Managing Compensation
The Challenges of Human Resources Management
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1–1
Chapter Objectives
After studying this chapter, you should be able to
LEARNING OUTCOME 1
Explain how to formulate a strategic
compensation program.
LEARNING OUTCOME 2
Indicate how pay is determined.
LEARNING OUTCOME 3
Know how to effectively perform a job evaluation.
LEARNING OUTCOME 4
Explain the purpose of a wage survey.
LEARNING OUTCOME 5
LEARNING OUTCOME 6
LEARNING OUTCOME 7
Define the wage curve, pay grades, and rate
ranges as parts of the compensation structure.
Understand the importance of using a
compensation scorecard.
Identify the major provisions of the federal laws
affecting compensation.
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36
Compensation
• Pay is a statement of an employee’s worth by
an employer.
• Pay is a perception of worth by an employee.
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36
Total Compensation
Direct
Wages / Salaries
Commissions
Indirect
Time Not Worked
• Vacations
• Breaks
• Holidays
Insurance Plans
Bonuses
Gainsharing
• Medical
• Dental
• Life
Security Plans
• Pensions
Employee Services
• Educational assistance
• Recreational programs
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Compensation Components
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Compensation Alignment
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Compensation Management and
Other HRM Functions
Aid or impair recruitment
Recruitment
Supply of applicants
affects wage rates
Pay rates affect selectivity
Selection
Selection standards affect
level of pay required
Pay can motivate training
Training and
Development
Increased knowledge leads
to higher pay
Training and development may
lead to higher pay
Compensation
Management
A basis for determining
employee’s rate of pay
Low pay encourages
unionization
Labor Relations
Pay rates determined
through negotiation
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Strategic Compensation
• Strategic Compensation

Links the compensation of employees to the
mission, objectives, philosophies, and culture
of the organization.

Serves to mesh the monetary payments made to
employees with specific functions of the HR program
in establishing a pay-for-performance standard.

Seeks to motivate employees through compensation.
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Linking Compensation to
Organizational Objectives
• Value-added Compensation

Evaluating the individual components of the
compensation program (pay and benefits) to see if
they advance the needs of employees and the goals
of the organization.
– “How does this compensation practice benefit
the organization?”
– “Does the benefit offset the administrative cost?”
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Common Strategic Compensation Goals
1. To reward employees’ past performance
2. To remain competitive in the labor market
3. To maintain salary equity among employees
4. To mesh employees’ future performance with
organizational goals
5. To control the compensation budget
6. To attract new employees
7. To reduce unnecessary turnover
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Strategic Compensation Policy Concerns
1. The rate of pay within the organization and whether it is to be
above, below, or at the prevailing community rate.
2. The ability of the pay program to gain employee acceptance
while motivating employees to perform to the best of their
abilities.
3. The pay level at which employees may be recruited and the
pay differential between new and more senior employees.
4. The intervals at which pay raises are to be granted and the
extent to which merit and/or seniority will influence the raises.
5. The pay levels needed to facilitate the achievement of a sound
financial position in relation to the products or services offered.
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The Pay-for-Performance Standard
• Pay-for-Performance Standard

The standard by which managers tie compensation to
employee effort and performance.

Refers to a wide range of compensation options,
including merit-based pay, bonuses, salary
commissions, job and pay banding, team/group
incentives, and various gainsharing programs.
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Designing a Pay-for-Performance System
• How will performance be measured?
• How will monies to be allocated for
compensation increases.
• Which employees will be eligible?
• How will payouts be made?
• How often will payouts occur?
• How large will the payouts be?
• Will employees perceive the rewards as valued?
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Motivating Employees through Compensation
• Pay Equity (also Distributive Fairness)

An employee’s perception that compensation received
is equal to the value of the work performed.

A motivation theory that explains how people respond
to situations in which they feel they have received less
(or more) than they deserve.
– Individuals form a ratio of their inputs to outcomes in
their job and then compare the value of that ratio with
the value of the ratio for other individuals in similar jobs.
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Relationship between Pay Equity and Motivation
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Expectancy Theory and Pay
• Expectancy Theory

A theory of motivation that holds that employees
should exert greater work effort if they have reason to
expect that it will result in a reward that they value.

Employees also must believe that good performance
is valued by their employer and will result in their
receiving the expected reward.
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Pay-for-Performance and Expectancy Theory
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Motivating Employees through Compensation
• Pay Secrecy

An organizational policy prohibiting employees from
revealing their compensation information to anyone.
– Creates misperceptions and distrust of compensation
fairness and pay-for-performance standards.

Arguments against secrecy:
– Knowledge of base pay is the strongest predictor of pay
satisfaction, which is highly associated with work engagement
– Knowledge of base pay more strongly predicts pay
satisfaction than does the actual amount of pay received
by employees.
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The Bases for Compensation
• Hourly Work

Work paid on an hourly basis.
• Piecework

Work paid according to the number of units produced.
• Salary Workers

Employees whose compensation is computed on the
basis of weekly, biweekly, or monthly pay periods.
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The Bases for Compensation (cont.)
• Nonexempt Employees

Employees covered by the overtime provisions of the
Fair Labor Standards Act.

