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MHR 6901, Compensation Management 1

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

5. Explain workers’ compensation. 5.1 Convince others that executive compensation is too high or is just right. 5.2 Identify compensation rules that apply to the flexible workforce.

Course/Unit Learning Outcomes

Learning Activity

5.1 Unit VI Essay

5.2 Unit VI Quiz

Reading Assignment Chapter 11: Compensating Executives Chapter 12: Compensating the Flexible Workforce: Contingent Employees and Flexible Work Schedules

Unit Lesson So far in this course, we have talked about how compensation is used and the components of a compensation system. Let us review these a bit before we move into compensating executives. Typically, compensation is used to recruit and retain highly qualified employees. The organization’s business strategy (lead, lag, or match strategy) determines how the organization recruits and retains employees. A good compensation system also increases morale or at least maintains employee satisfaction. As mentioned earlier in the course, compensation systems include wages and benefits. A good compensation system is one that evaluates the employees’ needs and makes adjustments, where possible, to meet those needs. Employees who have their needs satisfied are more likely to be productive and loyal to the organization, which, in turn, reduces costs for the organization. This is great for the average worker, but what about the organization’s executives? Executive compensation is a challenge for most organizations and is a highly controversial subject, especially after the government bailouts in 2008 and 2009. Executive compensation is different than that for most salary or hourly employees and can consist of a variety of options. It is generally focused on generating profits and long-term growth and is considered contingent compensation, which means that the pay is structured to reward or pay based on the organization’s performance and the shareholder’s value. Therefore, compensation must support the shareholder’s goals as well as the goals and objectives of the organization. Normally, executive compensation consists of the following components:

 annual base salary,

 short-term incentives or bonuses,

 long-term incentives,

 defined contribution or defined benefit retirement plans,

 perquisites, and

 severance payments. The annual base salary is the direct compensation for the executive. The salary is generally competitive and approved by a board of directors. There are tax implications for executive salaries, and normally a chief

UNIT VI STUDY GUIDE

Executive Compensation and Flexible Workforce Compensation

MHR 6901, Compensation Management 2

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executive salary is limited to $1 million for cash compensation and tax deductions. Salary beyond the $1 million is usually in the form of annual bonuses or long-term incentives. Short-term incentives for executives are usually related to company performance and goals set by the board of directors. Long-term incentives are usually the largest part of an executive’s compensation plan because they are intended to push the executive to meet the strategic objectives and maximize the shareholder’s value. Long- term incentives are typically in terms of equity compensation for a period of three to five years. The incentive is not paid for the executive until the end of the performance period. Defined and deferred contribution plans are similar to those available to salaried employees. Perquisites (or perks) refer to the extra benefits that hourly and salaried employees normally would not be entitled to and include things such as a personal driver, secured communication in the home, company jet, bodyguards, etc. These perks provide for the safety and security of the chief executive officer (CEO) and his or her family as well as the CEO’s availability. Severance pay refers to payments provided to executives in case of voluntary or involuntary terminations. Often, the severance agreement accompanies a non-compete or good reason provision to protect the organization. Severance pay is different than a golden parachute in that a golden parachute protects the executive’s pay in case of a merger or acquisition. The golden parachute option allows the executive to work on the sale or merger in the best interest of the shareholders rather than being worried about finding a new job. It is important to remember that executive compensation packages are developed by a board of directors with the organization's strategy, decision-making, and value creation in mind. Executive compensation is influenced by corporate management and federal law and is highly regulated. Another area that creates a challenge for compensation systems is the contingent worker. Today’s workforce has a variety of workers: part-time, full time, temporary, on-call, and independent contractors who we call contingent workers. A contingent worker is classified as an individual whose employment is based on business needs. Retail organizations, for example, often hire seasonal workers during the summer or holidays to meet customer demands. Contingent workers make up 30–40% of the U.S. workforce. For businesses, temporary workers allow the organization to have a flexible workforce when needed versus maintaining employees on the payroll who are not productive. Hiring and firing costs are high within most organizations. Temporary workers reduce this cost for the organization. The organization has access to labor for shorter periods of time without a long-term commitment and without the cost of benefits. Recent studies suggest that temporary workers tend to be female, younger than the average worker, and less likely to have an advanced degree. Most temporary workers are in transportation and material moving, production, or office and administrative support, and they typically work for a lower rate. For some people, temporary work allows for a better work-life balance or an opportunity to try other jobs in other industries. Temporary work also means reduced wages, unpredictable hours, little job security, and no benefits. This can create a challenge for the organization. It should be noted that there are two types of part-time employees: those who choose to work fewer than 35 hours per week and those who work fewer than 35 hours per week because they cannot find full-time work. It is not uncommon for people to work two or more part-time jobs. There are different rules when working with a contingent workforce. Certain federal, state, and even city laws have severe consequences if you violate the rules, intentionally or unintentionally. The biggest challenge when hiring a contingent workforce is misclassification. For example, the organization might hire an independent contractor as a 1099 worker (not paying employment taxes) and then have the Internal Revenue Service (IRS) and the Fair Labor Board rule that the person was actually performing the duties of a full-time worker. This type of misreporting results in adjudication, fines, and payment of back taxes. This can be significant for an organization that has a large contingent workforce. One way to mitigate the risk or misclassification is for the organization to hire through a third-party staffing agency and then treat the contingent workforce differently. The contingent workforce cannot take part in the

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organization’s reward and recognition programs, for example. They cannot be treated as a part of the permanent workforce. An organization does not need to make contributions to social security, unemployment insurance, workers’ compensation, and health insurance for contingent workers. The organization will save the administrative expenses of withholding various taxes, and not all labor and employment laws will apply. The worker will be responsible for his or her own taxes and social security payments. Using the economics reality test, as explained in your textbook, can help an organization to determine whether a worker is an employee or a contingent workforce. Consequences for not identifying workers properly are significant for an organization. Contingent workers provide a valuable service to an organization in terms of cost control and quality service. As the world becomes more complex, the challenges to meet organizational human capital needs becomes more complex as well.

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.