Chapter 1: A Model of Compensation
Overview: This textbook chapter reviews the basic model of the components of compensation
including the pay level, base pay, variable pay and benefits.
INTRODUCTION
Almost every worker receives a paycheck at some regular interval. The pay levels vary from the
minimum wage to the salary of the chief executive of a major corporation.
Why do employees earn the particular amount of their paychecks?
If we asked the individuals, we might get answers like these:
I worked all week.
My job is very important.
I did a good job on that project.
I'm paid what I'm worth!
This is the market rate for my job.
This job is boring and the work conditions are terrible!
These answers are almost as diverse as the pay levels for the individuals. People are paid for the
work they do. They are also paid for their performance, their skills, their tenure, and a host of other
factors. Their pay is influenced by the market value of labor, by unions, by social attitudes, and by
organization practices. The organization sets pay rates with programs and practices that align with
business objectives.
Compensation programs incorporate organizational systems and practices with influences from inside
and outside the organization. Of note are new outside influences that create new responses such as:
I get what the city determines to be a living wage.
I can check out what I earn against the competitive norms reported by www.salaryexpert.com.
The Chat Room members tell me that this is what they earn.
PAY AND WORK
In short, this text is about pay — how it is determined and managed. But pay, like a coin, has two
sides: it represents compensation to employees and cost to the employer. What the employer
provides the employee is called a wage or a salary. Often, the term compensation is used to indicate
the various forms of pay — money, benefits, and non-financial rewards. In countries other than the
United States, the term used is remuneration.
Employers
Employees







money
benefits
non-financial
rewards
training
career development
coaching/mentoring



showing up regularly, on
time
carrying out tasks
dependably
cooperating with others
making useful suggestions
What the employee provides the employer is labor service, usually called work. This labor service
consists of many different kinds of employee behavior, for example: showing up regularly and on time,
carrying out tasks dependably, cooperating with others and making useful suggestions.
So pay or compensation represents an exchange between the employee and the organization. Each
gives something in return for something else.
SIGNIFICANCE OF COMPENSATION
To an employee, pay is a primary reason for working. For some people, it may be the only reason. For
most of us, it is the means by which we provide for our own and our family's needs. Few people
refuse to accept pay for their work. Perhaps fewer would continue to work if they were told they would
not be paid. But pay can also represent status or recognition of accomplishment to an employee.
Compensation is also important to organizations. It represents a large proportion of expenditures. In
manufacturing firms it is seldom as low as 20 percent; in service enterprises it is often as high as 80
percent. (For more information on labor costs by industry, refer to http://146.142.4.24/cgibin/surveymost?ec.) Even more important, organizations try to accomplish many goals with
compensation. These goals include attracting, engaging, and retaining people and motivating them to
perform more effectively.
Compensation is also significant in the operation of the economy. Salaries and wages account for
about 60 percent of the gross U.S. national product. Compensation is the largest type of income
generated. This is not widely appreciated. For instance, most MBA programs do not include a course
regarding compensation and benefits. Sending young, new managers into business battles without
such knowledge is akin to fielding an army but never giving any of the troops small arms training.
Business leaders need to understand how to balance the "art" and science of compensation decisions
in the workplaces.
COMPENSATION DOMAINS
So far we have established that compensation (1) represents an employment contract, and (2) is
important to employees, organizations, and the economy. But in what scholarly discipline does it
belong? What kind of theory is applicable to it?
An Economic Concept
Compensation is a price for a factor of production. As such, it serves to allocate scarce human
resources to productive uses. To the employer, compensation is the price paid for labor services. As
an economic concept, compensation is governed by the same logic as any other purchase by a firm.
An organization strives to get the greatest quantity and the highest quality for its money. By the same
logic, the worker is selling labor services to obtain income and holds out for the highest price
obtainable. The actions of these buyers and sellers are supposed to set the price and to allocate labor
(employee services) to its most productive use.
