Critical Thinking HR

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Chapter 11

Pay Structure Decisions

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Chapter 11 discusses the nature of the pay structure and its component parts, the pay level, and the job structure. Pay is a powerful tool for furthering the organization’s strategic goals. First, pay has a large impact on employee attitudes and behaviors. It influences the kind of employees who are attracted to (and remain with) the organization, and it can be a powerful tool for aligning current employees’ interests with those of the broader organization. Second, employee compensation is typically a significant organizational cost and thus requires close scrutiny. This chapter’s focus is on why and how organizations attach pay policies to jobs. As the number of employees in an organization increases, so too does the number of human resource management decisions about jobs in an organization.

Learning Objectives (1 of 2)

LO 11-1 List the main decision areas and concepts in employee compensation management.
LO 11-2 Describe the major administrative tools used to manage employee compensation.

LO 11-3 Explain the importance of competitive labor market and product market forces in compensation decisions.

LO 11-4 Discuss the significance of process issues such as communication in compensation management.

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Learning Objectives:

List major decision areas and concepts in employee compensation management.
Describe major administrative tools used to manage employee compensation.
Explain the importance of competitive labor-market and product-market forces in compensation decisions.
Discuss the significance of process issues such as communication in compensation management.

Learning Objectives (2 of 2)

LO 11-5 Describe new developments in the design of pay structures.

LO 11-6 Explain where the United States stands from an international perspective on pay issues.

LO 11-7 Explain the reasons for the controversy over executive pay.

LO 11-8 Describe the regulatory framework for employee compensation.

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Learning Objectives, continued:

5. Describe new developments in pay structure designs.

6. Explain where U.S. stands on pay issues from an international perspective.

7. Explain reasons for executive pay controversy.

8. Describe the regulatory framework for employee compensation.

Introduction

Employer’s View:

Pay is critical in attaining strategic goals.
Pay impacts employee attitudes & behaviors.
Employee compensation is significant organizational cost.

Employee’s View:

Policies regarding wages, salaries & other earnings affect their overall income and standard of living.
Both level of pay & fairness compared with others’pay are important.

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From employer’s view:
Pay is critical in attaining strategic goals.
Pay impacts employee attitudes and behaviors.
Employee compensation is significant organizational cost.
From the employees’ point of view, policies having to do with wages, salaries, and other earnings affect their overall income and thus their standard of living. Both level of pay and fairness compared with others’ pay are important Total compensation, as noted, consists of cash compensation (salary, merit increases, bonuses, stock options, and other incentives) and benefits (e.g., health insurance, paid vacation, unemployment compensation).

Developing Pay Levels

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Pay Structure

Pay Level

Job Structure

Pay Policies

Salary level decisions can be broken into two major areas: Pay Structure and Individual Pay. Pay level is the average pay in organizations, including wages, salaries, and bonuses. Pay structure refers to the relative pay of different jobs (job structure) and how much they are paid (level). Job structure is the relative pay of jobs in organizations (i.e., the range of pay often expressed by salary grades).

Although each employee is unique and thus requires some degree of individualized treatment, standardizing the treatment of similar employees (those with similar jobs) can help greatly to make compensation administration and decision making more manageable and more equitable. Thus pay policies are often attached to particular jobs rather than tailored entirely to individual employees to make the process more manageable and equitable.

Equity Theory

People evaluate the fairness of their situations by comparing them with those of other people.

People compare their own ratio of perceived outcomes (pay, benefits, working conditions) to perceived inputs (effort, ability, experience) to the ratio of a comparison other.

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Equity theory -people evaluate fairness of their pay by comparing their pay to that of other people. A person will compare his or her ratio of perceived outcomes (e.g., pay, benefits, etc.) to perceived inputs (e.g., education, effort, experience) to the ratio of a comparison other. Employees evaluate their pay by comparing it with what others get paid, and their work attitudes and behaviors are influenced by such comparison. If the person's ratio is higher, rationalization will occur to account for the perceived overpayment. If the comparison other's ratio is higher, the person may attempt to restore equity by reducing one's inputs (e.g., working less), increasing one's outcomes (e.g., asking for a raise, theft), or leaving the company. Equal pay for two workers with unequal contributions would likely be perceived as unfair if this information is known, especially by the worker making the stronger contribution to the organization.

