COMPENSATION

PowerPoint Presentation by Charlie Cook Copyright 2002 South-Western. All rights reserved

The Importance of Compensation

Impacts an employers ability to attract and retain employees. Ensure optimal levels of employee performance in meeting the organizations strategic objectives. Compensations components
Direct compensation in the form of wages or salary
Base pay (hourly, weekly, and monthly) Incentives (sales bonuses and or commissions)

Indirect compensation in the form of benefits

Legally required benefits (e.g., Social Security) Optional (e.g., group health benefits)
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Copyright 2002 South-Western. All rights reserved.

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Equity Theory
Internal equity
Fairness of pay differentials between different jobs in the organization can be established by job ranking, job classification, point systems and factor comparisons.

External equity
Fairness of organizational compensation levels relative to external compensation is assessed by collecting wage and salary information to guide in setting the organizations pay strategy to lead, meet or lag labor market wages.

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Equity Theory (contd)

Individual Equity
Fairness about pay differentials among individuals who hold the same job in the organization is established by using:
Seniority-based pay systems that reward longevity with the organization. Merit-based pay systems that reward employee performance. Incentive plans that allow employees to receive part of their compensation based on their job performance. Skills-based pay systems where compensation is based on employees possessing skills that the firm values. Team-based pay plans that encourage cooperation and flexibility in employees.

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Compensation Equity Issues

Compensation equity: Is compensation judged to be fair? 3 Compensation equity issues
#1: Individual equity: compare the pay of individuals who do the same job in the same organization and judge if it is fair
Example: A retail store has 2 Assistant Store Managers (2 people doing the same job in the same organization) If they are paid the same, is that perceived as being fair? If they are paid differently, is the pay difference perceived as being fair?

Compensation Equity Issues

3 Compensation equity issues (more)
#2: Internal equity: compare the pay of different jobs in the same organization and judge if it is fair
Example: A retail store has an Assistant Store Manager and a Store Manager (2 different jobs in the same organization) If they are paid the same, is that perceived as being fair? If they are paid differently, is the pay difference perceived as being fair?

Compensation Equity Issues

3 Compensation equity issues (more)
#3: External equity: compare the pay of the same job in different organizations and judge if it is fair
Example: Retail store X has a Store Manager and retail store Y has a store manager (the same job in two different organizations) Do the two stores pay their store managers the same or not?

Compensation Equity Issues

3 Compensation equity issues (more)
#3: External equity (more)
External equity pay policies: Match the market (match the competition): the organization sets pay for some of its jobs to be about the same as what other organizations pay for the same jobs No advantage or disadvantage in costs or in attracting and retaining employees

Compensation Equity Issues

3 Compensation equity issues (more)
#3: External equity (more)
External equity pay policies (more) Lead the market: the organization sets pay for some of its jobs to be higher than what other organizations pay for the same jobs Above average pay levels would tend to increase costs Can the higher pay costs be offset by lower costs because of: Lower turnover rates Easier to recruit larger numbers of well-qualified applicants, allowing increased hiring standards (skim the cream) But we need to use valid selection methods to correctly identify the well-qualified applicants Otherwise, were paying more for poor performers (duds)
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Compensation Equity Issues

3 Compensation equity issues (more)
#3: External equity (more)
External equity pay policies (more) Lag the market: the organization sets pay for some of its jobs to be lower than what other organizations pay for the same jobs Below average pay levels would tend to decrease costs But the lower pay costs may be offset by higher costs because of: Higher turnover rates Harder to recruit well-qualified applicants, requiring lower hiring standards Can we provide employees with more of other things that employees value to compensate for the below average pay? Example: More opportunities for growth & promotions Example: Some of pay is in the form of company stock

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Equity Theory
Equity theory describes how an employee determines if his or her pay is fair
An employee judges if his or her pay is fair by examining 4 factors:
The employees pay (and other rewards) The employees contributions Other employees pay (and other rewards) Other employees contributions

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Equity Theory
Id feel underpaid if:
My contributions are the same as my co-workers, but Im paid less Im paid the same as my co-workers, but my contributions are greater than my coworkers contributions
Figure adapted from: Fisher, Schoenfeldt, & Shaw (2006), Figure 11.2, p. 487

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Equity Theory (contd)

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Equity Theory (contd)

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Pay Systems
We want to set pay in a way that takes into consideration the 3 compensation equity issues:
We want pay t0: Implement the organizations external equity pay policy Match, lead, or lag the market Achieve internal equity Appropriate pay differences across the jobs in the organization Achieve individual equity Appropriate pay differences across employees who perform the same job

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Pay Systems
Methods of determining a range of pay for each job in an organization:
Market-Based Pay Job Evaluation Pay Systems
Job Ranking Job Grading (Job Classification) Factor Comparison Point Method

