Compensation
Tenth Edition
George T. Milkovich
Cornell University
Jerry M. Newman
State University of New YorkBuffalo
Barry Gerhart
University of Wisconsin-Madison
McGraw-Hill
Irwin
Table of Contents
Preface
xiii
Chapter 2
Strategy: The Totality of Decisions 33
PART ONE
INTRODUCING THE PAY MODEL
AND PAY STRATEGY
Chapter 1
The Pay Model 2
Compensation: Does It Matter? (or, "So What?") 3
Compensation: Definition, Please 4
Society 4
Stockholders 6
Managers 7
Employees 8
Global Views—Vive la difference 10
Forms of Pay 10
Cash Compensation: Base 11
Cash Compensation: Merit PaylCost-of-Living
Adjustments 12
Cash Compensation: Incentives 12
Long-Term Incentives 13
Benefits: Income Protection 13'
Benefits: Work/Life Balance 13
Benefits: Allowances 14
Total Earnings Opportunities: Present Value of a
Stream of Earnings 14
Relational Returns From Work 14
A Pay Model 15
Compensation Objectives 15
Four Policy Choices 19
Pay Techniques 21
Book Plan 22
Caveat Emptor—Be an Informed Consumer 22
1. Is the Research Useful? 23
2. Does the Study Separate Correlation From
Causation? 23
3. Are There Alternative Explanations? 24
Your Turn: Circuit City 24
Similarities and Differences in Strategies 33
Different Strategies Within the Same Industry 35
Different Strategies Within the Same Company 36
Strategic Choices 36
Support Business Strategy 38
Support HR Strategy 40
The Pay Model Guides Strategic Pay
Decisions 41
• Stated Versus Unstated Strategies 42
Developing a Total Compensation Strategy:
Four Steps 43
Step 1: Assess Total Compensation
Implications 44
HR Strategy: Pay as a Supporting Player or
Catalyst for Change? 44
Step 2: Map a Total Compensation Strategy 47
Steps 3 and 4: Implement and Reassess 50
Source of Competitive Advantage: Three Tests 50
Align 50
Differentiate 50
Add Value 51
"Best Practices" Versus "Best Fit"? 53
Guidance From the Evidence 53
Virtuous and Vicious Circles 54
Your Turn: Merrill Lynch 55
Still Your Turn: Mapping Compensation
Strategies 57
PART TWO
INTERNAL ALIGNMENT:
DETERMINING THE STRUCTURE
Chapter 3
Defining Internal Alignment
68
Compensation Strategy: Internal Alignment
Supports Organization Strategy 69
69
iv
Table of Contents
Supports Work Flow 70
Motivates Behavior 71
Structures Vary Among Organizations 71
Number of Levels 72
Differentials 72
Criteria: Content and Value 72
What Shapes Internal Structures? 75
Economic Pressures 75
Government Policies, Laws, and Regulations 76
External Stakeholders 76
Cultures and Customs 77
Organization Strategy 78
Organization Human Capital 78
Organization Work Design 78
Overall HR Policies 78
Internal Labor Markets: Combining External and
Organization Factors 79
Employee Acceptance: A Key Factor 80
Pay Structures Change 80
Strategic Choices in Designing Internal
Structures 81
Tailored Versus Loosely Coupled 81
Hierarchical Versus Egalitarian 81
Guidance From the Evidence 83
Equity Theory: Fairness 83
Tournament Theory: Motivation and
Performance 84
Institutional Model: Copy Others 85
(More) Guidance From the Evidence 85
Consequences of Structures 86
Efficiency 87
Fairness 87
Compliance 87
Your Turn: So You Want to Lead an Orchestra! 8£
Chapter 4
Job Analysis 94
Structures Based on Jobs, People, or Both 95
Job-Based Approach: Most Common 97
Why Perform Job Analysis ? 97