But the labor market differs in many ways from the economic market for commodities. Labor service is
perishable. If today's labor is not purchased today, it has no value tomorrow. Also, labor service may
vary from hour to hour and day to day because it varies with the ability of a person to work.
Furthermore, the labor supplier cannot be separated from the labor services supplied; he or she can
change the quality and quantity of those services. This variability of supply has advantages and
disadvantages to the employer. Through various personnel policies and practices, the quality and
quantity of labor services may be enhanced. Also, the labor supplier can quickly fill the needs of the
organization as they change. This flexibility of labor supply permits the employer to vary his or her
demands.
Because the employer's demand for labor services is derived from the demand for the goods and
services the organization supplies, any change in demand may change the labor services needed.
These changes and the variety of labor supplies needed at any one time are evidence of how
organizations depend on the variability of labor supplies.
But this variability is also a disadvantage. The variability of both demand and supply makes it difficult
for the purchaser to quote a price. The real cost of labor services to the purchaser is the cost per unit
of output. But the seller requires that a price be quoted in advance. Hence, the purchaser must offer a
price before the bargain is made. This price must come from estimates of the value of average quality
and quantity of labor services in this exchange. This value is in turn derived from cost per unit of
product or service.
The supplier of labor service likewise experiences difficulty in deciding what price to accept. The labor
supplier can, at best, know only the range of going rates for particular jobs. Other aspects of the
employment exchange: design of the job, working conditions, supervision, work associates, personnel
policies and practices are typically unknown before the person is hired. Translating these elements
into money terms is not easy.
The labor market is assigned the task of making sense out of these forces. It brings together
purchasers and sellers of labor services, sets prices, and seeks to allocate labor to its most productive
uses. Many labor markets exist, corresponding to the many types of labor service and the many types
of employees of labor services. Neither a balance between demands and supplies nor a single price is
likely to emerge for a single type of labor service. A single price, when it does appear, is usually
caused by restrictions on the market mechanism, such as that caused by a strong union.
If compensation for labor services were influenced only by economic forces, pay for similar work
would be equal. Differences in pay between occupations would reflect only scarcities for which the
market had not had time to adjust or actual differences in ability.
This brief description of compensation as an economic concept shows that economic analysis is
essential in any study of compensation and will be explored more fully in chapter 3. But the
differences between labor markets and other markets suggest that economic analysis alone is not
sufficient.
A Psychological Concept
Compensation (pay) represents the psychological contract between the individual and the
organization. An organization's reward practices have consequences only through this contract. Thus
pay, as a psychological concept, is viewed from the standpoint of the individual.
The situation and the needs, perceptions, and attitudes of the individual determine behavior. The
situation is influenced by the individual’s perceptions triggered by felt states. The means for satisfying
individual needs are based on perceptions and their interpretation through attitudes (categories of
past experiences). Each individual need may be satisfied by a different set of means.
The psychological contract between the individual and the organization is created by perceptions.
Organizations and employees often speak and act as if they believe that employees work only for
money. Research shows that many other rewards are operating. In addition to pay, other factors like
interesting work, congenial associates, competent supervision, and security are perceived as rewards.
Rewards are offered by organizations to motivate many types of behavior. Which rewards motivate
what kinds of behavior, and how rewards operate, are functions of perceptions and attitudes
contributing to the organization culture. Motivation is a complex phenomenon only partially
understood. All rewards appear to follow the law of diminishing returns. It is therefore necessary to
determine whether a particular reward motivates, and if so, within what range.
Thus pay is a psychological concept tied to motivating individual behavior in organizations. As such, it
complements the economic perspective by emphasizing the perceptions of individuals. This
psychological perspective will be explored more fully in chapter 4.
A Sociological Concept
Pay is a status symbol within organizations and society. In less complex societies, the status of
individuals is a product of many standards of judgment; for example, their families, friends,
occupations, education levels, and religious and political affiliations. In large, mobile societies, many
of these standards are harder to measure and become less significant. Income as a symbol of status
does not present this problem.
