees: the Canada/Quebec Pension Plan (CPP/QPP), Employment Insurance, and Workers’ Compensation (which covers treatment
expenses and other costs for workers who are injured on the job). (Note, however, that
employers do not have to contribute to these plans for independent contractors.)
Employers must also provide minimum levels of holidays, rest breaks, and statutory vacation
time. In some provinces they must also pay health care taxes. The amount the employer must
contribute for each of these programs is based on the total cash compensation received by an employee. For lower-income employees, CPP/QPP, employment insurance, and workers’
compensation premiums alone can amount to 10 percent of total compensation. However,
because of caps on the premiums, these programs typically amount to a much smaller
percentage of the compensation of more highly paid employees, so that the average is 5 to 6
percent.3
Retirement Income
Because many employees are greatly concerned about securing a retirement income, many
firms offer a pension plan that goes beyond the basic pension plan provided by the
government. All Canadians are currently entitled to Old Age Security, which pays a small fixed
pension; low-income pensioners also receive a Guaranteed Income Supplement. All employees also qualify for the CPP or QPP, with the amount of their pension dependent on
their credited contributions.
After mandatory benefits, pension and retirement plans are the costliest items in most company benefits packages. There are two main types of private pension plans: defined
benefit and defined contribution. Hybrid pension plans, which combine the two, are used
mainly to transition from one system (usually defined benefit) to the other (usually defined
contribution).
Defined Benefit Plans
Defined benefit plans provide a specified stream of income from the time of retirement until death. The amount is usually geared to some proportion of the employee’s annual earnings,
modified by the number of years the employee has been covered by the plan. At Imperial Oil,
for example, employees receive 1.6 percent of the average of their best three years’ earnings
for each year of service. So if an employee retires after 35 years and has averaged $50,000 per year during his or her three best years, that person receives an annual pension of $28,000 from
Imperial ($50,000 30.016 335), in addition to payments from the CPP/QPP and Old Age
Security.
Defined Contribution Plans
With defined contribution plans (sometimes called “money purchase plans”), the employer
commits to putting a certain amount of money in an investment trust on behalf of each employee; then, at the time of retirement, the amount of the annual pension is paid based on
whatever amount of money is in that trust. Thus, there is no guarantee as to what amount the
annual pension at retirement will actually be. Contributions can be defined in two ways: either as a fixed sum of money, with the amount established each year, or as a fixed proportion of
company profits. In the latter case, the plan is known as a deferred profit-sharing plan (DPSP),
which was discussed in Chapter 11.
Both defined benefit and defined contribution pension plans can be contributory (i.e.,
employees are required to make contributions) or noncontributory (i.e., employees make no
contribution to the plan). The exception to this is deferred profit-sharing plans, all of which are
noncontributory.
Defined benefit plans are still the most common type in Canada, but there has been a trend
away from them toward defined contribution plans, especially in the private sector. According
to Statistics Canada, only 24 percent of private sector employees are covered by any kind of pension plan (in contrast, almost all public sector employees are covered).4 As of 2012, 59
percent of private sector firms that offered employee pension plans offered defined
contribution plans, whereas 85 percent of public sector organizations continued to offer defined benefit plans.5 The same study reported that, overall, 37 percent of organizations with
pension plans offered a group RRSP and that only 3 percent offered a hybrid plan (which
combines features of both plans). However, the same StatsCan study found that these hybrid plans covered a significant number (about 10 percent) of the employees covered by pension
plans.
There are several reasons for the trend toward defined contribution plans, which were almost unheard of 20 years ago. One early impetus was inflation, which was very high in the 1970s and
1980s. During inflationary times, the best three years of earnings end up being far higher than
companies had anticipated. When this happens, money that has been set aside over the years to fund the pension plan becomes insufficient to meet the plan’s obligations (this is what is
meant by an “underfunded plan”), and firms are compelled to make large contributions in
order for their pension plans to meet those obligations. This problem doesn’t exist for defined
contribution plans, since the employer’s liability is limited to the amount placed in the plan.
In recent years, the impetus for change has not been inflation, but the very poor (or even
negative) market returns earned by pension funds. During the 2008–09 financial meltdown,
most pension funds had a negative return, which led to defined benefit plans becoming seriously underfunded. To deal with this, firms had to make large extra payments to these
funds—money that some firms had a hard time finding. In fact, 2008 was the worst year ever
for pension funds—their value plunged by 15.9 percent.6
Another source of unexpected costs for defined benefit plans is increased life expectancies. This may pose a particular problem in fields in which more of the workforce is female, since
the life expectancy of women (83 years at birth) is four years longer than that of men (79 years
at birth), according to Statistics Canada.7 Some estimates suggest that the life expectancies figures are actually higher (89 years for women and 86 years for men).8 A man who reaches the
age of 65 can typically expect to live another 20.9 years; a woman, another 23.3.9 This can
make a big difference in the amount of money needed to fund these pensions. Moreover, if life spans continue to increase, then so will pension liability in defined benefit plans.
(Compensation Today 12.1 illustrates some interesting actuarial estimates for life
expectancies and the way they relate to retirement income.) Currently, organizations with
defined benefit plans pay about 9.3 percent of total compensation to their pension plans,
while organizations with defined contribution plans pay about 6.5 percent.10
COMPENSATION TODAY 12.1
Would You Take this Bet
Project yourself far into the future. You are just celebrating your 90th birthday. An obnoxious
relative (how did he get invited to my party, you wonder) who always lords it over you because he is four years younger, has the poor taste to comment that he is glad to see you enjoying
your birthday party so much, because it will probably be your last.
Hotly, you tell him that you plan to be around for a few more birthdays yet. He replies that if you are so sure about that, why don’t you make some money from it? He offers to pay you
$1,000 if you make it to your 91st birthday, but you have to pay him $1,000 if you don’t (the
money to be collected immediately and held by a third party until your demise or your 91st
birthday, whichever comes first—he may be obnoxious, but he is no fool).
You stop to think. You are in normal health for a 90-year-old, but just how likely is it that you
will see your next birthday? Should you take that bet?
You should—in fact, you should try to raise the ante. According to actuarial statistics, your
chances of making it to your 91st birthday are greater than 80 percent. In fact, you could be
105 and still have a better-than-even chance of making it to your next birthday.
Overall, Canadians enjoy one of the longest life expectancies in the world. This is good news
from a health perspective, but bad news from a retirement income perspective. Statistics
indicate that only a minority of Canadians are putting away enough money to maintain their
standard of living in retirement.a Although employees in public sector organizations are generally covered by pensions, only about one-quarter of Canadian employees are covered by
company pension plans, and many of those who are covered will not receive pensions
adequate to maintain their standard of living over the 15 to 20 years (or more) of retirement
they will enjoy.b Given that mandatory retirement has now been abolished in Canada, one possibility is that many employees without sufficient retirement income will continue to work
well past normal retirement age, a trend that appears to have already started.c
Of course, people vary in how much they value retirement income plans. Many young employees are especially prone to not worrying about retirement. Some say, why worry—I’ll
never even make it to retirement! But just what are the odds for a 25-year-old making it to age
65? In fact, better than 80 percent for males and about 90 percent for females. And if you are in normal health at age 25 and not in a hazardous occupation, the odds are much better than
that. As this realization sinks in, it is likely that companies that offer pension plans will be
increasingly favoured by potential employees.
a Sarah Scott, “More Risk, Higher Rewards? The New Look of Company
Pensions,” Maclean’s110, no. 39 (1997): 46–48. b Steven Chase, “Canada’s Growing Pension Puzzle,” The Globe and Mail, June 1, 2009, A1. c Shannon Klie, “Workers Delay Retirement as Economy Tanks,” Canadian HR Reporter,
January 26, 2009, 7.
Of course, the actuarial projections in Compensation Today 12.1 vary for specific employee
groups. Accountants have a better chance of surviving to a ripe old age than coal miners.
Making accurate actuarial predictions for a particular employee group and then incorporating
those predictions into the pension plan is a complex process, one that is not necessary for defined contribution plans. From an employer’s perspective, defined contribution plans are
much simpler than defined benefit plans.
From an employee’s perspective, defined contribution plans tend to be more portable than defined benefit plans. When employees move from one employer to another, their defined
benefit plan is subject to commuted values, which reduces the value of their plan, compared
to maintaining employment with the same firm.11 Defined contribution plans are not subject
to such commutations.
However, defined contribution plans have their own drawbacks. They are most beneficial to
employees who enter them at a young age and thus contribute for a long time; conversely, defined contribution plans may result in seriously inadequate pensions for those who join up
later in life. As long-term employment with a single employer becomes less common, many
employees may face this problem. Furthermore, “the employee is saddled with the investment risk and the risk that annuity prices will be high at retirement.”12 In essence, defined
contribution plans transfer the risk of retirement income accumulation from the employer to
the employee.
One expert points out that firms are better able to manage retirement fund portfolios and
their inherent risks than most employees. As she puts it: “Surely plan sponsors, with access to
the various types of expertise required, investment, actuarial, and otherwise, are far better
equipped to deal with these risks than are individuals.”13 Pitcher also points out that defined
benefit plans offer the advantage of averaging risk over a large group of employees. Some members will terminate, die, or retire when the timing is bad for the fund, but others will do so
when the timing is favourable. Such averaging is not possible under defined contribution
plans.
Hybrid Pension Plans
Hybrid pension plans combine elements of the defined benefit and defined contribution plans.
For example, some firms have a defined benefit plan but also allow employees to contribute to a defined contribution plan. Some firms match employee contributions to a certain maximum
level. These contributory plans are often set up as group registered retirement plans.
Employees are allowed to deduct their contributions from their taxable income, and the plan’s earnings accumulate on a tax-deferred basis. Employer and employee contributions to
defined benefit and defined contribution plans (both of which must be registered with the
government, and both of which are known as registered pension plans) are deducted from the amounts that may be contributed to a group RRSP. Group RRSPs have contribution limits
established by the federal government. As discussed earlier, more than half of all defined
contribution plans are implemented in conjunction with defined benefit plans, most often as
part of a process of transitioning away from the defined benefit plan.14
Experience with Pension Plans
Researchers have identified several important effects of pensions. For example, firms with
pensions have lower employee turnover, and their employees retire earlier than those at firms without pension plans.15 This can be beneficial to two types of firms: those for whom turnover
is expensive, and those for whom employee productivity drops off (relative to their earnings)
as employees near retirement. But recall from Chapter 3 that turnover can be low due to either affective or continuance commitment. Continuance commitment results in employees
exerting only enough effort to meet the minimum standards necessary to avoid being fired,
whereas affective commitment can lead to positive job attitudes and behaviour. If pension plans are reducing turnover by creating continuance commitment, this may not be much of a
benefit to the firm.
This may help explain research findings suggesting that pensions have a negative impact in unionized firms: if continuance commitment is the only type of commitment generated by the
firm, then high job security may allow employees to perform at the minimum standards
necessary for job retention. For example, a study of a large Canadian hospital found that the pension plan generated only continuance commitment, not affective commitment. Indeed, as
the amount of pension that employees would lose by quitting went up, affective commitment
actually went down.16 This suggests that many employees who would prefer to quit are continuing their employment because they do not want to lose their pension benefits, so they
are putting in the minimum effort necessary to keep their jobs. If this is what a pension plan
achieves, is it actually of much value to the firm?
This helps explain why classical firms, especially unionized ones, are so reluctant to implement benefits such as pensions. First of all, the cost of turnover is often not high for
them, so spending a lot of money on pension benefits is unlikely to pay off for the employer.
Second, the job security provided by the union may make it difficult to terminate employees
unless they are clearly below the minimum performance standards, so the pension system may result in dissatisfied employees who are able to get away with very low performance
levels that the firm can do very little about.
In contrast, it is easy to see why pensions are an asset to human relations organizations, which depend on employee stability and on a sense of gratitude and obligation among employees.
For these firms, positive social norms are sufficient to maintain employee productivity at
acceptable levels. Also, since these firms are often not unionized, a generous benefits package can help forestall future unionization, which these firms regard as a threat to the close
relationships that they like to cultivate between management and employees.
Health Benefits
One of the most highly valued employee benefits is coverage in the event of health problems,
including disability and death. These benefits are usually provided through some type of
insurance program and may include supplemental health insurance, dental insurance,
disability insurance, life and accident insurance, and health care spending accounts.
Supplemental Health Insurance
Canadians enjoy a large number of government-sponsored medical benefits under the system
generally known as “medicare.” In the United States, where government-sponsored universal
medical coverage does not exist, employers are expected to bear the cost of medical
insurance. This cost can be staggering in the United States. While recent changes with the
introduction of the Affordable Care Act have benefitted many employees, the costs are still
high for employers.17
However, because of medicare, health benefit costs for Canadian employers are much lower,
resulting in much lower benefits costs than in the United States. Nonetheless, many medical expenses are not covered by Canadian medicare, including optical/vision care, chiropractic
treatments, and prescription drugs. Until recently, the costs of these plans were rising quite
sharply, mainly due to rising prescription drug costs. However, recent years have seen a slowdown in these increases as generic drugs have become more widely available.18 Currently,
extended health plans average about 2 percent of total compensation.19
Disability Insurance
Many employers purchase long-term disability insurance for their employees to cover
disabilities arising from non-work-related causes. (Work-related disabilities are covered under
Workers’ Compensation.) This coverage typically provides for 60 to 70 percent of normal pay
and carries on until the employee is able to return to work, reaches retirement age, or dies (in
which case, benefits are usually provided for the surviving spouse and/or dependent children).
Historically, most disability claims have been based on physical disabilities. However, it
appears that this cause of disability has been declining and that mental disability is now
driving higher disability claims.20 By recent estimates, mental disorders now cost Canadian
employers at least $7 billion a year; this includes the costs of employee replacement, lowered
productivity, and disability programs.21 To counter these problems, some of which may stem from workplace stress or work/life conflicts, many employers have launched employee
assistance programs, wellness programs, and work/life balance programs.
Life and Accident Insurance
One item included in almost all benefits plans is term life and accident insurance. This
coverage is usually expressed in terms of a multiple of annual salary (e.g., two times annual
salary). Employees are often given the option of increasing their coverage, either at their own expense or on a cost-shared basis. In some cases, insurance coverage is also available for
family members, if the employee opts to pay the premiums for this coverage.
Dental Insurance
Dental insurance has expanded rapidly in the past few years. It has become popular because
dental coverage is not provided under medicare and can be a major expense (especially when
it comes to orthodontic services for dependant children). It is also a highly tax-favoured
benefit.
Tax Status of Pension and Health Benefits
Table 12.1 summarizes the tax status of the various insurance and pension benefits. It indicates that several aspects of these benefits programs have tax implications. First, how are
employer contributions treated? Are they deductible from corporate taxes, and are they
treated as a taxable benefit to employees on which income tax must be paid? Second, how are
employee contributions treated? If employees make contributions to the benefit, are their contributions tax-deductible? Third, is purchase of the benefit subject to a premium or sales
tax that may be levied by a provincial government? Fourth, in the case of pension funds, are
the earnings of the fund taxable as they are accumulating? Finally, when the benefit pays out
to employees, must they include it as income and pay tax on it?
As Table 12.1 shows, registered pension plans receive favourable tax treatment (up to the
limits imposed by the Canada Revenue Agency). Employees ultimately have to pay taxes on
the payouts from these plans, but not until retirement, when they are likely to be in a much lower tax bracket. Moreover, at retirement, employees can use the funds to purchase
annuities, so that income tax is spread over a number of years instead of being payable in the
year of retirement. Also very important for some married couples (in cases where one spouse has much higher pension income than the other) is that, as of 2007, pension income can be
split between spouses for tax purposes, which can dramatically reduce the overall amount of
tax payable by the couple.
Note that because of RRSP legislation, individual employees can now create their own
retirement plans that have tax benefits similar to those of company-provided plans. In the past, this was not the case, and company-provided pension plans had dramatic tax
advantages over individual retirement plans.
Insurance plans enjoy favourable tax treatment as well, especially health/dental insurance and accidental death/dismemberment insurance. In both cases, employees do not pay tax
either on the employer contributions for these plans or on the benefits that are paid out. Since
employee contributions to these plans are not tax-deductible but employer contributions are,
it makes sense for the company to provide these plans.
Look at it this way. Suppose that an employer currently pays $800 per employee to purchase a
dental plan. If the employer decided to instead give the $800 directly to each employee to purchase dental coverage, the employee would lose as much as $400 of this to federal and
provincial income taxes, leaving only $400 to purchase the dental coverage, so the employee
would receive much less coverage. On top of this, the employee would have to pay a higher
price for the coverage purchased, since individual plans typically cost much more than company plans. In fact, most employees would probably not find it feasible to purchase dental
coverage at all, leaving them liable for major dental bills that may arise.
So it is far more cost-effective for the employer to purchase dental coverage on behalf of employees. If an employer is not willing to provide the coverage, employees would be much
better off to have their pay reduced by the $800 and have their employer pay this money
toward health or dental coverage. Compared to purchasing their own coverage, employees
would save up to $400 in income taxes and would also get better coverage.
In contrast, employer-provided long-term disability insurance is not as tax-favoured.
Employees are not liable for income taxes on employer contributions to these plans, but they
are liable for tax on any benefits received. (On the other hand, if the employees pay for these plans themselves, employee contributions are not tax-deductible but any benefits received
are not taxable.) However, since the great majority of employees will be lucky enough never to
receive these payments, it is far better for them to have the employer purchase the coverage with pre-tax money than for the employees to have to purchase the coverage with their after-
tax money.
Another popular benefit, group life insurance, has become less tax-favoured over time as the tax rules have changed. It is the only benefit in which employer contributions are considered a
taxable benefit, so there is no tax advantage for the employee in having the employer
purchase the coverage. However, because employers receive much more favourable rates on purchase of this insurance than would employees, a company-provided group life insurance
plan (whether the employer or the employee pays the premiums) is still beneficial to
employees.
Health Care Spending Accounts
Because of their tax-favoured status, health care spending accounts have become popular in
recent years. By 2012, 56 percent of medium to large Canadian employers were offering
them.22 In this benefit plan, employers place a certain amount of money (health care spending credits) in a separate account for each employee. Employees may then draw on their
individual accounts to cover a wide variety of health care expenses not covered by their other
plans, including nonprescription drugs; services that are only partly reimbursed under other plans; cosmetic surgery; and even the deductible amounts from other insurance plans. The
key advantage of this benefit is that while employer contributions are still fully deductible for
the employer, the funds paid to each employee are not taxable at any point—not when they are placed in the health care account and not when they are received by employees (except in
Quebec, where reimbursements to employees are subject to provincial income tax). This is a
very
significant tax benefit.
Aside from the tax advantages, employers like the idea of a fixed amount set for health
coverage. In conventional health insurance plans, as costs increase, the employer must either pay them, pass them along to employees, or reduce coverage—all unpopular choices. With a
health care spending account, the employer has the option of not adjusting the health care
credits as health costs increase, or of increasing the credits less than the full increases in health costs. However, this may result in employee discontent if the plan is no longer able to
cover their needs.
Pay for Time Not Worked
This awkward-sounding but descriptive term is used to cover a variety of circumstances in
which employees receive pay even though they are not actually working. As discussed earlier, some pay for time not worked is mandatory, including basic vacations, statutory holidays, and
rest breaks. But many firms go beyond these mandatory levels and provide pay for additional
holidays, sickness and personal leave, educational and other types of leave, and severance
pay.
Vacations, Holidays, and Breaks
Most major employers go beyond the two or three weeks of vacation mandated by law (depending on the jurisdiction) and the nine statutory holidays, to give 11 to 13 paid holidays
on fixed dates and up to three paid “floater” holidays that can be moved around from year to
year. Most workplaces also give two paid rest breaks of 15 to 20 minutes (besides an unpaid
lunch break) during a seven- or eight-hour day.
One new twist on vacations is the concept of “vacation buying or selling.” Some firms allow
employees to “buy” additional vacation days by forgoing the pay for these days. Conversely,
employees can “sell” back to the employer any vacation days they don’t intend to use. Essentially, vacation buying or selling simply provides some additional flexibility for
employees. For some interesting benefits, including paid vacations, see Compensation Today
12.2.
COMPENSATION TODAY 12.2
Go West!
Have you ever been to Athabasca, Boyle, Lac La Biche, or Grassland in Alberta? Would you
consider living and working in any of these communities? Well, if you do, Alberta-Pacific Forest
Industries Inc. offers an interest-free loan of $25,000 to new employees. You will also start with four weeks paid vacation, with the option to take the fourth week as time off or as additional
income. The company has a flexible personal time-off program as part of its health plan (with
employees averaging 12 personal days off each year), and each employee receives an annual $3,800 taxable lifestyle contribution that can be used toward alternative health coverage or
even to purchase more vacation time. The company also offers employees free membership to
the on-site fitness facilities with treadmills, stationary bikes, stairmasters, instructor-led
classes (boot camp held periodically), weights, shower facilities, weigh scales, and television
and music system.
To support employees grow a long-time career, Albert-Pacific Forest Industries Inc. set up
many training programs including an Aboriginal apprenticeship program, a leadership development program, a tuition reimbursement program up to 100 percent of the cost, as well
as financial bonuses for the completion of certain accreditations ranging from $1,500 to
$10,000. The result is amazing. Among its 435 full-time employees, the longest-serving has 26
years tenure!
Source: Richard Yerema and Kristina Leung, Mediacorp Canada Inc. staff editors, Canada’s
Top 100 Employers, November 8, 2015, http://content.eluta.ca/top-employer-alpac,
accessed October 3, 2016.
Sickness, Compassionate, and Personal Absences
Most employers provide pay continuation for short-term absences from work due to illness or for other specified reasons, such as the death of a family member. Some firms have formal
plans that allot a certain number of allowable sick days in a given period, beyond which wages
will not be paid. In some cases, sick days can accumulate beyond a year; in most cases, they cannot. In other cases, employers do not formally provide sick leave, but neither do they dock
absences if the missing time is made up at some future time. In still other cases, absences may
be counted against the annual vacation allotment.
One issue here is whether the only allowable paid absences are for personal illness, or whether
other reasons (such as illness of a child) are allowable reasons for absence under the plan.
Some firms now refer to their “sick leave” days as “personal leave” days to avoid forcing
employees to claim personal illness when the actual reason is an illness or personal
emergency involving a family member. In other cases, employers are simply rolling all leave
days together, including vacation and sick leave, and providing these as the total allowable
number of paid absences. In a few cases, employers are willing to “buy back” unused leave days, so that employees who do not use all their allotted days are not penalized relative to
employees who do use all of their leave days. However, it may not be wise to buy back all of
these days at full rates if this creates too strong an incentive for employees to come to work
even when they are seriously ill.
Many firms also offer compassionate or bereavement leaves to permit employees to attend
the funerals of close family members. Under revisions to the Canada Labour Code effective January 2004, all employers in the federal jurisdiction are required to provide unpaid
compassionate care leave for employees who must be absent from work to provide support to
a child, parent, spouse, or common-law partner who is gravely ill with a serious risk of death, and their jobs must be held for them until their return to work. Most major firms also provide
paid leave for jury duty. Short-term absences to give birth or attend the birth of a child are also
included here. (Longer-term maternity/paternity leaves will be discussed shortly.)
One way to help address the need for short-term absences is through a flexible-hours or a
flexible-workplace program. For example, IBM Canada lets some staff compress their
schedules to four days and also allows them to adjust start and finish times by up to 2.5 hours per day to accommodate personal needs.23 Some employees are also permitted to work at
home for several days a week.
Supplemental Unemployment Benefits
When an employee is temporarily laid off and must go on Employment Insurance, many firms
offer supplemental unemployment benefits (SUBs), which are designed to “top up” the EI benefits to some proportion of the employee’s normal pay. The usual process is for the
employer to set up a fund to which it contributes regular amounts based on the number of
hours worked by employees. This fund is then used to provide the supplemental unemployment benefits to eligible employees; it may also include employees on maternity or
paternity leave. But the firm’s liability is limited to the amount in the fund. Note that these
plans must be approved and registered with the Employment Insurance Commission.
Parental Leaves
Some firms may also offer some period of paid maternity or paternity leave, usually in
conjunction with Employment Insurance, which provides coverage for up to 50 weeks of maternity or paternity leave (but not both to the same couple at the same time). Firms may
treat maternity or paternity leave in the same way as a temporary layoff and use funds from
their supplemental unemployment fund to top up the employee’s EI benefits to a certain proportion of normal income. Or if the firm does not have a SUB fund, it may simply have a
policy for topping up EI in the case of maternity or paternity leave.
Educational and Sabbatical Leaves
Some organizations have paid educational leave plans, in which employees are compensated
while undertaking a full-time educational program. In some cases full pay is provided, while in
others some portion of normal pay is provided. There is normally an expectation that the
employee will return to the employer after completing the educational program, and employees who don’t return are usually expected to reimburse the employer for the cost of
the leave. Because of their high cost, these plans are usually restricted to key individuals
within the organization, and/or there may be some competitive process that awards a
restricted number of paid leaves each year.
In some cases, firms offer unpaid sabbaticals. To facilitate sabbaticals, the Income Tax Act has
created some opportunities for employees to defer income taxes while putting aside money for the sabbatical. Once an employer has registered a sabbatical leave plan with the Canada
Revenue Agency, employees may put aside a portion of their earnings each year for a period of
three to five years prior to the sabbatical. For example, schoolteachers in Toronto may set
aside a fifth of their annual income for four years and then receive this money in the fifth
(sabbatical) year. There are two tax advantages to this plan. First, the earnings from the
deferred salary fund can accumulate tax-free until the funds are withdrawn. Second, the total amount of tax paid is reduced, because income is being “smoothed.” Instead of being taxed
for four years at a higher marginal rate (and then having zero income in the sabbatical year),
income is spread evenly over the five-year period.
Severance Pay
The ultimate form of pay for time not worked is severance pay. The federal and provincial
jurisdictions have statutory requirements either for notice to be provided when terminating
employees without cause or for pay in lieu of this notice, but these requirements are quite
minimal. For example, for employers covered by the federal jurisdiction, the only requirement
is two weeks’ notice, as long as an employee has been employed for at least three months. In Ontario, the requirement is generally a week’s notice (or pay in lieu of notice) for each year of
service up to eight years, to a maximum of eight weeks. Unionized firms typically have a
formula that goes beyond these minimums for providing a lump-sum payment to employees who receive permanent termination. At the executive level, extensive severance packages
(“golden parachutes”) are often negotiated on an individual basis at the time of employment.
Technically, if an employee has been dismissed for cause, no notice or severance pay is
required.24 However, unless cause can be proven, an employer may end up with a wrongful dismissal suit against it and be required to pay a substantial severance award if it loses the
suit. There are no hard and fast rules specifying the minimum notice for a given employee.
