Chapter 6
Compensation and Benefits
Author Chapter Notes
This chapter addresses determining a compensation strategy, including pay, benefits, and
other incentive programs. In some other books, this chapter is separated into two different
chapters. For the purposes of our book, we felt it was important to combine this chapter,
since benefits is part of compensation.
In this chapter, we discuss the various pay systems and types of benefits programs. We
also address the goals for compensation and how those goals should tie into the
company’s strategic plan.
Section 1 Learning Objective
1. Be able to explain the goals of a compensation plan.
Section Notes
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Most of us would not do a job without getting paid! That’s what this chapter is
about, creation of compensation packages.
WorldatWork offers several certifications in the area of compensation:
o Certified Compensation Professional (CCP)
o Certified Benefits Professional (CBP)
o Certified Sales Compensation Professional (CSCP)
o Certified Executive Compensation Professional (CECP)
These certifications involve taking a multiple-choice exam online or at one of the
WorldatWork testing locations. The exams test for knowledge, experience, and
skills in each of the compensation certification areas and can be a valuable asset
to you when applying for HR positions.
The goals of a compensation plan should be to attract the best candidates,
motivate people to stay with the company, and improve morale and satisfaction.
Compensation should also reward performance.
Happier employees usually mean happier customers, and happier employees are
fairly compensated. Organizational growth and manufacturing can create higher
profitability. Indirect cost savings might include savings on disability claims or
sick days.
Key Takeaways
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A compensation package is an important part of the overall strategic HRM
plan, since much of the company budget is for employee compensation.
© Laura Portolese Dias 2011, published by Flat World Knowledge
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A compensation package can include salary, bonuses, health-care plans,
and a variety of other types of compensation.
The goals of compensation are to attract people to work for your
organization and to retain people who are already working in the
organization.
Compensation is also used to motivate employees to work at their peak
performance and improve morale.
Employees who are fairly compensated tend to provide better customer
service, which can result in organizational growth and development.
Exercise and Solution
1. Visit a website that gives salary information for a variety of jobs, such as
www.salary.com. Using the search box, type in your ideal job and research
salary information. What is the median salary for the job you searched? What
is the lowest salary you would be willing to accept for this job? At which
point would you be completely satisfied with the pay for this job?
Answer: Answers will vary greatly for this question. Consider asking
students to share their findings in small groups. Or, if you are able to use a
computer lab, this would be a good in-class activity. When discussing this
question, you can make the point that determining compensation for
employees is not a willy-nilly process, that every salary posted is a
combination of strategic thinking and tie in to the company’s overall
objectives.
Extra Discussion Question
1. Discuss at least three indirect cost savings by implementing a fair
compensation plan.
Answer: When employees feel they are paid fairly, there is less overall
turnover in the company, fewer sick days are taken and disability claims
might be lessened. All of these costs can be high, so ensuring a fair (in the
employee’s view) compensation plan is an important step to making sure
these types of costs are reduced.
Key Term
compensation package
Includes all aspects of how employees are rewarded for their work, such as pay, benefits,
bonuses, and 401(k) plans.
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Section 2 Learning Objectives
1.
Be able to explain the internal and external considerations of compensation
package development.
Know how to develop a compensation philosophy.
2.
Section Notes
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A company should first determine the organizations philosophy regarding
compensation. For example:
o From the employee’s perspective, what is a fair wage?
o Are wages too high to achieve financial health in your organization?
o Do managers and employees know and buy into your compensation
philosophy?
o Does the pay scale reflect the importance of various job titles within the
organization?
o Is your compensation good enough to retain employees?
o Are state and federal laws being met with your compensation package?
o Is your compensation philosophy keeping in line with labor market
changes, industry changes, and organizational changes?
Other considerations before developing a compensation strategy might include the
regional differences in cost of living. If giving a lower salary than industry and
regional average, what additional benefits will be offered to make up the
differences?
Many companies use set pay scales; is this a viable option for your organization?
HR professionals should also look at the balance of salary versus other rewards.
Most companies have a written compensation policy. It can include a market
compensation policy, which pays what the market (regional and job type) pays. A
market plus policy means that a percentage of market plus some will be paid. In a
market minus philosophy, a percentage less than the market is paid.
Internal factors when choosing a policy might include the employer’s ability to
pay, the type of industry, the skills necessary to perform the job and the presence
of unions and union contracts.