Organizations have an inherent status structure of jobs as a result of creating a job worth hierarchy as
a basis for compensation programs. Status differences are measured by both organizations and
individuals in terms of pay and pay differences. In fact, employees learn to place associates in the
status structure of the organization according to how much they are paid. Because pay is such a
universal measure of status in organizations, it is easy to understand why even small differences in
pay have great perceived significance. Also explained is the symbolic significance of methods of
payment and frequency of payment. Salary may imply a status different from that of wage, while a
yearly salary may imply a higher status than a monthly or weekly salary, or hourly rate. This symbolic
significance adds another dimension to the importance of compensation to individuals; as pay
acquires more meanings, its importance increases.
Compensation viewed as a status symbol helps to explain the force of custom and tradition in pay
determination. The protection of present status and the desire to improve it appear to be universal
human values. Protection of present status gives force to the custom defined as "what is right."
Custom and tradition require that change be justified. The force of custom is conservative. When
changes are made, they call forth numerous other changes based on traditional relationships.
These values operate within an organization as well as in society in general. In designing the job
worth hierarchy and compensation structure, an organization is influenced by what pay the job
commanded in the past and what other organizations are paying at present. The force of outside
influences varies with the kind of people hired, their attachment to the organization, and the similarity
of the organization's jobs to those found elsewhere. If the organization can create unique jobs, hire
only for beginning jobs, and do its own training for higher level jobs, outside influence is minimized.
This practice results in creating customary relationships that are just as conservative soon arise inside
the organization. Groups within the organization struggling for status and pay bring forces at least as
powerful as traditional forces from outside the organization.
Unions are just as subject to these forces as employing organizations. In fact, unions tend to serve as
channels through which customary relationships are made or restored. Both unions and employing
organizations are subject to group pressures. Both hesitate to violate customary relationships.
Viewing compensation as a sociological concept focuses neither on the organization nor on
individuals but on the relationship between them. The mutual influence of individuals, organizations,
and of groups within and without constitutes another dimension of compensation decision making.
A Political Concept
Compensation as a political concept involves the use of power and influence. Organizations, unions,
groups, and individual employees all use their power to influence pay. Unions exert influence at the
time the contract is bargained and during the life of the contract through the grievance procedure.
Similarly, compensation in unionized organizations influences that in nonunion organizations.
Organizations exert power in the same situations. In addition, some choose to be pay leaders and
thus become major forces in labor markets. Within organizations, groups try to use their power to
enhance their influence and pay. As organizations acquire more differentiated but interdependent
units, more and more individuals achieve power to influence compensation. Highly skilled individuals
in demand by other employers also have the power to influence their pay.
Compensation as a political concept involves no notion that the parties have equal power. Nor does
all the power reside on the side of the organization. A political perspective stresses accommodating
the influence of all parties.
An Equity Concept
Few discussions of compensation are conducted without repeated appeals to fairness. Phrases such
as "a fair day's pay" or "a just wage" are common. In both cases, the equity sought is distributive
justice. The foundation concept is that returns should be proportionate to contributions.
Because people have different ideas of what to measure and how to measure, opinions differ widely
on what justice, fairness, and equity mean in pay. Everybody agrees that justice in distribution should
be based on merit of some sort. But people do not understand, nor necessarily agree, as to the
definition of merit.1
This probably means that equity is best viewed from the eyes of the beholder. This in turn may mean
that although equity in compensation can exist for both the organization and the individual, this
situation is unlikely unless it results from bargaining and a relatively complete specification of the
terms.
Viewing compensation as an equity concept means analyzing pay from the separate viewpoints of the
parties. Ideally, compensation will be adjudged fair by all of them.