However, based on court settlements, the following would seem to be the minimal notice amounts for fair severance in cases of termination without cause: for labourers, production
workers, clerical workers, administrative support staff: two weeks per year of service, two-
month minimum; for technical, professional, supervisory, and middle management: three weeks per year of service, three-month minimum; and for senior management: four weeks per
year of service, four-month minimum. For all groups, the maximum is 24 months.
In setting notice periods (or severance amounts in lieu of notice), courts take several factors into account: (1) the employee’s age, (2) the length of service, (3) the character of the
employment, (4) the availability of similar employment, and (5) whether enticement was
involved. Essentially, the more difficult it is for an employee to find similar employment, the
longer the notice period. Beyond this, the notice period is extended dramatically if an
employer had enticed the terminated employee away from secure employment in a different region of the country, and this applies even to new employees and to employees who have not
yet started their employment with the firm.25 Recently, Ontario courts have awarded a month
per year even to clerical employees in enticement cases, and have made sizable awards even
to employees with little or no seniority with the firm in these cases.26
Employee Services
Employee services are often not included in traditional surveys of employee benefits but are
often of considerable value to employees and may produce some favourable spinoffs for the
organization. A major advantage of these services is that most are tax-deductible to the
employer and are not subject to income tax for employees. This section discusses several of
the most common and important employee services.
Employee Assistance Programs
Most large Canadian firms have established employee assistance programs (EAPs) to help
employees deal with personal problems that have the potential to affect their work performance.27 One key problem covered by EAPs is substance abuse and addiction. In these
cases, the firm may contract the services of professional counsellors or other specialists, who
help employees to diagnose their problems and chart a course of action for dealing with them. This course of action may include paid leave to attend alcohol or drug treatment centres and
coverage of the costs of these programs.
EAPs may also deal with other problems, such as stress; workplace conflict; and marital, family, or financial problems, either through the use of in-house counsellors or through
referrals to outside specialists. (During the 2008–09 financial meltdown, the use of EAP
services soared in firms that offered them, as a result of employee financial worries.28) Some
organizations maintain 24-hour counselling hotlines.
There are obvious advantages to the employer if the EAP can help solve these problems, since
many of them have the potential to severely affect work performance or cause safety problems. Also, unresolved problems may cause valued employees to quit the firm. In some
cases, EAPs provide an alternative to simply firing troubled employees, an act that may be
seen as hardhearted and that may damage employee morale. Indeed, in order to effectively dismiss a problem employee and to avoid or win a wrongful dismissal suit, a company will
need to show that it did all it could to solve the problem, and employee assistance programs
can be used as evidence that the firm attempted to do so.
Wellness Programs and Recreational Services
Some organizations sponsor company sports teams or help support other types of
recreational programs. In addition, some firms provide on-site fitness centres or exercise
rooms. Hamilton-based steelmaker ArcelorMittal Dofasco provides a recreation and learning centre that includes two NHL-size arenas, a twin gym, a track, a golf driving range, tennis
courts, baseball diamonds, and a playground.29 Use of these facilities is typically nontaxable
for the employees, as long as they are not operated as commercial ventures. Alternatively,
some organizations purchase memberships in recreational clubs or sports facilities for employees and their families, but these do become taxable benefits for the employees if
utilized.
Some firms provide these benefits in a broader context of a “wellness program,” which typically deals with three main health issues: (1) individual health practices, such as smoking,
inactivity, and unhealthy eating; (2) organizational health issues, such as lack of job
satisfaction and stress; and (3) the physical work environment, such as ergonomics and musculoskeletal injury prevention.30 Proponents argue that such programs can benefit the
organization in a wide variety of ways, including reduced absenteeism, reduced health benefit
costs, and higher employee productivity.31 Overall, the trend toward such programs appears to
be gaining momentum—at least among medium to large employers—as the business case for
investments in workplace health and wellness gets easier to make.32 Compensation Today
12.3 illustrates an interesting wellness program.
COMPENSATION TODAY 12.3
Hungry? Go Healthy!
At Nature’s Path’s home office in Richmond, British Columbia, employees are encouraged to enjoy healthy snacks with a fully stocked store available for them at significantly reduced
costs. The company offers an on-site fitness facility, instructor-led fitness classes, and
personal trainer services. Employees also manage their own activity-based clubs, including running, walking, and even a juicing group. Nature’s Path maintains a highly focused
charitable program that is very much integrated into its core line of business, including the
“Gardens for Good” and the longstanding “EnviroKidz 1% for the Planet” program. It has established a zero waste target and even has a unique employee-maintained on-site organic
garden where employees can stroll outside and practise a little therapeutic gardening to
unwind during a busy day.
Sources: Canada’s Top 100 Employers, http://content.eluta.ca/top-employer-alpac,
accessed October 3, 2016; Nature’s Path website, http://ca-en.naturespath.com.
Child Care and Elder Care Services
Many employees with young children have difficulty finding satisfactory child care. As a result,
54 percent of major Canadian employers have some type of program to support child
care.33 The most common program is information and referral services, but 11 percent also
provide financial assistance, 11 percent provide emergency child care, and 14 percent provide
on-site or off-site child care. In addition, some companies provide subsidies to child care centres to reduce the costs to employees. These subsidies are not considered a taxable
benefit.
At the other end of the spectrum, some employees have the responsibility to care for aged parents or other elderly relatives. Nearly 48 percent of firms now provide some type of elder
care program, although most programs simply provide information and referral
services.34 About 8 percent provide some type of financial assistance, including subsidized services. Given the demographic trends in Canada, the issue of elder care is of growing
importance to many employees. If not dealt with effectively, it has the potential to lead to
problems for both employees and employer, including stress-related problems and even
withdrawal from the workplace.
Particularly under stress will be those employees who are responsible for both child care and
elder care—the so-called “sandwich generation.” Currently, about 10 percent of Canadians between 45 and 64 have both child care and elder care responsibilities, and 83 percent of them
are also employed.35 Given current trends toward later childbearing and increased longevity,
this “sandwich generation” will grow only larger in the future.36
Work/Life Balance Programs
Given all the stresses of balancing work and family life, many firms have created “work/life
balance” programs to minimize these stresses as much as possible.37 Work/life balance
programs typically include many of the features discussed so far, such as flexible schedules, parental and personal leave programs, health care programs, child care and elder care
programs, and wellness programs. However, while many organizations view work/life balance
as an essential element of a total rewards program, a major survey tracking work/life balance among Canadian employees in 1991, 2001, and 2011–12 found that work/life balance had not
improved over time; work demands were increasing, yet the availability of alternative work
arrangements such as flextime had actually been declining since 2001.38 Compensation
Today 12.4 illustrates aspects of work/life balance (and other benefits).
COMPENSATION TODAY 12.4
Taking Pride in Heritage
Aboriginal Peoples Television Network Inc. (APTN) is a television network for Aboriginal people
and by Aboriginal people. While producing programming for both Aboriginal and non-
Aboriginal audiences and employing a multicultural workforce, 66 percent of the employees self-declared as First Nations, Inuit, or Métis (in 2013). To instill pride among the employees,
inside the downtown head office in Winnipeg, the walls are painted using an Aboriginal colour
scheme of blue, red, and yellow, and custom-made boardroom tables reflect the traditional
medicine wheel. The company offers a variety of health and family-friendly benefits for
employees working more than 21 hours a week. New parents (biological and adoptive) receive
parental leave top-up of 80 percent for 17 weeks. APTN encourages employees to actively volunteer and support community initiatives. Among the community organizations supported
are United Way, Ma Maw Wi Chi Itata Centre, Alzheimer Society’s Memory Walk, Christmas
Cheer Board (sponsoring a family at Christmas), Broadway Neighbourhood Centre, Habitat for Humanity, Winnipeg Aboriginal Film Festival, Vision Quest Conference, and Soaring
Indigenous Youth Career Conference.
Sources: Richard Yerema and Kristina Leung, Mediacorp Canada Inc. staff editors, November
8, 2015, Canada’s Top 100 Employers, http://content.eluta.ca/top-employer-aboriginal-
peoples-television-network, accessed October 2, 2016; APTN website,
http://aptn.ca/corporate2, accessed October 3, 2016.
Financial or Legal Services
As retirement and financial planning becomes more and more complex, some firms are
providing employees with access to financial planners in order to help them make good
financial decisions. This service is most likely to be offered by firms with flexible benefit plans
to help employees understand the ramifications of the choices they make.
In some companies, prepaid legal services are provided. There are two main types of legal plans. Access plans provide free telephone or office consultation, document review, and
discounts on fees for more complex matters. Comprehensive plans cover matters such as real
estate transactions, divorce cases, and civil and criminal cases.
Food Services
Many organizations offer subsidized food services at company facilities. This program may be
necessary on sites where food services are not readily available. An advantage of on-site food services is that employees do not need to waste scarce break time by leaving the company
premises. In addition, subsidized food services constitute a taxable benefit for employees only
if prices are set “unreasonably low.” Employers can provide free food to employees without it becoming a taxable benefit to employees if business is conducted during the meal (i.e., a
“lunch meeting”) or if the food is provided in the context of overtime work, as long as the
employee works at least three hours following his or her normal shift and it does not occur
more than twice a week.
Outplacement Services
Finally, some firms provide assistance to employees whose jobs are being terminated, beyond simply awarding severance pay. This assistance may include advice on how to secure new
employment and how to manage financial affairs until new employment is found, as well as
counselling to ease the shock of termination. Although these services will, by definition, not be
used by continuing employees, employees notice whether terminated employees are being treated fairly, and this will condition their attitudes toward the employer; thus, provision of
these services has a positive impact beyond the direct recipients.
Miscellaneous Benefits
Organizations can provide a wide array of other benefits, often related to the type of work an
employee does or to the type of industry in which the firm operates.39 For example, sales
personnel who must travel extensively by automobile are often provided with a vehicle, which can also serve personal uses (although the personal use portion is taxable). Retailers may
provide discounts on their products. Banks may provide subsidized loans. In general,
businesses may provide their own products or services to their employees at a discounted rate, and these discounts will not constitute a taxable benefit to employees, unless they are
provided at prices below cost. Other commonly offered benefits include tuition
reimbursement and the provision of work equipment or clothing.
In the past, many firms have offered employee savings plans, where contributions by employees to company-sponsored savings plans are supplemented by employer
contributions. However, with the development of RRSPs, many firms have converted these
savings plans into group RRSP programs, which have significant tax advantages over nonregistered savings plans. With the introduction of the Tax-Free Savings Account (TFSA) by
the federal government in 2009, some firms may elect to make these plans available as
another savings option for their employees.40 Contributions to TFSAs are not tax-deductible;
however, the earnings on these accounts are not taxable at any time, unlike RRSPs, where the
earnings are taxable on withdrawal.
// FIXED VERSUS FLEXIBLE BENEFIT SYSTEMS
How would you like to be able to pick and choose among the benefits your firm offers,
selecting only the benefits of value to you, or possibly even forgoing some benefits and receiving the equivalent in cash? Some Canadian employers are now giving employees this
flexibility; they include well-known firms such as IBM Canada, DuPont, Husky Oil, and the
Potash Corporation of Saskatchewan. These “flexible benefit plans” have become popular in recent years, in contrast to the fixed benefit plans that held sway for many years. Both plans
have their advantages and disadvantages, and one of these plans may fit a given firm much
better than the other plan.
Fixed Benefit Systems
In fixed benefit systems, which have been the norm, all employees are covered by a standard
package of benefits. The advantages of this approach include simplicity, economies of scale in purchasing the benefits, relatively low administrative costs, and ease in communicating the
plan to employees. The key disadvantage of this approach is that it does not recognize
differences among employees regarding how much they may value each benefit. Also, fixed
benefit plans have a tendency to grow in cost as existing benefits escalate in cost or as new benefits are added to meet the diverse needs of the workforce. Existing benefits are seldom
dropped to make way for new benefits.
Semi-Flexible Benefit Systems
Most benefits systems are not entirely fixed. When they are not fixed but don’t meet the
criteria to be considered a flexible benefit system, they are known as “semi-flexible benefit
systems” or “simplified flex plans.”41
There are a variety of ways to make fixed systems more flexible. The most common approach
starts with a “core” set of benefits, to which employees “add on” additional levels of coverage
or additional benefit options at their own expense, using after-tax dollars. (Note, however, that in some circumstances, the Canada Revenue Agency will permit employees to convert
part or all of a performance bonus into flexible credits using pre-tax dollars.42)
For some firms, the only flexible component is a health care spending account, which is becomingly increasingly popular as an “add-on” to traditional fixed benefit plans. Another
approach is the “modular plan,” in which employees are given the choice between two or
more fixed benefit packages, each of which is designed to be of similar cost to the company.
However, this type of modular plan is rarely used.
Flexible Benefit Systems
The distinguishing feature of a flexible benefit system is employee control over the disposition
of benefits funds provided by the employer, in addition to any funds that employees
themselves provide. In a fully flexible approach, there is no “core” or “standard” benefits package. Instead, employees receive a set of “flexible credits” that they can use to “purchase”
the combination of benefits that best suits them. An example of this approach is the
“Beneflex®” system at telecommunications giant Telus, under which an employee can select several different levels of coverage (including none) for each of numerous benefits. Employees
can also use real money (i.e., their after-tax earnings) to purchase higher levels of particular
benefits after their “flexible credits” run out. If they have any unused flexible credits, they can
take them in the form of cash (which, however, is then fully taxable as employment income).
To give you a more detailed picture of what a flexible benefit plan may look
like, Compensation Today 12.5 describes the flexible system at AstraZeneca Canada.
Canada’s first flexible benefit plan was introduced in 1984 by Cominco Mining (now Teck Resources Limited), based in Vancouver.43 During the early 1990s, flexible benefit plans were
the fastest growing pay innovation in Canada,44 and by 2004, about 29 percent of firms were
using them, according to research conducted by one of the authors. However, since then, the popularity of these plans has plateaued, with about 29 percent of medium to large private
sector firms using them in 2012, and about 20 percent of public sector organizations.45
COMPENSATION TODAY 12.5
Flexible Benefits at Astrazeneca Canada Inc.
In keeping with its “total rewards” philosophy, the Canadian division of pharmaceutical giant AstraZeneca wanted to offer its Canadian employees the opportunity to customize their
benefit plan to suit their needs, so it converted its fixed benefit plan to a flexible plan in 2000.
All employees are issued “lifestyle dollars.” The firm has a medical and dental coverage program with four possible levels, and enough lifestyle dollars are issued to each employee to
allow them to purchase the highest level of these benefits, if they so choose. If an employee
wishes to purchase a lower level of these benefits, the excess lifestyle dollars can go into a
health care spending account (which can be used for reimbursement of medical, prescription, or dental expenses not otherwise covered). The employee can also direct excess lifestyle
dollars into a personal RRSP. In both cases, their lifestyle dollars remain nontaxable.
Employees also have the option of directing excess lifestyle dollars into a personal spending account (which can be used for a wide variety of health, wellness, and lifestyle expenses) or a
personal savings account. However, in the latter two cases, the employee must pay income tax
on the lifestyle dollars.
Finally, if employees want to generate more lifestyle dollars than they have been allotted, they may do so by contributing additional cash from their earnings to the company pension plan
(they can use pre-tax earnings to make these contributions), and the company will match this
contribution, providing a portion of the match in lifestyle dollars.
Sources: Robert J. McKay, Canadian Handbook of Flexible Benefits (Mississauga, ON: John
Wiley and Sons, 2007); AstraZeneca Canada website,
http://www.astrazeneca.ca/en/Careers/total-rewards-meta-data, accessed October 3, 2016.
Forces Promoting Adoption of Flexible Benefits
Flexible benefit plans began in the United States, where employers found themselves subject to skyrocketing benefit costs, especially health insurance costs. Between the mid-1960s and
the mid-1990s, the cost of benefits in the United States rose from 10 percent of total
compensation to 29 percent.46 If this weren’t enough motivation, flexible benefit plans in the United States (although not in Canada) are tax-favoured. In response, by 1995, 85 percent of
large U.S. firms had adopted flexible benefit plans.47 For these firms, the main impetus was
benefits cost reduction or containment.
Although Canadian firms have also been subject to increasing benefit costs, this escalation has
been much lower due to government-funded medicare. For example, according to research by
one of the authors, benefit costs in medium to large Canadian firms were about 15 percent of
total compensation in 2004, and had escalated much more gradually than in the United States. Therefore, while there is concern that escalating prescription drug costs coupled with
an aging workforce may push up health benefits costs in the future, there has been a much
lower incentive for Canadian firms to adopt flexible benefits in comparison to firms in the
United States.
Firms that are the most concerned about benefit costs are those that, over time, have found
themselves with very expensive benefit packages. As benefit costs increase, firms could simply
reduce coverage, increase deductibles, or increase employee contributions, without recourse
to a flexible benefit plan at all, and some firms have been doing this.48 But flex plans allow
employee preferences to play a major role in the evolution of the benefit package. At New Brunswick Power Corporation, a jointly developed flexible benefit plan reduced projected
health benefit costs dramatically, to the benefit of both the employer and employees,
as Compensation Today 12.6 describes.
COMPENSATION TODAY 12.6
Flexible Benefits Power Savings at the Power Company
In 1999, projections at New Brunswick Power Corporation (NBPC) indicated that the annual costs of its health benefit plan would rise from $5.3 million in that year to $20 million in 2009–
10. The company couldn’t unilaterally change the benefit plan because 2,200 of its 2,700
workers were unionized. However, because of a good relationship with its union, the company was able to share this problem with the union leadership and ask for their help in solving it.
Reduced health benefit costs would benefit union members, because under the collective
agreement, benefit costs are shared 60–40 between the company and its workers.
Over the course of a year, management and the union worked together to create a voluntary
flexible benefit plan that workers could opt into if they wished. By 2003, 68 percent of workers
had opted for the flexible system. Combined with a plan redesign, the projected expenditure for health benefits in 2009–10 was reduced to $11.6 million. Since 2013, the power company
has increased its contribution by an additional $7.69 biweekly.
Sources: Todd Humber, “The Power to Change,” Canadian HR Reporter, May 31, 2004, G1–
G10; Collective Agreement (2012–2015);
http://www.ibew37.com/uploads/Generation_20130215.pdf, accessed October 3, 2016.
Cutting benefit costs is not the only possible reason for implementing flexible benefit plans. A second reason is the increasing diversity of the workforce. Most traditional benefit systems
were developed in an era when the typical employee was a married man with a spouse not
employed outside the home and several dependant children. For example, in 1967, two-thirds of Canadian families fit this model.49 Because of the homogeneity of this workforce, it was
relatively easy to come up with a standard benefit package that would suit this “typical”
employee.
But by 1992, in 61 percent of married couples, both spouses were employed—in some cases by
the same employer. Since benefit plans typically cover all members of a family, often the
traditional benefits package unnecessarily duplicates benefit coverage. In this case, it might be efficient for one spouse to drop the duplicate coverage and use the benefit credits to
increase other benefits, add new benefits, or even take cash. At CUC Broadcasting (now part of
Shaw Cable) in Toronto, benefit costs dropped by more than one-quarter after a flex plan was implemented, largely because it allowed for better coordination of benefits between
spouses.50
Moreover, as the workforce has become more diverse, there has been increased demand for
additional types of benefits, such as child care or elder care, to supplement the traditional benefits. Flexible benefits are seen as one way of dealing with this diversity without raising the
costs of the benefits package to the employer. The company simply makes the new benefit
available, and employees who want the benefit redeploy their benefits credits from other
benefits less valuable to them until they come up with the combination that best suits their
personal needs. As their needs and circumstances change, they can realign their benefits accordingly. Essentially, this plan allows employees to maximize the value of the benefits
system for any given level of benefits expenditure by the employer. Flexible plans can also
help arrange the benefits package in the most tax-advantageous way, as Azizah Nessari,
in Compensation Today 12.7, discovered.
COMPENSATION TODAY 12.7
Azizah Nessari Gets Her Revenge on the Tax Collector
One of your employees, Azizah Nessari, is annoyed that the tax collector has recently decided
to declare the unpaved, muddy parking spot provided by her company as a taxable benefit.
But using your company’s flexible benefit plan, she has found a way to get even.
Currently, the company pays $360 per year for the premiums on Mary’s $100,000 life insurance
policy. At the same time, Mary has increased her dental package to the maximum level, which
requires an annual contribution from her (in after-tax dollars) of $360. This current arrangement has two tax implications. First, Mary’s contribution to the dental plan is not tax-
deductible, so she must earn about $643 to pay for this benefit (assuming an average 44
percent incremental tax bracket), since the tax collector will take nearly half of these earnings before she can pay the company for the upgraded dental coverage. Second, Mary will also
have to pay tax on the employer’s contribution to the life insurance, which will cost her about
$158 per year. Thus, the overall cost to her of these two benefits is about $801 per year.
But Mary has a better idea. What if she pays for the life insurance herself and directs the
company to allocate the $360 it saves to pay for the upgraded dental plan? Let’s look at the tax
consequences now. The money she pays for the life insurance is still not deductible, so she must use after-tax income. This means the after-tax cost of the life insurance is $643, exactly
the same as the dental upgrade would cost. But—and it is a big “but”—employer contributions
to the dental plan are not taxable as income to Mary. So simply reversing the way in which the payments are made saves Mary about $158 per year in income taxes, without increasing
company costs in any way.
A third impetus for flexible benefits is that many employers want to change the attitude
among employees that benefits are an entitlement (i.e., something provided as a condition of
employment) and to foster the idea that benefits are actually a form of pay—that they are not
simply granted but instead must be earned. Flexible benefit systems can encourage
employees to understand the cost and value of the benefits they are being provided.
Yet another factor in play is managerial strategy (see Chapter 2). When human relations
organizations move toward the high-involvement model or the classical model, their attitudes
toward benefits tend to change. Flexible benefits are attractive to both high-involvement and classical organizations, albeit for opposite reasons. For high-involvement organizations,
flexible benefits fit with the concept of partnership, as well as with the belief that employees
are responsible individuals capable of choosing their benefits more wisely than the firm could for them. Flexible benefit plans are simply one more way of increasing employee involvement
and self-control in the workplace.
By contrast, classical organizations may simply see flexible benefits as an opportunity to cut benefits costs, although, as will be discussed shortly, such plans may actually be less
successful in classical organizations than in other types of organizations. Research by one of
the authors shows that high-involvement firms are much more likely to have flex plans than
are other firms.
Some firms that currently do not have a benefits package may find flexible benefits appealing.
These employers may have stayed away from fixed benefit plans to avoid getting enmeshed in a program where costs can get out of hand. In this regard, a flex plan can be viewed as a type
of defined contribution plan, in which the employer commits to making a limited sum of
money available for benefits. Thus, there is less exposure for the employer if certain benefits
escalate in cost.
Firms with flex plans may enjoy a competitive advantage in terms of employee recruitment
and retention. First, prospective employees may find the idea of choosing their benefits
appealing. Second, if the flex plan is designed and communicated properly, firms with these
plans should be able to deliver more value to their employees than firms without flex plans for
the same number of benefits dollars. Of course, this assumes that the flex plan is not so
expensive to administer that the firm is forced to reduce the number of dollars it contributes to the plan, or to pay more for benefits because of loss of economies of scale (see below). It
also assumes that flex plans are seen as attractive by prospective employees and not simply as
code words for an inferior benefits plan.
Finally, as knowledge accumulates about any innovative practice, it becomes easier to apply.
Many benefits consultants now have considerable experience working with flex plans and can
both guide and promote implementation of these plans. In addition, computer software has been developed that makes the administration of a flex plan far more efficient and user-
friendly.
Forces Deterring Adoption of Flexible Benefits
Several factors can impede the adoption of flexible benefits plans. These include the cost of
implementation and administration, the loss of economies of scale when benefits are
purchased, possible confusion and poor decision making among employees, lack of fit with
the organizational culture, and possible resistance from employees or unions.
One-time implementation costs in developing a flexible plan can be substantial. These include
the costs of the personnel involved in the design process, as well as the costs of consultants.
Few firms have the in-house expertise to develop such a plan without help from consultants.
In addition, administration and communication costs are likely to be much higher than with
other benefits systems. Costing out the various options, predicting employee take-up, and
pricing the benefits options fairly is a complex process. Additional tasks include informing employees about their options and the tradeoffs involved, and simply managing the
paperwork. Add to this the fact that employees may be tinkering with their benefits packages
every year, and it is clear that the additional administrative burden is substantial. However, this administrative burden can be reduced by new spreadsheet packages that allow
employees to calculate their various options and costs and then submit their benefit choices.
Outsourcing benefits administration to specialized firms may also reduce administrative costs.
Another problem with flex plans is the possible loss of economies of scale in purchasing
benefits from suppliers. For example, most insurance is much cheaper if purchased in volume.
If there is relatively low take-up on some benefits, the costs of these benefits will be higher.
There is also the issue of adverse selection (adverse from the perspective of the insurance
company, not the employee!), in the sense that, for example, employees with large families
afflicted with many dental problems may load up on dental coverage, while those with no dental problems may forgo it entirely. Or people in ill health may be the only ones purchasing
medical coverage. These situations drive up the costs of these benefits tremendously. To
combat this problem, some firms impose mandatory minimum levels of some benefits, but this goes against the flexibility concept. Thus, for all these reasons, flex plans may actually
increase benefits costs, to both the employer and the employee.
Another drawback is that employees can become confused by the array of choices. To
illustrate the scope for confusion, analysis of one firm’s flex plan (which had nine benefit categories, with two to eight levels of coverage per category, and two flexible spending
accounts) revealed that employees had a choice of more than two million benefit
combinations.51 What are the odds that an employee will select the best possible combination for them? Critics of flex plans argue that this complexity can lead to poor benefits decisions
and decreased satisfaction with benefits.
Another possible obstacle to flex plans is company culture. Human relations firms may be reluctant to move to flexible benefits for fear that the system will be too complex for
employees, or that employees will make unwise benefits choices that leave them without
coverage in the event of emergencies. And in classical organizations, flexible benefits may fail if such firms are unwilling to commit the resources necessary to effectively communicate their
plans to employees and if the employees have little faith in the information they do receive,
since employees often have low trust of classical organizations. Employees and unions in
classical organizations may have especially strong resistance to flex plans, fearing that such
plans are simply a way to trick them into accepting reduced benefits.
Finally, some benefits consultants are starting to turn against completely flexible systems, arguing that they are too complex to serve employees well and that they don’t serve many
employers well because of their high administrative costs, which wipe out any savings.52 These
critics argue that semiflexible systems might be the best choice if the goal is to balance
employee needs against administrative complexity. The advent of health care spending accounts may encourage semiflexible systems, by adding a flexible element to an otherwise
fixed plan.
