CHAPTER 11:

COMPENSATION
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Importance
Importance of
of Compensation
Compensation
Impacts
Impacts employers
employersability
ability to
to attract
attract &
&retain
retain
employees
employees
Ensure
Ensure optimal
optimal levels
levels of
of employee
employee performance
performance in
in
meeting
meeting organizations
organizationsstrategic
strategic objectives
objectives
Compensations
Compensationscomponents
components
Direct
Directcompensation
compensationininwages
wagesororsalary
salary

Base
Basepay
pay(hourly,
(hourly,weekly,
weekly,monthly)
monthly)
Incentives
Incentives(sales
(salesbonuses
bonuses&/or
&/orcommissions)
commissions)

Indirect
Indirectcompensation
compensationininform
formofofbenefits
benefits

Legally
Legallyrequired
requiredbenefits
benefits(e.g.,
(e.g.,Social
SocialSecurity)
Security)
Optional
Optional(e.g.,
(e.g.,group
grouphealth
healthbenefits)
benefits)

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Exhibit
Exhibit11-1
11-1

Compensation
Compensation System
System

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Internal
Internal Equity
Equity

Fairness
Fairness of
of pay
pay differentials
differentials
between
between different
different jobs
jobs in
in
organization
organization
Established
Established by
by job
job ranking,
ranking, job
job
classification,
classification, point
point systems
systems or
or
factor
factor comparisons
comparisons
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External
External Equity
Equity
Fairness
Fairness of
of organizational
organizational
compensation
compensation levels
levels relative
relative to
to
external
external compensation
compensation
Assessed
Assessed by
by collecting
collecting wage
wage &
& salary
salary
information
information to
to guide
guide in
in setting
setting
organizations
organizations pay
pay strategy
strategy to
to lead,
lead,
meet
meet or
or lag
lag labor
labor market
market wages
wages
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Individual
Individual Equity
Equity
Fairness
Fairness about
about pay
pay differentials
differentialsamong
among individuals
individuals
in
in same
same job
job
Established
Established by
by using
using
Seniority-based
Seniority-basedpay
paysystems:
systems:Reward
Rewardlongevity
longevity
Merit-based
Merit-basedpay
paysystems:
systems:Reward
Rewardemployee
employeeperformance
performance
Incentive
Incentiveplans:
plans:Employees
Employeesreceive
receivepart
partofofcompensation
compensation
based
basedon
onperformance
performance
Skills-based
Skills-basedpay
paysystems:
systems:Compensation
Compensationbased
basedon
on
employees
employeespossessing
possessingskills
skillsthat
thatfirm
firmvalues
values
Team-based
Team-basedpay
payplans:
plans:Encourage
Encouragecooperation
cooperation&&flexibility
flexibility

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Exhibit
Exhibit11-2
11-2

Equity
Equity Theory
Theory

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Exhibit
Exhibit11-3
11-3

Equity
Equity &
& Work-Related
Work-Related Outcomes
Outcomes

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Exhibit
Exhibit11-4
11-4

Classification
ClassificationSystem
System
Federal
FederalGovernment
Government

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Exhibit
Exhibit11-4
11-4

Point
Point System
System
Method
Method

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Exhibit
Exhibit11-7
11-7

Comparison
Comparison of
of Job
Job Evaluation
Evaluation Methods
Methods

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External
External Equity
Equity
Collect
Collect wage
wage &
& salary
salary information
information to
to
determine
determine market
market wage
wage rates
rates
Also
Also consider
consider other
other forms
forms of
of compensation
compensation
Determine
Determine pay
pay strategy
strategy relative
relative to
to market
market

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External
External Equity
Equity
Lag
Lag policy
policy

Lower
Lowerwages
wagesthan
than
competitors,
competitors,
compensates
compensatesemployees
employees
through
throughother
othermeans
means
Opportunity
Opportunityfor
for
advancement
advancement
Incentive
Incentiveplans
plans
Good
Goodlocation
location
Good
Goodworking
working
conditions
conditions
Employment
Employmentsecurity
security

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Market
Market policy
policy

Wages
Wagesequal
equaltoto
competitors
competitors
Neutralizes
Neutralizespay
payas
asfactor
factor

Lead
Lead policy
policy

Higher
Higherwages
wagesthan
than
competitors
competitorstotoensure
ensure
organization
organizationbecomes
becomes
employer
employerofofchoice
choice

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Individual
Individual Equity
Equity
Basing
Basing pay
pay on
on seniority
seniority
Merit
Merit pay
pay systems
systems
Incentive
Incentive pay
pay

