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8Compensation and Incentives

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Learning Outcomes After reading this chapter, you should be able to do the following:

• Discuss various psychological perspectives on pay and reward systems.

• Apply motivation theories to pay and reward systems’ design and implementation.

• List and describe various pay structures and types of pay.

• Link compensation with other functions within the HRM process.

• Explain the ways HR laws and labor unions influence the design and implementation of compensation and reward systems.

• Discuss opportunities, challenges, and recent developments in the area of compensation.

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Introduction

Introduction Pay and benefits are critical factors in the attraction, motivation, and retention of talent. The key to a successful pay and benefits package it its power to motivate employees to consistently exhibit attitudes and behaviors that are aligned with the organization’s goals, strategies, and culture. Thus, the motivational role of these rewards should determine pay and benefits. Employ- ers should offer pay and benefits that are competitive with other employers’ pay and benefits; employers should also clearly use pay and benefits to motivate employees to attain specific out- comes that the organization wants to see. There are many perspectives on motivation, and each perspective has implications for how pay and benefit systems should be designed and imple- mented. The next section discusses some of these perspectives’ implications for compensation and incentives. These perspectives are applied to various types of benefits in the next chapter.

Opening Case Study Is There a War for Engineering Talent Driving Up Salaries?

Access the following links:

http://money.cnn.com/2013/07/25/news/economy/engineering-jobs-pay/index.html

http://www1.salary.com/Engineering-Salaries.html

Salaries rise and fall with supply and demand. The article in the first link highlights shortages in engineering talent, which are driving up salaries and benefits. However, this information can be misleading. It may be true that there are shortages in a few highly spe- cialized engineering subfields, but the higher salaries and benefits come at a high cost, namely unfavorable locations, hours, and working conditions. Furthermore, the shortages tend to be temporary, and so do the job assignments. The second link offers a more realistic perspective on salaries in various engineering subfields. These dilemmas require careful consideration and extensive analyses in order to determine the appropriate salaries and benefits for each position, and thus attract and retain talent. These topics are discussed in more detail in this chapter.

Discussion Questions 1. Browse through the various engineering subfields. Which ones seem to offer premium

salaries? At what level/years of experience do salaries seem to increase exponentially? When do they seem to level off ?

2. Look specifically for the specializations mentioned in the article. Are the salaries cited in the article realistic?

3. Try different zip codes. Do some locations seem to offer higher salaries than others? Are premium salaries related to cost of living in these locations, the desirability of those locations, both, or neither?

4. Broaden your search beyond engineering, perhaps in your own field and/or your city/ state. What are the salary ranges in your specialization and related fields? What about your geographic location?

5. What are some opportunities that you can pursue to improve your salary prospects?

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http://money.cnn.com/2013/07/25/news/economy/engineering-jobs-pay/index.html

http://www1.salary.com/Engineering-Salaries.html

Appropriate types of pay

Job classification

system

Pay grades and pay ranges

Pay structure

Strategic HR planning

Job analysis and job design

Attraction and recruitment of

talent

Selection and job fit

Performance appraisal/

management

Training and development

Compensation and incentives

Benefits and benefit

administration

Content perspectives

Motivation

Process and equity

perspectives

Behavioral perspectives

Section 8.1 The Motivational Role of Pay and Rewards: A Psychological Framework

8.1 The Motivational Role of Pay and Rewards: A Psychological Framework

Organizations look for ways to motivate employees in the workplace, and pay and rewards play an important role in motivation. This section offers three perspectives—content, process and equity, and behavioral perspectives—on motivation and the ways that pay and reward systems should be designed and imple- mented. As shown in Figure 8.1, these motivational perspectives are central to the effective design and implemen- tation of compensation and incentives processes.

Content Perspectives Content perspectives focus on the source that triggers motivation: peo- ple’s needs. When there is no need, there is no motivation. Many traditional motivation theories were developed based on content perspectives, includ- ing Maslow’s hierarchy of needs, Alder- fer’s ERG theory, Herzberg’s two-factor theory, and McClelland’s acquired needs theory.

Maslow’s hierarchy of needs (1943) places psychological needs in a hierar- chy that starts with the simplest physi- ological needs and ends with the most complex psychological needs. The theory argues that lower-level needs have to be met first in order for higher-level needs to motivate people. The hierarchy starts with the simplest needs:

• Physiological needs include hun- ger and thirst.

• Safety needs include the need for shelter and clothing.

• Belongingness needs include the need for love and affiliation.

• Esteem needs include the need for status.

• Self-actualization needs include the need for achievement.

Figure 8.1: Compensation and incentives

Appropriate types of pay

Job classification

system

Pay grades and pay ranges

Pay structure

Strategic HR planning

Job analysis and job design

Attraction and recruitment of

talent

Selection and job fit

Performance appraisal/

management

Training and development

Compensation and incentives

Benefits and benefit

administration

Content perspectives

Motivation

Process and equity

perspectives

Behavioral perspectives

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Section 8.1 The Motivational Role of Pay and Rewards: A Psychological Framework

For example, a regular paycheck is motivating because it can help fulfill physiological and safety needs. A supportive manager and friendly coworkers can help fulfill needs for belong- ing, and a promotion can help fulfill esteem and self-actualization needs.

Alderfer’s ERG theory (1969) simplifies Maslow’s hierarchy and divides core needs into three groups, represented by the abbreviation ERG:

• Existence can be compared to Maslow’s physiological and safety needs. • Relatedness can be compared to Maslow’s belongingness, or social, needs. • Growth can be compared to Maslow’s esteem and self-actualization needs.

Moreover, unlike Maslow, Alderfer believed that different people may be motivated to satisfy their needs in different sequences. For example, Alderfer believed that when growth needs are frustrated, people may regress back to what Maslow would consider lower-level needs. This regression may explain situations when employees are denied promotions and ask instead for a raise, corner office, or designated parking spot. In these cases, employees may play for coworkers’ sympathy by bragging about past accomplishments and complaining about managers’ lack of appreciation for their past efforts. These behaviors do not help employees satisfy their growth needs; instead, they show regression to existence and relat- edness needs.

Herzberg’s two-factor theory (Herzberg, Mausner, & Snyderman, 1959) describes factors that can increase and decrease employee motivation and satisfaction. This theory postis that factors that decrease motivation are likely to be extrinsic—such as working conditions, organizational politics and policies, compensation and benefits, and coworker relationships. These extrinsic factors are referred to as hygiene factors. On the other hand, factors that

increase motivation are likely to be intrinsic— such as nature of work, career advancement opportunities, and feelings of achievement. These intrinsic factors are referred to as moti- vators. Thus, hygiene factors are necessary to prevent job dissatisfaction, but they are not suffi- cient to motivate a person in the absence of moti- vators related to job content.

McClelland’s acquired needs theory (1958) argues that there are two types of needs: ones that people are born with, and others that are acquired through life experiences. Acquired needs include the needs for achievement, affiliation, and power, which motivate people to behave in ways they believe will help them fulfill these needs. For example, one employee may be motivated by promotion prospects that could fulfill his achieve- ment and power needs. Another employee may be motivated to do her fair share of the work in order for her team to appreciate her efforts, which can fulfill her affiliation needs.

