CM Journal II

MHR 6901, Compensation Management 1

Course Learning Outcomes for Unit II Upon completion of this unit, students should be able to:

3. Outline the similarities and differences between merit pay plans and incentive pay plans. 3.1 Define merit pay plans and incentive pay plans. 3.2 Express an opinion about whether a merit pay play or an incentive pay plan would be

better for employees in a fictional company.

Course/Unit Learning Outcomes

Learning Activity

3.1

Unit Lesson Chapter 3 Chapter 4 Unit II PowerPoint Presentation

3.2

Unit Lesson Chapter 3 Chapter 4 Unit II PowerPoint Presentation

Required Unit Resources Chapter 3: Traditional Bases for Pay: Seniority and Merit Chapter 4: Incentive Pay

Unit Lesson In the last unit, you learned about strategic compensation, the role of compensation as a business partner, and how strategic compensation decisions are made. You also reviewed the factors that contribute to pay differentials, the role of labor unions in setting compensation, and several key employment laws related to compensation. In this unit, we move into traditional bases of pay and an alternative to traditional pay, which is known as incentive pay. As you may recall from the last unit’s readings, as the world changes, organizations and the people within those organizations change as well. Some changes involve the government such as when laws are changed (e.g., minimum wage requirements in the United States). For instance, after the federal government sets a minimum wage, the states follow suit, often setting higher rates than the minimum required by the federal government. Some states have decided that the entire state will have the same minimum wage throughout the state whereas other states have decided to establish different minimum wages based on different wage zones within the state. These decisions, which are made at the federal level and the state level, have a direct impact on an organization’s compensation strategy and compensation budget. So let us go to the basics. First, compensation is used to recruit and retain employees and to increase morale and employee satisfaction. Does that refer to all types of compensation? Second, compensation is also used to reward and encourage top performance. The question is this: Are all types of performance improved through compensation systems? You will see in this unit that some compensation systems may not be designed to improve performance but are instead a reward for work completed.

UNIT II STUDY GUIDE

Pay Plans

MHR 6901, Compensation Management 2

UNIT x STUDY GUIDE

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Traditional Compensation Many organizations offer a traditional compensation plan. This means that the organization offers a form of basic pay based on the length of time an employee has been with an organization. The more years the employee has been employed with the organization, the more the employee can earn as a base pay. Most organizations have a set increase based on the number of years employed. This is especially true in those organizations that have a union. In fact, most collective bargaining agreements will articulate in detail the percentage of an increase based on years of employment with the organization for the duration of the bargaining agreement. This is also referred to as seniority-based pay. Public schools, civil service, and, to some extent, even the military use this type of compensation system. Unions do not condone rewarding employees individually, so the union will insist on a seniority system where everyone is rewarded equally regardless of performance or productivity. In this case, peak performance is not encouraged as everyone in the same job gets the same compensation and raise based on years of service and not on performance. The seniority system is easy to administer and provides a predictive budget projection. Everyone is treated equally, but how does this compensation system affect the morale of the top performers? Are there top performers in such a system? Collective bargaining agreements would not allow individual differences in compensation based on performance. Without top performers, is an organization truly competitive?

Merit Pay Another form of compensation is the merit pay plan. Merit pay plans are plans designed to reward employees based on individual performance. The employee’s performance is measured on a scheduled basis, usually once a year. Based on performance and obtainment of certain pre-established goals, an increase in salary is granted. A performance appraisal and a manager’s recommendation are used to justify a merit increase. This type of compensation system is largely dependent upon a performance appraisal system in that an underperforming employee would not receive a merit increase whereas the top performer would receive a merit increase and usually an increase at a larger percentage than an average performer. There are different types of performance appraisals, but the most common types are trait, comparison, behavior, and goal-oriented. A newer performance appraisal system is the rateless review system. The trait performance appraisal system uses descriptors to evaluate a specific trait or characteristic of the employee. Usually, this system uses a checklist in which the supervisor can check off the specific traits that the employee demonstrated during the reporting period. This system is highly subjective and is not considered reliable. The comparison performance appraisal system compares one employee’s performance against another employee’s performance and then ranks the employees in terms of high and low performers. This system or ranking is also referred to as forced distribution. Forced distribution is an attempt to prevent supervisors from ranking all employees in the same manner. It also allows for an opportunity to identify and terminate low performers. Behavior performance appraisal systems evaluate employees based on specific behaviors. This appraisal system is similar to trait appraisals, but instead, it evaluates specific behaviors that an employee demonstrates during a specific review period. The goals-oriented appraisal system is an attempt to remove some of the subjectivity and instead measures an employee’s performance based on agreed-upon goals. The supervisor and employee develop goals that the employee will reach during a rating period, and at the end of the rating period, the employee is measured against those goals. A newer concept for measuring employee performance is the rateless review system. Under this system of performance review, the employee is not assigned a number or descriptor. Rather, the employee receives feedback on performance on a regular basis and is advised on the consequences of not meeting expectations or requirements. Ongoing feedback allows the employee to focus on performance improvement. This review system aids in performance by providing transparency and closer connections to the supervisor.

MHR 6901, Compensation Management 3

UNIT x STUDY GUIDE

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All performance appraisal systems are subject to bias and potential discrimination. It is important for organizations to train employees on the proper implementation of all performance appraisal systems being used within the organization—especially those used as a part of an employee’s compensation.

Incentive Pay Aside from merit or seniority pay systems, some organizations use incentive pay as a way to motivate employees to meet the organization’s goals and objectives. For an incentive pay system to be effective, it is important that the organization’s business strategy and objectives are clearly defined and communicated to all employees. As the business strategy changes, the objectives should change as well if an organization wants to be competitive. With increases in globalization, organizations are forced to be more innovative, productive, and efficient. An organization’s goals and objectives should be aligned with these basic principles in order to be globally competitive: innovation, production, and effectiveness. Incentive pay is pay in addition to the base pay, and it is considered at-risk pay, which means it is not guaranteed. Unlike traditional or merit pay, if the organization’s objectives are not met, the incentive pay is not paid. Incentive pay systems are not effective when incentive pay becomes entitled pay, which means that employees begin to expect the incentive pay every year. Some organizations use incentive pay instead of merit pay or seniority pay as a way to control costs. If the organization is successful, so are the employees, but if the organization is not successful in meeting their objectives, the employees are not rewarded. Incentive pay is used to reward employees for excellent work in their normal job duties and should not be used to require effort beyond the normal job duties. Incentive pay should be used to differentiate between the top performers and average performers and should be significant enough to change behavior. Incentive pay plans are usually at the individual, group, and company-wide level, which means that individuals, groups, or everyone in the company are rewarded for meeting predetermined objectives. Individual incentive plans are effective when performance can be measured using objectives, when the individual can control the outcomes, and when the plan does not create unhealthy competition among the employees. Group incentive plans are designed to reward collective efforts versus individual performance. Finally, company-wide incentive plans reward all employees based on the overall performance of the organization. Important considerations when designing incentive pay plans are the establishment of the goals, the instrument to measure successful completion of the goals, and the time frame for the goals. Incentive pay plans are designed to entice workers to meet or exceed predetermined organizational goals, unlike traditional or merit pay, which is designed to reward employees for work and time on the job.

Learning Activities (Nongraded) Nongraded Learning Activities are provided to aid students in their course of study. You do not have to submit them. If you have questions, contact your instructor for further guidance and information. Each chapter of your textbook contains a case study related to the main theory or concept within the chapter. Review the case studies to gain a better understanding of the course materials as they relate to compensation considerations. Feel free to discuss the chapter case studies with your classmates in the Student Break Room forum.