Chapter 1
The Pay Model
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
2-1
Unit Topics
 Compensation: Definition
 Forms of Pay
 A Pay Model
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Perspectives of Compensation
Society’s
Views
Stockholders’
Views
Employees’
Views
Managers’
Views
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Perspectives of Compensation
(cont.)
 Society
 Considers pay as a measure of justice
 Benefits as a reflection of justice in
society
 Stockholders
 Using stock to pay employees creates a
sense of ownership and improves
performance
 Linking executive pay to company
performance supposedly increases
stockholders' returns
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Perspectives of Compensation
(cont.)
 Managers
 Major expense
 Used to influence employee behaviors and
to improve the organization's
performance
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Perspectives of Compensation
(cont.)
 Employees
 Major source of financial security
 Return in an exchange between employer
and themselves
 Entitlement for being an employee of the
company
 Reward for a job well done
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Perspectives of Compensation
(cont.)
 Incentive and sorting effects of pay on
employers’ behaviors
 Incentive effect - degree to which pay
influences individual and aggregate
motivation among the employees
 Sorting effect - effect that pay can have
on the composition of the workforce
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What is Compensation?
Compensation refers to all
forms of financial returns
and tangible services and
benefits employees
receive as part of an
employment relationship
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Exhibit 1.4: Total Returns for Work
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Forms of Pay
 Base wage
 It is the cash compensation that an
employer pays for the work performed
 Some pay systems set base wage as a
function of the skill or education an
employee possesses
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Forms of Pay
 Merit pay/cost-of-living adjustments
 Merit increases are given in recognition of
past work behavior
 Cost-of-living adjustments give the same
increases to everyone, regardless of
performance
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Forms of Pay (cont.)
 Incentives (variable pay)
 Tie pay increases directly to performance
 Do not increase base wage; must be
reearned each pay period
 Potential size of the payment will
generally be known beforehand
 Are one-time payments, and do not
permanently increase labor costs
 May be long-term (stock options) or
short-term
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Forms of Pay (cont.)
 Benefits
 Income protection (Medical insurance,
retirement programs, life insurance, and
savings plans)
 Work/life balance (vacations, jury duty,
financial planning, referrals for child and
elder care, telecommuting, nontraditional
schedules, nonpaid time off)
 Allowances
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Forms of Pay (cont.)
 A present-value perspective shifts
comparison of today's initial offers to
consideration of future bonuses, merit
increases, and promotions
 Relational returns from work
(nonfinancial returns) have a
substantial effect on employees’
behavior
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Forms of Pay (cont.)
 Network of returns is more likely to be
useful if bonuses, development
opportunities, and promotions all work
together
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A Pay Model
 Three basic building blocks:
 Compensation objectives
 Policies that form the foundation of the
compensation system
 Techniques that make up the
compensation system
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Compensation Objectives
 Guide the design of the pay system
 Serve as the standards for judging the
success of the pay system
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Four Policy Choices
 Internal alignment
 Compares 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
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Four Policy Choices (cont.)
 Pay relationships within an organization
affect employee decisions to:
 Stay with the organization
 Become more flexible by investing in
additional training
 Seek greater responsibility
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Four Policy Choices (cont.)
 External competitiveness
 Focus – pay comparisons with competitors
 Pay is ‘market driven’
 Objective:
 To ensure that pay is sufficient to attract and
retain employees
 To control labor costs to ensure competitive
pricing of products/ services
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Four Policy Choices (cont.)
 Employee contributions
 Directly affects employees’ attitudes and
work behaviors
 Management
 Focus - right people get the right pay for
achieving the right objectives in the right
way
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Chapter 2
Strategy: The Totality of
Decisions
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
2-22
Chapter Topics
 Similarities and Differences in
Strategies
 Strategic Choices
 Support Business Strategy
 Support HR Strategy
 The Pay Model Guides Strategic Pay
Decisions
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Chapter Topics (cont.)
 Developing a Total Compensation
Strategy: Four Steps
 Source of Competitive Advantage:
Three Tests
 “Best Practices” versus “Best Fit”?