Creatas Images/Creatas/Thinkstock

According to Herzog’s theory, factors that increase motivation, such as feelings of achievement, are likely to be intrinsic.

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Section 8.1 The Motivational Role of Pay and Rewards: A Psychological Framework

Process and Equity Perspectives Whereas content perspectives focus on the source of motivation, process and equity per- spectives focus on the process leading to motivation. They address the reasons and mecha- nisms for people’s actions as well as the resulting level of satisfaction. Motivation theories based on process perspectives include:

• Vroom’s expectancy theory • Goal setting theories • Equity theories • Justice theories

Each of those theories informs the design and implementation of compensation and incentive systems that would motivate employees. For example, compensation and incentive systems are more motivating when they are perceived to be more equitable and just.

Vroom’s expectancy theory (1964) explains the motivation process using three dimensions:

1. Expectancy is an individual’s belief that expending effort on an activity will probably lead to high performance. For example, an employee who believes that he can do a task is more likely to attempt it than an employee who feels incapable of complet- ing the same task. Rewards for low-expectancy tasks are unlikely to motivate an employee to make additional effort.

2. Instrumentality is the perceived probability that successful performance will lead to desired outcomes. For example, an employee who views bonuses as linked to per- formance on a particular task is more likely to focus on that task. The more strongly performance is linked to rewards, the more motivating the rewards are.

3. Valence is the relative weight or value that an employee places on particular rewards or outcomes. For example, an employee who cares more about growth opportunities than money will be more motivated to perform the tasks that are most likely to lead to those opportunities, such as volunteering for challenging projects, even if no extra pay is involved.

Goal setting theories view humans as being motivated to pursue challenging goals. In par- ticular, specific, measurable, difficult goals have been found to lead to higher performance than goals that are easy or ill-defined (e.g., when people are simply encouraged to do their best). This benefit fades when goals are so difficult that they are perceived as unachievable or unrealistic (Locke & Latham, 2002). Goals with set deadlines also tend to be more motivat- ing. Thus, rewards for meeting deadlines and for achieving specific, measurable, challenging goals will likely motivate employees toward higher performance. In fact, those goals some- times become their own rewards because the goals are intrinsically motivating and do not necessarily need any additional, extrinsic rewards (Amabile, Hill, Hennessey, & Tighe, 1994; Wiersma, 1992).

According to equity theory (Adams, 1965), employees choose specific behaviors based on whether they believe they are treated fairly. Employees form this belief as a result of com- paring their own inputs and outcomes with those of others. The behavior can be positive or negative, depending on the belief the employee holds. For example, one employee may

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Section 8.1 The Motivational Role of Pay and Rewards: A Psychological Framework

believe that he or she has invested the same amount of time, effort, and resources (equal inputs) as another employee, but the other employee received more pay, incentives, or recog- nition (unequal outcomes). This belief generates a perception of inequity. To restore equity, the employee may reduce his or her inputs (e.g., work less) or try to increase his outcomes (e.g., ask for a raise or a promotion). On the other hand, if an employee worked longer or harder than another employee but also received proportionately more outcomes, then both employees will perceive the situation to be equitable.

Employees are motivated by knowing that their employer treats them with fairness, respect, and dignity. They also want to make sure that their organization is being fair and transparent in its values, its processes, and the impact it has on various stakeholders. Justice theories (Colquitt, Conlon, Wesson, Porter, & Ng, 2001; Greenberg, 1993) attribute motivation to per- ceptions of five forms of justice:

• Distributive justice is the perceived fairness of the distribution of outcomes such as pay and incentives.

• Procedural justice is the perceived fairness of the procedures used to determine such outcomes as pay and incentives. For example, if an organization uses objective performance criteria as the basis for raises and promotions, then employees will perceive procedural justice in this arrangement.

• Informational justice is the thoroughness of the information provided to explain out- comes. For example, an organization may base annual bonuses on criteria that are high in procedural and distributive justice. But the decisions may still be perceived as unfair if those criteria and their application are not explained effectively.

• Interactional justice is the degree of perceived respect in interactions among individu- als in an organization. For example, it would be just not to give a raise or a promotion to a poor performer. However, if the performance deficiencies are communicated to the employee in a berating, demeaning, or belittling way, then that communication process is high on informational justice but low on interactional justice.

• Organizational justice is the overall perceived fairness of the organization’s pro- cesses and outcomes. For example, an organization may base its pay and incen- tives on a specific, clearly communicated set of criteria. But organizational justice will be perceived as low if the performance appraisal system used to assess the criteria is too subjective, or if the managers evaluating performance are biased or discriminating.

Behavioral Perspectives Generally speaking, behavioral perspec- tives are concerned with how behaviors are learned and reinforced. The founda- tions of those perspectives date back to Pavlov’s 19th century experiments, in which he conditioned dogs to salivate at the sound of a bell they associated with the presence of food. These perspectives can also be traced to Skinner’s early 20th century operant conditioning experi- ments, in which he manipulated the

The foundation for behavioral perspectives is based on Dr. Ivan Pavlov’s canine behavioral experiments from the 19th century.

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Section 8.1 The Motivational Role of Pay and Rewards: A Psychological Framework

behavior of lab rats and pigeons by varying the consequences he administered for various types of behavior. Thorndike’s law of effect captures the essence of behavioral perspectives: that behaviors followed by positive consequences tend to increase in frequency, while behav- iors followed by negative consequences tend to decrease in frequency.

Based on those behavioral perspectives, pay, incentives, and other workplace rewards should be directly linked to the workplace behaviors believed to lead to the desired performance. This linkage improves performance by making rewards contingent on performance. For example, sales representatives receive commissions that are proportionate to their sales vol- ume, which promotes selling behaviors. On the other hand, a fixed paycheck, while important and desirable, does not necessarily motivate employees to work harder. In fact, this reward may become an expectation and promote a sense of entitlement. In some situations, a fixed paycheck is necessary—e.g., in managerial jobs that do not lend themselves to commissions or unit-based pay. In these situations, it is best to use other incentives that can be adminis- tered contingently. Examples include regular feedback and recognition (Luthans & Stajkovic, 1999; Stajkovic & Luthans, 1997). Some organizations also provide blended forms of com- pensation, such as a combination of a fixed salary base and a variable commission-based component. This type of compensation package combines the benefits of income stability with the motivation and behavioral reinforcement of performance-based pay.

A Moment in the Life of an HR Manager You Get What You Pay For

How would you train a pet to behave in a certain way? You’d reward the desired behavior to reinforce it, and punish the undesirable behavior until it disappears. The same behavioral management foundations have been applied to motivation in human beings. Unlike the pro- cess theories of motivation, behavioral management is not too concerned with why people are motivated by certain rewards or the mental processes that explain their motivation. Behavioral management emphasizes observable behavior and how it can be predicted, using specific environmental cues and tangible or measurable reward systems.

Web Link Rewarding A, While Hoping for B:

http:www.ou.edu/russell/UGcomp/Kerr.pdf

This article is a management classic, in which Steven Kerr illustrates how reward systems can fail to promote performance if they are not linked to the right behaviors. It is one of the most read and appreciated resources on applying a behavioral perspective to reward systems.