A Communications Concept
Compensation is being drastically affected by the Internet.2 Employees now have easy access to the
competitive rates commonly paid for their positions within any given geographic area. A future where
employees know more than their employers about the value of their positions in the competitive
marketplace is what now faces worldwide employers. Unfortunately, when competitive values are
known, the effect appears to be inflationary. For example, before U.S. executives had ready access to
what their peers were receiving competitively, organizations could concentrate on internal goals.
Consultants and SEC requirements for reporting have made executive compensation a focus within
all publicly held companies' Boards of Directors and Compensation Committees. Since most
companies do not wish to pay below average rates and since all averages are known, the trend is for
everyone to attempt to pay "above average." This is not a new concept.3 It is now, however, a concept
being extended to the rank and file.
A Multidiscipline Concept
Compensation has thus been studied selectively by those in separate disciplines.
Economists have focused on the price (wage) of a factor of production and abstracted employee
behavior into labor units employed (typically in terms of working hours). Psychologists have focused
on the needs of individuals and the means by which they may be met by organizations, with less
emphasis on the needs of the organization. Sociologists, political scientists, and philosophers have
not often studied compensation per se, but concepts they have developed for other purposes may be
usefully applied to the study of pay. Management researchers and teachers have focused on the
more esoteric aspects of compensation; few have focused on the ability to control costs.
THE PARTIES
This discussion to pin down the appropriate domain for the study of compensation assumes the
existence of certain organizations, groups, and individuals involved in compensation decisions. It will
be useful now to enumerate these parties. The employing organization may be a private profitseeking organization, a nonprofit entity, or a government agency. Through pay policies and practices,
all of these organizations seek to obtain the participation of the types, number, and quality of
employees needed. They may also use pay policies and practices to elicit certain types of employee
behavior. Profit-seeking private organizations range from marginal operations very sensitive to
changes in labor markets to large, closed bureaucracies relatively isolated from labor-market
influences. Nonprofit entities and government agencies can vary in exactly the same way.
Employees of organizations fall into several categories: (1) production employees (those who work on
the products or provide the services of the organization), (2) clerical employees, (3) sales employees,
(4) technical employees, (5) professional employees, (6) supervisors, and (7) managers. Although the
pay of these employee groups is determined on similar grounds and administered in similar ways,
these determinants are not identical. Pay determinants may be weighted differently for different
employee groups.4 One reason for this is that the numbers and types of employees change with
changes in technology.
Unions, as representatives of employees, are parties to both pay determination and pay
administration.5 One or several unions may represent production employees. Where clerical
employees are organized, they are often represented by the same union that represents production
employees. Some technical and professional employees are organized, usually in a separate union. It
is conceivable that changing production technology could foster unionization of employee groups now
primarily not organized.
The public is a party to compensation determination. But public participation seldom occurs except
through the pressure of public opinion and through government policy. Consumers are very much
concerned with pay questions, but no mechanism exists for their voice to be heard. Individuals on
fixed incomes (pensions, for example) are much concerned with possible inflationary effects of pay
increases.
Federal, state, and municipal governments are also parties to compensation determination. Public
policy directly influences pay decisions, as does the less direct policy influencing collective bargaining.
Other parties, of course, may be involved in pay determination. For example, suppliers and industrial
customers of large corporations may indirectly influence or be influenced by a pay dispute.
Under our system, all of these parties either have a voice in or are influenced by compensation
decisions. Making pay decisions serve this variety of interests is not easy.
What to Pay For?
Before describing the component parts of a compensation program, it is important to ask the above
question "What to pay for?" A starting point would be to say that employees are hired to do the work
of the organization. The organization brings together resources, labor being one of them. These
resources then are used in a work process to create an outcome that is a product or service valuable
to society. At a micro level each person has some part in this work process, called their job, to which
they apply their efforts supported by their knowledge, skill and ability as well as other competencies
and their attitudes to produce some outcome. Thus we can say that we could pay employees for the
job, something about them as a worker, or the outcomes of their work.