Equity is not equality. Employees evaluate their pay by comparing it with what others get paid, and their work attitudes and behaviors are influenced by such comparisons. employee perceptions are what determine their evaluation. The fact that management believes its employees are paid well compared with those of other companies does not necessarily translate into employees’ beliefs. Employees may have different information or make different comparisons than management. For example, Toyota recently set a goal to move from using wages in the U.S. auto industry as the standard of comparison to using the (lower) prevailing wages in the state where each plant is located. To do so, however, Toyota recognizes its “challenge will be how to educate team members and managers . . . so they can understand and accept [this] change.”

External and Internal Equity

Two types of employee social comparisons of pay are especially

relevant in making pay level and job structure decisions.

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PAY STRUCTURE DECISION AREA	ADMINISTRATIVE TOOL	FOCUS OF EMPLOYEE PAY COMPARISONS	CONSEQUENCES OF EQUITY PERCEPTIONS
Pay level	Market pay surveys	External Equity	External employee movement; labor costs; employee attitudes
Job structure	Job evaluation	Internal Equity	Internal employee movement; cooperation among employees; employee attitudes

Two types of employee social comparisons of pay are relevant in making pay level and job structure decisions. First, external equity pay comparisons focus on what employees in other organizations are paid for doing the same general job. A market pay survey is the primary administrative tool organizations use in choosing a pay level. Second, internal equity pay comparisons focus on what employees within the same organization, but in different jobs, are paid. These comparisons may influence general attitudes of employees; their willingness to transfer to other jobs within the organization; their willingness to accept promotions; their inclination to cooperate across jobs, functional areas, or product groups; and their commitment to the organization. Job evaluation is the administrative tool organizations use to design job structures.

Developing Pay Levels – Market Pressures

Labor-market competition - amount an organization must pay to compete against other organizations that hire similar employees.

Product-market competition - sell goods and services at a quantity and price that will bring ROI.

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An organization faces two important competitive market challenges in deciding what to pay its employees: product market competition and labor market competition. An organization that has higher labor costs than its competitors will have to charge higher prices for products of similar quality.

If an organization is not competitive, it will fail to attract and retain sufficient numbers of high‑quality employees. This will likely lead to a loss of sales to the competition. Labor‑market competition places a lower bound on pay levels. If an organization is not competitive, it will fail to attract and retain sufficient numbers of high‑quality employees. Unless higher labor costs are offset by higher worker productivity or desirable product features that allow a higher product price, it will be difficult to sustain relatively high costs in a competitive product market.

Labor Costs

Two components of labor costs

Average cost per employee: wages, salaries, bonuses, health insurance, Social Security

Staffing level: number of employees

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Two components make up labor costs- (1) average cost per employee, made up of both direct payments (such as wages, salaries, and bonuses) and indirect payments (such as health insurance, Social Security, and unemployment compensation). (2) labor cost is the staffing level (number of employees). Financially troubled organizations often seek to cut costs by focusing on one or both components. Staff reductions, hiring freezes, wage and salary freezes, and sharing benefits costs with employees are several ways of enhancing the organization’s competitive position in the product market. An important competitive market challenge is labor market competition, the amount an organization must pay to compete against other companies that hire similar employees.

Employees as a Resource

A philosophy that considers employees to be an investment that will yield valuable returns

Controlling costs through noncompetitive pay can result in low employee productivity and quality

Pay policies and programs are important HR tools for encouraging desired employee behaviors and discouraging undesired behaviors

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The Employees as a Resource philosophy considers employees to be an investment that will yield valuable returns. Because organizations have to compete in the labor market, they should consider their employees not just as a cost but as a resource in which the organization has invested and from which it expects valuable returns. Although controlling costs directly affects an organization’s ability to compete in the product market, the organization’s competitive position can be compromised if costs are kept low at the expense of employee productivity and quality. Having higher labor costs than your competitors is not necessarily bad if you also have the best and most effective workforce, one that produces more products of better quality.

Pay policies and programs are one of the most important HR tools for encouraging desired employee behaviors and discouraging undesired behaviors. Therefore, they must be evaluated not just in terms of costs but in terms of the returns they generate—how they attract, retain, and motivate a high-quality workforce. Controlling costs through noncompetitive pay can result in low employee productivity and quality.