They must be paid time and one-half their regular pay
for all work performed after forty regular hours of work
in a workweek.
• Exempt Employees

Employees who not covered in the overtime provisions
of the Fair Labor Standards Act.

Managers, supervisors, and white-collar professional
employees are exempted on the basis of their exercise
of independent judgment and other criteria.
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Factors Affecting the Pay Mix
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The Wage Mix—Internal Factors
• Employer’s Compensation Strategy

Establishes the internal wage relationship among
jobs and skill levels

Sets organization compensation policy to lead, lag,
or match competitors’ pay.

Rewards employee performance

Guides administrative decisions concerning
elements of the pay system such as overtime
premiums, payment periods, and short-term or
long-term incentives.
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The Wage Mix—Internal Factors (cont.)
• Worth of a Job

Establishing the internal wage relationship among
jobs and skill levels.
• Employee’s Relative Worth

Rewarding individual employee performance
• Employer’s Ability-to-Pay

Having the resources and profits to pay employees.
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Comparison of Compensation Strategies
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The Wage Mix—External Factors
• Labor Market Conditions

Availability and quality of potential employees is
affected by economic conditions, government
regulations and policies, and the presence of unions.
• Area Wage Rates

A firm’s formal wage structure of rates is influenced by
those being paid by other area employers for
comparable jobs.
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The Wage Mix—External Factors (cont.)
• Cost of Living

Local housing and environmental conditions can
cause wide variations in the cost of living for
employees.

Inflation can require that compensation rates be
adjusted upward periodically to help employees
maintain their purchasing power.

Consumer Price Index (CPI)
– A Bureau of Labor Statistics measure of the average
change in prices over time in a fixed “market basket”
of goods and services
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The Wage Mix—External Factors (cont.)
• Collective Bargaining

Escalator clauses in labor agreements provide for
quarterly upward cost-of-living (COLA) wage
adjustments for inflation to protect employees’
purchasing power.

Unions bargain for real wage increases that raise the
standard of living for their members.

Real wages are increases larger than rises in the
consumer price index; that is, the real earning power
of wages.
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Job Evaluation Systems
• Job Evaluation

The systematic process of determining the relative
worth of jobs in order to establish which jobs should be
paid more than others within an organization.
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Job Evaluation Systems (cont.)
• Job Ranking System

Oldest system of job evaluation by which jobs are
arrayed on the basis of their relative worth.

Disadvantages
– Does not provide a precise measure of each job’s worth.
– Final job rankings indicate the relative importance of
jobs, not the extent of differences between jobs.
– Method can used to consider only a reasonably small
number of jobs.
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Job Evaluation Systems (cont.)
• Job Classification system

A system of job evaluation in which jobs are classified
and grouped according to a series of predetermined
wage grades.

Successive grades require increasing amounts of job
responsibility, skill, knowledge, ability, or other factors
selected to compare jobs.
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Point System
• Point System


A quantitative job evaluation procedure that
determines the relative value of a job by the total
points assigned to it.
Permits jobs to be evaluated quantitatively on the
basis of factors or elements—compensable factors—
that constitute the job.
• The Point Manual

A handbook that contains a description of the
compensable factors and the degrees to which
these factors may exist within the jobs.
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Work Valuation Methods
• Work Valuation

A job evaluation system that seeks to measure a
job’s worth through its value to the organization.

Jobs are be valued relative to financial, operational,
or customer service objectives of the organization.
– Considers that work should be valued relative to the
business goals of the organization rather than by an
internally applied point-factor job evaluation system.

Work valuation serves to direct compensation dollars
to the type of work pivotal to organizational goals.
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Job Evaluation for Management Positions
• Hay Profile Method

Job evaluation technique using three factors—
knowledge, mental activity, and accountability
—to evaluate executive and managerial positions.
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Compensation Implementation – Pay Tools
• Wage and Salary Survey


A survey of the wages paid to employees of other
employers in the surveying organization’s relevant
labor market.
Helps maintain internal and external pay equity
for employees.
• Labor Market

The area from which employers obtain certain types
of workers.
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Collecting Survey Data
• Outside Sources of Data

Bureau of Labor Statistics (BLS)
– National Compensation Survey


State and local wage surveys
Online survey data
• Problems with Surveys


They are not always compatible with the user’s jobs
The user cannot specify what specific data to collect.
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Collecting Survey Data (cont.)
• Conducting Employer-initiated Surveys

Select key jobs.

Determine relevant labor market.

Select organizations.

Decide on information to collect: wages/ benefits/
pay policies.

Compile data received.