Experience with Flexible Benefit Systems
Flexible benefits plans have now been in use for more than 20 years in Canada, yet very little
research has been conducted regarding their cost effects, so we don’t really know the impact these plans are having on benefits costs. Research conducted by one of the authors early in
the 21st century compared firms that had flex plans with those that did not. It found almost no
difference in the percentage of benefits as a proportion of their total compensation; for both groups of firms, it averaged about 16 percent in 2004 (the last year for which data are
available). Interestingly, four years earlier, firms with flex plans had devoted about 14 percent
of total compensation to benefits, while firms without flex plans devoted about 15 percent. This suggested that flex plans did not reduce employer costs, although they may have
increased the value of benefits to employees.
One must always be cautious when generalizing from a single study, especially one conducted some time ago. That said, the results suggest that flex plans in Canada may have had very little
impact on benefits costs, consistent with the views of some consultants.53 If so, this would help
explain why the popularity of flex plans has apparently plateaued in Canada.
Leaving costs aside, have these plans had any impact on employee satisfaction with their
compensation? Unfortunately, evidence is also sparse on this question. However, a study of
three Canadian firms, one with a fixed benefit system, one with a modular benefit system, and one with a fully flexible system, found the least satisfaction with the flexible system.54 To
explain this result, the researchers argued that a key determinant of satisfaction with benefits
is employee understanding of their benefits package and that this understanding is even more
important for a flexible system. They concluded that the firm with the flexible system had not
adequately communicated it to employees, resulting in employee discontent.
Other research indicates that employee satisfaction with flexible benefit plans depends on
whether they believe the plan has reduced their benefits. In a survey of Canadian employees with flexible benefit plans,55 75 percent of employees reported that their firm had not reduced
benefits in conjunction with the move to flexible benefits, while 25 percent reported that there
had been a reduction. Of those employees whose benefits had not been reduced, 87 percent had a favourable reaction to flexible benefits; only 13 percent expressed a “mixed” reaction. Of
those employees who had experienced a benefits reduction, just 40 percent had a favourable
reaction to the flex plan. Clearly, implementing a benefits reduction along with a flex plan has
a strong negative impact on employee perceptions of the flex plan.
Still other research suggests that employee satisfaction depends on the decision-making
support that the employer provides. In a study of a large U.S. firm’s flex plan, researchers wanted to determine whether a computerized system to aid in benefits decision making might
improve satisfaction with the benefits received in a flexible benefit system; they found that
those employees who utilized a computerized “expert system” made significantly better benefits decisions than those who did not, and that they also had a significantly higher level of
benefits satisfaction.56 However, as to what effects a flexible benefits system has on overall
employee behaviour, almost nothing is known. To date, the only study that has addressed this
question at all was undertaken in Holland and Belgium, where majorities of HR managers believed that flexible benefits increased a firm’s ability to attract and retain employees (86
percent for attraction; 65 percent for retention).57 While based on a relatively small-scale
study, these findings make sense—we know that higher employee satisfaction with their
compensation increases employee attraction and retention.
// DESIGNING THE BENEFIT SYSTEM
To develop an effective benefits system, organizations need to address five main questions.
First, can the provision of benefits help achieve compensation objectives? If so, how? And
what objectives should be set for indirect pay? Second, what will be the process for designing
the plan? Third, what benefits system will be used, and what specific benefits will be included? Fourth, how should each individual benefit be structured regarding coverage, funding,
eligibility, and flexibility? And fifth, what procedures for administering, communicating,
evaluating, and adapting the benefits system are needed?
We will now examine each of these issues in order to develop some understanding of benefits
design. However, this chapter will make no attempt to deal with all the details involved in plan
design. Benefits are the most technically complex aspect of the entire compensation system, and dealing with all the technical details would require an entire book. Fortunately, some
excellent sources of these technical details are available.58
Issue 1: Determine the Role of Indirect Pay in the
Compensation Strategy
The first issue in establishing an indirect pay system is to identify what compensation
objectives it will serve beyond those that can be served by direct pay. (Ideally, this will have
been done when formulating the compensation strategy; see Chapter 6.) The role that indirect
pay will play in generating the desired employee behaviour needs to be defined; this in turn will inform choices about the type of benefits system (if any) to be developed and the specific
benefits to be included.
As discussed in Chapter 4, examples of possible roles to be served by indirect pay may include encouraging membership, retaining senior employees, satisfying lower-order needs for
economic security, adding value to the compensation package, promoting specific behaviours
of strategic importance to the firm (such as encouraging continuing education and training), and helping remove possible hindrances to productivity (through the use of employee
assistance programs to address problems such as alcohol or drug abuse).
Issue 2: Choose the Process for Plan Design
Once an organization has decided that there is a significant role for indirect pay in its
compensation system, and once it has defined the objectives for indirect pay, it then needs to
establish a process for designing a benefits plan that will achieve these objectives. Most
experts argue that employee participation in the process is highly desirable.59 This participation can help achieve at least three important goals. First, it can provide a better
understanding of employee needs. A benefits system that does not address real employee
needs will be of little value to employees, yet it will still cost the employer money. Second,
participation can result in stronger acceptance of the plan. Third, it can help communicate the plan. Without effective communication, any investment in benefits a firm makes could end up
returning very little value to the employer.60
Firms vary enormously with regard to employee participation. High-involvement firms probably have extensive employee participation on the design team, whereas human relations
and classical firms are likely to rely more on staff specialists, management, and outside
consultants. Besides direct employee representation on the design team, employee input can
also be solicited through focus groups and benefits surveys.61
Issue 3: Identify the Benefits System and Benefits to be
Included
After choosing the process for designing the benefits system, the organization needs to decide
on the type of benefits system (i.e., flexible, semiflexible, fixed) and on the specific benefits to include in it. The design team must consider the extent to which a benefit contributes to the
objectives of indirect pay, the extent to which it is valued by employees, the cost to the
employer, and the net value it adds to the compensation package. Since firms have only a
finite budget for benefits, these benefits must be prioritized in order of total value to the firm.
Issue 4: Determine the Structure of Each Benefit
For each individual benefit, the organization must make decisions on four main structural
issues: benefit coverage, funding of the benefit, eligibility for the benefit, and the flexibility of
the benefit. In other words, what will the benefit provide? Who will pay for it? Who is eligible to
receive it? And will it be required or optional?
Coverage
A major decision for the design team is benefit coverage. How much coverage will be provided,
on what will it be based, and how far will it extend? Take dental insurance, for example.
Should a particular dental insurance plan cover all dental expenses, only certain types of dental expenses, or all dental expenses up to a certain prescribed limit in a given period? Will it
cover all the expenses of a given procedure, or will the employee need to pay a portion—say,
20 percent—of each bill? Will there be a deductible, so that an employee must pay the first $10
of every claim? Will some employees receive a richer plan than others?
In addition to all that, will the coverage be restricted to the employee, or will it extend to
family members? If it is going to be a family plan, how will “family member” be defined? In an era of blended families and nontraditional relationships, defining terms such as “family
member” and “spouse” may not be as straightforward as it first appears. At what point, for
example, is a common-law partner to be accepted as a “spouse” for the purposes of benefit coverage? What status will children of that “spouse” (but not of the employee) receive? Will
they be considered dependant children of the employee?
Also, will coverage levels vary for different employees? For example, it is common for life
insurance coverage to be provided as a multiple of salary. Pension contributions are also
geared to salary. But other plans may be based on seniority, as in the case of Imperial Oil’s savings plan, which matches 1 percent of salary the first year of employment and up to 5
percent of salary the fifth year. Will coverage continue after termination? Many firms do
continue coverage of certain benefits for retirees and their immediate families.
A related issue is whether coverage will be geared to base pay only or to base pay plus
performance pay. Many firms exclude performance pay as a basis for benefit calculations
simply because they have never thought to include it.62 Others exclude it because it raises benefits costs. But failure to include performance pay in benefits calculations actually
weakens performance pay and penalizes employees with a large component of performance
pay. By contrast, including performance pay in calculations of benefits entitlements is a way to
link indirect pay to employee performance, thereby reinforcing performance pay and adding a
performance element to indirect pay that is normally absent.
Funding
The cost of the benefit (such as the premiums for health insurance) may be fully paid by the
employer (noncontributory), or fully by the employee (fully contributory), or cost-shared
(contributory). One option is for the basic level of the benefit to be employer-paid, and then higher levels of the benefit to be cost-shared or employee-paid. Under a flexible benefit
system, the employee could have the choice of whether the benefit would be employer-paid
or employee-paid, as in the case of Azizah Nessari in Compensation Today 12.5.
Eligibility
A key issue for each benefit is to define which employee groups will be eligible to receive it.
Although firms typically cover all full-time employees, there is often a waiting period before
new employees become eligible for all benefits.
A more complex issue is the treatment of part-time, temporary, or contract employees. In
many firms, part-time employees (defined by Statistics Canada as anyone working less than 35
hours a week) are offered few or no benefits, even if they have been employees of the firm for many years. Only one province has legislation regarding benefits for part-time employees. In
1996, Saskatchewan passed legislation that all employees who work an average of at least 15
hours a week must receive the same benefits as a comparable full-time employee, although
these benefits can be prorated according to hours worked. Temporary full-time employees
can be excluded if they do not meet the minimum employment period for inclusion in the
benefits plan, and contract employees are typically excluded. In fact, some firms use part- time, temporary, and contract workers for the express purpose of avoiding having to pay
benefits.
Some firms distinguish between two categories of part-time employees. Casual part-time employees work entirely at the will of the employer when their services are required. They
receive no guarantee of weekly hours and can be terminated at will. By contrast, permanent
part-time employees are viewed as permanent employees of the firm, and the firm has
committed itself to provide them with a minimum number of hours on a weekly basis. These
employees are often included in the benefits program, although on a prorated basis. Part-time
employees are commonly found today in organizations that want to enjoy scheduling
flexibility but also want to encourage a permanent relationship with these employees. Permanent part-time arrangements are especially common in industries that depend on a
large number of part-time employees on an ongoing basis, such as banking (e.g., for tellers)
and health care (e.g., for nurses).
Flexibility of Each Benefit
The next issue is the degree of flexibility for each benefit. Will the benefit be mandatory or
optional? Even flex plans often include some benefits that all employees are required to take, such as long-term disability. And if a benefit is required, will there be a predetermined fixed
level, or will there be a minimum compulsory level plus optional levels? An organization that
has decided on a flexible plan will need to decide whether the benefit will be included in the core area of coverage or in the optional area. In addition, what value of flexible credits will be
offered? Will employees be able to take unused credits as cash?
Issue 5: Develop Procedures for Administering,
Communicating, Evaluating, and Adapting the System
Once an organization has designed the benefits system, it must create a system for
administering it and communicating it to employees. The complexity of these tasks depends
on the complexity and flexibility of the system that has been designed.
Administration of Benefits System
Benefits systems can be very complex to administer. The key administrative tasks include
enrolling employees in the benefits system; updating changes to employee records and
benefits packages; dealing with employees when they terminate and after they terminate; handling the tax issues associated with benefits; dealing with the fiduciary responsibilities of
funds held in trust; calculating employer and employee contributions; determining the validity
of benefit claims and overseeing benefit payouts; advising employees on their benefit status and answering questions; and monitoring and evaluating the program and recommending
changes. Another periodic administrative task is to select and replace sources of the various
benefit products.
Almost all organizations that offer benefits outsource some of this work. For some aspects, such as funds held in trust for pension plans, the law requires a separate trustee. Trust
companies, banks, insurance companies, and investment firms are often used for this
purpose. Most insurance firms handle the claims processing for insurance-based benefits. The degree to which the other aspects of the administrative process are outsourced varies
dramatically, but as benefits systems have grown more complex, and as specialized providers
of these services have emerged, use of outsourcing has been increasing.
An advantage of outsourcing routine benefits administration is that it frees the in-house HR
staff to focus on the strategic issues of indirect pay and on the communications aspects. A
disadvantage of outsourcing is that firms can lose touch with employees’ needs and problems.
That is why evaluation should be a key in-house function, as will be discussed shortly. Most
firms believe that communication should also be an in-house function.
Communication of Benefits Information
Ironically, although indirect pay may account for as much as one-quarter of an employee’s
total compensation, and although the company pension plan may represent the largest financial asset an employee will ever own, employee understanding of this aspect of their
compensation is generally limited.63 In one striking example, a firm conducting focus groups to
improve its benefits system discovered that employees in one location didn’t even know they were covered by a pension plan.64 It turns out that the firm had recently been acquired by
another firm, and these employees mistakenly believed that their pension plan had been
eliminated in the process.
If a benefits system is to shape behaviour and attitudes, then employees have to understand
it. As discussed earlier, research shows that satisfaction with benefits increases in direct
proportion to how well the benefits are understood. There are two situations where communication and comprehension are especially important: when employees must make
benefit selection decisions, and when they may be eligible to receive their benefits.
Among the traditional methods used to communicate benefits are employee handbooks and periodic newsletters, along with an annual statement of pension coverage, which is required
under law. But these approaches have generally enjoyed little success, due to the arcane and
legalistic language that usually prevails in these documents, combined with a lack of
motivation on the part of most employees to wade through the material. However, two events may help improve employee comprehension of their benefits: the development of computer-
based technology for communicating information on employee benefits, and the advent of
benefits systems that require employees to make choices on their benefits, often on an annual
basis.65
Evaluating and Adapting the Benefits System
Once the system has been put into place, it needs to be evaluated on a regular basis to determine whether it is meeting its objectives in the most cost-effective way. There are three
main types of analysis. Cost analysis examines the cost of each individual benefit and what is
being received for that cost. Competitive analysis uses data from competitors to compare
benefits plans. And benefits surveys examine employee satisfaction with each benefit and its
value to them. Evaluation issues are covered in more detail in Chapter 13.
// SUMMARY
This chapter has examined the third component of a compensation system: indirect pay.
Indirect pay is often a very large and growing component of many compensation systems, yet
many employers have not carefully examined whether their mix of direct and indirect pay is
optimal. Employers vary dramatically in the extent to which indirect pay is beneficial for them.
You are now familiar with the six main categories of benefits—mandatory benefits, retirement income, health benefits, pay for time not worked, employee services, and miscellaneous
benefits—and the possible role of each type of benefit. You also understand the trend toward
flexible benefit systems and the advantages and disadvantages of flexible systems.
Finally, you have learned about the five key issues in designing an effective indirect pay
system: determining the role of indirect pay in the compensation strategy, choosing the
process for plan design, identifying the benefits system and specific benefits to be included, determining the structure of each benefit, and developing procedures for administering,
communicating, and evaluating the benefits system.
Key Terms
• defined benefit plans
• defined contribution plans
• employee assistance programs (EAPs)
• fixed benefit system
• flexible benefit system
• health care spending account
• hybrid pension plans
• mandatory benefits
• pay for time not worked
• supplemental unemployment benefits (SUBs)
Discussion Questions
Discussion Question 12.1
Review
“Defined contribution pension plans are nothing more than an attempt by employers to shift risk from themselves to employees, who are much less able to bear this risk.” Do you agree or disagree with this
statement? Discuss why.
Your Answer
No answer submitted
Discussion Question 12.2
Review
“Wellness and work/life balance programs are all very nice, but other than providing a safe working
environment, why should it be up to the employer to look after an employee’s health and wellness? Don’t individuals have the responsibility to look after their own health and wellness?” Do you agree or disagree with the attitude expressed here? Discuss why.
Your Answer
No answer submitted
Discussion Question 12.3
Review
“Flexible benefits plans are beneficial to both employers and employees because they allow both groups
to satisfy their needs.” Do you agree with this statement? Discuss why or why not.
Your Answer
No answer submitted
Discussion Question 12.4
Review
Assume that you have been hired to implement a benefits plan by your employer. What are the key steps
you will advise your CEO to take?
Your Answer
No answer submitted
Using the Internet
Using the Internet Question 12.1
Review
Go to the Web links for the Benefits and Pension Monitor and the Canadian Human Resources Reporter listed above and make a list of the key issues that came up most frequently in these publications in the
past two months. Which of these issues do you think is the most important?
Your Answer
No answer submitted
Exercises
Steeping some tea...
Exercise Question 12.2
Review
Three firms are described briefly below. For each firm, identify the role (if any) that you believe indirect pay
should play in the compensation system, and the specific benefits that it would make the most sense to
offer. Explain why. a. A company offers lawn maintenance and yard cleanup services in the summer and
snow removal services in the winter. It employs about 600 people at peak season (in the summer) and has branches in major cities across the Prairies. b. A retail clothing chain offers personalized service and caters
to upscale customers. It is located in major cities across Canada and employs approximately 600 sales
staff. c. A computer software firm develops customized software for various specialized applications for
individual clients. Located near Ottawa, it employs about 1,000 people. Your Answer
No answer submitted
Case Questions
Case Question 12.1
Review
Analyze “The Fit Stop Ltd.” case in the Appendix, and identify the benefits system (including specific benefits) that would make the most sense for this firm.
Your Answer
No answer submitted
Case Question 12.2
Review
Analyze the “Plastco Packaging” case in the Appendix, and identify the benefits system (including specific benefits) that would make the most sense for this firm.
Your Answer
No answer submitted
Simulation Cross-Reference
If you are using Strategic Compensation: A Simulation in conjunction with this text, you will
find that the concepts in Chapter 12 are helpful in preparing Section L of the simulation.
// Notes
1. Richard Yerema and Kristina Leung, Canada’s Top 100 Employers (Toronto: Mediacorp,
2012), http://www.canadastop100.com/national, accessed October 3, 2016.
2. Statistics Canada, Workplace and Employee Survey (2006),
http://www23.statcan.gc.ca/imdb/p2SV.plFunction=getSurvey&SDDS=2615&Item_Id=1361&la
ng=en.
3. Conference Board of Canada, Benefits Benchmarking 2012 (Ottawa: 2012).
4. Statistics Canada, “Pension Plans in Canada,” The Daily Online, May 25, 2012.
5. Conference Board of Canada, Compensation Planning Outlook 2013 (Ottawa: 2012).
6. “2008: Worst Year Ever for Pensions,” Canadian HR Reporter, February 9, 2009, 2.
7. Statistics Canada, “Life Expectancy,” http://www.statcan.gc.ca/tables-tableaux/sum-
som/l01/cst01/health26-eng.htm, accessed October 3, 2016.
8. Office of the Chief Actuary, 12th Actuarial Report on the Old Age Security Program as at
31 December 2012, http://www.osfi-bsif.gc.ca/eng/oca-bac/ar-ra/oas-
psv/pages/oas12.aspx#tbl-24, accessed October 3, 2016.
9. Statistics Canada, “Life Expectancy.”
10. Conference Board of Canada, Compensation Planning Outlook 2013.
11. Charles Davies, “More DC Plans, More for Staff to Understand,” Canadian HR Reporter 17,
no. 11 (2004): G2–G8.
12. Laurence E. Coward, Mercer Handbook of Canadian Pension and Benefit Plans (Don
Mills: CCH Canadian 1991).
13. H. Clare Pitcher, “In Defence of the Much-Maligned DB Plan,” Canadian HR Reporter 17, no. 4 (2004): G4. See also Victoria Hubbell, “DB Pensions Best Option for Employers, Workers,”
Canadian HR Reporter 26, no. 1 (2013): 23.
14. Conference Board of Canada, Compensation Planning Outlook 2004 (Ottawa: 2004).
15. Steven G. Allen and Robert L. Clark, “Pensions and Firm Performance,” in Human
Resources and Performance of the Firm, ed. Morris M. Kleiner, Richard N. Block, Myron
Roomkin, and Sidney W. Salsburg (Madison: Industrial Relations Research Association, 1987),
195–242.
16. Andrew A. Luchak and Ian R. Gellatly, “What Kind of Commitment Does a Final Earnings
Pension Plan Elicit?,” Relations industrielles/Industrial Relations 56, no. 2 (2001): 387–418.
17. Jeremy Quittner, “Business Owners Share How They Actually Chose Their Health Care Plans,” Fortune, October 4, 2016, http://fortune.com/2016/10/04/business-owners-share-
how-they-actually-chose-their-health-care-plans, accessed October 18, 2016.
18. Canadian HR Reporter, “Health Benefit Plan Cost Increases Slowing Significantly for Employers: Survey,” July 24, 2012, http://www.hrreporter.com/article/13545-health-benefit-
plan-cost-increases-slowing-significantly-for-employers-survey, accessed October 18, 2016.
19. Danielle Harder, “Generic Drugs Cheaper South of Border,” Canadian HR Reporter,
February 9, 2009, 17.
20. Paula Allen, “Mental Health Absenteeism Threatens to Break Disability Bank,” Canadian
HR Reporter 17, no. 6 (2004): 5–8.
21. Uyen Vu, “Physical Disability Going Down, Mental Disability Going Up,” Canadian HR
Reporter 17, no. 6 (2004): 6.
22. Conference Board of Canada, Benefits Benchmarking 2012 (Ottawa: 2012).
23. Todd Rappit, “Need Help Being Creative with Perks?” Canadian HR Reporter 17, no. 21
(2004): 17.
24. Geoff England and Roderick Wood, Employment Law in Canada. (Markham:
Butterworths, 2001).
25. For a full discussion of these issues and for awards by the courts, see Stacey R.
Ball, Canadian Employment Law (Aurora: Canada Law Book, 2004).
26. Geoffrey J. Litherland, An Employer’s Guide to Dismissal (Aurora: Aurora Professional
Press, 2000).
27. Carolyn Baarda, Compensation Planning Outlook 2001 (Ottawa: Conference Board of
Canada, 2000).
28. Angela Scappatura, “EAP Use Soars as Economy Tanks,” Canadian HR Reporter, March
23, 2009, 1–2.
29. Rappit, “Need Help . . . ?”
30. Terry Martin, “Building the Business Case for Wellness,” Canadian HR Reporter 18, no. 6
(2005): 7.
31. David Brown, “Benefits Providers Strive to Meet Clients’ Wellness Needs,” Canadian HR
Reporter 18, no. 6 (2005): 5–6.
32. Conference Board of Canada, Making the Business Case for Investments in Workplace
Health and Wellness (Ottawa: 2012).
33. Carolyn Baarda, Compensation Planning Outlook 2001(Ottawa: Conference Board of
Canada, 2000).
34. Baarda, Compensation Planning Outlook 2001.
35. Uyen Vu, “‘Sandwich Generation’ Challenges Big, and Getting Bigger,” Canadian HR
Reporter 17, no. 18 (2004): 1–8.
36. Bonnie Schroeder, Jane MacDonald, and Judith Shamian, “Older Workers with Caregiving
Responsibilities: A Canadian Perspective on Corporate Giving,” Aging International 37 (2012):
39–56.
37. Chris Higgins and Linda Duxbury, Reducing Work-Life Conflict: What Works? What
Doesn’t? (2008), http://www.hc-sc.gc.ca/ewh-semt/pubs/occup-travail/balancing-
equilibre/index-eng.php.
38. Linda Duxbury and Chris Higgins, “Revisiting Work-Life Issues in Canada: The 2012 National
Study on Balancing Work and Caregiving in Canada” (2012),
http://www.healthyworkplaces.info/wp-content/uploads/2012/11/2012-National-Work-Long-
Summary.pdf.
39. Rappit, “Need Help . . . ?”
40. Angela Scappatura, “Support for Tax-Free Savings Account Limited,” Canadian
Compensation and Benefits Reporter13, no. 3 (2009): 6.
41. Robert J. McKay, Canadian Handbook of Flexible Benefits (Mississauga: John Wiley and
Sons, 2007).
42. McKay, Canadian Handbook of Flexible Benefits.
43. McKay, Canadian Handbook of Flexible Benefits.
44. Nathalie B. Carlyle, Compensation Planning Outlook 1997 (Ottawa: Conference Board of
Canada, 1996).
45. Conference Board of Canada, Benefits Benchmarking 2012.
46. Brian Hackett, Transforming the Benefit Function (New York: Conference Board, 1995).
47. McKay, Canadian Handbook of Flexible Benefits.
48. David Brown, “Employers Approach Benefits Cost Containment with Caution,” Canadian
HR Reporter, 18, no. 2 (2005): 2–4.
49. McKay, Canadian Handbook of Flexible Benefits.
50. Julie Charles, “Some Assembly Required,” Benefits Canada, January 1995, 25.
51. Michael C. Sturman, John M. Hannon, and George T. Milkovich, “Computerized Decision
Aids for Flexible Benefits Decisions: The Effects of an Expert System and Decision Support System on Employee Intentions and Satisfaction with Benefits,” Personnel Psychology 49,
no. 4 (1996): 883–908.
52. Daphne Woolf, “The Flux of Flex: How Flex Plans Are Faring,” Canadian HR Reporter 18,
no. 2 (2005): 15.
53. Woolf, “The Flux of Flex.
54. Michel Tremblay, Bruno Sire, and Annie Pelchat, “A Study of the Determinants and of the Impact of Flexibility on Employee Benefit Satisfaction,” Human Relations 51, no. 5 (1998):
667–88.
55. Hewitt Associates, Survey Findings: Canadian Flexible Benefit Programs and
Practices (Toronto: 1995).
56. Sturman et al., “Computerized Decision Aids.”
57. Xavier Baeten and Bart Verwaeren, “Flexible Rewards from a Strategic Rewards
Perspective,” Compensation and Benefits Review 44, no. 1 (2012): 40–49.
58. For the most up-to-date and comprehensive source of benefits information, see J. Bruce McDonald, Carswell’s Benefits Guide (Toronto: Carswell, 2013). See also McKay, Canadian
Handbook of Flexible Benefits.
59. John A. Haslinger and Donna Sheerin, “Employee Input: The Key to Successful Benefits
Programs,” Compensation and Benefits Review 26, no. 3 (1994): 61–70.
60. Robert Taylor, “The Benefits Are the Message,” Canadian HR Reporter, January 12, 2009,
15.
61. Excellent guidance on the preparation of benefits surveys can be found in
McDonald, Carswell’s Benefits Guide.
62. John M. Burns and Diane Gherson, “Should Variable Pay Count Towards Benefits
Calculations?” Compensation and Benefits Review 28, no. 5 (1996).
63. Andrew Luchak and Morley Gunderson, “What Do Employees Know about Their Pension
Plan?” Industrial Relations 39, no. 4 (2000): 646–70.
64. Haslinger and Sheerin, “Employee Input.”
65. Sarah Dobson, “Benefits Consultations Make SFU Top Employer,” Canadian HR Reporter,
March 9, 2009, 12.
