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STRATEGICCOMPENSATIONINCANADA6thedcopy.pdf
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
This book is dedicated to the memory of Richard Long.
—Parbudyal Singh
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 organization. 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
Steeping some tea...
Steeping some tea...
Steeping some tea...
Using the Internet
Steeping some tea...
Steeping some tea...
Exercises
Steeping some tea...
Steeping some tea...
Case Questions
Steeping some tea...
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
Steeping some tea...
Steeping some tea...
Steeping some tea...
Using the Internet
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Exercises
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Steeping some tea...
Case Questions
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Steeping some tea...
Steeping some tea...
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 challenge. 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 organizations 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
production 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 customers 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 intrinsically 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 hamburger? 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 providing 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
Steeping some tea...
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Using the Internet
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Exercises
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Case Questions
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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.
Part 2: Formulating Reward and Compensation Strategy
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
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Using the Internet
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Exercises
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Case Questions
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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 produc-
tion 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 deci-
sions 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...
Steeping some tea...
Steeping some tea...
Using the Internet
Steeping some tea...
Exercises
Steeping some tea...
Steeping some tea...
Steeping some tea...
Case Questions
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Steeping some tea...
Steeping some tea...
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 pre-
sented 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
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Using the Internet
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Exercises
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Case Questions
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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
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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).
Part 3: Determining Compensation Values
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
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Using the Internet
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Exercises
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Case Question
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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 lad-
ders, 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 hierarchy 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 rela- tively 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 prob-
ably 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
Steeping some tea...
Steeping some tea...
Steeping some tea...
Using the Internet
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Steeping some tea...
Exercises
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Steeping some tea...
Case Questions
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Steeping some tea...
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
Steeping some tea...
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Using the Internet
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Exercises
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Case Question
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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? Orga-
nizations 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 performance 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 performance 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 generating 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 dis-
tinction”); 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 negative 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 oth-
erwise. 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 continuing 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 interview.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 accomplishments, 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 indi-
vidual 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
Steeping some tea...
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Using the Internet
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Exercises
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Case Questions
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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.
Part 4: Designing Performance Pay and Indirect Pay Plans
Part 4: Designing Performance Pay and Indirect Pay Plans
4 items
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
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Using the Internet
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Exercises
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Case Questions
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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
Steeping some tea...
Steeping some tea...
Steeping some tea...
Steeping some tea...
Using the Internet
Steeping some tea...
Exercises
Steeping some tea...
Steeping some tea...
Case Questions
Steeping some tea...
Steeping some tea...
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
&lang=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.
Part 5: Implementing, Managing, Evaluating, and Adapting the Compensation System
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
Steeping some tea...
Steeping some tea...
Steeping some tea...
Steeping some tea...
Steeping some tea...
Using the Internet
Steeping some tea...
Exercise
Steeping some tea...
Case Question
Steeping some tea...
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.