External factors might include the economic state of the country, unemployment
rates, surpluses of employees.
Key Takeaways
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Before beginning work on a pay system, some general questions need to
be answered. Important starting points include questions ranging from
what is a fair wage from the employees’ perspectives to how much can be
paid but still retain financial health.
After some pay questions are answered, a pay philosophy must be
© Laura Portolese Dias 2011, published by Flat World Knowledge
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developed based on internal and external factors. Some companies
implement a market compensation philosophy, which pays the going
market rate for a job. Other companies may decide to utilize a market plus
philosophy, which pays higher than the average. A company could decide
their pay philosophy is a market minus philosophy, which pays less than
the market rate. For example, an organization may decide to pay lower
salaries but offer more benefits.
Once these tasks are done, the HR manager can then build a pay system
that works for the size and industry of the organization.
Exercise and Solution
1. Think of your current organization or a past organization. What do you think
their pay policy is/was? Describe and analyze whether you think it was or is
effective. If you haven’t worked before, perform an Internet search on pay
policies and describe/analyze the pay policy of an organization.
Answer: If a student has never worked before, ask them to consider the pay
policy of a company or business they frequent often. The possible answers
might include a market compensation policy, market plus philosophy, or
market minus philosophy. Effectiveness factors might include the ability to
retain employees, motivate employees, and the number of sick days
employees take.
Extra Discussion Question
1. Research salary for an administrative assistant in San Francisco and the salary in
Write down the salaries in both cities. Why might they are different?
Answer: When I researched this on salary.com, administrative assistants in San
Francisco had a median salary of $43,000, while in Savannah, GA, the median was
$32,000. Reasons for differences include the labor supply in that area, the cost of
living in the region, and the economic situation.
Key Terms
market compensation policy
A compensation policy that pays similar to what the market offers.
market plus philosophy
A compensation policy that determines the going rate and adds a percentage to the market
rate, so pay is higher than the market.
market minus philosophy
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A compensation policy that determines the going rate and subtracts a particular
percentage, so pay is less than the market.
Section 3 Learning Objectives
1.
Explain types of job evaluation systems and their uses.
2.
Be able to define and discuss the types of pay systems and factors
determining the type of pay system used.
3.
Know the laws relating to compensation.
Section Outline
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A job evaluation system determines which job is more important than other
job, and pay is set based on this.
In a paired comparison system, individual jobs are compared with every other
job based on a ranking system. Scores are then added and it is a quick way to
see the relative value of one job versus another.
In some organizations, such as the Navy, a job classification system is used.
With this type of system, every job is classified and grouped based on the
skills and knowledge required.
In a point factor system, the value of a job is calculated by points assigned to
specific skills needed for a job and points are given for compensable factors.
For example, knowledge, autonomy and supervision might be compensable
factors.
In the Hay profile method, specific statements are introduced and each
statement is given a point value within three categories (knowhow, problem
solving and accountability). These statements are used to create the job
description and the pay system.
After performing a job evaluation, we can begin to hone in on the specific pay
systems. Many organizations have a process where they create pay grade
levels and group different jobs together, providing a pay range for the specific
job.
The going rate model, an analysis of the specific job is performed and is
considered when creating the pay package.
In a management fit model, each new hire salary decisions are left up to the
manager. The downside to this model may be potential discrimination and
halo effects.
Other considerations might include skill-based pay (pay is based on skills as
opposed to job title), competency based pay (rather than looking at specific
skills, traits or characteristics are looked at when determining pay),
broadbanding (similar to a pay grade system, but all jobs are assigned a
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specific pay category) and a variable pay system (base pay, but certain
achievements will relate directly to pay).
Pay theories related to compensation include the equity theory. This means
that employees will compare their pay and inputs to their coworkers.
The expectancy theory says that employees will put in as much effort as
reward they expect to receive.
The reinforcement theory says that if high performance is followed by a
reward, desired behavior will likely occur in the future.
When implementing an incentive pay program, the program should be easy to
understand and communicated to all employees. The goals that must be
reached to obtain the incentive should be challenging, but not so challenging it
is unattainable.
Some of the laws relating to pay are shown in this slide. Comparable worth
refers to the fact that people should be paid similar for similar work
performed.
The Equal Pay Act (1963) makes it illegal to pay different wages to men and
women if they are performing different jobs.
Fair Labor Standards Act (FLSA) was established in 1938 and sets minimum
wage for jobs, overtime laws and child labor laws. The minimum wage can be
higher than the federal requirement in some states.