Job Analysis Procedures 98
What Information Should Be Collected? 99
Job Data: Identification 99
Job Data: Content 99
Employee Data 101
"Essential Elements" and the Americans With
Disabilities Act 104
Level of Analysis 105
How Can the Information Be Collected? .106
Conventional Methods 106
Quantitative Methods 106
Who Collects the Information? 108
Who Provides the Information? 108
What About Discrepancies? 109
Job Descriptions Summarize the Data 110
Using Generic Job Descriptions 110
Describing Managerial!Professional Jobs 110
Verify the Description 111
Job Analysis: Bedrock or Bureaucracy? 113
Job Analysis and Globalization 114
Job Analysis and Susceptibility to
Off shoring 114
Job Analysis Information and Comparability
Across Borders 116
Judging Job Analysis 116
Reliability 116
Validity 117
Acceptability 117
Currency 117
Usefulness 118
A Judgment Call 118
Your Turn: The Customer-Service Agent 119
Chapter 5
Job-Based Structures and Job
Evaluation 128
Job-Based Structures: Job Evaluation 129
Defining Job Evaluation: Content, Value, and
External Market Links 130
Content and Value 130
Linking Content With the External Market 130
"Measure for Measure" Versus "Much Ado About
Nothing" 131
"How-To": Major Decisions 131
Establish the Purpose 132
Single Versus Multiple Plans 132
Choose Among Job Evaluation
Methods 134
Table of Contents
Job Evaluation Methods 135
Ranking 135
Classification 136
Point Method 139
Who Should Be Involved? .149
The Design Process Matters 150
The Final Result: Structure 151
Balancing Chaos and Control 152
Your Turn: Job Evaluation at Whole Foods
Chapter 6
Person-Based Structures
The Perfect Structure 186
Your Turn: Climb the Legal Ladder
187
PART THREE
EXTERNAL COMPETITIVENESS:
DETERMINING THE PAY LEVEL
153
161
Person-Based Structures: Skill Plans 162
Types of Skill Plans 162
Purpose of the Skill-Based Structure 165
"How-To": Skill Analysis 166
What Information to Collect? 166
Whom to Involve? 167
Establish Certification Methods 167
Outcomes of Skill-Based Pay Plans: Guidance From
Research and Experience 169
Person-Based Structures: Competencies 170
Defining Competencies 171
Purpose of the Competency-Based
Structure 174
"How-To": Competency Analysis 175
Objective 175
What Information to Collect? 176
Whom to Involve? /176
Establish Certification Methods 180
Resulting Structure 180
Competencies and Employee Selection and
Training/Development 180
Guidance From the Research on
Competencies 182
One More Time: Internal Alignment Reflected in
Structures 182
Administering the Plan 183
Evidence of Usefulness of Results 183
Reliability of Job Evaluation Techniques 183
Validity 183
Acceptability 184
Bias in Internal Structures 184
Wages Criteria Bias 185
Chapter 7
Defining Competitiveness
198
Compensation Strategy: External
Competitiveness 199
Control Costs and Increase Revenues 199
Attract and Retain the Right Employees 202
What Shapes External Competitiveness? 205
Labor Market Factors 205
How Labor Markets Work 206
Labor Demand 207
Marginal Product 207
Marginal Revenue 207
Labor Supply 209
Modifications to the Demand Side 209
Compensating Differentials 209
Efficiency Wage 210
Signaling 211
Modifications to the Supply Side (Only Two
More Theories to Go) 212
Reservation Wage 213
Human Capital 213
Product Market Factors and Ability