 Guidance from the Evidence
 Virtuous and Vicious Circles
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Exhibit 2.1: Three Compensation
Strategies
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Similarities and Differences
in Strategies
 Different strategies within the same
industry
 Different strategies within the same
company
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Strategic Choices
 Strategy refers to the fundamental
directions that an organization
chooses
 A strategic perspective focuses on
those compensation choices that help
the organization gain and sustain
competitive advantage
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Exhibit 2.2: Strategic Choices
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Support Business Strategy
 Pay systems should align with the
organization's business strategy
 Based on contingency notions
 When business strategies change, pay
systems should also change
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Exhibit 2.3: Tailor the Compensation
System to the Strategy
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The Pay Model Guides Strategic Pay
Decisions
 Five strategic compensation choices:





Objectives
Internal alignment
External competitiveness
Employee contributions
Management
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The Pay Model Guides Strategic Pay
Decisions (cont.)
 These decisions, taken together, form
a pattern that becomes an
organization’s compensation strategy
 Stated versus unstated strategies
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Developing A Total Compensation
Strategy: Four Steps
 Step 1: Assess total compensation
implications
 Step 2: Map a total compensation
strategy
 Step 3: Implement strategy
 Step 4: Reassess
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Exhibit 2.6: Key Steps in Formulating
a Total Compensation Strategy
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Step 1: Assess Total Compensation
Implications
 Business strategy and competitive
dynamics – understand the business





Changing customer needs
Competitors’ actions
Changing labor market conditions
Changing laws
Globalization
 Competitive dynamics can be
assessed globally
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Step 1: Assess Total Compensation
Implications (cont.)
 HR strategy: Pay as a supporting
player or catalyst for change?
 Pay strategy is influenced by how it fits
with other HR systems
 Pay can be a supporting player, as in the
high-performance approach
 Pay can take the lead and be a catalyst
for change
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Step 1: Assess Total Compensation
Implications (cont.)
 Culture/values
 A pay system reflects the values that
guide an employer's behavior and
underlie its treatment of employees
 Social and political context
 Context refers to legal and regulatory
requirements, cultural differences,
changing workforce, demographics,
expectations etc
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Step 1: Assess Total Compensation
Implications (cont.)
 Employee preferences
 How to better satisfy individual needs and
preferences
 Choice
 People do not understand the
alternatives; too many choices confuse
them
 Challenging to design and manage
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Step 1: Assess Total Compensation
Implications (cont.)
 Union preferences
 Union preferences for different forms of
pay and their concern with job security
affect pay strategy
 Unions' interests can differ
 Compensation deals with unions can be
costly to change
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Step 2: Map a Total Compensation
Strategy
 A strategic map offers a picture of a
company’s compensation strategy
based on the five choices in the pay
model
 Clarifies the message the company is
trying to establish with its
compensation system
 Maps do not tell which strategy is the
“best”; provides a framework and
guidance
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Exhibit 2.8: Contrasting Maps of
Microsoft and SAS
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Steps 3 and 4: Implement and
Reassess
 Step 3
 Involves implementing the strategy
through the design and execution of the
compensation system
 Step 4
 Recognizes that the strategy must change
to fit changing conditions
 Involves periodic reassessment
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Sources of Competitive Advantage:
Three Tests
 Is it aligned?
 Does it differentiate?
 Does it add value?
 Calculate the return on investment (ROI)
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“Best Practices” versus “Best Fit”?
Best Practices
 Assumptions:
 A set of best-pay
practices exists
 Practices can be applied
universally across all
situations
 Results in better
performance with almost
any business strategy
Best Fit
 A company is more
likely to achieve
competitive
advantage if the
pay system:
 Reflects company’s
strategy and values
 Is responsive to
employees’ and unions’
needs
 Is globally competitive
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Guidance from the Evidence
 Internal alignment
 Pay differences among internal jobs can
affect results
 External competitiveness
 Paying higher than the average paid by
competitors can affect results
 Employee contributions
 Performance-based pay can affect results
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Guidance from the Evidence (cont.)
 Managing compensation
 All dimensions of the pay strategy need
to be considered
 Compensation strategy
 Embedding compensation strategy
within the broader HR strategy affects
results
 “What practices pay off best under
what conditions” is an important
question to be answered
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Virtuous and Vicious Circles
 A study concluded that how you pay
matters as much as how much you
pay
 Studies conclude that performancebased pay that shares success with
employees improves employee
attitudes, behaviors, performance –
especially when combined with highperformance practices
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Virtuous and Vicious Circles (cont.)
 Performance-based pay can be the
best practice under right
circumstances
2-48