Chapter 13: Activating and
Maintaining an Effective
Compensation System CHAPTER LEARNING OBJECTIVES
After reading this chapter, you should be able to:
• Identify the key issues in preparing to implement a compensation
system.
• Develop an implementation plan for a new compensation system.
• Describe the steps necessary for implementing a compensation
system.
• Develop a process for communicating the compensation system.
• Explain how to evaluate the effectiveness of a compensation system.
• Identify circumstances that may necessitate changes to the
compensation system.
• Discuss the issues to be considered in adapting the compensation
system.
THOUSANDS OF FEDERAL EMPLOYEES PLAGUED BY
PROBLEMS WITH NEW COMPENSATION SYSTEM
A new compensation system was blamed for the recent problems facing thousands of federal
employees. More than 80,000 employees were affected by July 2016; some of them were not receiving any pay or were short-changed, others were not getting benefits or only some
benefits, while many were not getting pay for overtime and supplemental pay for extra duties.
A few employees were even overpaid! These problems forced many employees, among other
strategies, to max out their credit cards, take loans to survive, and cash in RRSPs.
The problems started in early 2016 when the federal government replaced the 40-year old
payroll system for its 300,000 personnel. The new multi-million dollar payroll software,
Phoenix, was supposed to integrate the payroll and management systems. However, it appears as if the scope of the task was underestimated. According to senior government
officials, sufficient resources were not channelled into the implementation of the system. This
resulted in a lack of training for the compensation staff. Those responsible for implementation may have also underestimated the time it would take to activate and maintain the new
system.
The problems have resulted in about a dozen of the unions representing federal employees filing for a court hearing on the issue to force the government to pay the employees properly
and on time. At the time of writing this text, thousands of employees were still adversely
affected.
Sources: Kathleen Harris, “Phoenix Pay System Mess Affects 80,000, Government Officials
Say,” CBC News, July 18, 2016, at http://www.cbc .ca/news/politics/phoenix-payroll-
problems-fix-1.3683735, accessed October 4, 2016; Laura Payton, “Resolution in Pay Problems for 80,000 Civil Servants Still Months Away,” CTV News, July 18, 2016, at
http://www.ctvnews.ca/politics/resolution-in-pay-problems-for-80-000-civil-servants-still-
months-away-1.2991937, accessed July 19, 2106; Michelle Zilio, “System Glitch Leaves 80,000 Public Servants Waiting for Pay,” Globe and Mail, July 18, 2016, at
http://www.theglobeandmail.com/news/national/officials-apologize-as-more-than-80000-
civil-servants-have-issue-getting-paid/article30961062, accessed October 4, 2016.
// Introduction to Putting The Systems In
Place
At last! Your final destination on the road to effective compensation is in sight. You have
formulated your compensation strategy. You have designed the technical processes for
converting this strategy into a compensation system. What remains is to put this system into
place, along with the infrastructure to operate the system. Once in place, the system needs to
be communicated on an ongoing basis, evaluated to ensure that it is achieving the goals set
out for it, and adapted to fit changing circumstances. The purpose of this final chapter is to
deal with these issues.
This chapter first outlines the important issues to be dealt with in preparing to implement a
new compensation system, then discusses how to develop an implementation plan. Without
adequate preparation, the difficulties in effectively implementing a new compensation system will be magnified dramatically. As the opening story in this chapter shows, problems related to
improper implementation can cause major headaches!
Next, you will learn the main steps in the implementation process itself and examine ways to
communicate and evaluate the compensation system on an ongoing basis, after it is up and
running. After that, key circumstances that may create needs for change to the compensation system are identified. The chapter concludes with a discussion of some of the key issues in
adapting the compensation system.
// Preparing For Implementation
Even after the compensation strategy has been established and the technical processes have
been determined, there is still much to be done before the new compensation system can be
implemented. These tasks include preparing the compensation budget, planning the
infrastructure for compensation administration, planning for information technology, and
organizing for compensation administration.
Preparing The Compensation Budget
A compensation budget for the coming year is an essential part of the planning process for
most organizations. A compensation budget is simply a forecast of what the firm expects to
spend on compensation in the coming year. Such a budget can also serve as a way to control compensation costs (e.g., by requiring departments to secure authorization to exceed their
budgeted allocations) and as a benchmark against which to evaluate whether the
compensation system is behaving as expected.
Traditionally, compensation budgeting has been done in one of two ways—either bottom-up
or top-down. In the bottom-up approach, the compensation rates for the coming year are
applied to employees, factoring in probable merit and seniority increases as well as expected turnover (turnover reduces compensation costs because new employees usually start at a
lower rate than those who are retiring or quitting), and the compensation budget for the
coming year is based on the total dollar amount derived from this process. In the top-down approach, management sets a limit on the total amount of compensation available for the
coming year (usually based on some adjustment of last year’s compensation bill) and then
divides the available funds among departments and units, which then divide them in turn
among their employees.
The approach advocated in this book is top-down when compensation strategy is being
formulated, to ensure that it dovetails with other key strategic aspects of the organization, but
bottom-up for compensation budgeting. A top-down approach to budgeting, where an arbitrary amount is allocated to compensation, undermines the whole notion of strategic pay.
The main advantage of top-down budgeting is simplicity, although with new computer-based
human resource information systems, this advantage disappears.1
Planning for Compensation Administration
In this section we discuss four key issues that need to be dealt with when planning for
compensation administration: documenting the compensation system, administering compensation, assigning compensation responsibilities and planning the infrastructure, and
developing ongoing communications about the system.
Documenting The Compensation System
If an organization is to apply its compensation system uniformly, it must carefully document
the system. Two aspects of documentation are particularly important. The first is the
compensation system itself. If job evaluation is to be used, then manuals must be prepared that provide the compensable factors, the scales for measuring these, and the procedures for
applying them. If pay for knowledge is to be used, then procedures for assessing skill levels
and competencies must be documented. Benefits must also be described, along with
application procedures, limits, and the like.
Second, the organization must document assigned responsibilities for carrying out the various
compensation processes, spelling out which organizational units are responsible for which
tasks. It also needs to negotiate and draw up contracts with service providers. These contracts need to describe the services to be provided, including minimum performance standards and
penalties for failure to meet them, as well as the employer’s responsibilities. Beyond
addressing foreseeable tasks, contracts need to be flexible enough to deal with unknown
future events. Quite a challenge for any document!
Administering Compensation
For the compensation system to function, someone has to collect the necessary information about time worked by each employee, whether any employees are eligible for overtime pay or
bonuses, and which employees have been terminated or hired. Someone has to calculate
gross earnings and deductions from earnings, prepare and distribute the paycheques or notices of direct deposit for employees, and remit the proper amounts to various
governmental agencies. In firms that offer employee benefits, someone must keep track of
who is entitled to what and ensure that proper payouts are made. Taking care of these
responsibilities is called compensation administration.
Assigning Responsibilities and Planning the Infrastructure
Once all of the tasks and procedures for operating the compensation system have been identified, the organization needs to assign specific responsibilities for performing these tasks
and plan the infrastructure to support the system. Who exactly will be responsible for
inputting employee transactions? Who will develop the forms for recording these transactions
and the computer systems for performing the pay calculations? Who will prepare the cheques: a payroll section in the human resources department, the accounting department, or an
outside provider?
Communicating Compensation Information
A process must be developed so that the ongoing communication that is necessary for
effective operation of the compensation system takes place. Employees and their managers
need to be made aware of any changes to compensation that affect them, and also be made aware of any responsibilities they have for providing information necessary for the
compensation administration process. Any new managers or employees need to be briefed on
compensation issues or responsibilities that are relevant to them. All employees must have a reliable source of compensation information available to them to address any questions or
concerns. (We will devote more time to this issue later in this chapter because of the
importance of ongoing communication.)
Planning for Information Technology
Because it requires such a large number of mechanical calculations, payroll was one of the
first functions to be computerized in most organizations. Since then, many firms have also introduced integrated human resource information systems, in which compensation is just
one part. Computers facilitate compensation administration and can help transform complex
compensation concepts—such as flexible benefit plans—into usable practices.
For most organizations, the question is not whether to use computers in compensation administration, but how far to extend their use. Possible uses include job documentation and
evaluation, analysis of compensation survey data, communications, information collection,
calculation of pay and remittances, record keeping, and compensation planning and research.2 Firms must take steps to ensure that employees’ privacy rights are secure when
electronic systems are used. This imposes some restrictions on the types of IT systems that
can be used.
Job Documentation and Evaluation
Computers can be very useful in data collection for job analysis purposes, in developing factor
weightings for job evaluation systems,3 and for computing market lines and pay policy lines, as
discussed earlier in the text.
Labour Market Data Analysis
Analyses of labour market and compensation survey data can be greatly facilitated by computers. A great deal of labour market data can be downloaded directly from a variety of
governmental and other sources. As well, systems can be developed to store job matches from
various surveys and then to generate various “market rates” based on a number of variables
and assumptions.
Communication
Computers are being used more and more to communicate compensation policies and
information. An effective intranet can help firms deal with many of their compensation
communication needs.4
Information Collection
Online computer systems can be used to capture a wide variety of compensation information.
Departments can use direct entry for transactions such as new hires, terminations, and pay
rate changes, as well as for information such as hours worked and days absent. Appraisal and performance management systems, such as 360-degree feedback, can be greatly facilitated by
online systems for data collection, compilation, and analysis.5
Computers can also be used to collect employees’ choices regarding various aspects of compensation, especially benefits choices. Computers can guide employees through the
benefits selection process and help them make the choices that are most consistent with their
own needs (see Chapter 12).
Pay and Remittance Calculation
Once properly programmed, computers excel at performing routine computations, such as
calculating gross and net earnings and remittances to governmental agencies. Many off-the- shelf computer packages are available for such purposes, although many organizations find it
necessary to customize the software to the needs of their particular
organization. Compensation Today 13.1 describes how two hospitals cut costs by jointly
purchasing the necessary software for their pay systems.
Record Keeping
Accurate compensation records are essential for a wide variety of purposes, including internal
control, financial reporting, and external reporting (e.g., for income tax or pension purposes).
COMPENSATION TODAY 13.1
Hospitals Harvest Healthy Software Savings By Sharing
In the fall of 2005, the payroll system at Queensway Carleton Hospital (QCH) in Ottawa—
designed for handling 1,000 employees but now struggling to handle twice that number—was
already on life support when the technology provider announced that it would be pulling the plug on the system on April 1, 2008. Unfortunately, this turned out to be no April Fool’s joke,
and QCH had to scramble to find a new payroll system.
Because funds were scarce, QCH teamed up with Montfort Hospital, also in dire need of payroll system replacement. Working together, they were able to purchase one system (the VIP
Integrated HR-Payroll System provided by Quebec-based DLGL) that would suit both
hospitals, and split the nearly $1 million cost.
Besides its bargain price, the system has proved to be a good deal in other ways. For example,
with the previous payroll system, many transactions—such as maternity and parental leaves—
needed to be calculated manually, creating a considerable administrative burden. Now all of
these kinds of transactions are handled electronically by the system.
For the next phase of development, the hospitals plan to integrate employee scheduling and attendance with the system, thus eliminating the need for manual time sheets. This will also
allow new applications such as research on patterns of absenteeism.
Source: Danielle Harder, “Resuscitating a Hospital Payroll System,” Canadian HR Reporter, January 26, 2009, 1, at http://www.dlgl.com/reference/HR_Reporter_01-
2009_Resuscitating_hospital_payroll.pdf.
Compensation Planning and Research
Computers can be used to prepare compensation budgets and to make projections of future
compensation costs under a variety of assumptions.6 They can be used to analyze current pay structures or the distribution of merit money among departments. They can also be used to
analyze labour productivity, absenteeism, and turnover rates. In addition, they are helpful for
conducting online surveys of employee attitudes.
Privacy and Legal Issues
Online computer systems can dramatically reduce the amount of paperwork in compensation
administration. However, firms must protect employee privacy rights in the process. These “privacy concerns and legal restrictions on the use of electronic documents, including
electronic signatures, have limited employers’ ability to introduce electronic alternatives for
payroll purposes.”7
In 2000, to protect employee privacy in the face of electronic access to employee data, the federal government passed Bill C-6, known as the Personal Information Protection and
Electronic Documents Act (PIPEDA). Enacted in 2004, this legislation prohibits the release of
“personal health information” (e.g., employee medical and dental claims) to anybody (including third-party benefits providers) without informed employee consent. This means
that Web-based benefits systems must be careful to limit access to employee records to only a
few authorized persons. For example, supervisors cannot be allowed access to detailed information about their employees’ health claims. This legislation applies in all jurisdictions
that do not have equivalent provincial legislation—Saskatchewan, Manitoba, Nova Scotia,
Prince Edward Island, and the territories. Quebec, Alberta, British Columbia, Ontario, New
Brunswick, and Newfoundland and Labrador have equivalent provincial legislation.
Another issue is the legality of electronic forms. For example, until 2000, Ontario employment
standards legislation required that individualized employee pay statements be provided to each employee for every pay period in paper format. Since 2000, however, with the passage of
provincial Bill 88 (the Electronic Commerce Act), employers in Ontario have been permitted to
provide electronic pay statements, as long as these comply with certain conditions. For example, simply making the statements available on a website does not comply with the law;
the statements must be personally sent to each employee (i.e., through email), and the
employee must be able to keep (i.e., print or electronically save) a copy of the statement.
Organizing for Compensation Administration
A major issue confronting employers is whether to perform all aspects of compensation
administration in-house or to contract some or all of it to an outside agency.8 When deciding
whether to outsource compensation administration, organizations often distinguish between
direct pay (payroll) and indirect pay (benefits).
Depending on the nature and extent of employee benefits offered, benefits administration can
be very complex. Most organizations therefore outsource at least some of their benefits administration, often to the product provider, such as an insurance company. Although
payroll processing is usually more straightforward than benefits administration, many
companies outsource this work as well. Several large companies—such as Ceridian and ADP—
and many smaller companies specialize in this type of service.
At one time, there were few if any firms capable of providing the full range of compensation
administration services. That changed in 2001, when the Canadian Imperial Bank of Commerce outsourced nearly half of its human resources department, including payroll and
benefits administration, to EDS (now a part of HP Enterprise Services). In the process, some
200 of the bank’s HR employees were moved to EDS. According to bank officials, the primary motive for the move was not to save money but rather to free the bank’s HR department from
the detailed administrative work that could be done better by a specialized service
provider.9 In 2003, the Bank of Montreal followed suit, signing a ten-year deal with Exult
Consulting (now a part of Aon Hewitt) to outsource most of its HR transactional work.10
The movement toward outsourcing may be losing momentum, however. As far back as 2004, a
survey of the priorities of Canadian HR managers found that only 3 percent considered
outsourcing of HR functions a priority—dead last on a list of 21 possibilities.11 This may be at least partly due to the development of improved HRMS (human resources management
system) software, as was demonstrated in the opening vignette. By 2013, one prominent
commentator was asking aloud whether “the shine [has] come off HR outsourcing.”12 Many companies today (especially the larger ones) feel that they can handle HR functions more
effectively in-house.
Moreover, outsourcing is not necessarily an all-or-nothing proposition. For example, payroll can be done entirely in-house, or it can be entirely outsourced, or it can be co-sourced, with
the employer responsible for entering employee pay and attendance, and the outsourcer
preparing the paycheques and other documentation.
Trans Canada Credit Corporation (now Wells Fargo Financial Corporation Canada), a Toronto-
based consumer finance firm that had 2,200 employees at the time, opted for a co-sourced
model using an application service provider (ASP) model.13 ASPs specialize in providing access to specialized business systems software over the Internet, which eliminates the need for a
firm to purchase and maintain its own applications software.14 By paying a monthly fee, firms
receive access to specialized payroll and benefits software, thus eliminating one reason to
fully outsource compensation administration. At Trans Canada Credit, the ASP hosted and
managed the payroll application off-site, while providing direct management access for
purposes such as employee appraisals and employee access to their own pay information.
Advantages of Outsourcing
Outsourcing payroll and benefits administration has several advantages. The first is cost.
Outside providers generally realize economies of scale that most employers cannot. For
example, the costs of computerized benefits systems are very large for a single business, but an outside provider can spread these costs across numerous customers. Outside providers
also achieve economies in terms of training, for their staff can specialize in compensation
administration on a full-time basis, thereby also reducing costs.
A second advantage is expertise. Outside providers may be in a position to employ specialized
legal and professional experts that a single employer—especially a small or medium-sized
one—simply could not afford. Third, once freed of the responsibility for the day-to-day administration of the compensation system, in-house compensation managers may be able to
spend more time on the strategic aspects of pay rather than on simply keeping the system
running.15 However, there is debate about whether that actually happens. One U.S. researcher found “no evidence that an HR department becomes ‘more strategic’ after outsourcing major
parts of the HR function. In fact, I found the exact opposite.”16 In fact, as Canada Post realized,
with better management of its HR systems, it made sense to bring the payroll function back in-
house as illustrated in Compensation Today 13.2.
COMPENSATION TODAY 13.2
Canada Post Improves Its Integrated HR System
As the century turned, Canada Post had a big dilemma. It was trying to cope in the electronic
age with HR systems that had originated in the paper age. It seemed that every HR process had
its own system, none of which communicated well with the other systems or with users. Supervisors and employees had trouble getting basic information about pay and benefits, and
making simple changes to employee hours or pay was an arduous process. Moreover, none of
these systems connected well to the payroll function, which had been outsourced years
before.
Like many firms, Canada Post decided to create a new HR system to integrate all of its HR
processes. But unlike many firms, it avoided what is known as the “customization trap,” which is driven by the tendency of firms to want to customize commercial off-the-shelf systems to
match their existing systems. Because customized systems are very complex, customization
takes far longer than implementing an off-the-shelf system. Moreover, unanticipated
difficulties emerge, costs are much higher, program elements don’t work well together, and
upgrades are expensive because they too have to be customized.
Instead, Canada Post went with an off-the-shelf integrated HR system from a major provider of
HR software and customized only where absolutely necessary. This process was so successful that it even made economic sense to bring the payroll function back in-house, bucking a trend
toward payroll outsourcing that had been evident for two decades or more.
Source: Todd Humber, “Through Wind, and Sleet, and the Internet,” Canadian HR Reporter,
November 8, 2004, G1–G8.
Disadvantages of Outsourcing
One concern about the outsourcing of benefits administration is that the employer may lose
touch with emerging problems and issues, or even lose the capacity to understand the
benefits system. The firm may come to rely too heavily on advice from the service provider, who may not understand the organizational context, especially if changes to managerial
strategy are taking place. Moreover, service providers may not be concerned about looking for
the mix of benefits that best serves the particular compensation objectives of a given
employer.
Managing the relationship with the vendor can be difficult and time consuming. If service
contracts fail to specify all the details of who is responsible for what, within what time frame,
and with what recourse if performance failures occur, then disagreements may materialize that take time and energy to resolve. For example, if paycheques are late, who covers the cost
to employees of bounced cheques and late credit card payments?
Another potential drawback to outsourcing is the impact on employee morale if it is necessary to lay off employees when their functions are contracted out.17 This is not much of an issue for
classical firms, but for human relations and high-involvement firms, it is a serious
consideration. Costs of severance and termination counselling also need to be considered. Although CIBC avoided this problem by transferring its in-house employees to the service
provider, this option is not available to all firms.
So when should outsourcing be considered? Four factors are key:
• company size,
• internal capabilities,
• complexity and dynamism of the compensation system, and
• the strategic importance of compensation.
Regarding company size, research has shown that many large firms believe they can handle
payroll and benefits more efficiently in-house because they can achieve economies of scale
that are not available to smaller firms.18 Internal capabilities can also influence outsourcing
decisions: if the firm is already using a sophisticated human resources information system,
and if computer systems and supports are already in place, separating payroll and benefits
from the system by outsourcing them may make little sense.
The more complex, unique, and dynamic the compensation system is, the more preferable it is
to develop in-house expertise for running it, since an outside provider may be reluctant to
devote specialized resources to an individual customer, for this would reduce the provider’s economies of scale and drive up costs. Also, dynamic systems interfere with the provider’s
economies of scale if frequent changes are needed, which either drives up costs or generates
provider resistance to system changes, thus causing compensation system rigidity.
A final consideration is the strategic importance of compensation. The more that
compensation is regarded as a strategic variable, the more important it is to maintain in-house
control of the compensation system. However, as discussed earlier, some observers believe that the strategic focus of the compensation function is enhanced when routine
administrative functions are outsourced. The proper balance between outsourcing and in-
house provision of compensation services probably differs for each firm.
// Developing The Implementation Plan
Once all of these issues have been dealt with, an implementation plan needs to be developed.
Key aspects of the implementation plan include (1) the plan for managing the implementation
process, (2) the training plan, (3) the plan for communicating the new system, and (4) the plan
for evaluating the new system.
Developing the Plan for Managing Implementation
Of course, someone or some group needs to be assigned responsibility for spearheading
implementation. Depending on the magnitude and scope of the changes, several committees
or task forces may be needed, each responsible for a particular aspect of the new compensation system, operating under the supervision of an umbrella group. For example,
there may be one implementation task force for base pay, another for performance pay, and a
third for indirect pay. There may even be separate task forces for specific programs, such as
profit sharing. If the compensation plan is different for different employee groups, there may
be a separate task force for each group.
The composition of these task forces is an important matter. Normally, the umbrella group is
chaired by a senior executive, such as the head of Human Resources. It may even include the CEO if the changes are of sufficient magnitude. This could conceivably be the same body that
developed the new compensation system. Whether or not it includes employee
representatives will be a reflection of the managerial strategy pursued by the organization. For example, the inclusion of a broad spectrum of employees, especially on the subsidiary
committees or task forces, would certainly be expected for a high-involvement organization
but not for a classical organization.
The schedule for implementation is a crucial matter. When will the system start? How long will
it take to carry out the various implementation steps? It is crucial to develop an
implementation time line that details each step in the process and dates by which they will be
completed.
When developing the implementation plan, it is important to identify any matters that will
require attention before implementation can begin. For example, performance pay will be effective only if employees have control over performance. For there to be such control, it may
be necessary to decentralize decision making. But that decentralization will be irresponsible
unless employees have the information to make effective decisions and the training to interpret and utilize that information. When will this training be done? When will the
information systems be revamped? All of this must be considered when the implementation
schedule is being developed. Of course, the greater the number of changes, the more complex
this pre-implementation stage will be. But the more that an organization gets the stage
properly set, the larger the payoff will be later on.
Timing is another important implementation decision. If extensive changes are being made, should they be phased in? In theory, no. There is an old saying: “You can’t leap a chasm in two
jumps.” To function effectively, all complementary parts of the system need to be in place at
the same time. The reality, however, is that a single implementation date simply may not be feasible for all the needed changes. This timing dilemma is one reason that many
compensation changes fail to produce the intended results.
But as long as everyone understands that all of the pieces are coming, phasing in these
changes may not be a problem. For example, if jobs are changed to make them more
challenging and interesting, the intrinsic motivation from this alone may be enough to keep
employees motivated, at least for a while. But if employees do become more productive and
contribute more to the organization, this enthusiasm will fade if the promised financial recognition fails to follow promptly. Conversely, if group performance pay is introduced to
promote teamwork, changes to the job structure to allow employees more control over their
performance cannot lag too far behind.
If the organization is very large and is divided into separate business units, it may be possible
to implement the new system in one of these units first, in order to assess the consequences
and to identify any adjustments that need to be made.
Developing the Training Plan
Developing a training plan is important when implementing a new compensation system.
First, key support people in the Human Resources department must be trained to fully
understand the system and its components. They can then serve as trainers and advisers for the rest of the organization. Second, there must be sufficient training for managers and
supervisors, who will play a key role in many aspects of the system, from job description, to
job evaluation, to performance appraisal, to approving salary increases. The third step involves training all the other people who will play a role in operating the systems, ranging
from secretaries (who must submit departmental time information) to recruiters (so that they
will be able to explain the compensation system accurately to potential new employees).
Developing the Communications Plan
It is crucial to develop a plan to communicate the new system to all those who are affected by
it. As discussed earlier, a pay system will not have the desired impact on employee attitudes and behaviour if it is not understood; indeed, it could have a negative impact on attitudes and
behaviour if it is misunderstood.
Not only should the new system be well communicated, but so should the need for the new system. Employees are always sensitive about pay, so a misunderstanding of the motives
underlying the new system may arouse suspicion, mistrust, and even resistance. Preventing
this suspicion and mistrust is one reason that many experts recommend employee participation in compensation system development. Another advantage is that
communicating information on the final system will be easier, since employees have been
kept informed as it was being developed.
When developing the communication plan, organizations need to carefully plan the media and
processes, along with the timing. In some cases, the communication process starts with a
presentation by the CEO regarding the general features of the new system, the reasons for its
introduction, and its objectives. This may be followed by small-group meetings conducted by supervisors (once they have been trained in the new system) or by personnel from the Human
Resources department. If the new system is complex, separate meetings may be planned for
different aspects of the new system—one meeting for direct pay and another for indirect pay, for example. Some firms also prepare webcasts for employees who cannot attend these
meetings and for employees hired later. Informational brochures (or websites) typically need
to be developed for each plan aspect. In addition, a telephone or email hotline for questions
should be set up.
If individual performance pay is part of the compensation package, then performance
expectations also need to be communicated. If performance pay is to be linked to departmental or organizational indicators, then management must not only communicate
what these indicators are but also provide status reports on these indicators. Some
manufacturing plants actually have “electronic scoreboards” that provide immediate updates on the achievement of organizational goals.19 At Saskatoon-based Cameco Corporation, one of
the world’s largest producers of uranium, charts showing progress toward meeting divisional
and corporate goals are posted at every work unit and are updated throughout the year.
As discussed, effective communication is required not only when the compensation system is
being implemented but also on an ongoing basis, whether or not the compensation system is
new. Because of the importance of ongoing communication, we come back to this issue later
in the chapter.
Developing the Evaluation Plan
Before implementation, the organization needs to develop a plan for evaluating the success of
the compensation system, along with an approach to monitoring conditions that may warrant changes to it. Evaluation criteria need to be set out, as well as procedures for collecting the
evaluation information. Depending on the criteria, organizations may need to collect some
evaluation information (such as employee attitudes) prior to implementation, to serve as a
benchmark for evaluating the consequences of the new system. The evaluation criteria should be based on the strategic objectives for the compensation system; ideally, they will have been
developed during the compensation strategy formulation process. (Both of these crucial
issues—evaluating the compensation system and monitoring organizational circumstances—
are discussed in more depth later in the chapter.)