The Federal Unemployment Tax Act provides payments of unemployment
compensation to workers who have lost their jobs.
Key Takeaways
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job evaluation system should be used to determine the relative value
of one job to another. This is the first step in setting up a pay system.
Several types of pay systems can be implemented. A pay grade system
sets up specific pay levels for particular jobs, while a going rate
system looks at the pay through the industry for a certain job title.
Management fit gives maximum flexibility for managers to pay what
they think someone should earn.
HR managers can also develop pay systems based on skills and
competency and utilize broadbanding, which is similar to pay grades.
Another option might include variable pay.
There are several motivational theories in regards to pay. First, the
equity theory says that people will evaluate their own satisfaction with
their compensation by comparing it to others’ compensation. The
expectancy theory says people will put in only as much work as they
expect to receive in rewards. Finally, the reinforcement theory says if
high performance is followed by a reward, high performance is likely
to happen in the future.
Other pay considerations include the size of the organization, whether
the company is global, and the level of communication and employee
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involvement in compensation. HR managers should always be aware
of what others are paying in the industry by performing market
surveys.
 There are several laws pertaining to pay. Of course, the EEOC ensures
that pay is fair for all and does not discriminate. FLSA sets a minimum
wage and establishes standards for child labor. FUTA requires
employers to pay unemployment taxes on employees. FECA ensures
that federal employees receive certain benefits.
Exercises and Solutions
1. Name and describe three considerations in developing a pay system. Which do
you think is best?
Answer: Considerations include the company philosophy, the job evaluation
system (paired comparison, job classification, Hay profile method) used, and
theories related to pay systems (equity theory, reinforcement theory and
expectancy theory).
2. Which pay theory do you think is the most important when developing your
pay system? Why?
Answer: Answers will vary based on opinion. The three theories discussed in
the chapter include the equity theory, reinforcement theory, and expectancy
theory.
3. Visit http://www.dol.gov/dol/topic/wages/minimumwage.htm (please note,
sometimes web address change so you may need to search for the
information), which publishes minimum wage data for the United States.
View the map and compare your state with the federal minimum wage. Is it
higher or lower? Which two states have the highest minimum wage? The
lowest?
Answer: Information may change from this writing. As of October 2011,
Washington State had the highest minimum wage at $8.67 per hour. Oregon
has a minimum wage of $8.50 per hour. Federal law supersedes state
minimum wage laws, however the lowest are Georgia and Wyoming at $5.15
per hour.
Extra Discussion Question
1. What are the desirable traits of incentive compensation plans? Rank them based on
your opinion, from the most important to the least important.
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Answer: The desirable traits include communication of the plan, the plan is
attainable but challenging, easily understandable and tied to company goals. The
ranking will depend on student opinion; however, all are probably equally important
from an incentive program success perspective.
Key Terms
job evaluation
The process of determining the relative worth of jobs to determine pay structure.
paired comparison
Individual jobs are compared with every other job, based on a ranking system, and an
overall score is given for each job, determining the highest valued job for pay
decisions.
job classification system
A job evaluation system in which every job is classified and grouped based on the
knowledge and skills required for the job, years of experience, and amount of
authority for a particular job.
point-factor system
A job evaluation system that determines the value of a job by calculating the total points
assigned to compensable factors.
compensable factors
The aspects of a job that are assigned points in a point-factor system.
Hay profile method
A proprietary job evaluation method that focuses on three factors called know-how,
problem solving, and accountability; this method is most applicable to
management positions.
pay grading
The process of setting the pay scale for specific jobs.
pay grade levels
A compensation model that looks at all jobs within the organization and assigns each job
a pay level or pay grade.
delayering and banding
Similar to pay grade levels, but this structure offers more flexibility in that there are
fewer pay grades, called bands, which allows for greater flexibility.
going rate model
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In this pay model, analysis of the going rate for a particular job is the basis for
determining what people within the organization should be paid.
management fit model
In this model, each manager makes a decision about who much a new hire should be
paid.
equity theory
A theory that says people will evaluate their own compensation by comparing their
compensation to others’ compensation.
expectancy theory
The expectancy theory says that employees will put in as much work as they expect to
receive reward for.
reinforcement theory
A theory that says that if high performance is followed by some reward, then it is more
likely that the desired behavior will occur in the future.
comparable worth
States that people should be given similar pay if they are performing the same type of
job.