Can we shape people’s behavior in the workplace by managing the consequences of that behav- ior? Studies suggest that this process is indeed possible and can yield many desirable outcomes in many settings, including the workplace. In fact, behavioral management principles are the foundation for many reward systems today. This has become known as organizational behav- ior modification. In the workplace, this behavioral modification can be achieved in five steps:

1. Identify critical performance-related behaviors 2. Measure the current frequency of those behaviors

(continued)

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http:www.ou.edu/russell/UGcomp/Kerr.pdf

Section 8.1 The Motivational Role of Pay and Rewards: A Psychological Framework

A Moment in the Life of an HR Manager (continued) 3. Analyze the existing antecedents and consequences of the behaviors 4. Intervene with contingent reinforcers for the desired behaviors 5. Evaluate the results

Three decades of extensive research studies consistently support this approach (Stajkovic & Luthans, 1997, 2003). Specifically, three types of reinforcers have consistently emerged as effective in the workplace (Luthans & Stajkovic, 1999). These powerful motivators are:

• Money • Feedback • Recognition

Interestingly, although feedback and recognition can be used at no cost to the organiza- tion or the manager, they have been found to result in similar (and sometimes higher) per- formance outcomes than money. However, the key to the motivational potential of those rewards is that they must be linked directly to the desired behaviors, and they must not be:

• Given randomly (e.g., by managers who praise or berate their employees depending on whether they are having a good day or a bad day)

• Spread equally (e.g., through companywide bonuses or layoffs) • Allowed to become an entitlement (e.g., through the fixed paycheck or seniority-based

promotion, versus merit-based pay)

Meta-analytical research has shown that behavioral modification and management inter- ventions in the workplace, comparable to the five-step process described above, can increase performance by about 17% on average, and it can have a success rate of about 63% (Stajkovic & Luthans, 1997, 2003). People are unique in their needs and what they find motivating. Yet the motivational potential of money, feedback, and recognition, when administered contin- gently, seems to generalize across most worker populations. This generalization is true not only in the United States but in other cultures as well (Welsh, Luthans, & Sommer, 1993).

Discussion Questions

1. Follow the steps of organizational behavior modification outlined above to try to change the behavior of someone you know. You can choose a coworker, roommate, friend, or family member.

• Identify the specific behavior(s) you would like to change. • Example: “My coworker does not clean the microwave after using it.”

• Measure and record the current frequency of the behavior(s). • Example: “Three out of five days a week, my coworker leaves the microwave

messy after lunch.”

• Analyze and record the existing antecedents and consequences of the behaviors. • Example: “My coworker always eats lunch early and leaves before everyone else is

in the lunchroom. When the next microwave user arrives, the cleaning chore auto- matically gets taken care of by that next person.”

• Intervene with contingent reinforcers for the desired behaviors. • Examples: Make it a point to eat lunch early with your coworker and be next in

line to use the microwave to instill a sense of obligation to leave it clean. Then

(continued)

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Section 8.2 Pay Structures

8.2 Pay Structures An organization’s pay structure is the way it implements its philosophy and value system through two types of pay structures:

• Internally equitable structures emphasize equity of pay within and across jobs in the organization. They use a carefully designed grid to assess each job’s pay in relation to the other jobs in the organization. For example, one important concern of internally equitable structure is how many times greater the compensation is for the highest-paid employee (e.g., the CEO) than the compensation for the lowest-paid employee (e.g., the receptionist). Another concern is what the percentage increase in pay will be when a worker is promoted to a supervisory position.

• Market pricing structures, also referred to as externally equitable structures, assess the pay of each job in relation to prevailing market rates. For example, in a market pricing structure, it would be acceptable for an employee with a rare capa- bility or unique experience to make much more than his or her coworkers, since the much higher pay reflects the prevailing market rate for this caliber of capability or experience. Advocates of market pricing strategies argue that all that needs to be done to build a pay structure is to price all of a firm’s jobs in the labor market, array them from top to bottom (Heaps, 2011), and make frequent updates to reflect competitive market positions (McGrory-Dixon, 2012). “To hire great people, only ‘market rate’ matters, and if you are weighted down with any other considerations unrelated to ‘market rate’, you are giving an artificial and unfair advantage to your competition,” claimed Washington, D.C. based consultant, Bob Corlett (2012). With a market pricing strategy, strategies can be developed to lead the market (e.g., pay above market wages in order to gain a competitive edge in the labor market), meet the midpoint or average of market wages (e.g., remain competitive, on average), or lag behind market wages (e.g., wait a specific amount of time before adjusting pay

A Moment in the Life of an HR Manager (continued) thank your coworker for leaving behind a clean microwave. Or, for several days, agree with others not to clean the microwave and to bring a cold lunch instead so that the coworker has to clean it the next day; the negative behavior then will not be reinforced. Remind others to praise your coworker for a job well done if the coworker gives the microwave a good scrubbing the next day.

• Evaluate and record the results. • Examples: “Now the coworker only occasionally leaves a messy microwave

behind.” Or, “Now the coworker eats lunch at a different time and still does not clean the microwave.” Or, “Now my coworker is in the habit of cleaning the micro- wave but forgets to pick up after himself (which may need another intervention).”

2. How effective was your intervention? 3. Before learning about organizational behavior modification, what would have been your

most likely reaction to the undesirable behaviors you encountered? Ignore them? Com- plain about them? Be annoyed by them? Try to punish the offender? Report them?

4. What have you learned from this exercise?

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Section 8.2 Pay Structures

upward to reflect the market midpoint). Today, most employers base their pay struc- ture on market pricing alone (Woodward, 2012) with the justification that failure to at least match the market average or midpoint will lead to a decline in employee morale and productivity. Three factors are generally used to determine a relevant labor market: 1) skills, knowledge, and abilities required, 2) geography (willingness to relocate or commute), and 3) competitors in the same product/service and labor markets (Milkovich, Newman, & Gerhart, 2013).

Furthermore, not all jobs within an organization have the same pay structure. Jobs should be evaluated first using different methods, including the HR planning, job analysis, and job design processes described in Chapters 2 and 3. Through job analysis, an employer should be able to identify a number of factors for each particular job that will help establish appropriate com- pensation levels. These factors include the responsibilities and activities, skill levels, job envi- ronment and compensable factors, and necessary personal qualifications. Accordingly, com- pensation starts with the process of job analysis, which then leads to conducting a job evaluation for the purpose of pricing jobs. Each job is then assigned a value and ranked in relation to others, creating a position hierarchy within an organization. This hierarchy is cru- cial for establishing consistent compensation systems. However, some organizations empha- size internal equity for most of their jobs, but use a market pricing structure for positions where unique, rare skills are needed.

Based on the organization’s pay structure, a job classification system is then created. Creating this system entails describing each class of jobs, also called a job family, and then placing each job under a class or family. Examples of job families include clerical, production, service, supervisory, and managerial jobs. Different job families can have different pay structures. An organization’s mission, vision, strategy, culture, structure, and available resources all have an impact both on the types of pay structure adopted for different job families and on an organization as a whole.