// Implementing The Compensation System
Relative to the preparation, actual implementation of the new compensation system is
relatively straightforward. The implementation task forces need to be staffed and the
administrative infrastructure put in place and tested. The key actors in the system need to be
trained, and the system must be communicated. Finally, the new system needs to be
launched, and the wrinkles smoothed out.
Step 1: Establish the Implementation Task Forces
The first step in implementation is to appoint individuals to the implementation bodies and to
provide technical and administrative support for those bodies. Task force members need to
fully understand the new compensation system as well as the key issues and steps in the
implementation process.
Step 2: Put the Infrastructure into Place
Next, the compensation infrastructure must be put in place. Employees need to be hired or
assigned to the compensation unit. Facilities need to be provided. The computer system has
to be developed and tested. Additional hardware may need to be purchased. Human resources personnel must be trained in the system. The forms, brochures, communications
materials, and websites need to be developed. Trainers need to be selected and trained.
As well, necessary pre-implementation evaluation material needs to be collected. For example, it is often useful to conduct surveys of key employee attitudes before system
implementation in order to have a baseline for future comparisons. Such a survey should
ideally be done as early in the process as possible, since information about the new system
may affect these pre-existing attitudes.
Step 3: Test the System
It is crucial that the compensation system be tested before implementation. One approach is
to run a computer simulation. Employees would be put on the system, data collected and
input into the system, pay calculated, and so on—all before the previous system is abandoned.
This test allows flaws and bugs in the system to be identified and the accuracy of the
calculations to be double-checked.
Step 4: Conduct the Training
Once the infrastructure is in place and debugged, it is time to train all those outside the HR
department who will be playing a role in the new system. This normally includes managers,
supervisors, and other personnel who administer the process. Training sessions have to be
scheduled, trainees informed, and the training conducted.
Step 5: Communicate Information on the System
The communication program should now be activated. But simply making sure that everyone
has sat through the webcast from the company president, has received the plan brochures, or has been referred to the website doesn’t guarantee that communication has taken place.
Communication does not actually occur until understanding passes from the sender to the
receiver. Feedback is needed to check whether the key elements of the message were successfully communicated. Two-way communication greatly enhances the likelihood of
effective communication.
Step 6: Launch and Adjust the System
After all this preparation, the actual launch of the system may seem anticlimactic. However, it
is likely that the first “cycle” of the new compensation system will be extremely hectic, with
many unanticipated problems and issues arising. No matter how careful the preparation, some elements of the plan will not work. Adjustments will need to be made just to keep the
system running. Many of these changes will be short-term fixes, which will later be
incorporated into the system. For example, the computer system may not correctly calculate the holiday pay of permanent part-time employees who are on medical leave. But this
adjustment can be calculated by hand until the computer system is reprogrammed.
// Communicating Compensation System
Information
Two types of ongoing communication are important. One type focuses on ensuring that all
who play a role in operating the compensation system understand their roles. The other type
focuses on ensuring that all who are subject to the compensation system understand it.
Research has found that employee satisfaction with their compensation is directly related to their understanding of the compensation system. For example, one study found that 75
percent of employees with a “very good” understanding of their compensation system
thought themselves fairly paid, compared with 33 percent of those with a “poor”
understanding of the pay system.20
Keeping Managers Informed
An important part of compensation administration involves making sure that all of those who
help operate the system understand their roles. Some of these roles may seem obvious—such as reporting hours worked or employee absences—but new supervisors may not be aware of
them. In addition, someone must keep track of overtime hours and report them, along with
changes in job status, including terminations and hirings. When merit pay or bonuses are used, supervisors must understand the criteria and procedures for awarding these. Of course,
they must also understand the compensation system well enough to be able to accurately
answer employee questions about pay.
As an example of how to achieve this, a pharmaceutical company introduced new pay grades
and pay ranges, based on a points system of job evaluation, which had never been used at that
company before.21 The company assembled all of its managers for a day-long training session, during which the new job evaluation system was explained, including how compensation
surveys would be used to create the pay ranges, as well as the principles for ensuring that pay
would be equitable, competitive with the market, and performance based. Feedback
indicated that managers felt that this session would really help them in dealing with
employees regarding compensation issues.
Besides the “what” of the new compensation system, managers must also be given the tools
and knowledge to explain the “why” of the new compensation system to their employees, including the reasons for the change and how it will contribute to the company’s success. If
the compensation system has been designed strategically, managers need to understand the
intended links between compensation and organizational performance so that they can
communicate this connection to their employees.
Keeping Employees Informed
If compensation is to serve its intended role of shaping employee attitudes and behaviour,
those employees have to understand the compensation that applies to them—that is, the
types of compensation provided, the amount, and the procedures for determining the
amount. In addition, employees need to be informed of the compensation and benefits options available to them and may need guidance in selecting the options that are best for
them. Employees may have questions about their pay and the way it was calculated, and they
must have some avenue to discuss their concerns about pay. Of course, if pay is based on
certain performance indicators, as in the case of profit sharing or gain sharing, employees
should be kept up to date on this information.
A Canadian study has found that employee knowledge is especially weak when it comes to
pension plans.22 This may cause employees to discount the value of this important component of the compensation system. Although certain types of information, such as an annual
statement of pension contributions, are required by law, employers need to go beyond this
minimal communication if they want employees to recognize the value of this reward.
As employee benefits choices become more complex, and as pensions move away from
defined benefit plans toward defined contribution plans, the need for employee
communication and education increases greatly. But most firms have been slow to respond to this need. For example, a recent study of firms using defined contribution pension plans found
that most employees lacked the basic knowledge they needed to make informed choices
about managing their pension funds.23 For this reason, in 2004, pension regulators published Guidelines for Capital Accumulation Plans, which outlined employers’ responsibilities for
selecting and managing investments and for educating plan members.24 While the extent to
which employers can be held liable for poor pension choices by employees is unclear, making some effort to ensure that employees have the tools to make informed decisions in this very
important matter is clearly in the employer’s best interest.
Indeed, recent legal cases have found employers liable if they have failed to fully inform
employees about benefits to which they may be entitled. In one case, an employee with behavioural problems quit his job after his employer threatened to fire him for unacceptable
conduct.25 Later, it was discovered that the employee’s behaviour was due to mental illness.
The court found that the employer was negligent in not informing the employee of his right to make a claim under the long-term disability policy that covered employees, and in failing to
assist him in filing the claim.
This problem of keeping employees properly informed of their rights to benefits can be especially severe with flexible benefit plans, where there is much more potential for confusion
than under fixed benefit plans. One legal expert suggests the following steps, as a minimum,
to avoid legal liability in this area:
• Provide clear, concise information concerning each employee’s
entitlement
to benefits.
• Review benefits with each employee to identify his or her obligations
under
each benefit.
• Ensure that employees understand the timelines and processes for
filing any claims.26
// Evaluating The Compensation System
Evaluating the effectiveness of the compensation system is no simple matter, and this aspect
of compensation management is probably the most neglected. There are two main reasons for
this. The first is that separating out the precise impact of compensation on organizational performance with any degree of certainty is virtually impossible. There are just too many
factors that affect overall organizational performance. The second reason is that most
organizations don’t even try to evaluate their compensation systems, either because they
don’t know how or because they consider it futile.
If the right information is collected, useful inferences about the effectiveness of the
compensation system can be drawn. However, a thorough evaluation takes considerable effort using multiple indicators, and a slipshod attempt at evaluation that involves only a few
indicators may be misleading and do more harm than good. Only with a comprehensive set of
relevant indicators can useful conclusions about the success of a compensation system be
drawn.
Evaluating the impact of the compensation system can be approached in three main ways: by
examining its impact on compensation objectives, its impact on compensation costs, and its
impact on employee behaviours and attitudes.
Impact on Compensation Objectives
When formulating compensation strategy (see Chapter 6), the organization should establish
objectives for the compensation system, as well as specific indicators of success in achieving those objectives. During the pre-implementation phase, the organization should develop
procedures to collect the necessary data to assess these indicators. After implementation, the
firm then needs to assess the extent to which these objectives have been met.
A key issue when assessing whether objectives have been accomplished is the time span over
which the evaluation is to take place. The logical time for the first evaluation is one year after
implementation, because one complete cycle will have been carried out. But is one year long
enough to determine whether the desired consequences of the new system are materializing?
The answer: It depends on the magnitude of the changes being made and on the types of
consequences that are desired. Some indicators, such as employee attitudes, can change
fairly quickly (especially in a downward direction!), while other indicators, such as the ones that assess organizational performance, change much more slowly. A phenomenon known as
the initial dip often occurs; this is a tendency for performance to decline during the initial
stages of any change, until people start to understand and become proficient in the new system. Moreover, costs of changes are usually immediate, while benefits are gradual. For
example, a change in compensation strategy to lead the market will increase costs
immediately, but will increase productivity only gradually, as the turnover rate declines and as
the firm is able to attract a higher calibre of employees.
Conversely, some changes—such as slashing pay rates—may bring immediate gain (in terms of
reducing compensation costs) but long-term pain, as the company’s best performers
gradually leave. The key point is that it may take several years to really understand the impact
of sweeping changes to the compensation system; therefore, evaluation needs to be carried
out on a continuing basis.
Now let’s suppose that our compensation objectives have been fully achieved. We should pat
ourselves on the back, right? Not necessarily. We still need to examine whether there have
been any unintended negative consequences. The following examples illustrate actual cases where compensation objectives were achieved, but the net impact of the new compensation
system on company performance was actually negative.27
A retailer wanted store managers to improve their sales margins by introducing higher value
products, so it paid a bonus to managers based on the average margin of their store sales. In
fact, sales margins did increase to the desired levels. However, at the same time, overall sales
volumes and market share dropped. Closer examination revealed that most store managers
had raised their margins simply by increasing prices rather than by introducing new products.
A consumer electronics firm wanted to more rapidly reduce production costs of new products
after their introduction. (Whenever a new product is introduced, production costs usually
decrease over time.) So the firm instituted bonuses to production managers based on how quickly after a product launch these cost reductions were achieved. The objective was
achieved: after the bonus system was implemented, production costs fell much more rapidly
than before. However, the company eventually discovered that managers were achieving this cost reduction by delaying product launches until they could work out ways of reducing
production costs that could be quickly implemented after product launch. This slowed the
introduction of new products and translated into losses in sales and market share.
The key point here is that it is important to put success in meeting compensation objectives in
the context of broader organizational performance, and to carefully monitor a variety of
indicators beyond only those associated with the compensation objectives.
Impact on Compensation Costs
One aspect of compensation that all firms will want to evaluate is the impact on compensation
costs. Compensation costs can be examined by comparing actual to budgeted costs, and by
examining compensation cost indicators.
Budgeted versus Actual Compensation Costs
One way to examine the impact of the new system on compensation costs is by comparing actual to budgeted compensation costs. So, let’s say that you discover that actual
compensation expenditures are much lower than budgeted. Great news, right? Not
necessarily. Perhaps it means that senior employees hate the new system and are quitting in droves, only to be replaced by new employees who are paid much less—but are also much less
experienced. This may make compensation costs look good but will probably have adverse
consequences in terms of training costs and employee performance, which may well outweigh
the compensation savings over the longer term.
Now, let’s suppose the opposite has occurred and that total compensation expenditures are
much higher than budgeted. This can only be bad news, right? Maybe not. In fact, this may be
wonderful news, if these higher employee earnings are primarily a result of, say, a gain-sharing plan. Since cost savings are split between employer and employee in a gain-sharing plan, the
more employees earn from it, the greater the savings for the company that the gain-sharing
plan must be producing.
Or perhaps the higher-than-expected compensation expenditures stem from the fact that the
compensation system is increasing retention of experienced employees more than expected.
The result is fewer compensation savings from replacing senior employees with new
employees, but also lower recruitment and training costs and a more productive workforce.
Of course, higher-than-budgeted compensation expenditures may not be wonderful news.
Perhaps the job evaluation system has been overly generous in rating jobs, so that too many jobs are in high pay grades. Perhaps supervisors are granting merit increases too readily.
Perhaps the performance thresholds for individual bonus plans have been set too low.
Perhaps some employee benefits are costing much more than expected.
Of course, still another possibility is that the budgeted compensation figures were not realistic
in the first place; if so, any comparisons to the budget are meaningless.
Compensation Cost Indicators
When examining compensation costs, firms should at least examine two main indicators:
compensation cost ratios and average earnings per employee. Compensation cost ratios are
determined by taking total compensation costs as a percentage of total costs or as a
percentage of revenues. Average employee earnings takes total compensation and divides it by the number of full-time-equivalent employees it covers. These two measures are not
synonymous and tell us different things.
For example, it is possible for average employee earnings to go up but for the compensation
cost ratio to go down. It is also possible for average employee earnings to go down but for the
compensation cost ratio to go up. Finally, it is also possible for both average earnings and compensation cost ratio to go up and for company profits to go up at the same time. How can
this be?
Average employee earnings takes the perspective of the individual employee. If average employee earnings go up, then the typical employee is earning more money; if it goes down,
the typical employee is earning less money. Compensation cost ratio takes the total of all
compensation paid to all employees. It may change for one of three reasons: if average employee earnings change, if the total number of employees changes, or if total costs or
revenues change. Thus, it is possible for average employee earnings to increase but for the
compensation cost ratio to decrease, if fewer employees are required to perform the work of
the organization.
It is also possible for the compensation cost ratio to increase, even without any increase in
total compensation or average earnings, if total costs or revenues go down. If the increase in the compensation cost ratio is due to lower noncompensation costs, then the increase in the
compensation cost ratio is not necessarily bad news at all. However, if the increase in the
compensation cost ratio is due to declining revenues, then it is bad news, although not necessarily bad news caused by the compensation system. Conversely, a decrease in the
compensation cost ratio is not good news if it is due to increases in noncompensation costs,
but it is good news if it is due to increases in revenues. In the latter case, the decreased
compensation cost ratio is a sign of greater productivity.
Clearly, what happens with employee earnings and total compensation costs is just part of the
picture. Also important is what happens to employee performance and productivity.
Employee performance may be instrumental in reducing noncompensation costs or in increasing revenue. Also, higher average earnings may increase the employee retention rate,
thus reducing recruitment and training costs.
In medium to large organizations, it makes a lot of sense to examine compensation expenditures on a unit-by-unit basis. If one or two departments stand out from the others, this
difference may warrant investigation. These differences may turn out to be justified, or they
may indicate inconsistency in the application of the new system. Other ways to assess compensation costs are by comparing them with compensation expenditures in previous
years or with those of competitors.
But note that unless the goal of the new system is only to reduce compensation costs, compensation costs alone do not give the whole picture. What is important is what the
organization is receiving in return for its investment in compensation. So any evaluation that
starts and ends with compensation costs may be worse than useless. Instead, the total impact
of the system must be assessed.
Impact on Employee Behaviours and Attitudes
A variety of indicators can be used to assess the extent to which the desired employee
behaviours and attitudes are occurring. As you know, three types of employee behaviour— membership, task, and citizenship—may be important to an organization, as well as three key
job attitudes—job satisfaction, work motivation, and organizational identification. Additional
attitudes that are highly relevant are employee attitudes toward compensation processes and
compensation results.
Membership Behaviour
Three key aspects of membership behaviour are attraction, retention, and attendance. Various indicators measure how effective the organization is at attracting new members. One
indicator is simply the number of qualified applicants that job postings attract. Another is the
percentage of offers made to potential new employees that are refused.
The main indicator of retention is employee turnover; however, some types of turnover are
more serious than others. For example, is turnover spread across employees performing at
different performance levels, or is it mainly high-performing employees who are quitting? Is
turnover concentrated in certain departments or units? Reasons for turnover are also important. Some employees quit because they have received a better offer from another
employer; other employees quit because their spouses have been transferred to other cities. It
is important to know the main reasons for employee turnover. Many organizations use exit
interviews in an attempt to ascertain why employees are quitting the organization.
Another indicator of membership behaviour is absenteeism. Absenteeism can be measured in
a variety of ways. One method is to simply tally up all the days missed by employees for any reason and divide by the number of employees. Note, however, that some absenteeism is
unavoidable, due to reasons such as illness. That is why many experts argue that involuntary
absenteeism should be excluded from the calculations. But while it might be theoretically correct to do this, actually doing it may be quite difficult. An alternative is to add up the
number of occurrences and divide by the number of employees, thus yielding a statistic that is
less likely to be skewed by long absences owing to serious illness.
Task Behaviour
Employee performance has at least two dimensions: quantity and quality of work produced.
Quantity of work can be measured in a variety of ways. For example, units produced or number of clients served can be divided by the number of employees, and compared over
time or with competitors. Another measure is revenue divided by number of employees.
Quality of performance can also be measured using indicators such as customer satisfaction,
number of employee errors, or scrap losses.
Citizenship Behaviour
Citizenship behaviour is the most difficult of the three key behaviours to measure in a
quantitative way. One indicator might be the number of useful employee suggestions that are
submitted. In addition, indicators such as “shrinkage”—employee theft—can be expected to
decline if citizenship increases. Other departments or customers can be surveyed to determine
the degree of cooperativeness and citizenship practised by members of a given department. Feedback from customers about employees who go above and beyond the call of duty can be
gathered.
Job Attitudes
Throughout this book, three key job attitudes have been discussed: job satisfaction, work
motivation, and organizational identification. Over the years, many survey scales that
measure these attitudes have been developed. In recent years, surveys have also included measures of “employee engagement,”28 which is analogous to intrinsic motivation. Many firms
conduct employee attitude surveys on an annual basis to track these attitudes over time.
Compensation Attitudes
Employee attitudes toward the compensation system can also be surveyed. Two types of
compensation attitudes need to be assessed: satisfaction with the total amount of
compensation received (distributive justice), and satisfaction with the process by which compensation is determined (procedural justice). Both reflect the perceived fairness or equity
of the system (see Chapter 3).
Attitudes toward individual components of compensation can also be examined. For example, are employees satisfied with the amount and fairness of their merit pay? What about the
profit-sharing plan? Many organizations that use internal compensation surveys have a
section dealing with employee benefits. Which benefits are employees most satisfied with?
Least satisfied? Is the amount of the benefit satisfactory? Are benefits fairly allocated? Would
employees prefer to replace certain benefits with other benefits?
Another important aspect to examine is employee understanding of the compensation
system. Misunderstandings can cause dissatisfaction and complaints. Perhaps even more important, a system that is misunderstood will not have the desired effect on employee
attitudes and behaviour, even if it is designed properly.
Organizations can also infer compensation understanding and attitudes toward compensation from employee behaviours. For example, the number of employee calls to the
compensation office may provide an index of understanding. The number of complaints and
grievances that pertain to compensation can also be tallied and examined. Or if there is a formal appeals process for compensation, the number of appeals initiated and the number
granted can also be examined.
// Monitoring Changing Circumstances
“Compensation systems don’t suddenly break; instead they gradually become obsolete.”29 In
some cases, this obsolescence is so gradual that nobody notices that the compensation
system is no longer adding value to the organization. To prevent obsolescence and ensure
maximum value, organizations need to watch for changing circumstances that signal a need
for adjustments to the system. These changing circumstances may be external or internal to
the organization.
Changes in External Circumstances
External circumstances that may trigger a need for changes in the compensation system
include legislative and tax changes, labour market changes, changes in competitive
conditions, and socioeconomic changes.
Legislative and Tax Changes
Provincial and federal laws have a significant impact on compensation systems. Moreover,
these laws change quite often, because of revisions made by legislators or court decisions.
Examples include employment standards laws, human rights laws, and pay equity laws. At the beginning of each year, organizations need to be aware of changes to RRSP limits,
Canada/Quebec Pension Plan payments, Employment Insurance payments, and income tax
and/or corporate tax provisions. Any of these changes may have implications for the
compensation system.
Labour Market Changes
As the demand or supply of particular categories of workers changes, attracting and retaining
employees can become more—or less—difficult. The compensation system may need to
change in response to either situation.
Competitive Environment Changes
Changes in competitors’ policies or the emergence of new competitors may have significant implications for compensation policies, either directly or indirectly. An example of a direct
implication is when a competitor adds an attractive new benefit to its compensation package,
so that it is difficult to attract employees without offering a similar benefit. An example of an indirect implication is when new competitors force existing firms to adopt a new managerial
strategy, which then triggers a need for change in a variety of structural variables, including
compensation.
Socioeconomic Changes
Changes in either social attitudes or general economic conditions can also trigger a need for
changes to the compensation system. For example, if economic conditions become more buoyant, an organization may decide to focus on noneconomic types of rewards, such as
advancement opportunities or intrinsic rewards. If social attitudes toward a particular
industry become less favourable, the organization may need to boost pay levels.
Demographic changes may also be important. For example, an aging workforce will likely trigger a much greater focus on pension plans and health benefits. Demographers point out
that baby boomers (the generation born between 1947 and 1966) caused a major blockage to
career advancement in organizations because the top end of hierarchies simply cannot
accommodate so many people. However, this blockage should gradually diminish; the first of
the boomers started to reach retirement age in 2012.30
This process will take a decade or more, so in the meantime, experts suggest that spiral career
paths will continue to be important, with most employees taking at least two sideways steps for each step up the hierarchy. This spiral pattern creates more pressure for firms to adopt
pay-for-knowledge systems. However, whether or not a pay-for-knowledge system is
implemented, employees will also value training and education opportunities highly as rewards (both for intrinsic reasons and because this makes employees more marketable), and
organizations that offer these rewards will be much more attractive to employees than those
that do not.
Changes in Internal Circumstances
Internal changes that can trigger a need to change the compensation system include changes
in managerial strategy, in the workforce, in the organization’s financial circumstances, and in
the scope of the organization.
Changes in Managerial Strategy
Whenever the organization’s fundamental managerial strategy changes, so must the
compensation strategy. Factors that drive changes to managerial strategy have already been
covered; they include changes in the organization’s environment, its technology, its
competitive strategy, its size, and its workforce. These changes themselves may also trigger a
need for compensation changes.
Changes in the Workforce
Changes in the organization’s workforce affect reward and compensation systems in a variety
of ways. If the type of employee recruited by the firm changes over time, then the needs of these employees may be different from those of previous employees, and the compensation
system may have to change to recognize that. For example, if the workforce ages,
compensation will need to be oriented more toward pension plans and retirement income. Conversely, if the workforce becomes younger, more cash and more family benefits, such as
dental plans, may be needed.
A trend for most organizations in Canada is toward greater workforce diversity. This makes it more difficult to define a single reward system that meets everyone’s needs. Some
compensation elements, such as a flexible benefit plan, can accommodate diversity and
changes in the workforce more easily than other systems.
Changes in Financial Circumstances
A weakening of the organization’s financial circumstances may trigger a need to cut costs,
including compensation costs. The compensation strategy may be sound, but the
organization may simply no longer have the funds to support it. In these circumstances, firms
often ask for compensation concessions from their employees. As discussed later in the
chapter, organizations have a variety of options for dealing with this problem. Firms with a greater degree of variable pay are less vulnerable to these changes than firms with less
variable pay.
Changes in Scope of the Organization
One obvious circumstance requiring adjustment of the compensation system is a company
merger or acquisition. The two organizations will almost certainly have different
compensation systems. Merging the systems can be a very complex process, and there are no hard and fast rules for doing so. Of course, in some cases, integrating the compensation
systems may not be necessary if the organizations are to operate autonomously.
But when the units are to be integrated, a wide variety of compensation decisions will have to be made. The usual practice is to adopt the compensation system of the largest actor in the
merger, but there are many constraints on this process, including legal obligations.
Furthermore, not merging the compensation systems where employees will be working together doing similar work is a formula for inequity and dissatisfaction as well as an ongoing
administrative nightmare. This is just one of the reasons mergers often turn out to be much
less successful than originally envisaged.
// Adapting The Compensation System
What do you do when your evaluation has indicated that your compensation system is not
achieving the expected results? How do you identify adaptations that will produce the desired results? Before you can answer this question, you will need to know exactly what is going
wrong with your current system. The problems might not have anything to do with your
compensation system at all, so you must first ascertain whether this is the case.
This final section of this chapter discusses some key considerations when making adaptations
to the compensation system. Then it examines two specific situations that may call for making
adaptations: financial crises and labour shortages. Finally, it deals with the thorny question of
whether exceptions to compensation policy should be made for individual employees.
Identifying What to Adapt
Suppose your compensation system does not seem to be producing the desired results. Your
first reaction may be to ask yourself what changes to the compensation system should be
made to correct this problem. But this should not be your first question.
Your first question should be: Why are the desired results not occurring? There are many
possible answers. Perhaps the wrong compensation strategy was adopted. But maybe not. Perhaps the compensation strategy is correct, but the technical processes for transforming the
strategy into a compensation system were poorly designed. Or maybe these two aspects are
fine but the system itself has been poorly implemented.
Maybe the necessary complementary policies have not been implemented. For example, a system for employee participation in decision making is necessary to realize the benefits of
employee stock plans. Effective training programs are necessary for pay-for-knowledge
systems to work. Or the lack of results could also simply be a problem of time: you are expecting too much too soon. Alternatively, maybe the problem is due to some cause
completely unrelated to compensation, such as an aging plant or changes in the quality of raw
materials. Finally, perhaps your expectations for the compensation system were not realistic
in the first place.
So how do you know which it is? All of this shows that compensation is less a science than an
art and that there is no substitute for understanding the organization and its people. This is why comprehensive evaluation data are so important. Evaluation data should allow you to
rule out certain causes and perhaps pinpoint the problem. For example, if employees do not
understand the compensation system, or if they misperceive it, this should be corrected
before any changes are made to the compensation system itself.
The key point to remember here is that only when you have identified the cause of the
perceived problem can you identify the proper adaptations. And when considering adaptations, they must be placed in the context of the system as a whole. Piecemeal changes
to deal with specific problems may end up creating new problems, as will be seen shortly.
Adapting to Financial Crises
When a financial crisis hits an organization, compensation expenditures often look like a
tempting target. The classical approach to cutting costs is to either lay off employees or to
attempt to cut compensation or benefits. (Compensation Today 13.3 tells how one firm
stirred its workers into a real lather by cutting a treasured benefit!) However, this approach may be shortsighted, depending on the cause of the crisis, its likely duration, and the nature of
the organization. For example, if the crisis is not due to out-of-line compensation costs, or is
likely to be short term in duration, cutting compensation may not be a good solution.
In fact, if the organization practises human relations or high-involvement management,
cutting compensation should be the solution of last resort. Cutting compensation will cause
problems for most organizations, but these problems will be least severe for classical organizations, since they likely do not have positive job attitudes and citizenship behaviour to
protect and the organization is geared toward making employees replaceable. But cutting
compensation will likely cause serious problems for human relations and high-involvement
organizations, because this action may be seen as violating the psychological contract
between employees and the firm.