Deciding What to Pay

Deciding pay levels is discretionary and is based on a broad range.

The organization has to decide whether to pay at, below, or above the market average.

Efficiency wage theory - wages influence worker productivity.

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Deciding pay is discretionary, with a broad range. The organization has to decide whether to pay at, below, or above the market average. The benefits of higher wages may outweigh higher costs when the organization's technology or structure depends on highly skilled employees or when the organization has difficulty observing and monitoring employee performance. Paying above the market average has the ability to attract, retain top talent and help generate positive job attitudes and satisfaction, all of which can translate into an effective and productive workplace. The disadvantage is added cost.

Efficiency wage theory states that wages influence worker productivity. The theory is that employees who are paid more than they would be paid elsewhere will be reluctant to shirk because they wish to retain their good jobs. The benefits of higher wages may outweigh higher costs when the organization's technology or structure depends on highly skilled employees or when the organization has difficulty observing and monitoring employee performance. It may therefore wish to provide an above-market pay rate to ensure the incentive to put forth maximum effort. The theory is that employees who are paid more than they would be paid elsewhere will be reluctant to shirk because they wish to retain their good jobs.

Market Pay Surveys

Benchmarking - procedure by which an organization compares its own practices against the competition.

3 issues to consider before using pay surveys:

Which employers should be included in the survey?

Which jobs are included in the survey?

If multiple surveys are used, how are all rates of pay weighted and combined?

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Knowing what other organizations are paying and knowing what those organizations are getting in return for their investment in employees is helpful. To find that out, some organizations examine ratios such as revenues/employees and revenues/labor cost. it is important to use “big data” technology to go beyond simple benchmarking and better understand what value is created for a company by choosing different pay levels.

Benchmarking pay surveys provide information on the going rates of pay of the competition. The following issues must be determined before pay surveys are used:

Which employers should be included in the survey?
Which jobs are included in the survey?
If multiple surveys are used, how are all the rates of pay weighted and combined?

Knowing what other organizations are paying is only one part of the story. It is also necessary to know what those organizations are getting in return for their investment in employees.

Product Market vs. Labor Market Comparisons

Product Market valuable when:

Labor costs represent a large share of total costs.

Product demand is elastic.

The supply of labor is inelastic.

Employee skills are specific to the product market.

Labor Market valuable when:

Attracting and retaining qualified employees is difficult.

Costs of recruiting replacements are high.

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As well as knowing what other organizations are paying, it is necessary to know what those organizations are getting in return for their investment in employees. Ratios such as revenues to employees or revenues to labor cost could be used.

Rate Ranges, Key and Nonkey Jobs

Rate Ranges

different employees in same job that may have different pay rates

Key Jobs

benchmark jobs that have relatively stable content and are common so that market-pay survey data can be obtained

Nonkey Jobs

unique to organizations and cannot be directly valued or compared through the use of market surveys

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Use of rate ranges permit a company to recognize differences in employee performance. Different employees in the same job may have different pay rates. Key jobs are benchmark jobs that have relatively stable content and are common to many organizations so that market‑pay survey data can be obtained. Nonkey jobs are unique to organizations and cannot be directly valued or compared through the use of market surveys. For example: Typical key jobs would include administrative assistant, department manager, controls engineer, and so on.

Developing a Job Structure

Job structure - relative worth of various jobs based on internal comparisons.

Job evaluation - administrative procedure used to measure internal job worth.

Composed of compensable factors, which are characteristics of jobs that an organization values and chooses to pay.

Job evaluators often apply a weighting scheme to account for differing importance of compensable factors to the organization.

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A job structure refers to the relative worth of various jobs in the organization, based on internal comparisons. A job evaluation system is composed of compensable factors and a weighting scheme based on the importance of each compensable factor to the organization.

Compensable factors are characteristics of jobs that an organization values and chooses to pay for. These characteristics may include job complexity, working conditions, required education, required experience, and responsibility. Most job evaluation systems use several compensable factors. Job analysis provides basic descriptive information on job attributes, and the job evaluation process assigns values to these compensable factors.

An administrative procedure used to measure internal job worth. Compensable Job evaluation is an administrative procedure that measures a job's internal worth to the organization.