Equal Pay Act
Passed in 1963, the act makes it illegal to pay different wages to men and women if they
perform equal work in the same workplace.
Fair Labor Standards Act (FLSA)
A federal law established in 1938 that sets a minimum wage for jobs and other conditions
for pay.
Federal Unemployment Tax Act (FUTA)
FUTA provides for payments of unemployment compensation to workers who have lost
their jobs.
Federal Employees Compensation Act (FECA)
Provides federal employees injured in the performance of their jobs compensation
benefits, such as disability.
Section 4 Learning Objective
1.
Explain the various types of benefits that can be offered to employees.
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Section Outline
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A mandated compensation is required to be paid by the Federal Government.
They include Social Security, Medicare, unemployment, and workers’
compensation. The percentages paid per employee can vary from year to year.
Cobra or (Omnibus Budget Reconciliation Act) requires companies to allow
employees to extend their group health coverage for 36 months.
Incentive programs can include commissions, bonuses, profit sharing, stock
options, team pay, and merit pay.
Medical insurance includes providing healthcare, dental, and long- and short-term
disability. Types of medical plans include fee-for-service plans, where employees
pay for medical services and are reimbursed at the benefit level. An HMO plan
usually has greater coverage, but limits employees’ ability to see a doctor of their
choosing. Sometimes a co-payment is required. In a PPO plan, the medical plan
allows employees to see doctors outside of the network, and allows more freedom
for the employee.
Disability insurance provides income to individuals if they are injured or need
long term care resulting from an illness.
401(k) plans are when a set dollar or percentage of salary is set aside for
employees retirement. Usually, the employer matches a specific amount.
Paid time off can include paid holidays, sick leave, paid vacation or any
combination of the three.
Key Takeaways
 Before beginning work on a pay system, some general questions need to
be answered. Important starting points are questions such as what is a fair
wage from the employee’s perspective and how much can be paid but still
retain financial health.
 After some pay questions are answered, development of a pay philosophy
must be completed. For example, an organization may decide to pay lower
salaries but offer more benefits.
 Once these tasks are done, the HR manager can then build a pay system
that works for the size and industry of the organization.
 Besides salary, one of the biggest expenses for compensation is medical
benefits, including health, vision, dental, and disability benefits.
 Social Security and unemployment insurance are both required by federal
law. Both are paid as a percentage of income by the employee and
employer.
 Depending on the state, workers’ compensation might be a requirement. A
percentage is paid on behalf of the employee in case he or she is hurt on
the job.
 A mandatory benefit, COBRA, was enacted to allow employees to
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continue their health insurance coverage, even if they leave their job.
There are three main types of health-care plans. A fee-based plan allows
the insured to see any doctor and submit reimbursement after a visit. An
HMO plan restricts employees to certain doctors and facilities and may
require a copayment and/or deductibles. A PPO plan is similar to the
HMO but allows for more flexibility in which providers the employee can
see.
Pension funds were once popular, but as people tend to change jobs more,
401(k) plans are becoming more popular, since they can move with the
employee.
Profit sharing is a benefit in which employees receive a percentage of
profit the organization earns. Stock ownership plans are plans in which
employees can purchase stock or are granted stock and become an owner
in the organization.
Team rewards are also a popular way to motivate employees. These can be
in the form of compensation if a group or the company meets certain
target goals.
Paid time off, or PTO, can come in the form of holidays, vacation time,
and sick leave. Usually, employees earn more days as they stay with the
company.
Communication with employees is key to a successful benefits strategy.
Exercises and Solutions
1.
Of the benefits we discussed, which ones are required by law? Which are not?
Answer: Mandated compensation includes social security, Medicare,
unemployment insurance, workers compensation and COBRA. Voluntary
include incentives, medical insurance, 401(k) plans and paid time off (PTO).
2. Research current Federal Insurance Contributions Act (FICA) tax rates and
Social Security limits, as these change frequently. Write down each of these
rates and be prepared to share in class.
Answer: As of October 2011, FICA rates were at 7.65%. Social Security
rates are 4.2% on earnings up to $106,800.
3. Describe the considerations when developing medical benefits. Which do you
think would be the most important to you as the HR manager?
Answer: The cost of medical benefits is the most important concern. Also,
medical benefits can help retain employees, so a balance of cost and retention
are important considerations.
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4. Visit websites of three companies you might be interested in working for.