Once we have a pay range for each job, then we can figure out where inside the pay ranges each employee should fall
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Market-Based Pay
Alternative names: Market-Based Pay = Market Pricing = Rank to Market Method (for each job title):
Identify the relevant labor market
Local, regional, national, or international

Obtain market pay data in the relevant labor market

Either use pay data collected by others: http://www.salary.com/ http://www.bls.gov/bls/blswage.htm http://www.google.com/Top/Business/Human_Resources/Co mpensation_and_Benefits/Compensation/

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Market-Based Pay
Method (more):
Obtain market pay data in the relevant labor market (more)
Or perform a market pay (wage & salary) survey: Identify a sample of organizations in the relevant labor market that have the job title Contact each organization and ask how much they pay the job title (minimum, average, maximum) Avoid anti-trust (pay-fixing) concerns: Use an independent consultant to collect the pay data Collect pay data that is several months old (e.g., 3 months) Include at least 5 employers for each job title Have the consultant report only averages (e.g., average minimum pay for the job title, average maximum pay for the job title)
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Market-Based Pay
Method (more):
Use the market pay data on the average minimum pay and the average maximum pay directly to set the pay range (min to max) for the job title
If the external pay policy is: Match the market, then set the pay range for the job to be about the same as the market pay range for the job Lead the market, then set the pay range for the job to be a bit higher than the market pay range for the job Lag the market, then set the pay range for the job to be a bit lower than the market pay range for the job

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Market-Based Pay
Strengths:
Not too complicated

Weaknesses:
Assumes all jobs with the same job title in different organizations are truly identical
Example: We have to assume that all Store Manager jobs in every retail store are identical

Assumes market pay differences correctly capture internal equity issues

Example: We have to assume that we want the pay difference between our Store Managers and Assistant Store Managers to be the same as in other retail stores

Hard to use with unique jobs

If the job is unique to our organization, then we cant find comparable jobs in other organizations, so we cant get market pay data
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Job Evaluation Pay Systems

An alternative to market-based pay is to use a pay system based on job evaluation Job evaluation: systematically determine the relative value of jobs with an organization to create an internal hierarchy of jobs, and then use the hierarchy to set pay ranges for the jobs
Which job has the highest value to the organization and so should be paid the most? Which job has the second highest value and so should be paid second highest? Etc.

There are 4 job evaluation pay systems

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Job Evaluation Pay Systems

Source of figure: Fisher, Schoenfeldt, & Shaw (2006), Figure 11.3, p. 490
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Job Evaluation: Job Ranking

Method:
Review the job descriptions Rank the jobs in order of relative worth or importance to the organization
Frequently done by a committee of managers

Use the rank ordering to set pay for each job

Pay the highest ranked job the most, etc.

Weaknesses:
The rank ordering tells us that one job is worth more than another, but not how much more While the ranking takes care of internal equity, its not obvious how to take into consideration external equity
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Job Evaluation Pay Systems

Source of figure: Fisher, Schoenfeldt, & Shaw (2006), Figure 11.3, p. 490
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Job Evaluation: Job Grading (Job Classification)

Method:
Create a sequence of job grades
Example: US Government GS system has 15 job grades: GS1 GS15

For each job grade, define the job grade in words

Example: Define each job grade in terms of: Skill & knowledge Responsibilities Physical effort Working conditions

Use the job descriptions to classify each job into one job grade
Example (from the US Government GS pay system): Carpenter = GS9
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Job Evaluation: Job Grading (Job Classification)

Method (more)
Select a set of benchmark (key) jobs
Jobs with well-known, stable job content Jobs that are common in many organizations Jobs that represent the full range of job grades Jobs for which market pay data is available

Collect market pay data for the benchmark jobs Use the market pay data to set the pay range for the job grades
Example: http://www.opm.gov/oca/08tables/html/gs.asp

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Job Evaluation: Job Grading (Job Classification)

Strengths:
The sequence of job grades allows us to deal with internal equity The use of market pay data to set the pay range for each job grade allows us to deal with external equity

Weaknesses:
The classification of jobs into pay grades is subjective
Example: Carpenter = GS9, not GS8 or GS10 (are we sure?)

The method relies heavily on job titles in setting pay

Example: We have to assume that all Carpenter jobs are identical

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Job Evaluation Pay Systems

Source of figure: Fisher, Schoenfeldt, & Shaw (2006), Figure 11.3, p. 490
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Job Evaluation: Factor Comparison

Method:
Define a set of compensable factors
Compensable factors: the characteristics about jobs that are used to set pay Example: skill, effort, responsibility, & working conditions

Select a set of benchmark (key) jobs

Jobs with well-known, stable job content Jobs that are common in many organizations Jobs that represent the full range of jobs being evaluated Jobs that represent the range of each compensable factor Example: jobs with various skill levels, effort levels, etc. Jobs for which market pay data is available
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Job Evaluation: Factor Comparison

Method:
Rank the benchmark jobs on the basis of each compensable factor
Example: Rank the jobs from least skilled to most skilled

Collect market pay data for the benchmark jobs For each benchmark job, allocate market pay across the compensable factors
Example: If market pay for a benchmark job is $15, how much of that $15 is for skill, how much for effort, how much for responsibilities, and how much for working conditions?