to Pay 213
Product Demand 214
Degree of Competition 214
A Different View: What Managers Say 214
Segmented Supplies of Labor and (Different)
Going Rates 215
Organization Factors 216
Industry and Technology 216
Employer Size 216
People's Preferences 217
Organization Strategy 217
Relevant Markets 218
Defining the Relevant Market 218
Globalization of Relevant Labor Markets:
Offshoring and Outsourcing 219
v
vi
Table of Contents
Competitive Pay Policy Alternatives
220
What Difference Does the Pay-Level Policy
Make? 221
Pay With Competition (Match) 221
Lead Pay-Level Policy 222
Lag Pay-Level Policy 223
Different Policies for Different Employee
Groups 223
Not by Pay Level Alone: Pay Mix Strategies 223
Consequences of Pay-Level and -Mix Decisions:
Guidance From the Research 227
Choice of Measure 266
Updating 266
Policy Line as Percent of Market Line
266
From Policy to Practice: Grades and Ranges
266
Why Bother With Grades and Ranges? 266
Develop Grades 267
Establish Range Midpoints, Minimums, and
Maximums 268
Overlap 268
From Policy to Practice: Broad Banding
Efficiency 227
Fairness 228
Compliance 228
269
Flexibility-Control 271
Your Turn: Sled Dog Software 229
Still Your Turn: Fit the Pay-Mix Policy to the
Compensation Strategy 229
Balancing Internal and External Pressures:
Adjusting the Pay Structure 272
Reconciling Differences 272
Market Pricing
273
Business Strategy (More Than "Follow the
Leader") 274
Chapter 8
Designing Pay Levels, Mix, and Pay
Structures 238
Major Decisions 239
Specify Competitive Pay Policy
The Purpose of a Survey 240
239
Select Relevant Market Competitors
Review 274
Your Turn: Word-of-Mouse: Dot-Com
Comparisons 275
PART FOUR
Adjust Pay Level—How Much to Pay? 240
Adjust Pay Mix—What Forms ? 240
Adjust Pay Structure? 240
Study Special Situations 241
Estimate Competitors' Labor Costs 241
241
Fuzzy Markets 245
Design the Survey
From Policy to Practice: The Pay-Policy
Line 266
245
Who Should Be Involved? 246
How Many Employers? 246
Which Jobs to Include? 248
What Information to Collect? 250
Interpret Survey Results and Construct a Market
Line 253
Verify Data 253
Statistical Analysis 258
Update the Survey Data 259
Construct a Market Pay Line 261
Setting Pay for Non-Benchmark Jobs 263
Combine Internal Structure and External Market
Rates 265
EMPLOYEE CONTRIBUTIONS:
DETERMINING INDIVIDUAL PAY
Chapter 9
Pay-for-Performance: The Evidence 284
What Behaviors Do Employers Care About?
Linking Organization Strategy to Compensation
and Performance Management 285
What Does It Take to Get These Behaviors? What
Theory Says 290
What Does It Take to Get These Behaviors?
What Practitioners Say 294
Does Compensation Motivate
Behavior? 299
Do People Join a Firm Because of Pay? 299
Do People Stay in a Firm (or Leave) Because
ofPay? 300
Do Employees More Readily Agree to Develop Job
Skills Because of Pay? 301
Do Employees Peiform Better on Their Jobs
Because of Pay? 301
Table of Contents vii
Designing a Pay-for-Performance Plan
305
Efficiency' 305
Equity/Fairness 307
Compliance 307
Your Turn: Burger Boy
Chapter 11
Performance Appraisals 358
The Role of Performance Appraisals in
Compensation Decisions 359
308
Performance Metrics
What Is a Pay-for-Performance Plan? 317
Does Variable Pay Improve Performance Results?