A pay grade is a level assigned to each job that determines how much the job incumbent should be paid. There are two widely used methods for establishing pay grades:

• Job evaluation data • Market banding

The job evaluation data method links job evalua- tion points and data from pay surveys to identify how these two factors relate to job value. Subsequently, jobs that have similar point values are grouped together into pay grades, and each pay grade is then given a pay range, the minimum and maximum pay for that pay grade. Market banding, on the other hand, uses market pricing for the purpose of valuing jobs. In this method, jobs that have similar market survey amounts are grouped into pay grades.

Comstock Images/Stockbyte/Thinkstock

A pay grade is a level assigned to each job that determines how much an employee should be paid.

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Section 8.3 Types of Pay

After establishing a pay range for each of the pay grades, market lines are determined; they represent the midpoints of pay ranges. Minimum and maximum pay levels, as well as pay lev- els at different percentiles, are then calculated as specific percentages of the market line. Cur- rent and future pay ranges for various positions can be checked against each other to ensure internal and external equity.

It is possible to reduce the number of pay grades by combining some of them and widening the ranges. This practice is called broadbanding. Broadbanding is currently a popular prac- tice due to the increasing frequency of lateral movement in organizations; this fact leads to employees’ gaining more skills, which a wider pay range allows an organization to reward. Furthermore, with broadbanding, employees can now excel in their areas of expertise and be financially rewarded for their excellence without having to move to a management position to jump to the next pay grade, which is related to the concept of dual career paths, discussed in Chapter 4.

Advantages to broadbanding include encouraging and rewarding a broader range of compe- tencies and career development directions. However, broadbanding’s effects should be care- fully observed, since it has a significant impact on salary levels as well as costs (Fay, Schulz, Gross, & Van De Voort, 2004). Traditionally, promotion means moving to a higher grade and getting a pay raise. But this is not always the case with broadbanding. In fact, many organiza- tions will offer more lateral opportunities than upward opportunities, which may not meet the needs and expectations of all employees.

In contrast to broadbanding, pay compression is a serious issue that employers face now. The term refers to a small difference in pay among employees, regardless of their level of skill or experience, which many employees may see as unfair. The main factor that leads to pay compression is when internal salaries are not adjusted promptly as labor market pay levels increase (Ladika, 2005). Pay compression can occur when an employer experiences a specific skill shortage and tries to fill the job by offering higher salaries in an attempt to be competitive and attract top talent. One way to tackle the challenge of pay compression is to keep an eye on market changes and adjust pay ranges accordingly (Klein, Keating, & Ruggerio, 2002).

8.3 Types of Pay After pay structures, grades, and ranges have been established, an organization can choose among many different types of pay. The most frequently used types of pay are discussed in this section.

Hourly Pay Hourly pay is the simplest and most frequently used type of pay. Employees are paid a set rate for each hour worked. This type of pay is common for many types of jobs, including blue collar and clerical positions. The advantages of hourly pay are its predictability and ease of calculation, both for employers and employees. The primary disadvantage is that this type of pay is not very motivating or conducive to higher productivity. It rewards employees for showing up and staying longer, but not for working harder. Since pay is not contingent on performance, it does not promote effective work behaviors (except for being present).

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Section 8.3 Types of Pay

Piece-Rate Pay Piece-rate pay is another common type of pay. Unlike hourly pay, piece-rate pay is not stated in terms of a rate per hour. Instead, it is based on the number of units or “pieces” produced. Piece-rate pay is common in production jobs. Another very common example of piece-rate pay is commission-based compensation for sales jobs.

Since piece-rate pay is based on the amount of work done, it is aligned with the process and behavioral perspectives discussed ear- lier, which makes it motivating and condu- cive to high productivity. However, external factors beyond the employee’s control may affect productivity and, consequently, pay. These factors include machinery break- downs and supply and delivery problems, which may cause employees to perceive this type of pay as unfair. Furthermore, only a limited number of behaviors can be rewarded through piece-rate pay. Employ- ees are likely to focus on behaviors for which they are rewarded, compromising overall effectiveness. For example, com- mission-based sales representatives are often pushy, and once they sell a product, they may ignore customers’ calls or requests for after-sale service because they are not rewarded for responsiveness once the sale is complete.

Competency-Based Pay Competency-based pay is different from other compensation pay programs in that an employee is not rewarded for his or her ability to perform the tasks and duties required for a job. There are two types of competency-based pay, namely, knowledge-based pay (KBP) and skill-based pay (SBP). Accordingly, competency-based pay compensates employees based on their ability to learn and acquire more skills or expand their knowledge, which in turn helps them become valuable assets to an organization (Baca & Starzmann, 2006). In this case, training could be used as a method to help employees obtain competencies in specific areas that will help the organization achieve its goals and objectives (Heneman & LeBlanc, 2002; Lokshin, Gils, & Bauer, 2009). In other words, competency-based pay rewards employees for what they can do and for the knowledge and skills they possess or learn, rather than for the jobs they hold. For example, McDonnell Douglas Helicopter Sys- tems has been known for years now to give its employees pay raises upon demonstrating the successful completion of specific learning modules, rather than automatic raises based on seniority or job title.

Outcome-Based Incentives Outcome-based incentives are sometimes also referred to as merit pay; these incentives are usually offered in addition to wages and salaries and are linked to predetermined, quantifiable

Ramona d\’Viola/iStock/Thinkstock

Craftsmen often get piece-rate pay based on the quantity and quality of the goods they produce.

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Section 8.3 Types of Pay

outcomes. Their purpose is to energize employees and motivate them to be more effective and productive through rewards when they achieve desirable outcomes. For example, an employee or a team of employees may receive a bonus for meeting a certain sales volume or customer satisfaction scores. When employees know that they are going to be rewarded for their extra work, this certainty motivates them to try their best and produce more. Further- more, organizations that offer outcome-based incentives are able to attract high performers and are therefore able to recruit and retain top talent (Cadsby, Song, & Tapon, 2007; Salamin & Horm, 2005; Trevor, Gerhart, & Boudreau, 1997).

A case in point for outcome-based incentives is the Teacher Advancement Program (TAP). Created in 1999, the program provides teachers with financial incentives based on objec- tively measured outcomes such as student performance. These incentives include salary raises and bonuses, as well as nonfinancial incentives such as development and advance- ment opportunities. The program has been successful in enhancing learning outcomes in numerous schools across the United States. It has also been instrumental in attracting, moti- vating, and retaining talented teachers in poor or disadvantaged areas, and in difficult-to- teach subjects. Over the years, these results have led to an increased scope and funding for this program.

Because different types of incentives attract different kinds of employees, outcome-based incentives are part of the compensation process but should also be considered for other HR decisions such as job analysis and job design. For example, incentive systems designed around team-based outcomes will attract employees who are team oriented and pre- fer to work as part of a team (Bretz, Ash, & Dreher, 1989; Cable & Judge, 1994; Judge & Bretz, 1992).