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Job Evaluation: Factor Comparison

Method (more)
For each benchmark job, compare the factor rankings to the pay rankings & make adjustments as needed to bring the rankings into agreement
Example: Make sure that the job ranked as having the greatest skill requirements also has the greatest amount of pay for the skill compensable factor

Construct a job comparison scale, and slot the benchmark jobs onto the pay scale for each compensable factor
Example: For the skill compensable factor, create a skill pay scale that shows where each benchmark job falls on the scale

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Job Evaluation: Factor Comparison

Method (more)
Slot all the non-benchmark jobs into their proper places on the pay scale for each compensable factor Determine the pay for each job by adding up the pay from each compensable factor
Example: Pay = pay from skill + pay from effort + pay from responsibility + pay from working conditions Example: Fisher, Schoenfeldt, & Shaw (2006), Table 11.7, p. 498 Job 4: Pay = $3.50 for skill + $2.50 for effort + $3.75 for responsibilities + $1.25 for working conditions = $11.00

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Job Evaluation Pay Systems

Source of figure: Fisher, Schoenfeldt, & Shaw (2006), Figure 11.3, p. 490
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Job Evaluation: Point Method

Method:
Define a set of compensable factors
Compensable factors: the characteristics about jobs that are used to set pay Example: 11 compensable factors: (1) Education (2) Experience (3) Knowledge (4) Physical demands (5) Mental demands (6) Responsibility for equipment & work processes (7) Responsibility for materials & products (8) Responsibility for safety (9) Responsibility for the work of others (10) Working conditions (11) Job hazards

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Job Evaluation: Point Method

Method (more)
Define a factor scale for each compensable factor
Factor scale: define in words the different levels (or degrees) of the compensable factor Example: Factor scale for the Knowledge factor: 1st Degree Knowledge: reading & writing; simple arithmetic with whole numbers only; following instructions 2nd Degree Knowledge: arithmetic with decimals & fractions; use of formulas, charts, graphs, or diagrams 3rd Degree Knowledge: mathematics with complex formulas, drawings, or diagrams; precision measuring instruments 4th Degree Knowledge: advanced trades mathematics; advanced use of complex formulas, drawings, or diagrams 5th Degree Knowledge: higher-level engineering math; advanced use of complex engineering theories & practices
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Job Evaluation: Point Method

Method (more)
Assign points to each degree of each compensable factor
Example:

Source of table: Fisher, Schoenfeldt, & Shaw (2006), Table 11.4, p. 495

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Job Evaluation: Point Method

Method (more)
Perform the job evaluation: evaluate each job to determine the number of points to assign to that job on each compensable factor
Usually done by a committee of managers Use the job descriptions as the source of job information Add up the number of points from each compensable factor to get the total points for the job Jobs with more total points have more of the things we value in setting pay This should take care of internal equity

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Job Evaluation: Point Method

Method (more)
Select a set of benchmark (key) jobs:
Jobs with stable job content Jobs that are common in lots of organizations Jobs that can be defined with precision Jobs that are performed similarly across different organizations Jobs that represent the range of jobs being evaluated Jobs for which market pay data is available

Identify the relevant labor market for each benchmark job

Local, regional, national, or international

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Job Evaluation: Point Method

Method (more)
Select a set of benchmark (key) jobs:
Jobs with stable job content Jobs that are common in lots of organizations Jobs that can be defined with precision Jobs that are performed similarly across different organizations Jobs that represent the range of jobs being evaluated Jobs for which market pay data is available

Identify the relevant labor market for each benchmark job

Local, regional, national, or international

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Job Evaluation: Point Method

Method (more)
For each benchmark job, collect market pay data in the relevant labor market
Either use pay data collected by others, or Collect pay data yourself by performing a pay survey (wage & salary survey): Identify a sample of organizations in the relevant labor market that have the benchmark job Contact each organization & collect pay data for the job title (minimum pay & maximum pay) Avoid anti-trust (pay-fixing) concerns: Use an independent consultant to collect the pay data Collect pay data that is several months old (e.g., 3 months) Include at least 5 employers for each job title Have the consultant report only averages (e.g., average minimum pay for the job title, average maximum pay for the job title)
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Job Evaluation: Point Method