Work. The most common thing to pay for is the employee's job, also called a position or a role. It is
the activity the person engages in during the work week. The reason the job is the most common
thing to pay for is partially historical; from the time of the industrial revolution pay has been related to
the job. This is convenient for reasons both external and internal to the organization. Externally the
labor market is mostly related to jobs. Review job boards and company career web sites and the basic
organization of job postings is by job titles. Further, as we shall see, collecting wage information is
done through wage surveys organized by job titles. Inside the organization the job is used to do most
of the things related to Human Resource Management. Further, employees see themselves as
occupants of a particular job and make comparisons to others in terms of this common denominator.
Person. Recently there has been a change in the importance of the job in compensation. As
organizations have become more flexible and in constant change, the definition of jobs has become
more difficult, and the feeling is that a focus on jobs stifles the needed flexibility in what employees do
in the organization. This has led to more of a focus on paying for the employee's characteristics.
There are certain types of employees for which paying them for what they bring to the organization is
more in line with how they perceive themselves, mainly professional employees. As we shall see, this
has led to the development of competency-based pay.
Outcomes. This is the end product of the employee's efforts and is described as performance. There
has always been an emphasis in compensation on performance but this pressure has been
increasing. There is a lot of focus on performance-based pay systems. It should be noted that
performance is a criterion for pay in almost all compensation programs. There are, however, many
operational problems in developing clear performance-reward systems. In only a few cases is
performance the basic underlying criterion for the pay system. The increased focus on performance
does make it a major component in a compensation program.
Compensation programs use all three of these bases for determining the pay, job, person and
outcome. The systems are designed to include all three criteria but with varying weight given to each
one in different programs.
A MODEL OF COMPENSATION DECISIONS
A compensation program has a number of distinct component parts to it. These include a pay level,
base pay, and variable pay. These three combine to provide a pay rate for each employee in the
organization, what can be called total cash compensation. Added to this are the benefits the
organization offers. These added to the total cash compensation provide a figure for the total
compensation that each employee receives. To bring all this together compensation administration
requires a strategy, plans and controls. All these components are influenced by a number of
environmental and organizational variables. Examples of these variables are the economic,
social/cultural, and legal environments; and the organization's strategy and structure as well as the
workforce. All these variables are represented in Figure 1-1 and described in the pages that follow.
Figure 1-1. A model of compensation decisions and determinants
Determinants of Compensation
Compensation decisions are not made in a vacuum: one must consider a number of environmental
and organizational variables as illustrated by the boxes across the top of the model. As indicated
earlier, compensation is at least partly an economic concept: economic conditions are a major
influence upon what an employee is paid. Tied to this economic environment is the impact of unions
on the wages, both industry-wide and in each organization. These are discussed in Chapter 3.
Likewise, the social environment has an impact on compensation decisions. Members of a society
have ideas about the "worth" of different jobs, and these ideas need to be taken into account as
discussed in Chapter 4. The social environment has been changing dramatically along with the
changing views of women in the workforce. These views have spurred the recent impact on
compensation decisions and changes in law.
Compensation is also affected by the dynamics of the particular organization. Employee pay must be
consistent within the organization's strategy and structure. The organization's culture helps determine
the priority to be placed upon various compensation goals. The organization's work-force
characteristics influence the success of different compensation programs.
Finally, compensation is going to be affected by the internet and access to information. After all,
compensation and benefits is data perfectly suited to the Internet. The impact will be great: one can
expect severe communication conflicts relating to competitive practices. Email, social media and
crowd-sourced information companies who attract visitors to their site by giving employees
compensation data are all now having an effect. Larger organizations are now administering their
stock, salary, and incentive plans on a worldwide basis via the Internet. In time, smaller organizations
will gain this capability. The Internet has given Compensation Administration a new identity.