Many factors determine the effectiveness of outcome-based incentives: one factor is that performance measures must be associated with organizational goals. Performance stan- dards should be attainable, and employees should be provided with the resources needed to achieve those standards. These guidelines accord with the content, process, equity, and behavioral perspectives discussed earlier. Furthermore, employees should view the reward system as fair and see the rewards as valuable. Finally, organizations should consider the fact that unrewarded goals may possibly be ignored.

Salaries and Exempt Positions A salary is fixed pay that is stated in terms of a rate per week, month, or year. Salaries are offered for both exempt and non-exempt positions. However, employees who hold exempt positions do not receive overtime pay according to the Fair Labor Standards Acts (FLSA) regulations. Exempt positions include executive, administrative, knowledge, service, and pro- fessional jobs in general. These positions are expected to come with responsibilities that the employee should fulfill, regardless of how much time it takes. Thus, overtime is not offered. Factors that should exist in order for a position to be considered exempt are regulated by FLSA, although many employers try to cut overtime costs by reclassifying some of their posi- tions as exempt. This practice is illegal and has lately come under great scrutiny, causing substantial penalties for employers that engage in this false reclassification. The website below offers more detailed classification guidelines and examples of exempt and non-exempt positions.

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Section 8.3 Types of Pay

Team-Based Pay Team-based pay is an effective way to motivate teams by compensating them based on overall team performance instead of individual performance. It is based on the notion that cooperation and interaction among team members make the team effective. Team-based pay encourages team members to collaborate, which can enhance team productivity, efficiency, and effectiveness. However, high-performing team members should also be rewarded for their individual accomplishments to help avoid complacency (Merriman, 2009) and free riding. The organization’s goals and priorities as well as the tasks at hand should determine the balance between individual and team-based pay. In other words, it is important to link organizational strategy to pay and incentives and strategic HR processes such as planning, job analysis, and job design. For example, Honeywell, a leader in safety, security, and energy technologies, regu- larly recognizes and rewards teams that deliver exceptional results that support its major initiatives. These rewards are offered in addition to individual rewards and incentives.

Compensating Independent Contractors Independent contractors are not employees of the organization. They are self-employed individuals or entities that provide a product or a service to the organization for a contracted fee. Independent contractors are different from employees in that their employers do not have to contribute to their Social Security, Medicare, and unemployment taxes or to their workers’ compensation costs. Employers usually share those costs with regular employees, but independent contractors have to pay their own costs. If an organization offers additional benefits, such as the benefits discussed in the next chapter, then independent contractors are not usually eligible for them. This ineligi- bility significantly reduces the cost of hir- ing independent contractors.

However, in order for an employee to be classified as an independent contractor, a number of criteria have to be met. For example, independent contractors usually use their own tools, design their own schedules, and perform their roles as they see fit. The web site below provides more details and examples of classification cri- teria for independent contractors. Similar to using exempt classification to reduce overtime costs, many employers try to reclassify their employees as independent contractors to avoid paying the additional

Web Link Handy Reference Guide to Fair Labor Standards Act

http://www.dol.gov/whd/regs/compliance/hrg.htm

Blend Images/Blend Images/Superstock

Independent contractors, or freelancers, are self- employed individuals who provide a service or product for an organization for a contracted fee.

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Section 8.3 Types of Pay

taxes and offering them benefits. Unless justified by the nature of the job, this practice is ille- gal and subject to substantial penalties.

Executive Pay Executives are paid salaries like all other employees, but they also receive bonuses and stock as forms of compensation based, of course, on their performance. Generally speaking, top executives receive very high pay, especially in the United States, compared to all other coun- tries (Lawler, 2009). Many people compare the ratio of inputs to outcomes and see this high pay as unfair. The difference in pay between CEOs and lowest-level employees in the United States has been increasing during the past 20 years or more. According to equity theory, this difference in ratio has to be justified by the amount CEOs contribute to organizations and also by their level of contribution in comparison to CEOs in other countries, which is not the case. In fact, one research study found that as the difference in pay gets smaller, product quality is higher (Cowherd, & Levine, 1992). Cooper et al. (2013) found that firms paying their CEO in the top ten percent of executive pay was associated with shareholder wealth losses as great as eight percent because of CEO overconfidence leading to overinvestment and value destroying mergers and acquisitions. A recent study of 241 executives who in the past two decades were at one time or another rated among America’s highest paid CEOs reported that 22% led firms that either went out of business or received taxpayer bailouts after the 2008 financial crash, and another 8% were fired for poor performance but exited with golden parachutes averaging $48 million (Anderson et al., 2013). Azar (2012) concluded that to date there has been dem- onstrated no correlation under any reliable metric between executive pay and corporate per- formance. Other aspects of executive compensation are examined in the Eye on the Goal box.

Web Link Independent Contractor (Self-Employed) or Employee?

http://www.irs.gov/Businesses/Small-Businesses-%26-Self-Employed/ Independent-Contractor-Self-Employed-or-Employee

Eye on the Goal Celebrity CEOs and the Profitability of Their Organizations:

Managerial Success and Effectiveness Do Not Always Go Together The extremely high compensation for CEOs in the United States has been heavily criticized. This criticism has exponentially increased due to the current economic conditions, causing many of those CEOs to come under close scrutiny by investors, analysts, and the public at large. Further- more, CEO pay can reach millions of dollars a year, and it is usually only a small percentage of the total compensation package. In addition to their pay, many CEOs are rewarded with very large benefit packages that are not always linked to their performance. They are also promised substantial exit packages, called “golden parachutes,” often without any performance stipula- tions. Visit the three Web links below for interesting and insightful information on these topics.

(continued)

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http://www.irs.gov/Businesses/Small-Businesses-%26-Self-Employed/Independent-Contractor-Self-Employed-or-Employee

Section 8.3 Types of Pay

Eye on the Goal (continued)

Web Links America’s Highest-Paid CEOs: http://www.forbes.com/lists/2012/12/ceo-compensation- 12_land.html

The $1 Executive Club: http://upstart.bizjournals.com/news/wire/2008/03/26/the-1- executive-club.html

Golden Parachutes: http://www.usatoday.com/money/companies/management/story/ 2011-11-07/100-million-dollar-chairmen/51116304/1

In the first linked article, note the significant discrepancies between the CEOs’ compensa- tion rankings column and the efficiency rankings column on the right. Apparently, pay and efficiency are not directly related. As discussed in the article in the second link, even when CEOs give up their pay, their total compensation continues to be extremely high and difficult to justify in performance terms. Namely, CEO compensation is not contingent on their per- formance in terms of the content, process, equity, and behavioral motivation perspectives discussed earlier. In fact, as the third link shows, golden parachutes handsomely reward CEOs for quitting, even when their organizations have deteriorated over their tenure, and when they know that their poor performance has cost many investors their life savings, and cost many employees their jobs and livelihoods.

