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Compensation: Methods Compensation: Methods and Policiesand PoliciesCompensation: Methods Compensation: Methods and Policiesand Policies

chapterchapter

11

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A Compensation system should

be:(* focus of this chapter)

AdequateEquitable

Balanced*

Cost-effective*

Secure*

Incentive-providing

Acceptable to the employee*

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To the individual

employee, the most

important

compensation decision

is how much he or she

will earn.

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Determination of Individual PayDetermination of Individual Pay

Three questions need to be addressed:

1. How should one employee be paid relative to another when they both hold the same job in the organization?

2. Should we pay all employees doing the same work at the same level the same?

3. If not, on what basis should we make the distinction?

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Pay differentials are based on:Pay differentials are based on:

1. Individual differences in experience, skills, and performance

2. Expectations that seniority, higher performance (or both) deserve higher pay

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Reasons for choosing to pay employees at Reasons for choosing to pay employees at different rates for the same job: different rates for the same job: (1 of 3)(1 of 3)

Pay differentials allow firms to recognize that different employees performing the same job make substantially different contributions to meeting organizational goals

Differentials allow employers to communicate a changed emphasis on important job roles, skills, knowledge, etc.

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Reasons for choosing to pay employees at Reasons for choosing to pay employees at different rates for the same job: different rates for the same job: (2 of 3)(2 of 3)

Differentials provide organizations with an important tool for emphasizing norms of enterprise without having employees change jobs (i.e., promotion)

Pay differentials allow firms to recognize market changes between jobs in the same grade without requiring a major overhaul of the whole compensation system

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Reasons for choosing to pay employees at Reasons for choosing to pay employees at different rates for the same job: different rates for the same job: (3 of 3)(3 of 3)

Without differentials,the pay system violates the internal equity norms

of most employees,reducing satisfaction with pay, andmaking attraction and retention of employees

more difficult

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Methods of PaymentMethods of Payment

Flat Rates

Payment for Time Worked

Variable Pay: Incentive Compensation

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Payment for Time WorkedPayment for Time Worked

General, across-the-board increase for all employees

Merit increases paid to some employeesbased on some indicator of job performance

Cost-of-living adjustment (COLA)based on the consumer price index (CPI)

Seniority

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Variable PayVariable Pay

Percentage of an employee’s paycheck is put at risk

If business goals are not met, the pay rate will not rise above the lower base salary

Annual raises are not guaranteedHelps manage labor costsDoes not guarantee equitable treatment of

employees

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Support bymanagement

Acceptance byemployees

Supportiveorganizational

cultureTiming

Variable Pay: Key Design FactorsVariable Pay: Key Design Factors

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Types of Variable PayTypes of Variable Pay

Individual Incentives

Group Incentives

Organization Incentives

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Individual Variable PayIndividual Variable Pay

Merit incentives

Individual incentivespieceworkproduction bonusescommissions

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Merit Pay ProblemsMerit Pay Problems

1. Employees fail to make the connection between pay and performance

2. The secrecy of the reward is perceived by other employees as inequity

3. The size of the merit award has little effect on performance

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Individual IncentivesIndividual Incentives

Possible only in situations where performance can be specified in terms of outpute.g., sales dollars generatede.g., number of items completed

Employees must work independently of each other so that individual incentives can be applied equitably

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Conditions for Effective Individual Conditions for Effective Individual Incentive PlansIncentive Plans

1. The task is liked2. The task is not boring3. The supervisor reinforces and supports the system4. The plan is acceptable to employees and managers5. The incentive is financially sufficient to induce

increased output6. Quality of work is not especially important7. Most delays in work are under the employees’ control

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Reasons to Use Team IncentivesReasons to Use Team Incentives

When it is difficult to measure individual output

When cooperation is needed to complete a task or project

When management feels this is a more appropriate measure on which to base incentives

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Organization-wide IncentivesOrganization-wide Incentives

Usually based on one of two performance concepts:A sharing of profits generated by all employees

altogetherA sharing of money saved as a result of

employees’ efforts to reduce costs

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Approaches to Organization-wide IncentivesApproaches to Organization-wide Incentives

SuggestionSystems

Gainsharing

Profit Sharing Ownership

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Suggestion Systems: Essential ElementsSuggestion Systems: Essential Elements

1. Management commitment

2. Clear goals

3. Designated administrator

4. Structured award system

5. Regular publicity

6. Immediate response to each suggestion

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Gainsharing PlansGainsharing Plans

Employees earn bonuses tied to unit-wide performance as measured by a predetermined, gainsharing formula

Commonly used gainsharing plans:Lincoln Electric PlanScanlon PlanRucker PlanImproShare

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Key Elements in Designing a Gainsharing Key Elements in Designing a Gainsharing PlanPlanStrength of reinforcement

Productivity standards

Sharing the gains

Scope of the formula

Perceived fairness of the formula

Production variability

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Newer Approaches to GainsharingNewer Approaches to Gainsharing

Business Plan Gainsharing

Winsharing

Spot Gainsharing

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Typical Profit Sharing PlansTypical Profit Sharing Plans

1. Cash or current distribution plans provide full payment to participants soon after profits have been determined

2. Deferred plans credit a portion of current profits to employees’ accounts with cash payments made at the time of retirement, disability, severance, or death

3. A combination of both incorporates aspects of current and deferred options

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OwnershipOwnership

Employee stock ownership plan (ESOP) – employees receive stock in the company

ESOPs are tax qualifiedi.e., in return for meeting certain rules designed to

protect the interests of plan participants, ESOP sponsors receive various tax benefits

ESOPs are defined contribution plansthe employers makes yearly contributions that

accumulate to produce a benefit that is not defined in advance

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People-Based PayPeople-Based Pay

Skill-BasedPay

Knowledge-Based Pay

Credential-Based Pay

Feedback Pay

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Executive PayExecutive Pay

More likely to be based on More likely to be based on comparative performancecomparative performance::

1. Compensation committees link CEO’s pay to returns to shareholders

2. Variable performance-based pay is emphasized over guarantees

3. CEOs are encouraged to invest in company stock

4. Performance yardsticks are linked to actual key productivity indices, to the competition, or to both

5. CEOs are held responsible for the cost of capital

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Issues in Compensation AdministrationIssues in Compensation Administration

Pay Secrecy or Openness

Pay Security

Pay Compression

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GuaranteedAnnual Wage

(GAW)

SupplementaryUnemploymentBenefits (SUB)

Cost of LivingAdjustments

(COLAS)Severance Pay

Pay Security PlansPay Security Plans

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Solutions to the Problem of Pay Solutions to the Problem of Pay Compression Compression (1 of 2)(1 of 2)

1. Reexamining how many entry-level people are needed

2. Reassessing recruitment itself

3. Focusing on the job evaluation process, emphasizing performance instead of salary-grade assignment

4. Basing all salaries on longevity

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Solutions to the Problem of Pay Solutions to the Problem of Pay Compression Compression (2 of 2)(2 of 2)

5. Giving first-line supervisors and other managers the authority to recommend equity adjustments for incumbents who have been unfairly victimized by pay compression

6. Limiting the hiring of new employees seeking excessive salaries

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SummarySummary

There is a growing realization that traditional pay systems do not effectively link pay to performance

The trend is toward a total compensation approach made up of base pay, variable pay, and benefits

Flexibility is an essential ingredient in any compensation plan and can be built using a variable pay approach