COMPENSATION TODAY 13.3
Reduced Suds Puts these Workers into a Real Lather!
The tough economic circumstances in 2009 caused many employers to look for ways to cut costs. Layoffs risk losing valuable workers and pay cuts are strongly resisted by workers, so
many firms first chisel away at employee benefits. Surveys show that things such as fitness
club memberships, tuition reimbursement, and subsidized dining are among the first to go.
But Molson Breweries has really hit its employees where it hurts. For many years, both
employees and retirees have been entitled to up to six dozen free bottles of Molson beer every
month for as long as they live. (The beer is, however, deemed a taxable benefit by the Canada
Revenue Agency, so employees and retirees are not getting away scot-free.)
In a cost-cutting move, the brewery announced that the free beer “ration” would be cut back
to two dozen bottles of beer a month for current workers, one dozen a month for retirees (to be phased out completely in five years), and none at all for new employees. The retirees are so
frothed up that they recently demonstrated outside the brewery in St. John’s, Newfoundland,
and their union has promised to fight the changes to the free beer ration.
Source: “Molson Free Beer Allocation Goes Flat for N.L. Retirees,” CBC News, June 5, 2009, at
http://www.cbc.ca/canada/newfoundland-labrador/story/2009/06/05/beer-cut-605.html.
If there is no alternative to pay cuts, there are five measures that can minimize the damage to
employee morale:
• First, provide full information on the crisis, showing that all other
possible avenues for addressing the problem have been exhausted.
• Second, seek employee input on ways to deal with the crisis. In some
cases, this may even produce a solution, but if not, communication
creates an organization-wide understanding of the crisis.
• Third, ensure that compensation cuts are fairly shared throughout the
organization.
• Fourth, consult with employees on how best to achieve the necessary
compensation reductions. For example, some employee groups may
prefer reductions in certain benefits rather than decreases in base
pay, while others may want to keep their benefits and reduce base
pay. In some firms, early retirement programs may be preferred over
layoffs. Another alternative to layoffs is to share the available work by
going on a shortened workweek. As Compensation Today
13.4 describes, firms that opt for work-sharing programs can get
federal support for so doing.
• Fifth, make commitments to provide future rewards when
circumstances permit. For example, some firms have implemented
employee stock bonus plans when cutting other compensation, as
one way of guaranteeing that employees receive rewards from any
upturn in the firm’s fortunes.
COMPENSATION TODAY 13.4
Work-Sharing or Layoffs: To Share or not to Share?
As the economy went into a tailspin in 2008, Essar Steel Algoma, in Sault Ste. Marie, Ontario,
faced a serious problem—a drastic reduction in the demand for steel. To survive, the firm
needed to slash costs.
However, the firm wanted, as much as possible, to avoid layoffs in dealing with this problem.
So the firm looked for ways to cut costs and still keep people working. It curbed discretionary
spending. It stopped outsourcing some work and used its own employees instead. It
eliminated overtime. It offered early retirement incentives.
All of these measures helped but were not enough. Layoffs loomed. But before going ahead with them, the firm approached its two locals of the United Steelworkers Union (one local for
salaried employees and the other for hourly workers) to see whether they would consider
entering into a work-sharing program, whereby employees would work 32 hours a week
instead of 40 hours and receive Employment Insurance to cover the lost 8 hours of work. The 600 salaried workers voted 54 percent in favour, while the 2,700 hourly workers voted against
the plan.
Under the federal work-sharing program (which must be approved by both employee and
employer representatives and the Employment Insurance Commission), the company pays
each of its salaried workers for four days of work a week at normal pay rates. On the day that
employees don’t work, Employment Insurance provides 55 percent of their normal daily pay. Overall, this amounts to a pay reduction of about 12 percent for working four days instead of
five. Starting in February 2009, this arrangement would last for 26 weeks, with the option to
extend it another 12 weeks if all parties agreed.
What happened with the hourly workers, who voted against work sharing? By the end of
February 2009, 180 of them had been laid off. However, the company continued to experience
financial difficulties. By late 2015, with steel prices and demand dropping across North
America, production levels had to be curtailed and additional workers laid off.
Sources: Shannon Klie, “El Program Helps Employers Avoid Layoffs,” Canadian HR Reporter, March 9, 2009, 1–2; Elaine Della-Mattia, “Layoffs at Essar Start Sunday,” Sault Star, October 5,
2015, at http://www.saultstar.com/2015/10/02/layoffs-at-essar-start-sunday, accessed July
2016.
Perhaps it is not necessary to actually cut compensation costs, but rather to contain them.
Several possibilities are available:
• Enact a hiring freeze.
• Contain benefits costs.
• Replace fixed pay with variable pay.
• Replace some raises with bonuses.
• Tighten controls to slow progress through the pay range.
• Ensure that regional differences in wages are reflected in regional pay
levels.
• Create a two-tiered pay system, under which new employees come in
under new salary scales that are lower than the salary scales for
existing employees.31
Of course, the best approach to financial crises is to avoid them, or failing that, to have a
system in place that will adjust to financial problems. Financial problems are less likely to arise if the compensation system adds maximum value to the organization. Use of an
appropriate variable pay component within the compensation system can promote employee
performance and can also help make compensation adjust to the firm’s financial circumstances. Some firms attempt to avoid having to cut compensation costs by maintaining
production slightly below demand. Others keep a workforce of part-time employees or
contingent employees to help protect core employees. There are many possibilities.
Adapting to Labour Shortages
One problem organizations often encounter is a shortage of particular types of labour. For
example, several years ago, Canada experienced shortages of technical employees,
particularly those skilled in computer applications and software development. One way of coping with this problem is the use of technical premiums, through which technical
employees receive extra compensation.
According to a survey of Canadian firms, the most common approach to providing a technical
premium is to place the needed employees higher in the pay range than would normally be
justified. One-third of the firms offering technical premiums offered one-time cash “signing bonuses.” Some firms used the normal pay rates but added a fixed percentage that would be
carried along with these employees as they progressed through the pay range. A few firms
offered special stock options to these employees.32
The danger of making many of these adjustments is that they can undermine the overall
integrity of the compensation system. Equity concerns can arise if this group of employees is
being treated significantly differently from other groups of employees. Moreover, because of compounding, compensation costs for these employees can easily spin out of control,
especially if incentives and benefits are calculated as a percentage of base pay. There is also
the issue of how to deal with these salaries when there is no longer a shortage of the particular
skill in question.
Of course, rather than attempting to lure away one another’s employees, organizations can
deal with a skills shortage through internal training. Although training may not be feasible for all employers, especially if they need quick expansion, this approach has numerous benefits. It
provides opportunities for training and development to current employees, shows
commitment by the organization, is more likely to create employees with skills specific to employer needs, avoids skewing the compensation system, and helps solve the labour
shortage.
// Should Exceptions be made for Individual
Employees?
A dilemma every organization has to deal with occurs when an individual employee demands
special treatment. For example, an employee may brandish a job offer from another
organization, asking her or his current employer to “meet it or beat it.” Of course, frequent
occurrences of this sort suggest that your compensation system needs to be reassessed. But what do you do about the individual employee? The temptation is to match the competitor’s
offer, even if it puts the individual outside the pay range for that job.
The problem with that solution is that it undermines the integrity and equity of the total compensation system. To avoid doing so, it may well be preferable to let the employee go to
the other job. This individual may be more valuable to the other employer, justifying the
higher rate of pay the other employer is offering. Or the other job may not really be comparable—it might include different job duties or duties not included in your company’s
job.
There may also be some other way of satisfying the employee, such as transferring the employee to more rewarding work or to work that has more opportunities for promotion, or
providing training opportunities. In fact, sometimes presentation of a job offer may represent
a cry for recognition by the employee or some other problem, rather than a true desire to leave
the firm.
A dilemma can also arise when recruiting new employees during brief, dramatic periods of shortage of certain kinds of expertise. If the firm responds by sweetening its offers to new
employees, these employees may end up earning more than existing employees. Even if this
inequity is subsequently corrected, this action may shake employees’ confidence in the equity of the system. It is far better to address this issue before it becomes a problem or to address it
in a comprehensive way, rather than in a piecemeal fashion.
// SUMMARY
This chapter has covered the final stretch along the road to an effective compensation system:
the processes for implementing, managing, evaluating, and adapting the system. You now
understand the issues that need to be dealt with in preparing for implementation, including
preparing the compensation budget, planning for the mechanics of compensation
administration, planning for information technology, and whether to do compensation
administration in-house or to outsource some or all of it.
You have also learned the key components of an implementation plan, including development
of a plan for managing implementation, for training, for communication, and for evaluation of
the success of the new compensation system. You have learned the six steps in the
implementation process itself: establishing the implementation bodies, putting the
infrastructure in place, testing the system, conducting training, communicating the system,
and launching and adjusting the system.
And you have learned the importance of carrying out ongoing communication about the
compensation system, once implemented, and of ongoing evaluation of the compensation
system. To truly understand the impact of the compensation system, you must use a variety of indicators, because simply reviewing the system against projected costs or goal attainment
can give a misleading picture.
The chapter has noted that compensation systems usually do not suddenly “break,” but gradually become ineffective. To prevent this occurrence, you always need to be vigilant about
monitoring circumstances external and internal to the firm. External circumstances include
legislative, labour market, competitive, and socioeconomic changes. Internal circumstances include changes in managerial strategies, the workforce, financial conditions, and
organization scope.
Even if the compensation system appears in need of change, the exact adaptations that need
to be made are not always obvious. You first need to understand what is going wrong with the current system. It may turn out that what looked like a compensation problem is actually
caused by something else.
A final issue is how to adapt to financial problems, labour shortages, and individual employees
who are threatening to quit. You have learned that piecemeal adaptations made for the
purposes of expediency can undermine the integrity of the entire compensation system, and
so must be avoided.
With this chapter, you have now followed the entire road to compensation effectiveness. But
that does not mean that your learning is at an end. Unlike reading a book, the journey to effective compensation has no end, because compensation needs to evolve as the
organization and its circumstances change. The road to effective compensation is actually
more like an ever-changing maze than a speedy expressway. But that’s what makes
compensation so challenging and interesting!
Key Terms
• average employee earnings
• compensation administration
• compensation cost ratio
• initial dip
• spiral career paths
• technical premiums
Discussion Questions
Discussion Question 13.1
Review
Why is compensation communication such an important aspect of an effective compensation system? Your Answer
No answer submitted
Discussion Question 13.2
Review
What issues should you consider when deciding whether to outsource compensation functions?
Your Answer
No answer submitted
Discussion Question 13.3
Review
Why is it so important to have a process for evaluating the compensation system?
Your Answer
No answer submitted
Discussion Question 13.4
Review
What are the key forces that could trigger a need to adapt or modify the compensation system? Which of
these do you think are the most important?
Your Answer
No answer submitted
Discussion Question 13.5
Review
Discuss three ways in which an organization can evaluate the effectiveness of its compensation systems. Your Answer
No answer submitted
Using the Internet
Using the Internet Question 13.1
Review
Go to the Resources and Fact Sheets page of the Office of the Privacy Commissioner of Canada website.
Scroll down the page and review the ten employer responsibilities under PIPEDA. What are the ways in which adhering to these responsibilities might affect the practice of compensation management?
Your Answer
No answer submitted
Exercise
Exercise Question 13.1
Review
Form small groups. Each member of the group should check with a current or previous employer (or some
other employer if this is not convenient) to determine whether the organization is outsourcing some or all
of its compensation administration. Is the company happy with the current system? Why or why not? Your Answer
No answer submitted
Case Question
Case Question 13.1
Review
In previous chapters, you may have prepared compensation strategies for The Fit Stop or one of the other cases in the Appendix. If so, develop a detailed plan for implementing the new compensation strategy at one of these firms. If not, prepare a compensation strategy for one of these firms, design the technical
processes, and develop the implementation plan.
Your Answer
No answer submitted
Simulation Cross-Reference
If you are using Strategic Compensation: A Simulation in conjunction with this text, you will
find that the concepts in Chapter 13 are helpful in preparing Sections N and O of the
simulation.
// Notes
1. Anne C. Ilsemann and Mark Simms, “Using Information Technology for Salary Budgeting and
Planning,” in The Compensation Handbook, ed. Lance A. Berger and Dorothy R. Berger (New
York: McGraw-Hill, 2000), 189–96.
2. David M. van De Voort, Stephen W. McDonnell, Philip Drouillard, and David E. Tyson,
“Computers in Compensation,” in Carswell’s Compensation Guide, ed. David E. Tyson
(Toronto: Thomson Carswell, 2009), 14B-1–14B-26.
3. Nadine Winter, “Job Evaluation in a New Business Environment,” Canadian HR Reporter,
March 27, 2000, 17.
4. Cathy Ledden and Brenda McKinney, “Well-Made Intranet Offers Boundless
Opportunity,” Canadian HR Reporter 18, no. 2 (2005): 14.
5. Larry Shetzer, “Online 360-Degree Feedback Encourages Bottom-up Decision-
Making,” Canadian HR Reporter, November 6, 2000.
6. Ilsemann and Simms, “Using Information Technology.”
7. Alan McEwen, “Privacy Concerns, Technology, Fuel the Debate over Electronic
Forms,” Dialogue, April–May 2001, 16–19.
8. Vic Murray, “Contracting Out HR Services: Passing Fad or Here to Stay?,” Human Resources
Management in Canada, July 1997, 637–41; Steve White and Penny Plante, “A Midsized Proposition: Benefits Outsourcing Is Not Just for Large Organizations,” Benefits Quarterly, 27,
no. 2 (2011): 19–23.
9. David Brown, “CIBC HR Department Halved as Non-Strategic Roles Outsourced,” Canadian
HR Reporter 14, no. 11 (2001): 1, 6.
10. Todd Humber, “Has the Shine Come Off HR Outsourcing?,” Canadian HR Reporter,
January 29, 2013, online.
11. Conference Board of Canada, Compensation Outlook 2005 (Ottawa: 2005).
12. Humber, “Has the Shine Come Off HR Outsourcing?”
13. Lisa Crowley, “Outsourcing Payroll: How Much Do You Want to Give Up?,” Canadian HR
Reporter17, no. 15 (2004): G5.
14. Kevin Dobbs, “Rightsourcing: Using a Mix of In-House and ASP Software,” Canadian HR
Reporter14, no. 10 (2001): G5, G10.
15. Brian Hackett, Transforming the Benefit Function (New York: The Conference Board, 1995); Sarah Dobson, “Plowing Ahead with Payroll, HRIS,” Canadian HR Reporter, 27, no.1 (2014):
7, 9.
16. Statement by John Sullivan, Professor of Management at San Francisco State University, cited in Karen Beamon, ed., Out of Site: An Inside Look at HR Outsourcing (Burlington:
IHRIM, 2004).
17. Monica Belcourt, “Outsourcing—The Benefits and the Risks,” Human Resource
Management Review, 16 (2006): 269–279.
18. Suzanne Harrison, Outsourcing and the “New” Human Resource
Management (Kingston: IRC Press, 1996).
19. Claudio Belli, “Strategic Compensation Communication,” in The Compensation
Handbook, ed. M.L. Rock and L.A. Berger (New York:McGraw-Hill, 1991), 604–16.
20. David E. Tyson, ed., Carswell’s Compensation Guide (Toronto: Thomson Carswell, 2009).
21. Rob Lewis, Susan Hunter, and Marie Donnelly, 2012. “Getting Managers On Board with
Total Rewards,” Canadian HR Reporter 25, no. 14 (2012): 18.
22. Andrew A. Luchak and Morley Gunderson, “What Do Employees Know About Their Pension
Plan?,” Industrial Relations 39, no. 4 (2000): 646–70.
23. David Brown, “Employees Ill-Equipped to Make Pension Choices,” Canadian HR
Reporter 14, no. 10 (2001): 1, 12.
24. Joe Nunes, “How Pensions Got Tangled in Total Rewards,” Canadian HR Reporter 18, no.
3 (2005): R10.
25. Natalie C. MacDonald, “Going Flex Comes with Obligations for Employers,” Canadian HR
Reporter17, no. 4 (2004): G5–G11.
26. MacDonald, “Going Flex,” G11.
27. Alexander Roberts, “Integrating Strategy with Performance Measures,” Management
Development Review 7, no. 6 (1994): 13–15.
28. Alan Saks, “Engagement: The Academic Perspective,” Canadian HR Reporter, January 26,
2009, 31.
29. Paul B. Britton and Christian M. Ellis, “Designing and Implementing Reward Systems:
Finding a Better Way,” Compensation and Benefits Review 26, no. 4 (1994): 44.
30. David K. Foot and Rosemary A. Venne, “Population, Pyramids, and Promotional
Prospects,” Canadian Public Policy 16, no. 4 (1990): 387–98.
31. Although it is more than 20 years old, the most comprehensive source for learning about
two-tier compensation systems remains James E. Martin and Thomas D. Heetderks, Two-Tier
Compensation Structures: Their Impacts on Unions, Employers, and
Employees (Kalamazoo: W.E. Upjohn Institute, 1990).
32. Ann Allen, “Trolling for Technical Employees: Using Technical Premiums as Bait,” Human
Resources in Canada, June 1997, 621–25.
Appendix // Cases for Analysis
The following cases, which reflect a range of compensation issues and organizational types,
can be used in a variety of ways. They are presented without any questions attached to them
to allow instructors flexibility in their use. They can be used in conjunction with the end-of- chapter case questions to illustrate compensation issues relevant to that chapter and to
provide opportunities for applying compensation concepts. They can also be used as a basis
for major term assignments or group projects. Some are short enough to be used as exam cases. And, of course, they can serve as a basis for lively class discussions of many important
compensation issues.
Achtymichuk Machine Works
At the Achtymichuk Machine Works, each department has one or two clean-up employees who
clean around the machines and also take care of the washrooms, hallways, and other areas.
The cleaning job has the lowest status of any in the plant, although the pay is fairly good
because the plant has had difficulty getting enough cleaners. The pay for cleaners is based on
a flat hourly rate and provides only mandatory benefits.
There are 20 cleaners in all. They report to the supervisors of the departments in which they work, but the supervisors are very dissatisfied with them. A common complaint is that as soon
as a cleaner knows what is expected on the job and learns to do it right, he or she quits.
Moreover, the cleaners are frequently absent and often come late.
Alliston Instruments
Alliston Instruments is a manufacturer of specialty medical instruments located in southern
Ontario. Manufacturing involves two types of processes. First, individual workers produce the components for the medical instruments in batches of various sizes, using a variety of
machine tools and equipment. Then other workers assemble the components into finished
products. Assembly is done sequentially, with each product passing through four to six workstations before completion. The quality of the products, which is crucial, depends on
both the quality of the component parts that are produced and the quality of the assembly
process.
It is late January 2016 and the financial statements for 2015 have just been released. They are grim. For the first time in the company’s 50-year history, the firm has shown a loss. The
company’s chief executive officer believes a lot of this has to do with production problems.
The 2015 production reports indicate that although the number of units produced per employee showed a slight increase last year, the number of defective units reached an all-time
high. In addition, there was a high rate of wastage of raw materials and other supplies.
Although total sales (and therefore total production) are down from the previous year, total
labour costs are up. As a result, costs per unit are at an all-time high.
Because you are an expert in human resources management, the CEO has asked for your help.
As background for your work, the CEO briefs you on industry conditions. Until two years ago, the firm had enjoyed increasing sales over many years. It had also had increasing profits, with
a record profit of over $3 million in 2012. However, in the last two years, the medical
instruments industry has become more competitive. High-quality medical instruments are now being produced by several Asian firms, two of which entered the Canadian market in
2013. (Previously, the main competitors in the Canadian market were U.S. and European firms,
but they are not much of a problem because their products are very high priced.)
Because of low labour costs, the Asian firms are able to price their products attractively;
however, buyers initially held back, concerned about potential quality problems. So for a
while, it appeared as if Alliston’s customers (mainly hospitals and health clinics) would remain
loyal, even though they were themselves under pressure to cut costs, due to budget cuts. But in late 2013, an Asian competitor made a major sales push by slashing prices, and this cut
dramatically into Alliston’s 2014 sales. In mid-2014, Alliston laid off 50 employees. Although
the firm had laid off employees from time to time in the past during production lulls, this was
the largest layoff in company history.
To make up for the loss of sales, Alliston added a number of new products to its line. (Over the
years, the company had tended to stick with the same set of products, although new products
were being put into use in the hospitals.) While some of these new products sold well, they didn’t really make money, because production costs were higher due to the need for new
equipment and extensive employee training. Moreover, most employees preferred to work on
the old products, so supervisors had to use a lot of pressure to get them to work on the new
products.
Alliston’s 250 production workers have been unionized since the 1960s. In 2012, they staged a
short but bitter strike. Because product demand was so high, the company did not want a long work stoppage, and the union was able to win significant wage increases for 2013 and 2014 (a
two-year contract was signed). Since then, union-management relations, never very good,
have been quite strained. Relations between supervisors and workers are no better.
Supervisors complain about lazy workers who don’t care if they do a good job or not, and
workers complain about overbearing supervisors who allocate work unfairly and spend all
their time watching and harassing employees.
Interestingly, the employee turnover rate is low at Alliston. Pay at the firm is above average,
and the benefits package, which increases with seniority, is very good, comprising about 25
percent of total compensation. Comparable alternative employment opportunities in the area
are quite scarce.
In late 2014, in an effort to increase efficiency, the firm persuaded the union to accept an
incentive system in which employees would receive, in addition to their hourly wages, a bonus
based on individual output, rather than an increase in base pay for 2015. A standard per-hour
production rate for each item or assembly operation was established, based on estimated
2014 production levels. (However, because the firm had never kept detailed records, these
standards were simply based on the estimates of supervisors.)
Under the new system, if production per hour for a particular item exceeds 2014 levels, the
employee receives a fixed sum for each piece produced over that level, in addition to the
normal hourly pay. Of course, employees do not receive a bonus for items that are not of satisfactory quality, and supervisors are expected to deduct these from the employee totals.
However, there are no set standards for quality, and each supervisor seems to set different
standards.
There seem to be many problems with this new pay system. For example, workers complain
that the production standards for some tasks are set too high and that they have no chance of
earning a bonus on these items. Everybody tries to avoid these jobs, and productivity on them is poor. On the other hand, there are some jobs that everybody wants to do, because
substantial bonuses can be earned, and productivity is up dramatically on these jobs. But the
net effect is that overall units produced per employee have not really changed at all, while
substantial sums are being paid out in bonuses.
In the past year, ten production workers have retired or quit and not been replaced, but this
workforce reduction was made possible by the drop in sales during the year, not by increased
productivity. However, this reduction in the workforce has been partly offset by the need to hire two additional supervisors to handle the increased needs for supervision, inspection, and
administration of the bonus system, plus one additional full-time clerical person in the payroll
department just to handle the calculations for the new bonus system.
Supervisors have complained bitterly about the new system, saying it is placing additional pressure on them. They say it is causing increased conflict with employees because nobody
wants the “bad” (i.e., poor-paying) jobs, and that employees resent it when these “bad” jobs
are assigned to them. They find that employees don’t care about quality as long as output meets minimum standards, nor do they care about the high wastage of raw materials.
Supervisors have to supervise more closely to deal with these problems and try to keep quality
and productivity up on the “bad” jobs.
And to top it off, supervisors are now making less money than some of the workers, since they
are not eligible for the bonus system. The fact that none of the non-union employees received
any pay increase last year does not help their mood, either. During the year, three experienced supervisors have quit. The firm had never had more than one or two supervisors quit in a
single year before.
Although the union is generally opposed to individual performance pay plans, it had accepted this one in return for a clause in the collective agreement ensuring job security for the current
unionized workforce. Any workforce reductions occurring from greater efficiency will have to
be achieved through attrition. Management had agreed to this condition because they did not expect to have to lay off employees. They had expected the new bonus system to reduce unit
costs of production so that Alliston could lower its prices and win back the business that had
been lost.
It hasn’t worked out that way. Financial data for the last four years are shown below. They indicate that sales peaked two years ago at $31 million and have since fallen to $24 million.
Customers are complaining about product price and quality. However, the company cannot
afford to reduce prices, because unit costs are so high. It is clear to management that
something needs to be done, and quickly, but exactly what should be done is not so clear!
Eastern Provincial University
The following job descriptions are used for compensation purposes at Eastern Provincial
University, which employs around 900 professors and 1,500 nonacademic staff and has about
20,000 undergraduate and graduate students. Descriptions are provided for the job classes of
clerk stenographer, draftsperson, grounds worker, and medical laboratory technologist.
CLERK STENOGRAPHER I
Kind and Level of Work
Employees of this class perform a variety of clerical tasks of limited complexity. These may include taking shorthand dictation and transcribing it. The vocabulary involved is usually free
of technical terms and limited to the everyday language of business. Typing assignments,
whether from hard copy, dictation, or machine transcription, require only normal speed and accuracy. The material copied may include scientific papers, theses, and special reports
written in technical language from any of the university course subjects; the employee is
responsible only for the accurate transcription of material already written or typed.
These employees maintain courteous and cooperative working relations with students and
with faculty and other university staff, for whom they provide typing, simple duplicating,
telephone reception, and other services. While some positions are located away from the supervisors, preliminary detailed instructions and established procedures leave little
responsibility for the exercise of initiative or the formation of independent judgment.
Typical Duties and Responsibilities
1. Type correspondence, class assignments, and technical papers using
special vocabulary, from hard copy.
2. Act as receptionist at the counter and on the telephone, relaying calls,
recording messages, and answering simple questions.
3. File and retrieve materials arranged in simple alphabetical, numerical,
chronological, or geographical order.
4. Reproduce copies of materials by photocopy or other simple
duplicating methods.
5. Transcribe correspondence and other materials containing everyday
language, from dictating machines.
6. Prepare form letters by inserting appropriate material from files or
other sources. Check forms for completeness.
7. Post figures to budget accounts or other simple statistical and
accounting records.
8. Open, sort, route, and deliver mail according to predetermined
patterns.
9. In some positions, take and transcribe correspondence and other
materials; only a good vocabulary or grasp of ordinary language is
required.
Desirable Qualifications
Previous office experience desirable but not required. Grade 12 and completion of a standard
course in word processing, spreadsheets, and shorthand. Ability to meet test standards in
typing and shorthand (for those positions requiring the use of shorthand).
CLERK STENOGRAPHER II
Kind and Level of Work
Employees of this class perform a variety of moderately complex clerical tasks, which may include taking and transcribing shorthand dictation that requires knowledge of a technical
vocabulary. Their work is supervised by academic, administrative, or senior clerical
employees. This position is distinguished from Clerk Stenographer I in that it requires more knowledge of the organization, programs, and policies of the work unit; requires a higher
degree of specialized clerical skills or knowledge of a technical vocabulary; carries
independent responsibility for the maintenance of significant records; or some combination of these attributes. These workers maintain helpful and courteous relations with students and
staff, for whom they provide information and services.