The Pay Level
The pay level is the overarching factor that creates the competitive stance of the organization vis-à-vis
the labor market. This decision determines how much the organization will pay for labor services, or
what its average pay will be. Pay level refers to the average pay for jobs, for departments, or for the
entire enterprise. An average pay must be set that will secure and keep a productive workforce. Major
considerations affecting the pay level are (1) public policy, (2) pay for comparable work in the
community or industry (usually called the "going rate"), and (3) company response to economic,
political, and social issues. These considerations may be weighed unilaterally or together with the
union(s) representing employees. These determinants are discussed in Chapter 7. Some of these
considerations result in an individual product, each employee's wage or salary and some result in a
group determination such as a medical insurance benefit.
The pay level of an organization is a response to the changing pressures of the labor market. If it is
too low, the organization may have difficulty attracting and holding qualified people. There may also
be legal penalties from those charged with administering minimum wage and public-contract laws.
Unions within or seeking entry into the organization may exert pressure. If the pay level is too high, on
the other hand, the competitive position of the firm in the product market may suffer. In times of wage
controls, too high a level may bring government sanctions.
An organization's pay level is decided after consideration of many factors, among them are (1) public
policy on pay, (2) going wages for comparable work in the community and/or industry, (3) union wage
policy and collective bargaining, and (4) management's philosophy on proper pay levels as reflected
in its reaction to the economic, social, and legal environment.
Base Pay
The biggest part of most employees' compensation is usually their base pay. This is the amount on
the employee's pay stub labeled gross wages. It is also the major section of this text as we look at
how jobs in the organization are structured in a way that is both perceived as equitable and reflect to
a major degree the labor market. Pay structure usually involves arraying jobs in a hierarchy and
setting pay for these jobs relative to their status within the hierarchy. In order to develop this pay
structure, we need to first be able to describe the jobs in the organization; a task for job analysis
(Chapter 10). Further, jobs need to be ordered in a rational way through job evaluation (Chapter 11)
and then combined with salary survey data (Chapter 8) to develop a wage structure (Chapter 12).
The salary structure provides average salary for groups of jobs in the organization which would
translate to individual employees' salaries only if all employees in the group were paid the same. But
once a decision is made to differentiate the pay of employees on the same job, the basis for this
determination needs to be made (Chapter 13). It is at this point that the factors of performance and
the person come into play (Chapters 14 and 15).
Together the pay level and base pay involve external and internal standards. Presumably, pay level
decisions ensure that the organization is in line with the requirements of the external environment,
and pay structure decisions ensure that the pay for jobs is internally consistent. Although pay level
and pay structure decisions have been cited as providing external and internal equity, it might be
more accurate to relate pay level to external competitiveness and pay structure to internal equity
(fairness). If equity is synonymous with fairness, it seems meaningless in economic decisions.
Relationships between the pay of different jobs within the organization may be more important to
employees than pay level. Although the pay level may attract qualified employees, inequitable pay
relationships may do the opposite. If, for example, Herb is earning less money than Jim, on a job he
believes is worth more than Jim's, he is likely to consider the situation unfair and do something about
it.
Preventing such inequities and correcting them if they do occur are two of the objectives of the pay
structure. Pay structures may be set up by management judgment or constructed through collective
bargaining. The technique traditionally used in the mid-1900s in the U.S. was formal or informal job
evaluation. Today, the technique most utilized in the U.S. is that of market pricing. (Interestingly,
Brazil, Argentina, Canada and other countries continue to heavily utilize job evaluation plans.)
Although there are several methods of traditional job evaluation, they all involve the following steps.
First, jobs are analyzed and job descriptions written. Then the factors on which pay will be based are
identified; such factors as skill, effort, and responsibility are typical. Next, jobs are evaluated on the
basis of these factors. The result is a logical job structure. The final step is assigning pay rates that
relate to the job structure. These rates constitute a salary structure. (Market pricing circumvents the
first few steps and assigns the pay rate by comparing the job and job description to the external
benchmark job descriptions and corresponding competitive labor market data.)