Returns
Returnsfinancial
financialrewards
rewardstotoemployees
employeesresponsible
responsiblefor
for
creating
creatingthem
them
Allows
Allowsorganizations
organizationstotoadjust
adjustcompensation
compensationexpenses
expenses
based
basedon
onorganization
organizationperformance
performance
Variety
Varietyofofforms
forms
Tied
Tiedtotoemployees,
employees,work
workunits,
units,orororganizations
organizationsresults
results

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Individual
Individual Equity
Equity
Skill-based
Skill-based pay
pay systems
systems
Base
Basecompensation
compensationon
onacquisition
acquisition&&mastery
masteryofof
skills
skills
Give
Giveemployees
employeesincentives
incentivestotolearn
learn
Promote
Promoteflexibility
flexibility
Easily
Easilylinked
linkedwith
withtraining
trainingprograms
programs&&strategic
strategic
needs
needs

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Individual
Individual Equity
Equity
Team-based
Team-based pay
pay plans
plans

Can
Canbe
beless
lesstime-consuming
time-consumingthan
thanadministering
administeringindividual
individual
reward
rewardsystems
systems
May
Mayimpact
impactgroup
groupdynamics
dynamics
Can
Canadversely
adverselyimpact
impact&&intensify
intensifyconflict
conflict
Need
Needdecentralized
decentralizeddecision-making
decision-makingsystem
system
Need
Needhigh
highlevel
levelofofcommunication
communicationwith
withemployees
employees
Employees
Employeesshould
shouldhave
havevoice
voice&&provide
provideinput
inputinto
intodesign
design
Team
Teammembers
membersneed
needtotofeel
feelsystem
systemisisfair
fair&&equitable
equitable

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Legal
Legal Issues
Issues in
in Compensation
Compensation
Title
TitleVII
VII of
of Civil
Civil Rights
RightsAct
Act of
of 1964
1964
Protects
Protectsworkers
workersrights
rightstotofair
fairtreatment
treatment

Equal
Equal Pay
PayAct
Act of
of 1963
1963

Requires
Requiresequal
equalpay
payfor
forequal
equalwork
work

Comparable
Comparable worth
worth

Argues
Arguesthat
thatstandards
standardsofofequal
equalpay
payfor
forequal
equalwork
workshould
shouldbe
be
replaced
replacedwith
withdoctrine
doctrineofofequal
equalpay
payfor
forequal
equalvalue
value
Objective,
Objective,measurable
measurabledata
datatotosupport
supportassessment
assessmentofofvalue
value
ofofdifferent
differentjobs
jobsisislacking
lacking
No
Nobasis
basisinincurrent
currentlaw
lawfor
forarguments
argumentsofofcomparable
comparableworth
worth

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Legal
Legal Issues
Issues in
in Compensation
Compensation

Fair
Fair Labor
Labor Standards
Standards Act
Act of
of 1938
1938
Regulates
Regulates minimum
minimum wage
wage
Sets
Sets overtime
overtime policy
policy
Establishes
Establishes exempt
exempt classes
classes for
for managers
managers &&
other
other professional
professional employees
employees

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Executive
Executive Compensation
Compensation
No
No real
real average
average or
or standard
standard
Typical
Typical annual
annual compensation
compensation for
for senior
senior
executives
executives
20%
20%salary
salary
30%
30%annual
annualincentives
incentives
50%
50%long-term
long-termincentives
incentives

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Executive
Executive Compensation
Compensation
Stock
Stock Grants
Grants

Require
Requireorganization
organizationmeet
meetspecific
specificfinancial
financialgoals
goals

Stock
Stock Options
Options

Provide
Provideopportunity
opportunitytotopurchase
purchaseshares
sharesatatsome
somefuture
futuredate,
date,
atatprice
pricedetermined
determinedwhen
whenoptions
optionsare
areawarded
awarded
Focus
Focusemployee
employeeattention
attentionon
oncreating
creatingshareholder
shareholdervalue
value
Do
Donot
nothave
havetotobe
bereported
reportedas
asexpenses
expenses
Can
Cancreate
createculture
cultureobsessed
obsessedwith
withimproving
improvingstock
stock
performance
performanceatatexpense
expenseofofother
otherconcerns
concerns
Can
Canprompt
promptexecutives
executivestotoengage
engageinincreative
creativeaccounting
accounting
practices
practices

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Key
Key Strategic
Strategic Issues
Issues in
in
Compensation
Compensation
Determining
Determining compensation
compensation relative
relative to
to market
market
Balance
Balance between
between fixed
fixed &
&variable
variable compensation
compensation
Deciding
Deciding whether
whether or
or not
not to
to utilize
utilize team-based
team-based
versus
versus individual
individual pay
pay
Creating
Creating appropriate
appropriate mix
mix of
offinancial
financial &
&nonnonfinancial
financial compensation
compensation
Developing
Developing cost-effective
cost-effective compensation
compensation program
program
resulting
resulting in
in high
high performance
performance