Typical Duties and Responsibilities
1. From general instructions, compose and type routine correspondence,
bulletins, and other materials requiring knowledge of the
departments they serve.
2. Type from hard copy or dictating machine, class assignments, tests,
research papers, and other materials requiring understanding of
technical vocabulary, the use of special symbol keyboards, or
judgment in the selection of format.
3. Answer students’ inquiries concerning class schedules, timetables,
general course content, class prerequisites, and similar matters
requiring basic knowledge of calendars and departmental programs.
4. Train new employees by providing factual information on office
routines, staff names and locations, work methods, and schedules.
5. Maintain records of budget expenditures, class attendance, class
credits, grade distribution, and other data requiring accurate posting
and simple calculations of totals, percentages, and balances, all
subject to periodic review.
6. Compile simple statistical tables and graphs according to prescribed
patterns, incorporating data flowing into or retained in their
departments.
7. Organize, reorganize, and maintain filing systems based on alphabetic,
numeric, or simple subject matter arrangement.
8. Act as receptionist for officials, screening telephone calls and visitors,
providing answers to inquiries, making appointments, and referring
callers to other officials.
9. Assist in the maintenance of counselling schedules at the time of
student registration.
10. In some positions, take and transcribe shorthand dictation of
correspondence, reports, research papers, and other materials
containing technical language and concepts.
Desirable Qualifications
Several years of office experience, preferably in a university setting. Grade 12 and completion of a standard course in word processing, spreadsheets, and shorthand. Ability to meet test
standards in typing and shorthand (for those positions requiring the use of shorthand).
CLERK STENOGRAPHER III
Kind and Level of Work
Employees of this class perform responsible, varied, and complex clerical tasks, which may
include taking and transcribing shorthand dictation. Typically, their assignments require a broad understanding of departmental structure and division of responsibility, functions, and
programs. In most of these positions, they are secretaries to heads of larger departments and
take initiative in relieving them of administrative details that do not require professional judgment. Their work is subject to supervision by academic or administrative supervisors, but
they carry out a series of clerical operations calling for decisions without detailed instruction
or review. The work of this class is distinguished from that of Clerk Stenographers I and II by broader knowledge requirements, greater latitude, and supervision of other clerk
stenographers. In contacts with students, faculty and other staff, and the public at large, these
employees attempt to promote public attitudes that support the work of the units.
Typical Duties and Responsibilities
1. For their superiors, compose and type correspondence that requires
good knowledge of departmental organization, functions, and
policies.
2. Maintain records pertaining to students’ marks, credits, and degree
requirements, or supervise the maintenance of such records.
3. Maintain records on budget allotments, expenditures, commitments,
and residual balances, and notify department office of over
expenditures and balances, thus providing a measure of budget
control.
4. Give elementary counselling services to students by advising them of
degree requirements, class schedules, class prerequisites, and (in
general terms) course content, using information from the calendars
or from the faculty.
5. At the time of registration, schedule counselling interviews between
students and professors and maintain records so that students are
referred to the same counsellor each time.
6. Attend and record proceedings of faculty meetings or meetings
between faculty and non-university groups, making shorthand notes
summarizing discussions and transcribing the reports for the review of
superiors.
7. Supervise assistants and participate in their selection, assign their
duties, train them, reallocate work to meet deadlines, and exercise
disciplinary control in minor matters.
8. Screen phone and office calls of visitors, setting up interviews with
superiors as necessary, answering questions where possible, and
referring visitors to other sources where appropriate.
9. Type tests and examinations for members of the faculty, ensuring that
contents are kept confidential and that papers are properly secured.
Desirable Qualifications
Approximately five years of office experience, including several years in a university setting and preferably including experience in a supervisory capacity. Grade 12 and completion of a
standard course in word processing, spreadsheets, and shorthand. Ability to meet test
standards in typing and shorthand (for those positions requiring the use of shorthand).
DRAFTSPERSON I
Kind and Level of Work
Employees of this classification use computer-aided design drafting (CADD) techniques to
carry out assignments delegated by their supervisor, with direction from the project
originator, where appropriate. They work from rough sketches and notes, verbal instructions,
and other sources of information. While their day-to-day work is subject only to general supervision, completed assignments are reviewed. Although the projects on which they work
may range across a variety of engineering and architectural fields, the more complex work is
allocated to more senior positions. They may communicate with professional engineers and
others who initiate the work they do in order to clarify certain requirements and details.
Typical Duties and Responsibilities
1. Interpret existing records and information for the purpose of producing
required CADD information.
2. Prepare finished CADD drawings from rough sketches, notes, and
instructions.
3. Share in filing and managing inventory of records information.
4. Assist physical plant staff, professional engineers, and consultants in
locating physical records information.
5. Use and be familiar with operating various equipment, including
computer input/output devices, keyboards, digitizing equipment, and
a blueprint machine.
6. Assist in site verification of existing campus buildings and facilities.
7. Periodically assist in making site surveys with senior or surveying staff.
8. Participate in training programs relative to the CADD system.
9. Interact and communicate in a professional manner with physical plant
staff, the university community, consultants, contractors, etc.
Desirable Qualifications
Previous related experience preferred. Grade 12 plus a two-year diploma in a related architectural/engineering-associated technical program. Completion of computer-assisted
design and drafting course work or equivalent experience required. Eligibility for membership
as an applied science technologist preferred.
DRAFTSPERSON II
Kind and Level of Work
Employees in this classification use more complex computer-aided design drafting techniques to carry out assignments delegated by their supervisor, with direction from the project
originator where appropriate. Their work is differentiated from that of junior positions by the
complexity of their assignments, the judgment they use in completing their work, and their degree of independence. Delegated projects may range across a variety of engineering and
architectural fields. They develop and maintain cooperative working relations with
professionals and tradespersons in fulfilling their tasks.
Typical Duties and Responsibilities
1. Participate in production and design work of various projects as
required.
2. Assist in the development, evaluation, implementation, and
documentation of ongoing computer system procedures.
3. Assist in coordinating and supervising work of junior staff.
4. Complete site verification of existing campus buildings and facilities.
5. Participate in training in CADD system applications and in new and
more complex portions of the system, and support other staff as
required.
6. Interact and communicate in a professional manner with physical plant
staff, the university community, consultants, contractors, etc.
Desirable Qualifications
Minimum of two years’ related experience in architectural and other engineering fields. An “operator” level of CADD and related computer operations is required. Grade 12 plus a two-
year diploma in a related architectural/engineering-associated technical program. CADD
course work or equivalent experience required. Eligibility for membership as an applied
science technologist is also required.
DRAFTSPERSON III
Kind and Level of Work
Employees in this classification are responsible for directing the operation of a unit producing
computer-aided design drafting information and drawings, under the general supervision of
the Facilities Management Design and Information Systems manager. Their work is differentiated from that of other operational staff in the unit on the basis of the skill level
involved and the responsibility to supervise others. They develop and maintain cooperative
working relations with professionals and tradespersons to facilitate project completion.
Typical Duties and Responsibilities
1. Supervise, allocate, assist, and participate in the work of subordinate
staff.
2. Review work and ensure standards are maintained.
3. Assess incoming work, organize project priorities and flow, and plan
and schedule workloads as appropriate.
4. Train and support physical plant staff in the use of system applications
for records information access.
5. Assist in the design of computer system enhancements and general
strategies.
6. Participate in the more complex design work of projects as required.
7. Interact and communicate in a professional manner with physical plant
staff, the university community, consultants, contractors, etc.
Desirable Qualifications
A minimum of five years’ experience in the architectural field and a variety of engineering
fields, including some experience in a supervisory capacity. Must have experience in CADD and
related computer operations at an “operator” and “systems” level. Grade 12 plus a two-year diploma in a related architectural/engineering-associated technical program. CADD course
work or equivalent experience required. Eligibility for membership as an applied science
technologist is also required.
GROUNDS WORKER I
Kind and Level of Work
The employees in this classification carry out routine gardening by maintaining the grass, flowers, shrubs, and trees on the campus grounds. They either may be assigned an area on
campus to look after or may work on a crew assigned to a task such as planting or pruning.
These employees are responsible to a Grounds Worker II, who acts as a lead hand, assistant
supervisor, or a supervisor.
Typical Duties and Responsibilities
1. Water lawns and flowerbeds in a particular area.
2. Trim lawns in areas where larger mowers cannot cut.
3. Hoe weeds in flowerbeds, shrubbery beds, and gravel parking lots.
4. Perform general cleanup work in an area.
5. Prune broken branches on shrubs and trees.
6. Use hand clippers to trim areas of lawn not accessible to machines,
such as along buildings and around ponds.
7. Assist in the planting of flowers, shrubs, trees, and grass.
8. Assist in sodding operations, which would involve removing old grass,
preparing soil, laying new sod, spreading peat moss, and watering.
9. Do minor maintenance of small machinery.
Desirable Qualifications
Gardening experience preferred but not required. Grade 9 education.
GROUND WORKER II
Kind and Level of Work
Employees in this class are responsible for a wide variety of gardening jobs involving many of
those done by a Grounds Worker I. Generally, they are distinguished from the Grounds Worker
I class in that they may be the lead person in a small group or may be a machine operator. These employees may be in charge of a specific operation, such as the greenhouse, a
maintenance department, or the nursery. They are usually supervised by an assistant
supervisor and supervisor.
Typical Duties and Responsibilities
1. Supervise the grounds maintenance in a particular area.
2. Supervise a special work crew engaged in an activity, such as sodding,
planting, or pruning.
3. Supervise the work done in the greenhouse and the stocking of indoor
planters.
4. Operate a mower for cutting playing fields and large areas of grass.
5. Operate a rototiller around trees and shrubs to kill weeds.
6. Operate a tractor or other large machine and all attachments, such as
front-end loader, grader blade, and backhoe.
7. Carry out maintenance on all equipment used in the department.
8. Train subordinates in all gardening operations.
9. Communicate instructions from the supervisor.
Desirable Qualifications
Several years’ experience as a grounds worker. Grade 9 education.
GROUNDS WORKER III
Kind and Level of Work
Employees in this classification collectively perform a wide variety of tasks related to the
positions of ice making, machine operation, nursery management, irrigation, landscape
maintenance, and tree and shrub pruning. Their work is distinguished from that of subordinate personnel by the degree of knowledge, skill, and understanding required to
perform the duties, the extent of their supervisory and administrative responsibilities, or some
combination of these factors. Their work is given general supervision and direction, usually by a supervisor or assistant supervisor, but these employees independently organize and
supervise the work of the subordinates assigned to them.
Typical Duties and Responsibilities
The incumbent is expected to be able to perform all of the duties shown under the general
listing below, and one of the specialties listed below that.
General
1. Supervise subordinate employees in their unit by training, allocating
their work, assessing their performance, and ensuring acceptable
standards.
2. Perform administrative work related to their units, such as recording
time, maintaining stocks of supplies, setting up work schedules, and
arranging for replacements when necessary.
3. Be familiar with the operation and general maintenance of all
machines and tools in their area of responsibility.
4. Act as a lead hand and be familiar with all duties of subordinates and
be prepared to carry them out, including shift work, when
appropriate.
5. Liaise with supervisors and subordinates on a regular basis to ensure
effective communication and coordinated operation.
Nursery/landscaping/pruning
1. Read and interpret blueprint information.
2. Supervise the application of herbicides or fungicides, or the
landscaping of a specific area.
3. Perform a full range of skilled horticulture duties in areas such as
pruning, tree surgery, landscaping, greenhouse, and nursery.
Incumbents are expected to direct the work of and train subordinate
staff in the operation of tree-pruning equipment, such as extension
ladders, cranes, and pruners, and chemical applicators, such as hand-
held sprayers, boom sprayers, and fertilizer spreaders.
4. Diagnose and treat various types of lawn and tree diseases in
conjunction with the horticulture supervisor and assistant supervisor,
using the proper application of appropriate chemicals.
5. Be familiar with all the duties required of a nursery person including all
propagation practices, such as grafting, budding, seeding,
transplanting, hardening, stratifying, etc.
Facilities
1. Oversee the operation of the skating and curling facilities in a
cooperative spirit with the College of Physical Education to promote
optimum facility use and goodwill with patrons and staff.
2. Make ice in curling and skating rinks and paint markings on ice
according to specifications.
3. Maintain ice surfaces with the use of appropriate equipment and tools.
4. Inspect mechanical rooms to ensure that ice-making equipment is
functioning correctly, and call service people as required.
5. Ensure that patrons conform to regulations governing behaviour in the
rinks, and call for assistance from security personnel in case of serious
problems.
6. Supervise personnel in ice maintenance and janitorial work.
7. Supervise gardening crews in the maintenance of playing fields, track-
and-field facilities, and landscaped areas, parking lots, etc.
8. Be familiar with and supervise the operation of all gardening
equipment used in the assigned area.
9. Inspect grounds and work areas regularly and take corrective action
when required.
Machine Operator
1. Operate all the mowers for cutting playing fields and open areas.
2. Operate tree spade for tree transplanting.
3. Operate equipment such as large dump truck, front-end loader,
Bobcat, and snowplow.
4. Operate sanding truck in winter, including mixing sand and loading.
5. Do maintenance work on all equipment, but with primary emphasis on
the maintenance of power machines (which this person normally
operates).
Irrigation
1. Read and interpret blueprint information.
2. Troubleshoot and repair electric and electronic components, and
hydraulic controls of automated irrigation system as well as
mechanical components.
3. Be responsible for opening and shutting down the irrigation system in
spring and fall, including the blowing out of all lines.
4. Liaise with the supervisor and assistant supervisor for the scheduling of
irrigation throughout the campus.
5. Through liaison with the foreman and supervisor, ensure optimum
water use efficiency when setting irrigation run times and repeat
cycles, considering factors such as soil capacities, turf usage, and
sprinkler and line capacities and pressure, etc.
6. Repair and/or install lawn water service including cutting and fitting
pipe (PVC and poly) and placing or replacing all types of fittings
including galvanized, brass, PVC, and plastic.
Desirable Qualifications
(A) Several years of work experience, including experience in supervision and in the specialty
skill area that is pertinent. This must include considerable knowledge of horticultural identification of plant materials for the nursery position, and several years’ experience with
the installation and maintenance of manual and automatic irrigation systems for the irrigation
position. Additionally, an aptitude in electrical and electronic applications would be of value in the irrigation position. (B) The ability to do rigorous manual labour. (C) Possession of a
diploma in horticulture or a related field for the nursery and irrigation positions. (D)
Completion of Grade 12. (E) Driver’s licence. (F) Pesticide applicator’s licence for those
positions involved in the application of herbicides, insecticides, or fungicides.
MEDICAL LABORATORY TECHNOLOGIST I
Kind and Level of Work
This class comprises positions that require medical laboratory technologist certification and
involves positions that are generally located in the medical, dental, and veterinary medical
colleges of the university. These are full working-level technologists who are expected to conduct a variety of routine and semispecialized tests and analyses in their areas of
specialization, such as bacteriology, immunology, parasitology, virology, histology, etc. They
are engaged in the examination of predominantly biological materials, such as blood, sera, tissue, urine, feces, etc., by chemical, bacteriological, or related techniques. After an initial
orientation period, these employees work independently and are responsible for the accuracy
of techniques and the reliability of results. Their work is subject to the general supervision of
academic, technical, or administrative superiors.
Typical Duties and Responsibilities
1. Perform routine and semispecialized diagnostic analysis using manual
and automated techniques.
2. Prepare and standardize reagents, solutions, media, and cultures for
study requiring special techniques.
3. Operate basic scientific or technical equipment, maintain as necessary,
and monitor quality-control procedures to ensure reliability of results.
4. Perform sample entry, recording, reporting, and filing of results.
5. Assist with the teaching program by preparing materials and providing
demonstration or explanation of equipment and/or diagnostic
techniques and procedures to students.
6. Assist students with material identification and with projects as
required.
7. Assist in the orientation and instruction of new staff; may also
supervise student assistants, technical assistants, or first-level
technicians.
8. Assist with research experiments by carrying out a variety of
standardized quantitative and qualitative analyses by performing
assays, routine spectros-copy and chromatography, and
microbiological and other standard test procedures.
9. Prepare purchase requisitions; order, receive, and store supplies, tools,
and equipment; care for materials; and maintain required inventory
and other records.
Desirable Qualifications
A minimum of one year of experience related to the position assignment. Completion of Grade
12 plus a related technical school diploma from a recognized technical institute. Current
certification as a registered technologist with the Canadian Society of Laboratory
Technologists (CSLT).
MEDICAL LABORATORY TECHNOLOGIST II
Kind and Level of Work
This class comprises positions that require medical laboratory technologist certification and involves positions that are generally located in the medical, dental, and veterinary medical
colleges of the university. Employees in positions allocated to this class are experienced
technologists who conduct complex tests and/or provide supervision and training to
technologists assisting with complex tests or performing common tests. Their work involves
the analysis of predominantly biological materials and processes in support of a variety of
specialized areas, such as bacteriology, immunology, parasitology, virology, etc. This class is distinguished from the Medical Laboratory Technologist I by the complexity of tasks
performed, judgment factors involved, responsibility for work output, and the involvement in
training and supervision of junior staff. Their work is subject to general supervision and direction, usually by a member of faculty, but these employees independently organize and
supervise the work of their assistants and laboratories.
Typical Duties and Responsibilities
1. Perform complex and specialized diagnostic analysis using manual and
automated techniques.
2. Operate and maintain a variety of complex scientific equipment,
ensuring accurate calibration and reliability of results.
3. Verify procedures, evaluate effectiveness of experiments, and modify or
develop techniques and/or procedures as required.
4. Provide demonstration and problem-solving consultation involving
complex equipment and/or diagnostic techniques and procedures to
students in an undergraduate or graduate teaching environment, or
on a one-to-one basis with students as required.
5. Participate in the selection and assume responsibility for the training,
assigning, and reviewing of the work of subordinate staff or less
experienced staff engaged in semiskilled or skilled work; supervise
students in the use of equipment and facilities.
6. Assist individual faculty members with research projects by carrying
out experiments, usually involving relatively advanced techniques and
procedures, and analyze and report on results.
7. Search published scientific papers for information relating to specific
projects.
8. Perform administrative work related to the units such as budgeting,
advising on the purchase of material and capital equipment,
maintaining appropriate inventory and records, etc.
Desirable Qualifications
Several years of work experience related to the position assignment including demonstrated supervisory experience. Grade 12 and either a technical school diploma in laboratory
technology with ART standing, or a university degree relating to the position assignment.
Current certification as a registered technologist with the Canadian Society of Laboratory
Technologists (CSLT).
The Fit Stop Ltd.
The Fit Stop Ltd. is a brand-new firm that will open its doors exactly four months from today.
Its business objective is to sell all types of training, fitness, conditioning, and exercise
equipment to the general public. The Fit Stop plans to specialize in this equipment and to
provide customers with personalized advice geared to a customer’s specific training or conditioning needs (e.g., training for a particular sport, rehabilitation from injuries,
strengthening of back muscles to deal with back pain, general conditioning and fitness),
whether the customer is eight or 80 years of age.
In order to provide high-quality advice, each store will employ a physiotherapist (to provide advice on problems such as injuries or chronic back pain) and a person with a bachelor’s
degree in kinesiology (to provide advice on training for various sports or other physical
activities). A staff member will even sit down with customers and develop a personalized training or conditioning program that meets their own specific objectives and needs, at no
cost to the customer.
The remainder of the staff in the store will consist of a manager, with a Bachelor of Commerce degree, and sales staff, who will have at least high school diplomas. Due to the long opening
hours, it is expected that between 8 and 12 salespeople will be needed for each store. Because
the stores are located in shopping malls, they will operate on a seven-day-a-week basis, open
9:00–9:00 weekdays, 9:00–6:00 Saturdays, and noon to 6:00 on Sundays.
Aside from personally helping customers, the roles of the physiotherapist and kinesiologist will be to train other employees in how each type of equipment can be used for various
conditioning and rehabilitation purposes. Initially, sales staff will be given general training, but
as time goes by, each salesperson will be expected to learn in depth about all the different pieces of equipment, to help customers diagnose their needs accurately, and to be able to
explain proper use of the equipment. Because of the high level of training required, all
employees will be full-time.
The founder of the business is Susan Superfit, who has undergraduate degrees in kinesiology
and commerce from the University of Saskatchewan. While at university, she participated in
many sports (and suffered many injuries due to her all-out style of play). She came up with the idea for this business while laid up with one of her injuries. While there were businesses that
sold fitness and conditioning equipment, she often found that the people selling it had very
limited knowledge and often gave poor advice on what to buy and how to use it.
She has secured funding from private investors and from Growthworks, a large Canadian
labour-sponsored investment fund. In order to get volume discounts on the equipment she
will be purchasing and to beat competitors into the market, she wants to start off quite large, with stores in major cities in Ontario and the four western provinces, before expanding to
Quebec and the Atlantic provinces. She knows that this is a risky strategy and that cost control
will be essential to keep the business going long enough to become well known and develop a
stable clientele. She does not expect the business to make a profit for at least one year, or
maybe even two.
Her main competitors will be sporting goods megastores and department and discount stores,
each of which sells some of the same equipment. Some of these outlets will be able to price their equipment lower than The Fit Stop will be able to, but none have the range of equipment
that The Fit Stop will have, and none provide the personalized services that The Fit Stop will.
Susan believes that the key to her business success will be highly motivated and knowledgeable employees who have a strong concern for their customers and who are able to
work as a team with the other employees to provide the best possible customer service. Since
no two customers are exactly alike, employees will have to be innovative in developing solutions that fit their needs. It will also be crucial to keep up with the latest fitness and
training trends, as knowledge about fitness is continually increasing, along with new and
different types of specialized equipment. A key aspect of company strategy is to be the most
up-to-date and advanced supplier of new products and techniques.
Although Susan has given a lot of thought to her business, one thing she hasn’t really given
much thought to is how to compensate her employees. Since she doesn’t really know much about compensation, she tends to feel that the safest thing would be to just do what her
competitors are doing.
Henderson Printing
Henderson Printing is a small- to medium-sized manufacturer of account books, ledgers, and
various types of record books used in business. Located in Halifax, the company has annual
sales of about $12 million, mostly in the Atlantic provinces.
The owner, George Henderson, is a firm believer in making a high-quality product that will
stand up to many years of use. He uses only high-grade paper, cover stock, and binding materials. Of course, this has led to high production costs and high prices. He also believes in a
high level of customer service and is willing to make the products to customers’ specifications
whenever they so request. However, resetting the equipment for relatively short production
runs of customized products takes considerable extra time and, of course, also drives up costs.
The firm employs about 80 people, most of whom work in production. The firm has a few
supervisors to oversee production, but their responsibilities are not clearly spelled out, so the supervisors often contradict one another. There is no system for scheduling production; in
fact, there are few systems of any kind. Whenever there is a problem, everyone knows that you
have to go to George if you expect a definite answer.
The company also has several salespeople who travel throughout the Atlantic region; most of them are relatives of George or his wife. The company has one bookkeeper to keep records
and issue the paycheques, and several office employees to handle routine administrative
chores. The firm has no specialists in accounting, marketing, human resources, or production; George handles these areas himself, although he has no real training and little interest in any
of them except production. He focuses most of his attention on ensuring product quality and
on dealing with the countless problems that everyone brings to him every day. He has often been heard to exclaim, in his usual good-natured way, ‘Why am I the only one who can make
decisions around this place?” as he deals with each of these problems.
When George was growing up, both his parents (his father was a printer and his mother was a seamstress in a garment factory) had to work hard in order to scratch out a living for their
family. In those days, employers who showed little consideration for their employees were the
norm, and George resolved that things would be different if he ever became an employer. Today, George tries hard to be a benevolent employer. Although he feels the organization
cannot afford any formal employee benefits, he often keeps sick workers on payroll for a
considerable time, especially if he knows the worker has a family to support. George is well
liked by most employees, who have shown little interest in unionization during the few
approaches made by union organizers.
George has no formal system for pay and tends to make all pay decisions on the spur of the
moment, so almost everybody has a different pay rate. He has never gotten around to giving annual raises, so any employee who wants a raise has to approach him. He gives raises to
most people who approach him, but the amount depends on his mood at the time and on how
well he knows the employee. For example, if the firm has just lost a major customer, raises are lower, and if the firm has just booked a large order, they are higher. They are also higher if he
knows the employee has a family to support, or if the employee’s spouse has been laid off, or if
the employee has added a new member to the family.
George believes that a good employer should recognize the contributions made by employees
during the year. So every Christmas, if profits allow, he gives merit bonuses to employees,
which he says are based on their contributions to the firm. One day in early December, he sits down with his employee list, in alphabetical order, and pencils in an amount next to each
name.
Everybody gets something, but the amounts vary greatly. If he can associate a face with the name (which is difficult sometimes, because new employees seem to turn over a lot), he tends
to give larger bonuses. And if he can remember something such as a cheerful attitude, the
bonuses are higher still. But if he remembers anyone complaining about that employee for some reason or another (he usually can’t recall the exact reasons), the employee gets a
smaller bonus. Not surprisingly, longer-term employees tend to receive much higher bonuses
than new employees. He has noticed this tendency, but assumes that if an employee has been
with the firm longer, that person must be more productive, so this is fair. He personally
distributes the bonus cheques on the last working day before Christmas.
Since he has just turned 60, George is planning to retire in the next year or two and turn the business over to his daughter, Georgette Henderson, who is just finishing her commerce
degree at Dalhousie University. Ironically, it was on the day of his 60th birthday that his
bookkeeper informed him that there wasn’t enough money in the bank account to meet
payroll.
Multi-Products Corporation
It is early February. Late last year, the firm you work for, Multi-Products Corporation, acquired
the rights to a new type of golf club, invented by a retired machinist who had been a lifelong golfer until his untimely demise (it turns out that golfing during a lightning storm is not such a
great idea). The machinist had produced only a few sets of the clubs, but their superiority over
existing clubs was so pronounced that word of his invention had spread far and wide. Fortunately for him (for his estate, actually), he had patented the design of these clubs, so
nobody could copy them.
Multi-Products Corporation has numerous divisions, each producing different products in the sporting goods field. The company has never produced golf equipment of any kind, and plans
to set up a separate division to produce and distribute the new clubs. You found out yesterday
that you have been selected to head the new division. Corporate management will provide
you with all the financial resources you need to get the division going and will also help you
staff the division with experienced managers from the parent corporation. Because of their
confidence in you, management has given you complete freedom to organize and operate the
division as you see fit, as long as you attain the financial goals that have been set for the
division.