Figure 1-2. Job Evaluation Process
At this final step, pay level and pay structure decisions come together. Often, a salary survey is used
as an aid in both decisions. Ideally, the pay rates not only meet the test of internal consistency but are
in tune with the external environment. But as we will see, some of the most difficult pay decisions
involve correlating these two separate standards. Figure 1-3 offers a useful way of distinguishing pay
levels and pay structures. Pay level is the height of the line above the x-axis. Pay structure is the
slope of the line. (Line b represents a higher pay level than line a, but its structure is the same.)
Figure 1-3. Pay
level and pay structure comparison
Pay level and pay structure provide a decision on the pay for jobs. It is individuals who are paid,
however, and a decision is now required as to whether all individuals in the same job shall receive the
same pay. Most organizations decide that employees in the same job will get different pay.
Organizations, either consciously or unconsciously, pay longer tenured employees more than lesser
tenured employees, presumably because they are concerned with retaining experienced, more
tenured employees. When most headcount growth is with external hiring, then pay compression may
result with new hires paid more than longer tenure employees. Organizations that rely on pay level
and pay structure comparisons state that higher performers should be paid more than lower
performers. These pay systems are called merit performance management systems. In practice, pay
differences among people in the same job are, for the most part, based on a combination of
performance and seniority, on the assumption that the organization wants to reward both membership
and effectiveness.
Variable Pay
While most organizations reward the performance of employees using a merit performance
management system a more important method is a variable pay plan. The difference is that although
merit performance management systems attempt to relate pay to performance, variable pay plans
clearly tie pay to performance. Variable pay has become a popular and important part of
Compensation Administration in recent years. Originally, true variable pay plans were for piece work
and salespersons. Under a variable pay plan the usual practice is to set a base rate for the job and to
vary individual pay with some measure of output. Logically, the applicability of a variable pay plan
depends on technology. Practically, however, it depends more on tradition and custom. Variable pay
plans involve substantial administrative costs but often are associated with raising productivity above
costs. Variable pay plans can be based on group or organization-wide output as well as individual
output.
As indicated, there are a few cases of pure variable pay in which base pay is not a consideration. In
most cases there is a base pay with variable pay as an addition, or there is a division of total cash
compensation between the two types of plans. While base pay provides a consistent payment,
variable pay is just that, variable. It varies by some measure of performance, be it individual, group or
organizational. This variability puts some proportion of the employee's pay at risk. This can be both
energizing and scary to the employee. Different employees respond differently to this incentive. The
structure of these plans differs greatly from those of base pay by relating what the employee receives
in a particular time period to the particular performance measure. In the next time period, pay may rise
or fall with the fortunes of the performance standard. All this introduces an element of uncertainty into
the employment relationship. These types of plans are covered in Chapter 16. Further, three groups
whose pay is based to a large degree on variable pay, sales personnel, managers and, in particular,
executives, are considered separately in Chapters 17,18 and 19.
Benefits
The dollar sign in the middle of the model (Figure 1-1) represents the total cash compensation of the
employee, being the combination of base pay and variable pay. Below this is a box along the bottom
of the model labeled Benefits. While most of an employee's compensation is cash in the form of takehome pay, a growing portion is indirect, in the form of benefits. At least one-third of an average
employee's pay consists of benefits. In fact, the growth in benefits is a major cause of the slow
increases that have occurred in base pay in recent years. Some benefits are required by legislation;
others are voluntarily provided by the employer or are required by union agreement. The rise of
benefits consumerism, employee differences in benefit needs, and greater individualization of
organization benefit programs are important issues in the practice of compensation administration
today.