Developing a Pay Structure

Market Survey Pay Policy Line Pay Grades

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Includes examining and balancing both internal and external comparisons. There are significant differences in employers in terms of whether they place priority on internal or external comparisons. Three pay‑setting approaches include the market survey approach, the pay policy line and pay grades. Disadvantages of using grades are that some jobs may be underpaid while others may be overpaid.

Market survey approach - The greatest emphasis is on external comparisons. It bases pay on market surveys that cover as many key jobs as possible.
Pay-policy line - A mathematical expression that describes the relationship between a job’s pay and its job evaluation points.
Pay grades - Grouping jobs of similar worth or content together for pay administration purposes.

Range spread is the distance between the minimum and maximum amounts in a pay grade.

Conflicts: Market Pay Surveys and Job Evaluation

Internal data drives up labor costs and creates product-market problems.

If external market data are emphasized and a job is paid lower internally, comparisons that employees make internally would result in dissatisfaction.

An organization should consider its strategy, what jobs and/or functions will be critical for success and market-competitive pressures.

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The relative worth of jobs is quite similar overall, whether based on job evaluation or pay survey data. However, some inconsistencies do arise. In resolving the conflict, emphasizing the internal data would create a situation of overpaying jobs that are paid less in the market, which drives up labor costs (and creates product-market problems). If external market data are emphasized and a job is paid lower internally, the comparisons that employees make internally would result in dissatisfaction.

An organization should consider its strategy and what jobs and/or functions will be critical for success. Also, external comparisons deserve greater weight because organizations are finding it increasingly difficult to ignore market competitive pressures. The approach with the greatest emphasis on external comparisons (market survey data) is achieved by directly basing pay on market surveys that cover as many key jobs as possible.

Monitoring Compensation Costs

Examine the difference between policy and practice

Compute a compa-ratio, which is an index of the correspondence between actual and intended pay.

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Pay structure influences compensation costs in a number of ways. Most obviously, the pay level at which the structure is pegged influences these costs. However, this is only part of the story. The pay structure represents the organization’s intended policy, but actual practice may not coincide with it. One way to examine the difference between policy and practice is to compute a compa-ratio, which is the actual average pay for grade/midpoint pay for grade. The compa-ratio directly assesses the degree to which actual pay is consistent with the pay policy.

Globalization, Geographic Region, and Pay Structures

Pay structures differ across countries in level & relative worth of jobs.

Expatriate pay and benefits depend on assignment’s nature and length.

Most companies have a policy that provides for pay differentials based on geographic location to prevent inequitable treatment of employees who work in more expensive parts of the country.

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Pay structures can differ substantially across countries both in terms of their level and in terms of the relative worth of jobs. These differentials are intended to prevent inequitable treatment of employees who work in more expensive parts of the country. Although expatriate pay and benefits have been linked more closely to the home country, this link appears to be slowly weakening and now depends more on the nature and length of the assignment.

Participation and Communication in the Process

Participation

Should involve those who will manage and be affected by the process.

Includes recommending, designing and communicating a pay program.

Typically, pay-level decisions are only made by top management.

Communication

Impacts employees' perceptions of equity, attitudes and behaviors.

Managers must be prepared to explain why the pay structure is designed the way it is and to judge whether changes should be made to the structure.

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Since pay decisions might be viewed in different ways by different groups in the organization and technology rarely provides a "right" answer, how decisions are made and communicated is critical. Participation should involve both those who will manage the process and those who will be affected by it (HR staff and line managers). Employees increasingly have access to salary survey information, which is likely to result in more comparisons and thus a greater need for effective communication. Managers play the most crucial communication role because of their day-to-day interactions with their employees. Therefore, they must be prepared to explain why the pay structure is designed as it is and to judge whether employee concerns about the structure need to be addressed with changes to the structure. One common issue is deciding when a job needs to be reclassified because of substantial changes in its content. If an employee takes on more responsibility, she will often ask the manager for assistance in making the case for increased pay.