Review the incentives they offer and be prepared to discuss your findings in
class.
Answer: Many students will find extra incentives such as bonuses or other
incentive plans to be interesting. Flexible scheduling, telecommuting and inhouse benefits, such as gyms and daycare, might be attractive as well.
Extra Discussion Question
1. Research the cost of Medicare taxes for employers.
Answer: As of October 2011, the tax was 1.45% on all earnings.
Key Terms
disability insurance
A type of insurance that provides income to individuals (usually a portion of their salary)
should they be injured or need long-term or short-term care resulting from an
illness.
Pension Benefit Guaranty Corporation (PBGC)
A US government agency created by the Employee Retirement Income Security Act
(ERISA) to protect pension benefits in private sector pension plans.
Consolidated Omnibus Budget Reconciliation Act (COBRA)
A law enacted in 1985 that requires companies to allow employees to extend their group
health-care coverage for up to thirty-six months.
vesting period
For 401(k) plans, a certain time period before the employer will match the employee
funds contributed.
straight commission plan
An incentive plan in which the employee receives no base pay and the entire pay is based
on meeting sales goals.
base pay
The minimum pay an employee receives.
stock option
A type of incentive that allows the employees to buy stock at a fixed price.
employee stock ownership plan
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A type of incentive that gives employees stock (ownership) in the organization.
cost of living annual increase (COLA)
A pay increase not tied to merit but given to employees as an annual inflationary
increase.
OASDHI
A federally mandated retirement program that stands for Old Age, Survivors, Disability,
and Health Insurance Program and includes Social Security and Medicare.
Chapter Case
The Author discusses the case for Chapter 6:
http://blip.tv/play/sDyCsI4dAA
Additional Case Study Exercise
There is much current debate on the topic of executive compensation. In 1980, a
Chief Executive Officer made $42 for every dollar earned by a worker. In 1990,
the gap was $85. By 2000, the figure reached $531 for every dollar taken home by
a workeri. In 2010, the average CEO of a Standard and Poor’s 500 Company
earned $11.4 million. The breakdown of pay isii:
$1,093,989
Salary
$251,413
Bonus
$3,833,052
Stock Awards
$2,384,871
Option Awards
$2,397,152
Nonequity Incentive Plan Compensation
$1,182,057
Pension and Deferred Compensation Earnings
$215,911
Other Compensation
1. Do you find executive compensation mentioned to be excessive? Why or
why not?
2. For companies using a broadbanded pay system, how does CEO pay fit
into this system? Do you think the high salary can be justified when a
company is using a broadbanded system?
3. How can HR professional manage this issue, assuming their organization
pays the CEO much higher than workers?
Answers: This case brings about one of the challenges in our current economy
about CEO pay and requires critical thinking skills to address the questions. Some
students may feel the pay is justified; however, it is important to note that often,
CEO pay does not fit into the pay systems that other employees are put into. HR
professionals should be transparent when discussing CEO salary and point out the
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reasons for the higher differential in salary, since most of the time, the CEO may
be a founder or owner of the organization. In addition, often HR does not set the
salary of upper level executives, as it is the Board of Director’s responsibility. I
use this topic as a debate in my classes.
Useful Outside Resources
The Human Resource Certification Institute: http://www.hrci.org/
Society for Human Resource Management: http://www.shrm.org/Pages/default.aspx
YouTube videos:
HR That Works Compensation Strategy:
http://www.youtube.com/watch?v=xIx-5nMnQHo
Example of compensation software-NuVu HR:
http://www.youtube.com/watch?v=CUAKyYFxxu0&feature=related
Professor Judi McLean Parks at Olin Business School discusses the “other” side
of compensation:
http://www.youtube.com/watch?v=RBQmqVFxTZM&feature=related
Short funny Dilbert video on vacation time:
http://www.youtube.com/watch?v=-Bdqepo4_vQ&feature=related
Importance of compensation communication:
http://www.youtube.com/watch?v=7pc4UtaqO2M
Seeking Alpha, “Executive Compensation Out of Hand,” accessed October 1, 2011 from
http://seekingalpha.com/article/8080-executive-compensation-out-of-hand-case-studies-from-officemaxservicemaster-baxter-omx-svm-bax
i
AFL-CIO Website “2011 Executive Watch,” accessed October 1, 2011 from
http://www.aflcio.org/corporatewatch/paywatch/
ii
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