An interesting stream of research started in the late 1980s, investigating what managers really do (e.g., Luthans, 1988; Luthans, Hodgetts, & Rosenkrantz, 1988). After conducting many observational studies, the researchers were able to classify the activities of managers into four main categories:

• Traditional management, which includes planning, decision making, scheduling, and controlling

• Human resource management, which includes staffing, training, motivation, rewarding, disciplining, and conflict management

• Communication, which includes exchanging information and paperwork • Networking, which includes interacting with outsiders, socializing, and politicking

The researchers then proceeded to find commonalities and distinguishing factors along these four dimensions between two types of managers: those who were effective and those who were successful. Effective managers were defined as those whose units were high per- forming, in quantity and quality, and whose employees were satisfied and committed. Suc- cessful managers were defined as those who were promoted the quickest. Interestingly, the researchers found that effective managers invested more time in the human-oriented activities of human resource management and communication. On the other hand, success- ful managers invested a lot more time in networking activities, especially politicking!

Two lessons can be learned from these findings. First, if you want to be successful, you can- not ignore politics. There’s no such thing as an organization with no political games. You don’t have to give up on your ethical standards, but you do need to learn how to play the game if you want to advance. Second, when you are in a decision-making position, be care- ful what you reward. If managers are promoted based on their ability to play politics, then politics is where they will invest their time and energy. If effective managers are left behind and passed over for promotions, what message is sent to managers and employees?

(continued)

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http://www.usatoday.com/money/companies/management/story/2011-11-07/100-million-dollar-chairmen/51116304/1

Section 8.3 Types of Pay

Ownership Rewards Some organizations offer employees ownership rewards to encourage them to think and act like part owners, thereby motivating employees to focus on making the organization more competitive and effective. Ownership rewards can be in the form of stock options or employee stock ownership plans. Stock options are noncash rewards offered to employees to give them the right to buy shares of an organization’s common stock at a price that is lower than market rates. Stock options were originally offered only to executives. However, many organizations now offer them to employees at all levels.

Employee stock ownership plans (ESOP) are also a form of noncash rewards. However, unlike stock options, they are usually offered to all employees. In an ESOP, employees receive shares of an organization’s stock; the shares are then placed into a trust. Employees regularly receive reports on the value of their shares. They have the right to sell their stock to the organization when they leave; they can also sell it on the open market if the organi- zation is publicly traded, and the income they get is nontaxable. ESOPs give employees the right to vote as shareholders. Not all organi- zations offer the same level of participation to employees. Nevertheless, the greater the par- ticipation is, the greater the ESOP benefits will be (Klein, 1987).

Eye on the Goal (continued)

Discussion Questions

• In your opinion, why is CEO compensation in the United States higher than in other countries? What are some of the contributing factors?

• Select a few CEOs or companies that you are particularly interested in from the Forbes list. Further investigate the leadership styles, rewards, and performance of those CEOs and their companies over the last few years. What are some of your observations?

• Give some examples of exceptional leaders whom you admire. Research how they were compensated or rewarded. Remember to incorporate nonfinancial rewards.

• Outline an equitable reward package for the CEO of your current organization, an orga- nization you are familiar with, or one where you or someone you know has worked in the past. This outline can also be for one of the exceptional leaders you have researched for the previous question. What does your reward package include? How does it meet the motivational characteristics you have learned from the content, process and equity, and behavioral perspectives discussed at the beginning of this chapter?

lukas_zb/iStock/Thinkstock

Organizations may choose to compensate their employees with nonmonetary rewards such as stock options and employee stock ownership plans (ESOPs), which generally increase in value over time.

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Section 8.4 Linking Compensation to the HRM Process

Stock ownership can enhance employee commitment to the organization and increase reten- tion rates. It is also associated with increased sales per employee (Kramer, 2010) and job satis- faction (Hsu, 2008). However, one drawback of stock ownership is that employees may experi- ence difficulties in associating their performance with an organization’s stock price. The bigger the organization, the harder it is for employees to link pay and performance. The reason for this difficulty is that the only time employees can benefit from their stock is when they sell it.

8.4 Linking Compensation to the HRM Process Decisions regarding pay level and structures can influence organizational performance. Put- ting together a compensation plan for local, domestic, or international employees is no easy task. Employers often find it challenging to provide competitive compensation to employees across geographic locations (Brown, Sturman, & Simmering, 2003; Reilly & Audi, 2006). Orga- nizations use the job market as a source of information when they put together compensation plans for employees. This job market information is usually collected through the HR plan- ning processes discussed in Chapter 2. Based on that information, organizations may position themselves in the labor market using below-, middle-, or above-market strategies.

Using a below-market strategy, or first-quartile strategy, means offering salaries below the market rate—usually in the lowest quartile (25%) of employers in its market. An organiza- tion may pursue this strategy if it is experiencing a shortage of funds or has a sufficient num- ber of workers, or if unemployment rates are high. A below-market strategy can increase turnover rates, making it challenging to attract and retain talent.

However, some organizations that use a below-market strategy may be able to attract and retain talent by offering additional nonmonetary rewards and benefits. As discussed earlier, exam- ples of those nonmonetary rewards are stock options and ESOPs, which have lower short-term costs for the organization but which generally increase in value over time—rewarding employ- ees for their long-term commitment. Other important nonmonetary rewards are employee benefits. As discussed in the next chapter, benefits have a significant value for employees, so talented employees may choose to work at below-market pay rates because these benefits can save them substantial amounts of their income that they would have spent to obtain those benefits independently. Moreover, employ- ees now look for organizations that grant opportunities for learning, growth, and career advancement. Organizational training and development programs can serve this purpose and can therefore be used as non- monetary rewards (Hansen, 2010).

In a middle-market strategy, or second- quartile strategy, an organization positions itself at about the average market rate. Although they will not make the organiza- tion stand out for its compensation pack- age, middle-market strategies are often used by organizations with established reputa- tions. These organizations are attractive to

vadimguzhva/iStock/Thinkstock

Nonmonetary rewards, such as health care benefits, can be an important factor in recruiting long-term employees.

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Section 8.4 Linking Compensation to the HRM Process

talented employees for other reasons, such as stability and opportunities for advancement. On the other hand, an above-market strategy, or third-quartile strategy, puts an organization above 75% of employers in terms of pay rates and gives it the advantages of being able to attract and retain top talent and being more selective during the hiring process.

There are a number of factors, some external and some internal, to be considered when choosing a compensation strategy. For instance, competitive pressures and unemployment rates are among the external factors. Among the internal factors for an organization are its goals, strategies, financial strength, nonmonetary benefits, and the learning and development opportunities it offers its employees.

As discussed earlier, job analysis and job design are also fundamental to sound compensa- tion decisions. Job analysis and job design can help an organization determine not only the compensation level for each job but also its pay philosophy and the various types of pay and rewards it will use to motivate employees. In turn, the organization’s value system for pay and incentives can help determine the characteristics of employees who would best fit the organization and inform selection and placement decisions.

Finally, compensation can be based on employee performance. It establishes perceptions of equity and justice to associate employees’ compensation with their performances and their contributions to organizational goals. This association also motivates employees to be more productive and effective, and it accords with the motivational perspectives discussed earlier. Performance-based compensation can take many forms, such as profit sharing, bonuses, and gain sharing. However, in order for compensation to be legal and to be effective in motivating performance, an objective performance appraisal system (discussed in Chapter 6) must be in place, and regular feedback and performance reviews must be conducted.