The General Evidence 319
Specific Pay-for-Performance Plans:
Short Term 319
Merit Pay 319
Lump-Sum Bonuses 320
Individual Spot Awards 321
Individual Incentive Plans 322
Individual Incentive Plans: Advantages and
Disadvantages 326
Individual Incentive Plans: Examples 327
Team Incentive Plans: Types
327
Comparing Group and Individual Incentive
Plans 333
Large Group Incentive Plans 334
Gain-Sharing Plans 334
Profit-Sharing Plans 339
Earnings-at-Risk Plans 340
Group Incentive Plans: Advantages and
Disadvantages 341
/
Group Incentive Plans: Examples 342
Putting It All Together: The Performance
Evaluation Process 377
Equal Employment Opportunity and Performance
Evaluation 380
Tying Pay to Subjectively Appraised
Performance 382
Promotional Increases as a Pay-for-Performance
Tool 386
Your Turn: Performance Appraisal at
Burger King 386
Appendix
Employee Stock Ownership Plans (ESOPs) 344
Performance Plans (Performance Share and
Peiformance Unit) 345
Broad-Based Option Plans (BBOPs) 345
Combination Plans: Mixing Individual and
Group 346
Appendix
The Balanced Scorecard Approach 361
Strategy 1: Improve Appraisal Formats 362
Strategy 2: Select the Right Raters 370
Strategy 3< Understand How Raters Process
Information 373
Common Errors in Appraising Performance:
Criterion Contamination 373
Strategy 4: Training Raters to Rate More
Accurately 377
Competency: Customer Care 383
Performance- and Position-Based Guidelines 384
Designing Merit Guidelines 384
Explosive Interest in Long-Term Incentive
Plans 342
Your Turn: Incentives in the Clubhouse
360
Strategies for Better Understanding and
Measuring Job Performance 361
Chapter 10
Pay-for-Performance Plans 317
346
ll-A: Balanced Scorecard Example:
Department of Energy (Federal Personal
Property Management Program) 390
11-B:
Sample Appraisal Form for Leadership
Dimension: Pfizer Pharmaceutical 393
PART FIVE
EMPLOYEE BENEFITS
10-A: Gain-Sharing Plan at Dresser
Rand 348
Chapter 12
The Benefit Determination Process 414
10-B:
Why the Growth in Employee Benefits?
Profit-Sharing (401K) at
Walgreens 353
Wage and Price Controls 416
416
viii Table of Contents
Unions 416
Employer Impetus 416
Cost Effectiveness of Benefits 417
Government Impetus 417
The Value of Employee Benefits 417
Key Issues in Benefit Planning, Design, and
Administration 419
Benefits Planning and Design Issues 419
Benefit Administration Issues 420
Components of a Benefit Plan 423
Employer Preferences 423
Employee Preferences 427
Administering the Benefit Program 429
Employee Benefit Communication 431
Claims Processing 433
Cost Containment 433
Your Turn: World Measurement 434
Dental Insurance 465
Vision Care 465
Miscellaneous Benefits 465
Paid Time Off During Working Hours 465
Payment for Time Not Worked 466
Child Care 467
Elder Care 467
Domestic Partner Benefits 467
Legal Insurance 467
Benefits for Contingent Workers 467
Your Turn: Mr. Baldy Car Wash 468
Chapter 13
Benefit Options 442
Who Are Special Groups? 478
Compensation Strategy for Special Groups 479
Supervisors 479
Corporate Directors 480
Executives 480
What's All the Furor Over Executive
Compensation? What the Critics and Press
Say 486
What's All the Furor Over Executive
Compensation? What Academics Say 489
Scientists and Engineers in High-Technology
Industries 491
Sales Forces 494
Contingent Workers 498
Your Turn: Compensation of Special Groups 499
Legally Required Benefits 445
Workers' Compensation 446
Social Security 447
Unemployment Insurance 450
Family and Medical Leave Act
(FMLA) 452
Consolidated Omnibus Budget Reconciliation Act
(COBRA) 452
Health Insurance Portability and Accountability Act
(HIPAA) 452
Retirement and Savings Plan Payments 452
Defined Benefit Plans 453
Defined Contribution Plans 453
Individual Retirement Accounts
(IRAs) 455
Employee Retirement Income Security Act
(ER1SA) 455
How Much Retirement Income to
Provide? 457
Life Insurance 458
Medical and Medically Related Payments 458
General Health Care 458
Health Care: Cost Control Strategies 462
Short-and Long-Term Disability 464
PART SIX
EXTENDING THE SYSTEM
Chapter 14
Compensation of Special Groups 477
