Compensation System

Development
Determining Pay Rates
Employee compensation
■ All forms of pay or rewards going to employees
and arising from their employment.

Direct financial payments

■ Pay in the form of wages, salaries, incentives,
commissions, and bonuses.

Indirect financial payments

■ Pay in the form of financial benefits such as
insurance.
 Compensation System

Indirect Direct
Compensation Compensation

Base Pay Merit Pay

Salary Wage

Protection Incentive Pay: Deferred Pay

Pay for Time Services and
Programs: Not Worked: Perquisites
Bonus, Savings Plan
Medical Commission Stock
Vacations Recreational
Insurance Piece rate Purchase
Holidays facilities
Life Profit sharing
Sick Leave Car
Insurance Stock option
Low Cost or
Disability Shift
free meals
Income Differential
Pension
Social
Security
Corporate Policies, Competitive Strategy,
and Compensation

Aligned reward strategy

■ The employer’s basic task is to create a bundle
of rewards specifically aimed at the employee
behaviors the firm needs to support and
achieve its competitive strategy.
Compensation Policy Issues
Pay for performance
Pay for seniority
Salary increases and promotions
Overtime and shift pay
Probationary pay
Paid and unpaid leaves
Paid holidays
Salary compression
Geographic costs of living differences
Compensation Policy Issues (cont’d)
Salary compression
■ A salary inequity problem, generally caused by
inflation, resulting in longer-term employees in
a position earning less than workers entering
the firm today.
Equity and Its Impact on Pay Rates
The equity theory of motivation
■ States that if a person perceives an inequity,
the person will be motivated to reduce or
eliminate the tension and perceived inequity.
Forms of Equity
External equity
■ How a job’s pay rate in one company compares to the
job’s pay rate in other companies.
Internal equity
■ How fair the job’s pay rate is, when compared to other
jobs within the same company
Individual equity
■ How fair an individual’s pay as compared with what his
or her co-workers are earning for the same or very
similar jobs within the company.
Procedural equity
■ The perceived fairness of the process and procedures to
make decisions regarding the allocation of pay.
Methods to Address Equity Issues

Salary surveys
■ To monitor and maintain external equity.
■ Aimed at determining prevailing wage rates.
A good salary survey provides specific wage rates for
specific jobs. Formal written questionnaire surveys are
the most comprehensive, but telephone surveys and
newspaper ads are also sources of information.
Job analysis and job evaluation
■ To maintain internal equity.
■ Job evaluation is a systematic comparison done in
order to determine the worth of one job relative to
another.
Methods to Address Equity Issues
(Cont’d)
■ Job evaluation considers compensable factors
for the comparison. Compensable factor is a
fundamental, compensable element of a job,
such as skills, effort, responsibility, and
working conditions.

Performance appraisal and incentive pay

■ To maintain individual equity.
Communications, grievance mechanisms,
and employees’ participation
■ To help ensure that employees view the pay
process as transparent and fair.
Incentives
■ Financial rewards paid to workers
whose production exceeds a
predetermined standard.

Frederick Taylor
■ Popularized scientific management
and the use of financial incentives
in the late 1800s.
Law of individual differences
■ The fact that people differ in
personality, abilities, values, and
needs.
■ Different people react to different
incentives in different ways.
■ Managers should be aware of
employee needs and fine-tune the
incentives offered to meets their
needs.
■ Money is not the only motivator.
Types of Incentive Plans
(cont’d)
Pay-for-performance plans
■ Individual incentive/recognition
programs
■ Sales compensation programs
■ Team/group-based variable pay
programs
■ Organization wide incentive
programs
Individual Incentive Plans
Piecework Plans
■ The worker is paid a sum (called a piece rate) for
each unit he or she produces.
Straight piecework: A fixed sum is
paid for each unit the worker produces
under an established piece rate
standard.
Standard hour plan: The worker gets a
premium if his or her work performance
exceeds the established standard.
Individual Incentive Plans
(cont’d)
Pros and cons of piecework
■ Easily understandable, equitable, and powerful
incentives
■ Employee resistance to changes in standards
or work processes affecting output
■ Quality problems caused by an overriding
output focus
■ Possibility of violating minimum wage
standards
■ Employee dissatisfaction when incentives
either cannot be earned due to external factors
or are withdrawn due to a lack of need for
output
Individual Incentive Plans
(cont’d)
Merit pay
■ A permanent cumulative salary increase
the firm awards to an individual
employee based on his or her individual
performance.
Merit pay options
■ Annual lump-sum merit raises that do
not make the raise part of an
employee’s base salary.
■ Merit awards tied to both individual and
organizational performance.
 Lump-Sum Award Determination Matrix
(an example)

To determine the dollar value of each employee’s incentive award: (1)

multiply the employee’s annual, straight-time wage or salary as of
June 30 times his or her maximum incentive award and (2) multiply
the resultant product by the appropriate percentage figure from this
table. For example, if an employee had an annual salary of $20,000 on
June 30 and a maximum incentive award of 7% and if her performance
and the organization’s performance were both “excellent,” the
Individual Incentive Plans
(cont’d)
Incentives for professional employees
■ Professional employees are those whose work
involves the application of learned knowledge to
the solution of the employer’s problems.
Lawyers, doctors, economists, and engineers.
Possible incentives
■ Bonuses, stock options and grants, profit sharing
■ Better vacations, more flexible work hours
■ improved pension plans
■ Equipment for home offices
Individual Incentive Plans
(cont’d)
Recognition-based awards
■ Recognition has a positive impact on
performance, either alone or in conjunction
with financial rewards.
Combining financial rewards with
nonfinancial ones produced
performance improvement in service
firms almost twice the effect of using
each reward alone.
■ Day-to-day recognition from supervisors,
peers, and team members is important.
Incentives for Salespeople
Salary plan
■ Straight salaries
Best for: prospecting (finding new clients), training
customer’s sales force, or participating in national and
local trade shows.
Commission plan
■ Pay is only a percentage of sales
Keeps sales costs proportionate to sales revenues.
May cause a neglect of nonselling duties.
Can create wide variation in salesperson’s income.
Likelihood of sales success may linked to external factors
rather than to salesperson’s performance.
Can increase turnover of salespeople.
Incentives for Salespeople
(cont’d)
Combination plan
■ Pay is a combination of salary
and commissions.
■ Plan gives salespeople a floor
(safety net) to their earnings.
Team/Group Variable Pay
Incentive Plans
A plan in which a production standard is set
for a specific work group, and its members are
paid incentives if the group exceeds the
production standard.
Gainsharing
■ An incentive plan that engages many or all
employees in a common effort to achieve a
company’s productivity objectives.

Scanlon plan (Joseph Scanlon, 1937)

■ Employees receive 75% of savings from their
suggestion.
Organization wide Variable Pay Plan
Profit-sharing plans
■ Cash plans
Employees receive cash shares of the firm’s profits at
regular intervals.
■ Deferred profit-sharing plans
The employer puts cash awards into trust accounts for
he employees’ retirement.

Employee stock ownership plan

(ESOP)
■ A corporation annually contributes its own
stock—or cash (with a limit of 15% of
compensation) to be used to purchase the
stock—to a trust established for the employees.
Organization wide Variable Pay
Plans (cont’d)
Stock option
■ The right to purchase a specific number of
shares of company stock at a specific price
during a specific period of time.

• At-Risk Pay Plans/Risk-sharing

Plans
— To put some portion of the employee’s pay at risk. If
employees meet or exceed their goals, they earn
back not only the portion of their pay that was at
risk, but also an incentive.