Problems with Job-Based Pay Structures

reinforces top-down decision making as well as status differentials.

bureaucracy, time and cost required to generate and update job descriptions can become a barrier to change.

job-based structure may not reward desired behaviors, where the knowledge, skills, and abilities needed yesterday may not be helpful today and tomorrow.

system encourages promotion-seeking behavior, but discourages lateral movement.

encourages lack of flexibility and initiative;

“not in my job description”

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Although most commonly used, job‑based pay structures can create the following problems:

They encourage bureaucracy.
They reinforce top‑down decision making as well as status differentials.
The bureaucracy, time, and cost required to generate and update job descriptions and job evaluations can become a barrier to change.
The job‑based structure may not reward desired behaviors, where the knowledge, skills, and abilities needed yesterday may not be helpful today and tomorrow.
The system encourages promotion‑seeking behavior, but discourages lateral movement.
It can also encourage a lack of flexibility and a lack of initiative on the part of employees,

“Why should I do that? It’s not in my job description.”

Responses to Problems with Job-Based Pay Structures

Delaying and Banding
Skill-based
Competency-based

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Three Responses Job-Based Pay Structures:

Delayer – reducing the number of job levels to provide more flexibility in job assignments and assigning merit increases. It is moving away from linking pay to jobs toward building structures on skill, knowledge and competency. Broader groupings of jobs are known as broad bands.
Skill-based pay -pay based on the skills employees acquire and are capable of using. It’s paying individuals for skills they are capable of using rather than for the job they are performing.
Competency‑based covers exempt employees. Flexibility helps promote lower staffing levels and aids in situations where the manufacturing process demands adaptable and flexible responses.

Can the U.S. Labor Force Compete?

Factors to consider when determining where to locate production

Instability of country differences in labor costs

Skill levels

Productivity

Considerations other than labor costs

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Companies seek to control labor costs, in part by deciding where (e.g., which countries) to locate production. They also consider factors such as proximity to customers and the need to not become too dependent on any single country. Relative labor costs are very unstable over time because of fluctuations in currency exchange rates.

The quality and productivity of national labor forces can vary dramatically. Lower labor costs may reflect the lower average skill level of the labor force. Labor cost per hour divided by productivity per hour worked. One indicator of productivity is gross domestic product (or total output of the economy) per person. Operating costs may be high enough to compensate for lower labor costs.

Product development and customer response may be faster when manufacturing is closer to staff groups. Being close to where customers are matters a great deal. Product development speed may be greater when manufacturing is physically close to the design group. Quick response to customers (like making a custom replacement product) is difficult when production facilities are on the other side of the world. Inventory levels can be dramatically reduced through the use of manufacturing methods like just-in-time production, but suppliers need to be in close physical proximity. Some firms are aggressively offshoring jobs (including professional or knowledge worker jobs) primarily to reduce labor costs.

Executive Pay

Executive pay makes up a small portion of labor costs.

Executives have a disproportionate ability to influence organizational performance.

Issues include not only how much executives are paid but how they are paid.

U.S. executives are highest paid in the world.

Ratio of executive pay to average worker pay creates a "trust gap" - workers do not trust executives' intentions and resent their pay.

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Much press has been given to high executive pay. Executives influence organizational performance and help help set the culture. Employees may wonder why executives’ pay isn’t reduced when company performs poorly. Employees might ask, “If the company needs to cut costs, why not cut executive pay rather than our jobs?” Perhaps more important than how much top executives are paid is how they are paid (i.e., whether performance-based).

There is much criticism of executive pay, However, these figures reflect participation in a stock plan. Some executives are very highly paid. Executives in the United States are the best paid in the world. Often, the ratio of executive pay to average worker pay is cited as creating a "trust gap" in which workers do not trust executives' intentions and resent their pay. The issue becomes even more salient when companies are engaging in layoffs but are not cutting executive pay.

Equal Employment Opportunity

Equality of treatment in pay percentages has generally risen over the last two to three decades, but significant race and sex differences in pay clearly remain

Asian Americans earn 16% more than Whites

Between 1960 and 2014, whites decreased from 90% to 80% of all employees

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Organizations must deal with changing labor market and demographic realities. Equal Employment Opportunity (EEO) (Title VII) prohibits discrimination in all employment outcomes, including pay, unless business necessity can be proven.

Comparable Worth

Comparable worth (or pay equity) is a public policy that advocates remedies for any undervaluation of women's jobs.

Based on the idea that individuals should obtain equal pay, not just for jobs of equal content, but for jobs of equal value or worth.