Determine wage structure and benefits to pay.
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Bureau of Labor Statistics
National Compensation Survey
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Bureau of Labor Statistics
National Compensation Survey (cont.)
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The Wage Curve
• Wage Curve

A curve in a scatter gram representing the relationship between
relative worth of jobs and wage rates.
• Pay Grades

Groups of jobs within a particular class that are paid the same
rate.
• Rate Ranges

A range of rates for each pay grade that may be the same for
each grade or proportionately greater for each successive grade.
• Red Circle Rates

Payment rates above the maximum of the pay range.
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Freehand Wage Curve
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Single Rate Structure
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The Federal Wage Poster
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The Wage Curve (cont.)
• Competence-based Pay, (also skill-based pay
or knowledge-based pay)

Compensation for the different skills or increased
knowledge employees possess rather than for the
job they hold in a designated job category.
– Greater productivity, increased employee learning and
commitment to work, improved staffing flexibility to meet
production or service demands, and the reduced effects
of absenteeism and turnover,
• Broadbanding

Collapses many traditional salary grades into a few
wide salary bands.
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Compensation Assessment
• Assessing the effectiveness of your
compensation system is vitally important to
linking compensation with strategy.
• Measures:
1. help the company detect potential compensation
problems,
2. make compensation decisions more transparent, and
3. improve the alignment of compensation decisions with
organizational objectives.
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Compensation Assessment (cont.)
• The compensation scorecard collects and
displays the results for all the measures that
a company uses to monitor and compare
compensation among internal departments
or units.
• The scorecard creates a comparative tool
within the organization that can reinforce
desired outcomes that are unique to the
company’s strategy.
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Compensation Scorecard
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Government Regulation of Compensation
Davis-Bacon Act
(1931)
Required minimum wage, prevailing wage rates,
1½ overtime premium payments by federal
contractors.
Walsh-Healy Act
(1936)
Required overtime payments after 8 daily or 40
regular work hours for workers on federal
contracts.
Fair Labor
Standards Act
(FLSA) 1938
Interstate commerce clause used to cover
workers except agricultural and exempted
(managerial) employees, child labor (under 16) is
prohibited.
(as Amended)
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The Issue of Wage Rate Compression
• Wage-Rate Compression

Compression of pay between new and experienced employees
caused by the higher starting salaries of new employees; also
the differential between hourly workers and their Managers.
• Reducing Wage-Rate Compression

Reward high performance and merit-worthy employees with
large pay increases.

Design the pay structure to allow a wide spread between
hourly and supervisory employees.

Prepare high-performing employees for promotions to jobs
with higher salary levels.

Provide equity adjustments for selected employees hardest
hit by pay compression.
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The Issue of Wage Rate Compression
• Child Labor Provisions

The “floor” it imposes makes it more difficult for high
school students and young adults to find jobs
• Exemption from Overtime Provisions

The FLSA perhaps creates the most confusion in
the exemption from overtime requirements for certain
groups of employees or from coverage of certain of the
act’s provisions
• Pay Equity Provisions



The Equal Pay Act of 1963
Title VII of the Civil Rights Act of 1964
Age Discrimination Act of 1967
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Key Terms
• broadbanding
• competence-based pay
• consumer price index
(CPI)
• escalator clauses
• exempt employees
• Hay profile method
• hourly work
• job classification system
• job evaluation
• job ranking system
• nonexempt employees
• pay equity
• pay-for-performance
standard
• pay grades
• piecework
• point system
• real wages
• red circle rates
• wage and salary survey
• wage curve
• pay rate compression
• work valuation
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Chapter 9 - Learning Outcomes
Learning Outcome Statements
Related Outcomes from Body of the Text
Facebook has over 1,700 employees and offices in twelve countries.
How would you develop a compensation strategy to match Facebook’s
business objectives of continual innovation and growth?
1
Explain how to formulate a strategic compensation
program.
2
Indicate how pay is determined.
3
Know how to effectively perform a job evaluation.
During the financial crisis of 2008–2010, companies had to reassess the
value of specific jobs—leading to some unfortunate cuts in salary and
benefits. How would you determine the worth of someone’s job to ensure
equity?
4
Explain the purpose of a wage survey.
Imagine you have been assigned by Delta to decide if the pay being
offered to new customer service representatives is consistent with what
competitors are paying. What tools would you use to help in your
assessment?
5
Define the wage curve, pay grades, and rate ranges as
parts of the compensation structure.
One of the objections to Google granting wage increases on a percentage
basis is that the lowest-paid employees, who are having the most trouble
“dealing with sky-high property prices, mortgages, and those kinds of
things,” get the smallest increase, while the highest-paid employees get
the largest increase. Is this objection a valid one?
6
Understand the importance of using a compensation
scorecard.
How do you know if a company’s compensation system is helping to
reach its objectives?
7
Identify the major provisions of the federal laws affecting
compensation.
Federal laws governing compensation raise important issues for both
employers and employees. How do regulations influence compensation
decisions? How do they protect employees from discrimination?
Google’s decision to increase pay by 10 percent was based on many
internal and external factors. What specific factors would you say led to
Google’s compensation redesign?
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