HR Laws Governing Compensation As is the case with HR processes in general, compensation is governed by Title VII of the Civil Rights Act, the Americans with Disabilities Act (ADA), and the Age Discrimination in Employ- ment Act (ADEA), which are enforced by the Equal Employment Opportunity Commission (EEOC). Thus, it is illegal for employers to discriminate in pay based on gender, religion, national origin, race, color, disability, or age. HR planning, job analysis, and job design should inform fair recruitment and selection practices. In the same way, these processes should also guide compensation decisions. Nondiscriminatory practices require that recruitment, selec- tion, training, and compensation be based on job responsibilities, employee qualifications and performance, and accurate market analysis.

As discussed in Chapters 3 and 5, two employment laws specifically address compensation: the Equal Pay Act, which prohibits pay differentials for equal jobs across genders; and the Fair Labor Standards Act (FLSA), which regulates minimum wage, hours of work, child labor, and the distinction between exempt and non-exempt employees.

However, equal pay and fair labor standards continue to be subject to interpretation, and they are sometimes manipulated in more subtle ways to reduce costs. For example, most employers avoid litigation through equal pay for male and female employees with exactly the same job titles. Yet female employees continue to struggle with a glass ceiling—social and professional challenges that prevent them from reaching upper management levels—which decreases their earning power over their careers.

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Section 8.5 Opportunities, Challenges, and Recent Developments in Compensation

Some careers were traditionally dominated by females during and after World War II; exam- ples include secretaries, teachers, and nurses. These employees were informally dubbed “pink-collar” workers, and they continue to earn lower wages. Originally, these jobs were perceived to provide supplemental family income. However, many males and females now establish their careers in these fields. These careers are the primary source of income for many families and single-earner households; however, these are still low-paying careers—a phenomenon that is not regulated by any labor laws.

Labor Unions and Compensation Employers are not the only ones who determine compensation. Labor unions are often heav- ily involved in the process and have a major impact on designing pay plans. The National Labor Relations Act (NLRA) gave employees the right to organize and engage in collective bargaining, through which compensation is usually determined. Collective bargaining is also used for other employment conditions. These conditions can include working hours, paid time off, cost-of-living allowances, and income security.

8.5 Opportunities, Challenges, and Recent Developments in Compensation

As introduced in the opening case study and discussed throughout this chapter, there are numerous options and challenges in designing competitive compensation packages that can attract and retain talent. However, when managed strategically compensation can yield a sus- tainable source of competitive advantage for the organization in the labor marketplace. This section discusses some of the pertinent opportunities, challenges, and developments in the area of compensation.

Economic Challenges: Payroll Costs Payroll tends to be one of the largest cost items for most organizations, and payroll costs have become a critical issue and challenge that organizations face today. On the one hand, pay decisions have a strategic impact due to the present fierce competition for talent. Strategi- cally positioning the organization’s pay in the market is critical to attract and retain talent. On the other hand, payroll costs have exponentially escalated. For that matter, so have HR costs in general—including compensation, benefits, and training. These costs consume significant percentages of organizations’ resources, and this expenditure can compromise organizations’ competitiveness in other areas. Especially in a tight economy, it is difficult to strategically allo- cate scarce resources across functions without compromising the organization’s competitive ability to attract and retain top talent.

Global Challenges: Competitive Pay Structures or Sweatshops? In the United States, it is very costly and challenging for organizations to offer competitive pay structures. Accordingly, many employers look for ways to minimize payroll costs through out- sourcing jobs or setting up low-cost factories in lower-wage countries. However, determining

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Section 8.5 Opportunities, Challenges, and Recent Developments in Compensation

pay rates in foreign countries has also become a major challenge. Critics argue that employers seek to operate in countries with lax or nonexistent laws and regulations governing human rights—sidestepping requirements to offer benefits, acceptable working conditions, or a liv- ing wage. These practices may mean that workers in these countries endure unsafe and unhealthy work environments for longer hours, are not paid enough money to cover the cost of basic needs, and are subjected to physical abuse (“Thai women,” 2000). Workplaces with these conditions have been dubbed sweatshops; they exist mainly in developing countries such as Vietnam, China, the Philippines, and Mexico.

Many organizations have unethically used sweatshops to drive down costs and increase prof- its. On the other hand, many other organizations routinely pay their employees in developing countries much higher rates than the local market rates and offer benefits that are unheard of in those countries, at a fraction of the cost of U.S. operations. The dilemma then becomes the loss of jobs in the U.S. market. However, there is also some evi- dence that outsourcing can create jobs in the U.S. market, but that the types of jobs are simply different. It has also been debated whether outsourcing can boost economic growth and trade by increasing the purchasing power of developing coun- tries that would then import more U.S. products and services. The lower wage rates abroad may also put a cap on infla- tion locally. However, in light of the recent global recession, these long-term effects remain to be explored.

Compensation for International Assignments Because of globalization and the growing world economy, more employees are now working oversees. Whether employees abroad are citizens of the foreign company where the parent company operates (i.e., local country nationals) or assigned to international responsibilities (i.e., expatriates), global compensation represents a challenge to employers due to differences in laws, living costs, tax codes, and other factors. In addition, changes in currency values may require frequent salary adjustments. These factors complicate the process of putting together a compensation plan for international assignments (Latta, 2006).

Extrinsic Rewards and Intrinsic Motivation There are two ways employees can grow more motivated: extrinsically and intrinsically. Intrinsic motivation exists within the person, and it does not rely on external factors. Interest in the work itself drives the worker. In contrast, extrinsic motivation relies on such external factors as rewards, pay, or benefits. Both extrinsic and intrinsic motivation are usually associ- ated with job performance, which is consistent with the motivation perspectives discussed at the beginning of the chapter.

BambooSIL/BambooSIL/Superstock

Many organizations have unethically used overseas sweatshops to drive down manufacturing costs and increase profits.

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Section 8.5 Opportunities, Challenges, and Recent Developments in Compensation

However, research findings are mixed regarding the link between those two types of moti- vation. Some studies suggest that offering extrinsic rewards for an intrinsically motivating task can actually reduce motivation. For example, a given employee who intrinsically enjoys organizing parties may resent that activity’s becoming part of his job expectations. This feel- ing may result from the activity’s losing its intrinsic value and becoming a chore once it is an expectation for which he is paid. On the other hand, many other studies show that the positive effects of intrinsic and extrinsic motivation can add up and complement each other (Amabile et al., 1994; Wiersma, 1992).

These contradictory findings pose a dilemma for those who design jobs and compensation packages. Should employers design jobs to be intrinsically motivating, or should they provide extrinsically motivating compensation and benefits, or should they try to unite both aims? How the organization answers this question will determine its job design and compensa- tion philosophies. Balancing various HR processes to address this and other similar issues requires a holistic approach that integrates numerous factors, requiring HR professionals to keep in mind the changing needs and priorities of employees in the workplace, as discussed in the next section.

Diversity, Demographics, and Changing Views of Compensation Increasing diversity and changing demographics have a significant impact on compensation decisions. Recognized as the melting pot of the world, the United States is embracing people from around the world. U.S. employers are coming to realize even more the importance of diversity to organizational success, since diversity contributes to better decision making, higher innovation, more creativity, and other benefits. Therefore, U.S. organizations are hir- ing people from a broader base of ethnic, racial, and religious backgrounds than in the past. Age and gender diversity are also increasing in the U.S. workplace.