Courts have consistently ruled that using the going market rates of pay is acceptable defense in comparable worth litigation suits.

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Comparable worth (or pay equity) is a public policy that advocates remedies for any undervaluation of women’s jobs. The idea is to obtain equal pay, not just for jobs of equal content (already mandated by the Equal Pay Act of 1963) but for jobs of equal value or worth, on the basis of Title VII of the Civil Rights Act. Typically, job evaluation is used to measure worth. It advocates remedies for any undervaluation of women’s jobs.

Typically, comparable worth becomes an issue when comparisons between internal (job evaluation) and external (market surveys) data suggest that there is conflict in which jobs predominantly occupied by women are evaluated more highly internally than in terms of the market data. One problem is that job evaluation is most often used to help apply market‑pay policy and not replace the market. There is also concern that EEO regulations will attempt to replace market forces (although there are no regulations related to comparable worth) and that using only internal comparisons would result in overpayment and underpayment in several instances in relationship to the market, which would create a market disadvantage.

Wage Laws

Fair Labor Standards Act (FLSA) of 1938 established a minimum wage and overtime pay rate.

Minimum wage is the lowest amount that employers are legally allowed to pay.

Exempt – those employees (executive, professional, administrative and outside sales) not covered by the FLSA and not eligible for overtime pay.

Davis-Bacon Act and Walsh-Healy Public Contracts Act require federal contractors to pay employees no less than area’s prevailing wages.

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The Fair Labor Standards Act (FLSA) of 1938 established a minimum wage and overtime pay rate. Minimum wage is the lowest amount that employers are legally allowed to pay. Minimum wage is now $7.25 an hour. FLSA permits a sub-minimum wage to workers under the age of 20 for a period of up to 90 days. State laws may specify higher minimum wages.

Exempt status depends on job responsibilities and salary. All exemptions (except for outside sales) require that an employee be paid no less than $455 per week, but those salary limits are to increase.
The Davis‑Bacon Act (1931) and Walsh‑Healy Public Contracts Act (1936) require federal contractors to pay employees no less than the prevailing wages in the area.
Employers must take care in deciding whether a person working on their premises is classified as an employee or independent contractor

Overtime Pay

FLSA requires that employees be paid at a rate of one and a half times their hourly rate for each hour of overtime worked beyond 40 hours in a week. The hourly rate includes base wage plus other components such as bonuses and piece-rate payments.

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If the employer knows the employee is working overtime but neither moves to stop it nor pays time and a half, a violation of the FLSA may have occurred

Summary (1 of 2)

Equity theory - social comparisons influence how employees evaluate their pay.

Employees make external comparisons between their pay and pay they believe is received by employees in other organizations which may have consequences for employee attitudes and retention.

Employees make internal comparisons between what they receive and what they perceive others within the organization are paid which may have consequences for internal movement, cooperation and attitudes and play a role in the controversy over executive pay.

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Equity theory suggests that social comparisons are an important influence on how employees evaluate their pay.
Employees make external comparisons between their pay and the pay they believe is received by employees in other organizations which may have consequences for employee attitudes and retention.
Employees make internal comparisons between what they receive and what they perceive others within the organization are paid. These comparisons may have consequences for internal movement, cooperation, and attitudes (like organization commitment).
Such comparisons play an important role in the controversy over executive pay.

Summary (2 of 2)

Pay benchmarking surveys and job evaluation are tools used in managing pay level and job structure components of the pay structure.

Pay surveys permit organizations to benchmark their labor costs.

Globalization is increasing the need to be competitive in labor costs and productivity.

Pay structure is moving to fewer pay levels to reduce labor costs and bureaucracy and shifting from paying employees for narrow jobs to giving broader responsibilities.

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Pay benchmarking surveys and job evaluation are tools used in managing pay level and job structure components of the pay structure.
Pay surveys permit organizations to benchmark their labor costs.
Globalization is increasing the need to be competitive in labor costs and productivity.
Pay structure is moving to fewer pay levels to reduce labor costs and bureaucracy and shifting from paying employees for narrow jobs to giving broader responsibilities and paying them to learn necessary skills Pay structure decisions influence the success of strategy execution by influencing not only labor costs, but also employee perceptions of equity, and the way that different structures provide flexibility and incentives for employees to learn and be productive.