Compensation: Introducing The Pay Model and Pay Strategy

MILKOVICH │ NEWMAN │ GERHART
COMPENSATION TWELFTH EDITION
Part One
Introducing the Pay Model
and Pay Strategy
Chapter One
The Pay Model
© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Overview
 Chapter one begins with the importance of
compensation and provides a definition.
 The chapter continues with a discussion
on the various forms of compensation.
 The major focus presents a pay model
with three main components:
• compensation objectives, policy decisions,
and techniques.
1–2
Compensation: Does It Matter?
It Matters: So What?
 Nucor Steel.  General Motors.
 Troubled Asset Relief  Incentive plans for taking
Plan (TARP). risks.
 A well-designed  Poorly designed
compensation system compensation systems
can help an organization can play a major role in
achieve and sustain undermining
competitive advantage. organizational success.
1–3
Society Stakeholders
Compensation
Managers Employees
Compensation does not mean the same

thing to everyone.
1–4
Society
 Some people see pay as a measure of
justice.
• Laws and regulations aim to eliminate the gap
between male/female earnings differentials.
• Benefits may also be seen as a reflection of
equality or justice in society.
 Job losses (or gains) in a country is partly
a function of labor costs (and productivity).
1–5
EXHIBIT 1.1
Hourly Compensation Costs For Production Workers
In Manufacturing and Economy-wide Productivity
(GDP/Employee), in U.S. Dollars
1–6
Stockholders
 Some stockholders say using stock to pay
employees creates a sense of ownership.
 Others argue it dilutes stockholder wealth.
 Stockholders have a particular interest in
executive pay.
 Linking executive pay to company
performance increases stockholders' returns.
1–7
EXHIBIT 1.3
Chief Executive Officer (CEO) Return and Shareholder
Return
In the absence of a linkage between executive pay and

company performance, concerns arise that executives
can somehow obtain high pay without performing well.
1–8
Managers
 Compensation influences manager’s
success in two ways.
• First, it is a major expense that must be
managed.
• Second, it is a major determinant of employee
attitudes and behaviors.
1–9
Employees
 Pay is usually a major source of financial
security.
 Employees may see compensation as:
• a return in an exchange,
• an entitlement for being an employee of the
company,
• an incentive to take/stay in a job and invest in
performing well, or
• as a reward for having done so.
1 – 10
Employees
 Pay can influence employee motivation
and behavior in two ways:
• The incentive effect is the degree to which
pay influences individual and aggregate
motivation.
• The sorting effect is the effect that pay can
have on the composition of the workforce.
 How an organization pays can result in sorting
effects.
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What is Compensation?
Compensation
All forms of financial returns and
tangible services and benefits
employees receive as part of an
employment relationship.
1 – 12
Forms of Pay
 Forms of pay are categorized in two ways.
• Total compensation:
 is pay received directly as cash and indirectly as
benefits.
• Relational returns:
 are psychological.
1 – 13
EXHIBIT 1.5
Total Returns For Work
1 – 14
Cash Compensation: Base
Base wage Salary Wage

• Cash that an • Pay given to • Pay for workers –
employer pays in employees who are nonexempts –
return for the work exempt from covered by overtime
performed. regulations of the Fair and reporting
• A function of the skill Labor Standards Act provisions of FLSA.
or education an (FLSA). • Calculated on an
employee possesses. • Calculated at an hourly basis.
annual or monthly
rate.
1 – 15
Cash Compensation: Merit
Increases/Merit Bonuses/COLAs
 A cost of living adjustment (COLA) is made
to base pay on the basis of changes in:
• what others are paying, living costs, or
experience/skill.
 Merit increases are increments to base pay
based on performance.
 Merit bonuses are paid in a lump sum
rather than becoming a part of base pay.
1 – 16
Cash Compensation: Incentives
 Incentives are a one-time payment which
differs from merit adjustments.
• Incentives do not increase base wage.
• Incentive payment is known beforehand.
• Incentive programs use objective measures of
performance.
 Incentives may be long-term (stock
ownership, or stock options) or short-term.
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Benefits
 Income protection.
• Medical insurance, retirement programs, life
insurance, and savings plans are common.
 Work/life balance.
• Includes time away from work, access to
services, and flexible work arrangements.
 Allowances often grow out of short supply.
• China’s housing and transportation allowances.
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Total Earnings Opportunities
 Present value of a stream of earnings.
• Comparison of today's initial offers to
consideration of future bonuses, merit increases,
and promotions.
 Relational returns from work.
• Nonfinancial returns that substantially impact
employee behavior.
 A network of returns.
• Created by different forms of pay; useful if
bonuses, development opportunities, and
promotions all work together
1 – 19
A Pay Model
 Three basic building blocks:
1. The compensation objectives.
2. The policies that form the foundation of the
compensation system.
3. The techniques that make up the
compensation system.
1 – 20
EXHIBIT 1.6
The Pay Model
This model
serves as both
a framework
for examining
current pay
systems and a
guide for most
of the text.
1 – 21
Compensation Objectives
 Pay objectives guide the design of the pay
system and are standards for judging success.
• Efficiency is improving performance, increasing
quality, and controlling costs.
• Fairness (procedural fairness) is the process used
to make pay decisions.
• Ethics means the organization cares about how its
results are achieved.
• Compliance is conforming to federal and state
compensation laws and regulations.
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Four Policy Choices:
Internal Alignment
 Internal alignment:
• refers to comparisons among jobs or skill
levels inside a single organization.
• pertains to the pay rates both for employees
doing equal work and for those doing
dissimilar work.
 Pay relationships affect the compensation
objectives of efficiency, fairness and
compliance.
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Four Policy Choices:
External Competitiveness
 External competitiveness refers to pay
comparisons with competitors.
• Pay is ‘market driven’.
• Objectives:
 To ensure that pay is sufficient to attract and
retain employees.
 To control labor costs to ensure competitive
pricing of products/ services.
1 – 24
Four Policy Choices
Employee Contributions Management
 Understanding the  Right people get

basis for judging the right pay for
performance, helps achieving the right
perceive pay as objectives in the
fair. right way.
1 – 25
Pay Techniques
 Techniques tie the four basic policies to
the pay objectives.
 Many variations of pay techniques exist.
1 – 26
Summary
 Chapter one began with the importance of
compensation and provided a definition.
 The chapter continued with a discussion
on the various forms of compensation.
 The major focus presented a pay model
with three main components:
• compensation objectives, policy decisions,
and techniques.
1 – 27

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MILKOVICH │ NEWMAN │ GERHART

COMPENSATION TWELFTH EDITION

Compensation does not mean the same

In the absence of a linkage between executive pay and

Base wage Salary Wage

 Understanding the  Right people get

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