However, these diverse groups may vary in what they value and find most motivating. For some, pay may be critical. For others, benefits such as healthcare, childcare, eldercare, and retirement are more important. For still others, learning and growth opportunities are the highest priorities. As you will learn in the next chapter, many organizations are allowing their employees to customize their benefit packages to best suit their needs. A holistic approach to compensation and benefits is critical because it is often the total package, as well as the flexibility of that package, that helps leverage diversity, attract and retain talent, and motivate employees to be productive, innovative, and loyal to the organization.

The HR Manager’s Bookshelf Compensation, by George Milkovich, Jerry Newman, and Barry

Gerhart http://www.amazon.com/Compensation-George-Milkovich/dp/007802949X

This book is one of the most authoritative references on compensation. Although it is rela- tively long and often used as a textbook for advanced HR courses, many HR professionals also find it useful as a resource for practitioners.

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http://www.amazon.com/Compensation-George-Milkovich/dp/007802949X

Summary & Resources

Key Points

• Compensation directly affects the attraction and retention of talent, affects employee motivation through the satisfaction of various needs, and provides a mechanism to psychologically link performance with outcomes. Compensation also enhances per- ceptions of equity and justice and promotes desirable behaviors in the workplace.

• Effective pay structures balance internal equity across jobs inside an organization with external equity in relation to market rates, and they integrate information from various HR processes such as HR planning, job analysis, job design, recruitment, selection, training, and performance appraisal.

• Hourly pay, piece-rate pay, competency-based pay, outcomes-based incentives, sala- ries, overtime, team-based pay, independent contractor compensation, executive pay, and ownership rewards are all types of pay that organizations use to reward and motivate their employees.

• Organizations should address the economic, global, demographic, legal, and union- related trends, challenges, and opportunities in compensating their employees.

Key Terms

Best Companies to Work For Ten Highest Paying Companies to Work For

http://www.valuewalk.com/2015/04/10-highest-paying-companies-in-the-u-s/

The above linked article lists the companies that offer the highest pay in 2015, several of which are also on the list of best companies to work for featured in every chapter of this book. For example, imagine working for Netf lix, where the average salary is $180,000, or for one of the prestigious consulting firms on the list, where the average salary is $135,000– $150,000. Also note that most of these companies offer additional compensation and incen- tives beyond base salary. Higher salaries certainly facilitate the attraction and retention of talent in these organizations.

Alderfer’s ERG theory A content motiva- tion theory that divides core needs into three groups: existence, relatedness, and growth.

broadbanding Reducing the number of pay grades by combining some of them and widening the pay ranges.

competency-based pay A type of pay that rewards employees for what they can do and the knowledge and skills they possess or learn, regardless of their positions.

content perspectives Motivation theories that focus on the sources or needs that trig- ger motivation.

employee stock ownership plans (ESOP) Noncash rewards for employees in the form of shares of an organization’s stock.

equity theory A process motivation theory that explains actions based on equity per- ceptions, which are formed through compar- ing one’s inputs and outcomes with those of others.

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http://www.valuewalk.com/2015/04/10-highest-paying-companies-in-the-u-s/

Summary & Resources

exempt positions Jobs in which employees are not eligible for overtime pay; examples include executive, administrative, knowl- edge, service, and professional jobs.

goal setting theory A theory that views humans as being motivated by the pursuit of challenging goals.

Herzberg’s two-factor theory A content motivation theory which suggests that the factors that decrease motivation will most likely be extrinsic (these factors are also referred to as hygiene factors), while the fac- tors that increase motivation will likely be intrinsic (these factors are also referred to as motivators).

hourly pay Compensation based on a set rate for each hour worked.

independent contractors Self-employed individuals or entities that provide a product or a service to the organization for a con- tracted fee.

internally equitable structures Pay struc- tures that emphasize equity of pay within and across jobs in the organization.

job classification system A system that entails describing each class of jobs, also called a job family, and then placing each job under the class or family it matches.

job evaluation data method A method for establishing pay grades that links job evalu- ation points and data from pay surveys to identify how these two factors relate to job value; jobs that have similar point values are then grouped into the same pay grade.

job family A group of jobs that follow the same pay grade structure.

justice theories Process motivation theo- ries that attribute motivation to a combi- nation of five forms of perceived justice: procedural, distributive, informational, interactional, and organizational justice.

market banding A method for establish- ing pay grades that uses market pricing to value jobs and group them into the same pay grade when the jobs have similar market survey amounts.

market line The midpoint of a pay range.

market pricing structures Also referred to as externally equitable structures, these pay structures focus on assessing the pay of each job in relation to prevailing market rates.

Maslow’s hierarchy of needs A content motivation theory that places needs in order—starting with the simplest needs and ending with the most complex— ranging from physiological and security needs to needs for belongingness, esteem, and self-actualization.

McClelland’s acquired needs theory A content motivation theory that argues that there are two types of needs: ones that people are born with, and others that are acquired through life experiences, including the needs for achievement, affiliation, and power.

non-exempt positions Jobs in which employees are eligible for overtime pay.

outcome-based incentives Financial incentives, usually offered in addition to wages and salaries, and linked to predeter- mined, quantifiable outcomes.

pay compression A situation when the difference in pay among employees is small regardless of their level of skill or experience.

pay grade A level assigned to each job that determines how much the job incumbent should be paid.

pay range The minimum and maximum pay for each pay grade.

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Summary & Resources

pay structure An organization’s approach to using pay to implement its philosophy and value system.

piece-rate pay Compensation based on the number of units or “pieces” produced.

process and equity perspectives Motivation theories that focus on explaining the process leading to motivation.

salary Fixed pay that is stated in terms of a rate per week, month, or year.

stock options Noncash rewards offered to employees to give them the right to buy shares of an organization’s common stock at a price that is lower than market rates.

team-based pay Compensation based on overall team performance instead of indi- vidual performance.

Thorndike’s law of effect The notion that behaviors that are followed by positive consequences tend to increase in frequency, while those followed by negative conse- quences tend to decrease in frequency.

Vroom’s expectancy theory A process motivation theory that explains the motiva- tion process using three dimensions: expec- tancy, valence, and instrumentality.

Critical Thinking Questions

1. Is it better for organizations to have employees who are internally or externally motivated to work? Are there some job types that lend themselves to one type of motivation over the other (that is, are some jobs likely to be more driven by internal motivation vs. external motivation and vice versa)?

2. Besides working less or asking for a raise or a promotion, what are other ways that employees might try to restore equity when they perceive that they are not being fairly paid?

3. Is distributive justice the only thing that really matters? Talk about times in your career that outcomes were fair, but procedures, information, interactions, and/or organizational processes were not.

4. Much attention has been paid to CEO pay compared to compensation of entry-level employees. Based on internal equity and market pricing, when would extremely high CEO pay be warranted?

5. Managerial and high-level professional jobs often don’t lend themselves to commis- sion or piece-rate pay systems. What are better ways to motivate people in these jobs through pay-for-performance systems?

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