Chapter 15
Union Role in Wage and Salary
Administration 505
The Impact of Unions in Wage
Determination 506
Union Impact on General Wage Levels 506
The Structure of Wage Packages 508
Union Impact: The Spillover Effect 509
Role of Unions in Wage and Salary Policies and
Practices 509
Table of Contents ix
Unions and Alternative Reward Systems
Lump-Sum Awards 514
Employee Stock Ownership Plans
(ESOPs) 514
Pay-for-Knowledge Plans 514
Gain-Sharing Plans 515
Profit-Sharing Plans 515
Your Turn: General Technology 516
513
Chapter 16
International Pay Systems 521
The Global Context 523
The Social Contract 525
Centralized or Decentralized
Pay-Setting 526
Regulation 527
Culture 530
Culture Matters, But So Does Cultural
Diversity 532
Trade Unions and Employee Involvement 534
Ownership and Financial Markets 534
Managerial Autonomy 535
Comparing Costs 536
Labor Costs and Productivity 536
Cost of Living and Purchasing Power 537
Comparing Systems 540
The Total Pay Model: Strategic Choices 540
National Systems: Comparative Mind-Set 540
Japanese Traditional National System 540
German Traditional National System 544
Strategic Comparisons: Traditional Systems in
Japan, Germany, United States 545
Evolution and Change in the Traditional Japanese
and German Models 547
Strategic Market Mind-Set 549
Localizer: "Think Global, Act Local" 549
Exporter: "Headquarters Knows Best" 549
Globalizer: "Think and Act Globally and
Locally" 550
Expatriate Pay 550
Elements of Expatriate Compensation 552
The Balance Sheet Approach 554
Expatriate Systems —> Objectives? Quel
dommage! 558
Borderless World —> Borderless Pay?
Globalists 559
Your Turn: IBM's Worldwide Business and
Employment Strategies and Compensation 559
PART SEVEN
MANAGING THE SYSTEM
Chapter 17
Government and Legal Issues in
Compensation 573
Government as Part of the Employment
Relationship 575
Demand 575
Supply 575
Fair Labor Standards Act of 1938 578
Minimum Wage 578
"Living Wage" 580
Overtime and Hours of Work 580
Child Labor 586
Employee or Independent Contractor? 586
Prevailing Wage Laws 588
Pay Discrimination: What Is It? 589
The Equal Pay Act 591
Definition of Equal 591
Definitions of Skill, Effort, Responsibility, Working
Conditions 592
Factors Other Than Sex 592
"Reverse" Discrimination 593
Title VII of the Civil Rights Act of 1964 and
Related Laws 593
Disparate Treatment 594
Disparate Impact 595
Executive Order 11246 595
Pay Discrimination and Dissimilar Jobs 597
Proof of Discrimination: Use of
Market Data 597
Proof of Discrimination: Jobs of Comparable
Worth 598
Earnings Gaps 599
Sources of the Earnings Gaps 601
Differences in Occupations and
Qualifications 602
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Table of Contents
Differences in Industries and Firms 603
Union Membership 604
Presence of Discrimination 604
Gaps Are Global 605
Comparable Worth 605
The Mechanics 606
Union Developments 607
A Proactive Approach 608
Your Turn: Self-Evaluation and Pay
Discrimination 608
Still Your Turn: From Barista to Manager
Chapter 18
Management: Making It Work
609
618
Managing, Controlling (and Sometimes
Reducing) Labor Costs 619
Number of Employees (a.k.a.: Staffing Levels or
Headcount) 620
Hours 624
Controlling Benefits 624
Controlling Average Cash Compensation 625
Control Salary Level: Top Down 625
Current Year's Rise 626
Ability to Pay 626
Competitive Market Pressures 626
Turnover Effects 626
Cost of Living 627
Rolling It All Together 628
Control Salary Level: Bottom Up 629
Ethics: Managing or Manipulating? 631
Where Is the Compensation Professional? 631
Embedded Controls 632
Range Maximums and Minimums 632
Compa-Ratios 633
Variable Pay 633
Analyzing Costs 634
Analyzing Value Added 634
Communication: Managing the Message 636
Say What? 640
Pay as Change Agent • 641
Structuring the Compensation Function 641
Centralization—Decentralization 641
Flexibility Within Corporatewide
Principles 642
Reengineering and Outsourcing 643
Balancing Flexibility and Control 643
Your Turn: Communication by Copier 644
Still Your Turn: Ethics in Compensation
Decisions 645
Glossary 650
Name Index 669
Subject Index 679