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Reading
Reading11.1
11.1

Compensating
Compensating Teams
Teams
Reasons
Reasons for
for tailoring
tailoring compensation
compensation to
to
individuals
individuals
Motivation
Motivationcomes
comesfrom
fromwithin
withinindividual
individualas
asopposed
opposed
totogroup
group
Development
Developmentofofskills
skills&&behaviors
behaviorsisisindividual
individual
undertaking
undertaking
Fairness
Fairnessinindealing
dealingwith
withteams
teamsdoes
doesnot
notmean
meanequal
equal
pay
payfor
forall
all
Team
Teamcompensation
compensationisisnot
notpayoff
payoffbut
butmeans
meansofof
nurturing
nurturingbehavior
behaviorthat
thatbenefits
benefitsteam
team
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Reading
Reading11.1
11.1

Compensating
Compensating Teams
Teams
Look
Look for
for ways
ways to
to add
add on
on incentives
incentives &
&recognition
recognition
for
for team
teamparticipation
participation
Reward
Reward behaviors
behaviors &
& activities
activities rather
rather than
than results
results
Other
Other ways
ways of
of saying
saying thank
thank you
you constitute
constitute best
best
incentive
incentive over
over long
long run
run
Nonmonetary
Nonmonetaryrecognition
recognition
Gifts
Giftsofofappreciation
appreciationafter
afterfact
fact

Be
Be careful
careful about
about anything
anything that
that may
may be
be viewed
viewed as
as
buying
buying
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Reading
Reading11.1
11.1

Compensating
Compensating Teams
Teams
Management
Management often
often overlooks
overlooks powerful
powerful
intrinsic
intrinsic rewards
rewards that
that come
come from
from
Team
Teamparticipation
participation
Being
Beingpart
partofofcorporate
corporatedecision-making
decision-makingprocess
process

Let
Let team
team decide
decide who
who gets
gets what
what from
from awards
awards
basket
basket

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Reading
Reading11.2
11.2

Executive
Executive Compensation:
Compensation: New
New
Perspectives
Perspectives

CEOs
CEOs in
in larger
larger firms
firms generally
generally earn
earn
more
more
Mixed
Mixed empirical
empirical evidence
evidence on
on
relationship
relationship between
between executive
executive
compensation
compensation &
& firm
firm performance
performance

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Reading
Reading11.2
11.2

Executive
Executive Compensation:
Compensation: New
New
Perspectives
Perspectives
Classifications
Classifications of
of firm
firmstrategy:
strategy:

Prospector
Prospectorfirms
firmsemphasize
emphasizelong-term
long-termincentives
incentives
Defender
Defenderfirms
firmsare
aremore
morelikely
likelytotoemphasize
emphasizefixed
fixedpay
pay
Analyzer
Analyzer
Reactor
Reactor

Significant
Significant relationship
relationship between
between organizational
organizational
strategy
strategy &
&executive
executive compensation
compensation
Firm
Firmsize
size continues
continues to
to be
be major
major determinant
determinant of
of
executive
executive compensation
compensation
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Reading
Reading11.2
11.2

Executive
Executive Compensation:
Compensation: New
New
Perspectives
Perspectives

Earnings
Earnings per
per share
share isis significant
significant predictor
predictor
of
of short-term
short-term executive
executive compensation
compensation
earned
earned as
as annual
annual bonuses
bonuses
Predictors
Predictors of
of long-term
long-term executive
executive
compensation
compensation earned
earned through
through stock
stock option
option
exercise
exercise
Share
Shareprice
pricegrowth
growth
Return
Returnon
onstocks
stocks
Market
Marketmeasures
measuresofoffirm
firmperformance
performance
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Reading
Reading 11.3:
11.3:
New
New Thinking
Thinking for
for New
New Millennium
Millennium
Strategic
Strategic approaches
approaches to
to make
make compensation
compensation
systems
systems more
more effective
effective

Pay
Payperson
personfor
forindividual
individualworth
worth(knowledge,
(knowledge,skills
skillsand
and
competencies)
competencies)rather
ratherthan
thanfor
forvalue
valueofofjob
jobthey
theyperform
perform
Reward
Rewardexcellence
excellencethrough
throughpay
payfor
forperformance
performance
compensation
compensationthat
thatestablishes
establishesclear
clearrelationship
relationshipbetween
between
significant
significantamount
amountofofpay
pay&&attainment
attainmentofoforganizational
organizational
objectives
objectives
Individualize
Individualizepay
paysystem
systemtotogive
giveemployees
employeeschoices
choicesininhow
how
they
theyare
arerewarded
rewarded&&what
whatreward
rewardthey
theyreceive
receive

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