Your first task is to design the organization structure. But you recognize that before doing so,
you need to understand some key aspects about the organization and its context. Market research suggests that the demand for your product will be strong and stable. This demand
will not be very price-sensitive, since golfers who want your product will generally be willing to
pay what it takes to get it. Therefore, it will be relatively easy for you to secure distributors. In
fact, one distributor is willing to agree to a four-year sales contract for your equipment, with a
fixed volume and a fixed price. This distributor is confident enough to make this offer because
it believes that nobody else will be able to manufacture a similar club, due to the patent
protection.
The production side also looks straightforward. Your production process includes readily
available materials and there are many possible suppliers. You expect to be able to negotiate long-term contracts with suppliers at a fixed price. Acquiring the production equipment will
also be straightforward, since the equipment is readily available in the marketplace.
The basic production technology, which will involve a sequential, step-by-step manufacturing process, has been in use for many years and has been refined to a high degree of efficiency.
Since you know the likely volume of demand for your product, it is easy to decide on the
optimum plant size, which will involve about 600 workers. The type of semiskilled worker that you need is readily available, and since unemployment is quite high in your region, acquiring
employees should not be very difficult. Employees in this industry are usually unionized, but
the main union in the industry has not been highly militant in recent years, so labour
disruptions don’t seem likely.
Government regulations represent another possible factor that might affect your operations.
However, as long as your clubs meet CSA (Canadian Standards Association) standards, the government is unlikely to get involved with your product. Similarly, except for some groups
opposed to the expansion of golf courses in ecologically sensitive areas (such as national
parks), consumer and environmental groups are not likely to pose any concerns.
Future technological change is another possible issue, but it does not appear to be of great concern. You will start out with the most up-to-date production equipment, which has not
changed much in recent years. The product itself (golf clubs) is not likely to be replaced by
anything radically different. The pace of technological change for golf clubs is quite slow, and
some of the most popular clubs have been virtually unchanged in 30 years.
Plastco Packaging LTD.
Plastco Packaging Ltd. is a medium-sized manufacturer of plastic bags, located on the West
Coast. These bags are used in the retail sector for purposes ranging from groceries to clothing
and other goods. These bags are made from a variety of types of plastic and in a variety of
sizes, depending on the intended purpose. Usually the retailer’s name is printed on them.
There are three main phases in the bag-manufacturing process: (1) producing the plastic
sheeting (produced as rolls of tubing); (2) printing the retailer’s name on the tubing; and (3)
passing the rolls of tubing through bag-making machines that cut and seal the tubing into bag
lengths.
This case focuses on the third step of the production process, the bag-making department.
The department has 12 bag-making machines. Each machine operates semiautomatically but
has to be manually loaded, set for the type of bag to be produced, started, monitored, and adjusted. The machines need frequent servicing to replace the cutting knives, adjust slipping
belts, and lubricate the many moving parts. These functions and major repairs, when
necessary, are carried out by mechanics from the maintenance department, a separate
department reporting to the plant manager. The mechanics report machinery problems and future replacement and servicing needs to the maintenance supervisor, who reports
significant problems to the plant manager. The plant manager then conveys any implications
for production of bags to the bag-making supervisor.
There are six bag-making machine operators, with each operator tending two machines. There
are also six inspectors/packers, who inspect the bags to ensure quality and pack them into
boxes. Defective bags are thrown into waste bins, based on the type of plastic. They are then melted down and remanufactured. Whenever an inspector/packer discovers poor-quality
output, she must notify the operator to correct the problem. If the inspector/packer deems
waste to be excessive, she is expected to report the operator to the bag-making supervisor.
In addition, four utility workers handle miscellaneous tasks, such as delivering rolls of plastic
tubing and hauling boxes of finished bags to the shipping department. Traditionally, operators
and utility workers have always been male, while inspectors/packers have always been
female.
When a new operator is needed, the bag-making supervisor selects one of the utility workers
and assigns him to an experienced operator for on-the-job training. It takes up to six months before a new operator is able to consistently produce an acceptable-quality product without
supervision, since the machines are “finicky” to operate. The length of time needed to do bag
changeovers also declines as the new operator gains experience.
The plant is unionized, and pay is based on an hourly wage. Operators receive approximately $28 per hour, utility workers $21 per hour, and inspectors/packers $14 per hour. Overall,
benefits constitute about 20 percent of total compensation and increase with seniority.
The bag-making supervisor sees a number of problems at present. First is the high turnover
among the inspectors/packers, as high as 100 percent a year. Turnover among the utility
workers is about one-third of that, and lower than that among operators, who quit or retire at
the rate of about one a year. Second, while the department usually meets the minimum
production levels, the bag-making supervisor believes that productivity could be much higher.
He also believes there’s a high level of waste. However, whenever he questions an operator
about this, the operator either blames maintenance for doing a poor job servicing the
machines or the inspectors/packers for being unnecessarily fussy. It is also difficult to pinpoint
specific operators for performing poor-quality work, since inspectors/packers seldom report
an operator to the bag-making supervisor. When one does so, the operators usually accuse the inspectors/packer of incompetence. All in all, there are very poor interpersonal relationships
among the operators, mechanics, and inspectors/packers. Few members of the department
appear to enjoy being at work.
Another problem is that customers are complaining about inconsistent quality in the products
they receive. Sometimes the bags are of very high quality, but at other times, many bags are
defective. These complaints are a concern to the plant manager since a new competitor has
recently opened up nearby and is competing aggressively for business. This competitor seems
to be producing a product with fewer defects for a lower price. As if this weren’t bad enough,
the overall market for plastic bags has become more uncertain, as they have become the
target of environmentalists; some communities have actually banned the use of plastic bags.
Glossary
360-degree feedback
An appraisal system that uses feedback from superiors, peers, subordinates, and possibly
customers.
A
affective commitment
Attachment to an organization based on positive feelings toward the organization.
agency theory
Agents (employees) will pursue their own self-interests rather than the interests of their
principals (employers) unless they are closely monitored or their interests are aligned with the
interests of their principals.
aging the data
The process of adjusting compensation data to bring it up to date with the time period in
which the new compensation will take effect.
analyzer business strategy
Focuses on exploiting new opportunities at a relatively early stage while maintaining a base of
traditional products or services.
attribution theory
Theory of motivation arguing that humans often act without understanding their motives for
their behaviour and afterward attempt to attribute motives for their actions.
average employee earnings
Total compensation divided by the number of full-time equivalent employees.
B
balance sheet approach to expatriate pay
Approach to designing expatriate compensation that attempts to provide a standard of living
comparable with the home country.
base pay structure
The structure of pay grades and pay ranges, along with the criteria for movement within pay
ranges, that applies to base pay.
base pay
The foundation pay component for most employees, usually based on some unit of time
worked.
beauty effect
The tendency for the physical attractiveness of a ratee to affect their performance appraisals.
behavioural observation scales (BOS)
Appraisal method under which appraisers rate the frequency of occurrence of different
employee behaviours.
behaviourally anchored rating scales (BARS)
Appraisal method that provides specific descriptors for each point on the rating scale.
benchmark job
A job in the firm’s job evaluation system for which there is a good match in the labour market
data.
broadbanding
The practice of reducing the number of pay grades by creating large or “fat” grades,
sometimes known as “bands.”
business strategy
An organization’s plan for how it will achieve its goals.
C
central tendency error
Occurs when appraisers rate all employees as “average” in everything.
classical managerial strategy An approach to management that assumes most employees inherently dislike work but can be
induced to work in order to satisfy their economic needs.
classification/grading method
The use of generic grade descriptions for various classes of jobs to assign pay grades to
specific jobs.
combination profit-sharing plan
A plan that combines the current distribution and deferred profit-sharing plans by paying
some of the profit-sharing bonus on a current (cash) basis and deferring the remainder.
communication and information structure
A dimension of organization structure that describes the nature of and methods for
communication in an organization.
compa-ratio
A measure of distribution of employees within their pay range calculated by dividing the mean
base pay by the midpoint of the pay range.
compensable factors
Characteristics of jobs that are valued by the organization and differentiate jobs from one
another.
compensating differential
A higher compensation level offered by an employer because of undesirable aspects of the
employment.
compensation administration
The process through which employee earnings are calculated and the appropriate remittances
are paid to employees, governments, and other agencies.
compensation cost ratio
The ratio of total compensation costs to total costs or to revenues.
compensation strategy
The plan for the mix and total amount of base pay, performance pay, and indirect pay to be
paid to various categories of employees.
compensation system
The economic or monetary part of the reward system.
competency-based pay
Pay that is based on the characteristics, rather than the performance, of individual employees;
usually applied to managerial or professional employees.
competitive bonus plan
A group pay plan that rewards work groups for outperforming other work groups.
content theories of motivation
Theories that focus on understanding motivation by identifying underlying human needs.
contextual variables
Factors in the firm’s context that indicate the most appropriate managerial strategy and
organizational structure.
contingency approach to organization design
An approach to organization design based on the premise that the best type of structure for an
organization depends on the key contingencies (contextual variables) associated with that
organization.
contingent workers
Workers not employed on a permanent full-time basis.
continuance commitment
Attachment to an organization based on perceived lack of better alternatives.
contrast effect The tendency for a set of performance appraisals to be influenced upward by the presence of a
very low performer or downward by the presence of a very high performer.
control structure A dimension of organization structure that describes the nature of the processes used to
control employee behaviour in an organization.
conversion selling
Selling established products to new customers.
coordination and departmentation
A dimension of organization structure that describes the methods used to coordinate the work
of individual employees and subunits in an organization.
correlation coefficient
A statistic that measures the extent to which plots of two variables on a graph fall in a straight
line.
current distribution profit-sharing plan
A profit-sharing plan that distributes the profit-sharing bonus to employees in the form of cash
or shares, at least annually.
D
decision-making and leadership structure
A dimension of organization structure that describes the nature of the decision-making and
leadership processes used in an organization.
defender business strategy
Focuses on dominating a narrow product or service market segment.
deferred profit-sharing plan (DPSP)
A profit-sharing plan in which the profit-sharing bonuses are allocated to employee accounts
but not actually paid out until a later date, usually on termination or retirement.
defined benefit plans
Pension plans that provide retirement income based on a proportion of the employee’s pay at
the time of retirement.
defined contribution plans
Pension plans that provide retirement income based on the accrued value of employer and
employee contributions to the plan.
demographic characteristics
A person’s age, gender, ethnicity, education, marital status, and similar characteristics.
differential piece rate A lower sum of money per piece is paid if employee production does not meet the production
standard, and then a higher sum per piece is paid once the production standard is met.
differentiator business strategy A business strategy that depends on providing unique products or services to a broad range of
customers.
distributive justice
The perception that overall reward outcomes are fair.
domain
Describes the specific products or services offered by a given organization.
E
employee assistance programs (EAPs)
Employer-provided programs to help employees deal with a variety of personal problems.
employee profit-sharing plan A formal pay program in which a firm provides bonus payments to employees based on the
profitability of the firm.
employee share purchase plan
A plan through which employees may purchase shares in their employer firm.
employee stock bonus plan
A plan through which employees receive shares in their employer firm at no cost to the
employee.
employee stock option plan
A plan through which employees are provided with options to purchase shares in their
employer at a fixed price within a limited time period.
employee stock plan
Any type of plan through which employees acquire shares in the firm that employs them.
employment standards legislation
Legislation that sets minimum standards for pay and other conditions of employment.
equal increase approach
Method to establish pay grade sizes, in which each pay grade increases in width by a constant
number of points from the preceding pay grade.
equal interval approach
Method to establish pay grade widths, in which the point spreads are equal for all pay grades.
equal percentage approach
Method to establish pay grade sizes, in which each pay grade increases in width by an equal
percentage from the preceding pay grade.
equity sensitivity
A personality trait that entails a high predisposition toward perceiving personal inequity.
equity theory
Employees’ base perceptions of equity (fairness) on a comparison of their
contributions/rewards ratio to the ratios of others perceived as being similar.
expectancy theory
A theory stating that individuals are more likely to exert effort to perform a particular behaviour if they believe that behaviour will lead to valued consequences and if they expect
they can perform the behaviour.
extrinsic rewards Factors that satisfy basic human needs for survival and security, as well as social needs and
needs for recognition.
F
factor comparison method
Assigns pay levels to jobs based on the extent to which they embody various job factors.
family of measures plan A gain-sharing plan that uses a variety of measures to determine the extent to which a bonus
payout is justified.
fixed benefit system
An employee benefit plan that provides a standard set of benefits to all those covered by the
plan.
flexible benefit system
An employee benefit plan that allows employees to allocate employer-provided credits to
purchase the benefits of most value to them.
focused differentiator business strategy
A business strategy that depends on providing unique products or services to a narrow range
of customers.
focused low-cost business strategy
A business strategy that depends on providing low-cost products or services to a narrow range
of customers.
forced distribution method
A performance appraisal method that stipulates the distribution of employees across the
performance categories.
G
gain-sharing plan
Group performance pay plan that shares cost savings or productivity gains generated by a
work group with all members of that group.
goal-sharing plan
A group performance pay plan in which a work group receives a bonus when it meets
prespecified performance goals.
graphic rating scale
An appraisal method in which appraisers use a numerical scale to rate employees on a series
of characteristics.
group commissions
A performance pay plan in which the commissions of a group of sales workers are pooled and
then shared out equally among members of the group.
group piece rates
A performance pay plan in which group members get paid based on the number of completed
products produced by the group.
H
halo error
Occurs when appraisers rate an individual either high or low on all characteristics because one
characteristic is either high or low.
harshness effect
The tendency of some appraisers to provide unduly low performance appraisals.
health care spending account
A tax-favoured employee benefit that allows employees to use employer-provided health care
spending credits to purchase a wide array of health care services.
high-involvement managerial strategy
An approach to management that assumes that work can be intrinsically motivating if the
organization is structured properly.
high–low method
Determines entry-level and skill-block pay amounts by pricing comparable entry-level and
top-level jobs in the market and allocating the difference to the various skill blocks.
horizontal fit
Alignment of strategies at the same level.
human relations managerial strategy
An approach to management that assumes most employees inherently dislike work but can be
induced to work in order to satisfy their social needs.
human rights legislation
Legislation that prohibits discrimination in hiring or employment on the basis of race, ethnic
origin, religion, gender, marital status, or age.
hybrid compensation policy
A compensation-level strategy that varies across employee groups or compensation
components.
hybrid pension plans
Pension plans that combine features of the defined benefit pension plan and the defined
contribution pension plan.
I
Improshare
A gain-sharing plan that focuses on labour hours per unit of output and does not usually
include worker participation.
incentive
A promise that a specified reward will be provided if a specified employee behaviour is
performed.
indirect pay
Noncash items or services that satisfy a variety of specific employee needs, sometimes known
as “employee benefits.”
individual/team merit grid
A method for linking individual merit pay to both individual and team performance.
initial dip
A tendency for performance to decline during the initial stages of any change.
intergrade differential percentage
Calculated by dividing the intergrade differential (expressed in dollars) of each pay grade by
the midpoint (in dollars) of the previous pay grade.
intergrade differentials
The differences between the range midpoints of adjacent pay grades in a pay structure,
expressed in dollars.
interquartile range
A measure of pay dispersion across employers, calculated by dividing the difference between
the 25th and 75th percentile values by the value of the 25th percentile.
intrinsic rewards
Factors that satisfy higher order human needs for self-esteem, achievement, growth, and
development.
J
job analysis
The process of collecting information on which job descriptions are based.
job autonomy
The degree of freedom workers have in deciding how to perform their jobs.
job description A summary of the duties, responsibilities, and reporting relationships pertaining to a particular
job.
job design A dimension of organization structure that describes the manner in which the total task of an
organization is divided into separate jobs.
job enrichment
The process of redesigning jobs to incorporate more of the five core dimensions of intrinsically
satisfying work.
job evaluation
Establishing base pay by ranking all jobs in the firm according to their value to that firm.
job feedback
The extent to which the job itself provides feedback on worker performance.
job satisfaction
The attitude one holds toward one’s job and workplace.
job specifications
The employee qualifications deemed necessary to successfully perform the duties for a given
job.
job-to-job method
Establishes pay equity by comparing a female job class to a male class that is comparable in
terms of job evaluation criteria.
just noticeable difference (JND)
The amount of pay increase necessary to be considered significant by employees receiving the
increase.
K
key job matching
Including jobs on a compensation survey that are well understood and numerous in the labour
market, and asking respondents to supply compensation information for those jobs.
L
labour market constraints
Constraints on compensation strategy flowing from the relative levels of demand and supply
for particular occupational groups.
lag compensation-level strategy
A compensation-level strategy based on paying below the average compensation level in a
given labour market.
lead compensation policy
A compensation-level strategy based on paying above the average compensation level in a
given labour market.
leniency effect
The tendency of many appraisers to provide unduly high performance appraisals.
leverage selling
Selling new products to existing customers.
living wage
The minimum income necessary to help a worker enjoy a decent standard of living.
localization approach to expatriate pay
Approach to designing expatriate compensation that entails paying expatriate employees the
same compensation as local nationals in equivalent positions.
long-term incentives (LTIs)
A type of performance pay in which the incentives are tied to an organization performance
horizon that ranges beyond one year, often three to five years.
low-cost business strategy
A business strategy that depends on providing low-cost products or services to a broad range
of customers.
lump-sum approach to expatriate pay
Approach to designing expatriate compensation in which various allowance amounts are paid
directly in home-country currency.
M
maintenance selling
Selling established products to existing customers.
management by objectives (MBO) An approach to management that involves setting employee goals and providing feedback on
goal accomplishment.
managerial strategy One of three main patterns or combinations of structural variables that can be adopted by an
organization—namely, classical, human relations, or high involvement.
mandatory benefits Government-provided employee benefits, such as pensions and employment insurance, to
which employers must contribute on behalf of their employees.
market comparator firms
Firms selected as comparators when constructing a sample of market data.
market comparator job
A job in the market data that matches a benchmark job within the firm’s job evaluation
system.
market line
A regression line that relates job evaluation points to market pay (in dollars) for the
benchmark jobs.
market pricing
Establishing base pay by determining the average amount of pay other employers are offering
for a given job.
Maslow’s hierarchy of needs
A content theory of motivation that groups human needs into five main levels and states that
humans seek to satisfy the lowest order needs before satisfying higher order needs.
match compensation policy
A compensation-level strategy based on paying at average compensation levels in a given
labour market.
mean or simple average
A measure of central tendency of a set of values derived by summing the values and dividing
by the number of values.
median
The middle value in an ordered list of values.
membership behaviour
Occurs when employees decide to join and remain with a firm.
merit bonus
A cash payment, provided to recognize good employee performance, that does not increase
base pay.
merit pay grid/merit pay matrix
A tool for allocating merit raises, based on the performance level of the employee and the pay
range quartile in which they fall.
merit raise
An increase to an employee’s base pay in recognition of good job performance.
mission
An organization’s reason for existence.
N
need salience
The degree of urgency an individual attaches to the satisfaction of a particular need.
negotiation approach to expatriate pay
Approach to designing expatriate compensation that entails negotiation between employer
and employee to create a mutually acceptable compensation package.
new market selling
Selling new products to new customers.
noncash employee recognition programs
A program that provides noncash rewards to employees in recognition of employee
accomplishments or actions that are valued by the organization.
O
optimal reward system
The reward system that adds the most value to the organization, after considering all its costs.
organization structure
The means through which an organization generates the behaviours necessary to execute its
business strategy.
organizational citizenship behaviour
Occurs when employees voluntarily undertake special behaviours beneficial to the
organization.
organizational commitment
The strength of the individual’s attachment to his or her organization.
organizational culture
The set of core values and understandings shared by members of an organization.
organizational identification A sense of shared goals and belongingness, and the desire to remain a member of the
organization.
P
paired comparison method
Determines the rank order of all employees in a unit by comparing each employee with each of
the other employees in the unit.
paired comparison method
Every job is compared with every other job, providing a basis for a ranking of jobs.
pay for time not worked An employee benefit that covers a wide array of different types of employee absences from
work.
pay grade
A grouping of jobs of similar value to the organization, typically grouped by point totals.
pay policy line
The intended pay policy for the organization, generated by adjusting the market line for the
intended pay level strategy of the organization.
pay range
The minimum and maximum pay rates (in dollars) for jobs in a particular pay grade.
pay-for-knowledge system (PKS)
Establishing base pay according to the total value of the skills and competencies an employee
has acquired.
performance appraisal reliability
Occurs when a performance appraisal system produces the same scores even when applied by
different appraisers.
performance appraisal
The process of assessing the overall performance levels of individual employees.
performance appraisal validity
The process of assessing the overall performance levels of individual employees. Occurs when employees who receive the highest scores in a performance appraisal system are in fact the
highest performers.
performance management Method for improving employee performance based on goal-setting, feedback,
encouragement and support, and rewards for success.
performance pay Relates employee monetary rewards to some measure of individual, group, or organizational
performance.
performance share plan
A long-term incentive in which the bonus amounts are expressed in company shares.
performance unit plan
A long-term incentive in which the bonus amounts are expressed in units for which the
monetary value will fluctuate, depending on degree of goal accomplishment.
permissible differences
Pay differences between female and male job classes that are not considered inequitable
because they stem from certain specified allowable circumstances, such as seniority.
personal competencies
A person’s physical, verbal, and mental skills.
personal values
A person’s core beliefs about appropriate and inappropriate behaviour.
personality characteristics
A person’s behavioural and emotional tendencies.
phantom equity plan
A plan that helps retain key employees by providing rewards based on the stock performance
of a portfolio of promising new high-tech firms.
phantom share plan
A plan through which employees participate in the appreciation of company shares and any
associated dividends, without ever owning any company shares.
piece rates
A pay system under which individuals receive a specified sum of money for each unit of output
they produce or process.
point method
Establishes job values by the application of points to each job, based on compensable factors.
pooled performance pay
A pay plan in which the performance results of a group are pooled and group members share
equally in the performance bonus.
procedural justice
The perception that the process for reward determination is fair.
process theories of motivation
Theories that focus on understanding motivation by determining the processes humans use to
make choices about the specific actions they will take.
product/service market constraints
Constraints on compensation strategy caused by the nature of the product or service market
in which the firm operates.
proportional value method
Establishes pay equity where no comparator male job class exists by extrapolating a
hypothetical male comparator job class based on other male job classes.
prospector business strategy
Focuses on identifying and exploiting new opportunities quickly.
proxy comparison method Establishes pay equity in public sector organizations where neither the job-to-job method nor
the proportional value method can be used.
psychological contract Expectations about the rewards offered by a given job and the contributions necessary to
perform the job.
purpose of a compensation system To help create a willingness among qualified persons to join the organization and to perform
the tasks needed by the organization.
Q
quartiles or deciles
Division of an ordered list of values into either four groups (quartiles) or ten groups (deciles).
R
range spread percentage
A percentage calculated by dividing the range spread for a given pay range by the minimum
for that pay range.
range spread The difference between the maximum and the minimum pay level, in dollars, for a given pay
range.
ranking method
The relative values of different jobs are determined by knowledgeable individuals.
recency effect
The tendency of appraisers to over-weight recent events when appraising employee
performance.
reinforcement theory
A theory that states that a behaviour will be repeated if valued outcomes flow from that
behaviour, or if performing the behaviour reduces undesirable outcomes.
reliability
The extent to which a measuring instrument consistently produces the same measurement
result when measuring the same thing.
reward
Anything provided by the job or the organization that satisfies an employee need.
reward strategy The plan for the mix of rewards to be provided to members, along with the means through
which they will be provided.
reward system
The mix of intrinsic and extrinsic rewards that an organization provides to its members.
Rucker plan
A gain-sharing plan similar to the Scanlon plan but that expresses labour costs as a percentage
of value added.
S
salary
Pay based on a weekly, monthly, or annual time period.
sales commissions
Pay that is geared to the dollar volume of sales or transactions conducted.
Scanlon plan A gain-sharing plan that creates mechanisms for employee participation in developing
productivity improvements and that shares the financial benefits of those improvements with
the employee group that generated them.
share appreciation rights
A plan through which employees are awarded shares in their employer at no cost to
themselves if the price of employer shares rises during a specified period.
similarity effect
The tendency of appraisers to inflate the appraisals of appraisees they see as similar to
themselves.
skill block
The basic component of a skill-based pay system, containing a bundle of skills or knowledge
necessary to carry out a specific production or service delivery task.
skill certification
The testing process that determines whether an individual has mastered a given skill block
and should be granted the pay raise associated with that skill block.
skill variety
The variety of skills required for task completion.
skill-based pay (SBP)
Pay that is based on the specific skills and capabilities of individual employees, rather than on
the specific tasks they are carrying out; usually applied to operational-level employees.
special-purpose incentive
An incentive designed to motivate a specific type of employee behaviour.
spiral career paths
Career advancement marked by a combination of sideways and vertical progression.
statistical/policy capturing method
Combines use of statistical methods and job questionnaires to derive job values based on
prevailing external or internal pay rates.
straight commission
Pay that is geared only to the volume of sales or transactions, with no base pay component.
straight piece rate
The same specified sum of money is paid for each piece produced or processed, regardless of
how many pieces are produced or processed.
suggestion system
An incentive plan through which employees receive cash bonuses for submitting money-
saving suggestions.
supplemental unemployment benefits (SUBs)
An employer-provided benefit that extends government-provided unemployment benefits.
T
task behaviour
Occurs when employees perform the tasks that have been assigned to them.
task environment
The portion of the general environment that has direct relevance to a given organization.
task identity
The extent to which a worker performs a complete cycle of job activities.
task significance
The perceived importance or social value of a given task.
technical ladder
Defined progression of skills development to keep work interesting and provide opportunities
for higher compensation.
technical premiums
Compensation measures that increase the compensation of technical employees.
total rewards A compensation philosophy that considers the entire spectrum of rewards that an
organization may offer to employees.
trade union legislation
Legislation that defines the rights of parties involved in a collective bargaining relationship.
two-factor theory of motivation
Argues that intrinsic factors influence work motivation, while extrinsic factors influence job
satisfaction.
U
utility analysis
A method used to analyze whether a lead, lag, or match compensation-level strategy is most
efficient for a given organization.
V
validity
The extent to which a measuring instrument actually measures what we intend it to.
values
Principles, beliefs, and attitudes that drive behaviour.
vertical fit
Alignment of strategies at different levels.
vision
An organization’s desired future state.
W
wage
Pay based on an hourly time period.
weighted mean or weighted average
A measure of central tendency of a set of values that adjusts the average based on the number
of cases to which each value pertains.
work motivation
The attitude one holds toward good job performance.