One way of viewing benefits is to recognize that in most organizations employees receive three forms
of pay: membership pay, job pay, and performance pay. Membership pay is given employees as a
consequence of their joining and remaining in the organization. Job pay is based upon accepting a
particular job and performing at a satisfactory level. Performance pay is contingent upon differential
employee behavior. In this sense, all forms of pay are contingent on some form of employee work
behavior. In the case of benefits, membership is the major factor. The benefits the employee receives
are a function of being and remaining a member of the organization.
In the area of benefits, the organization must determine the amount and type of benefits to provide.
This involves determining what benefits to offer and then what the cost of these benefits will be.
Unlike pay, the value of which the employee can readily see, benefits historically has not been as
visible to the employee since the employer was paying 100% of the costs. This has changed with the
advent of cost sharing strategies where the employee and employer both contribute to benefits costs.
Thus the employer needs to identify relevant benefits that align with the type of employees in the
organization and then develop a communication system and tools to ensure employees maximize the
services of the programs.
Wage Costs vs. Labor Costs. Benefits are the best example that the labor costs of the organization
are much more than the cost of the payroll. In most organizations the payroll is the biggest single cost
item, but to calculate labor costs, there are many other factors starting with the cost of benefits. Other
factors include most Human Resource functions such as recruitment, selection and training of
employees.
Compensation Planning and Control
Bringing the components of compensation together in a cohesive and comprehensive program is the
function of planning and control. This function is becoming more important for two reasons. The first is
the increased complexity of planning and control that is being reflected in the administration of Human
Resources. This is particularly a function of technology that has allowed compensation administration
to increase and provide more timely information. The second reason is that with the high cost of
American labor, controlling this cost in today's competitive world is critical. In addition, legality in terms
of pay discrimination requires organizations to keep accurate data on their workforce.
In sum, compensation planning and control coordinates the various components to help achieve the
goals of the organization and of employees. The primary question is economic: is the firm really
getting the employee contributions that it is paying for? In most organizations, pay is expected to
obtain many different kinds of employee behavior. Is the organization getting the value it is paying
for? Are employees getting the rewards they want for their contributions? Other questions are legal:
Are the pay programs meeting legal requirements? Do regular audits show that pay programs do not
discriminate against members of protected groups?
International Compensation and Relocation
Two somewhat related topics occupy the last parts of this compensation model. The first of these is
international compensation or as it is called in most of the rest of the world, remuneration. This topic in
turn has two aspects. The first is compensation of American employees assigned to foreign
operations, called expatriates. As American industry continues to expand overseas to foreign
countries in this era of globalization, the number of expatriate employees increases and the
importance of proper compensation for this group of employees becomes a new problem. Moving
employees to other countries raises a number of issues of equity, both for the expatriate and for the
local employees. And the second aspect is the compensation of local employees and the differences
of local customs and laws that require adaptations to the compensation program of the organization.
The second topic is that of relocation. Compensation gets involved in this process as it creates labor
costs to the organization. It also must deal with the equity issue as labor rates and cost of living in
different places vary. Thus, there are considerations of whether local wage rates or cost of living will
prevail as the standard for setting pay. Relocation may entail whole organizations as well as individual
employees and the decision as to whether this is a good idea is partially a function of the cost of labor
in each location within the context of business strategy.
THE PLAN OF THIS BOOK
In this book compensation administration is seen as having a number of components whose design
and operation are influenced by a set of environmental and organizational influences. The rest of part
I investigates these various environmental influences, particularly legal, economic and social. In Part II
of the book, the overarching component of compensation, the pay level, is considered. This
component determines the competitiveness of the organization in the labor market and the
information collected to determine this. Part III deals with the largest part of compensation - the
determination of base pay. This moves from the organizational systems used to organize pay
structures to the determination of individual employees' pay. Part IV explores the expanding use of
variable pay, the techniques used for this component and the major groups whose pay is largely
based upon it. Part V discusses the other expanding component of compensation - benefits - and how
to get these under control. Part VI brings the compensation program together with planning and
control. Lastly, part VII examines international compensation and relocation of employees and
facilities.