Method (more)
Estimate the market pay lines
Estimate 2 simple regressions using the benchmark jobs as the data points Minimum pay line: regress minimum pay (dependent variable) on points (independent variable) Maximum pay line: regress maximum pay (dependent variable) on points (independent variable)

Use the market pay lines to determine the pay ranges for each job (both benchmark & non-benchmark jobs)
This takes care of external equity

Optional: create pay grades

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Job Evaluation Pay Systems

Source of figure: Fisher, Schoenfeldt, & Shaw (2006), Figure 11.3, p. 490
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Pay Policy Issues

Periodically update the pay ranges Jobs above or below the desired pay range:
Green circle jobs: jobs whose current pay is below the pay range for the job
Develop & implement a plan to give these jobs slightly larger pay increases to catch the job up with the pay range

Red circle jobs: jobs whose current pay is above the pay range for the job
Develop & implement a plan to give these jobs slightly smaller pay increases to allow the pay range to catch up with the job

Compression: the pay differences across jobs shrink over time

Can mess up internal equity because the pay differences across jobs gets too small
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Pay Policy Issues

Broadbanding: combine adjacent pay ranges to create a smaller number of pay ranges in which each pay range is wider
May help with red & green circle jobs & with compression Frequently implemented as part of restructuring & downsizing
Source of figure: Fisher, Schoenfeldt, & Shaw (2006), Figure 11.7, p. 511

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Pay Policy Issues

Set the pay for each employee doing each job (where the employee falls inside the pay range for the employees job)
Methods:
Seniority: Each employee moves up their pay range by the same amount (usually determined as a percentage pay increase) Creates incentives for a stable, experienced workforce Typically used with unionized jobs, when merit pay isnt accepted by employees, when it is hard to measure job performance, or when there are very minor differences in job performance across employees (e.g., assembly line) Merit Pay: Each employee moves up their pay range based on their job performance (creates incentives for improved job performance) Skill-based Pay: Each employee moves up their pay range based on the skills & knowledge mastered by the employee (incentives to add skills)
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Pay Policy Issues

Legal issues in pay
Fair Labor Standards Act (FLSA)
4 Primary provisions: Minimum wage: 9/1/97: $5.15 7/24/07: $5.85 7/24/08: $6.55 7/24/09: $7.25 Overtime pay Restrictions on employment of children Recordkeeping requirements http://www.dol.gov/esa/whd/flsa/

Minimum wage set by state laws

http://www.dol.gov/esa/minwage/america.htm Example: Minnesota (for large employers): $6.15

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Pay Policy Issues

Equal Pay Act: equal pay for equal work
Forbids sex discrimination in pay when the employees perform the same job in the same organization
If a man and a woman are both doing the same job in the same organization, dont pay them differently because of their sexes Pay differences based on other factors is okay (e.g., seniority, job performance, etc.)

Comparable worth: equal pay for equal worth

If a man and a women are doing different jobs, but the company evaluates that both jobs are of equal value to the company, then they should be paid the same
Example: If a companys job evaluation determines that a secretarial job (held mostly by women) and a maintenance job (held mostly by men) make contributions of equal value to the company, then the two jobs should be paid the same
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Job Evaluation: Point System Method

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Five Levels of the Compensable Factor Technical Skills

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Job Evaluation Methods

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Legal Issues in Compensation

Title VII of Civil Rights Act of 1964
Protects workers rights to fair treatment.

Equal Pay Act of 1963

Requires equal pay for equal work.

Comparable Worth
Argues that standards of equal pay for equal work should be replaced with the doctrine of equal pay for equal value. Objective, measurable data to support an assessment of the value of different jobs is lacking. There is no basis in current law for the arguments of comparable worth.
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Legal Issues in Compensation (contd)

Fair Labor Standards Act of 1938
Regulates the minimum wage Sets overtime policy (time and one-half after forty hours) Establishes exempt classes for managers and other professional employees.
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Key Strategic Issues in Compensation

Determining compensation relative to the market. Striking a balance between fixed and variable compensation. Deciding whether or not to utilize team-based versus individual pay. Creating the appropriate mix of financial and nonfinancial compensation. Developing a cost-effective compensation program that results in high performance.

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Reading 11.1: Compensating Teams

Reasons for tailoring compensation to individuals:
Motivation comes from within the individual as opposed to the group. The development of skills and behaviors is an individual undertaking. Fairness in dealing with teams does not mean equal pay for all. Team compensation is not a payoff but a means of nurturing behavior that benefits the team.

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Reading 11.2: New Thinking for the New Millennium Strategic approaches to may compensation (pay) systems more responsive:
Pay the person for individual worth (knowledge, skills and competencies) rather than for the value of a job they perform. Reward excellence through a pay for performance compensation that establishes a clear relationship between a significant amount of pay and attainment of organizational objectives. Individualize the pay system to give employees choices in how they are rewarded and what reward they receive.

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