International Human Resource Management:
Chapter – 6:
COMPENSATION MANAGEMENT
Introduction: One of the key components of IHRM is the compensation
administration in MNCs. Today, compensation and employee benefits contribute to
40-50% of the total costs. Compensation is strategically reported and monitored at the
broad – levels and with the investors to assess the health of the organization. What is
compensation management? Effective and efficient process of managing the earnings
– financial and non financial rewards of the employees in an organization based on
their performance towards organizational goal is called compensation management.
International Compensation is an internal rate of return (monetary or non monetary
rewards / package) including base salary, benefits, perquisites and long term & short
term incentives that valued by employee’s in accordance with their relative
contributions to performance towards achieving the desired goal of an organization.
It influences:
•
•
•
Organizational culture
Recruitment and selection of competent employees
Motivation and performance
Objectives of compensation:
Compensation decisions are strategic decisions and play a key role in achieving
performance and sustainable competitive
advantages for
national as well as
international firms. Therefore the key objectives are:
•
•
•
•
•
Attract employees who are qualified , experienced and interested in
international assignments.
Facilitate the movement of expatriate’s from one subsidiary to another,
from home to subsidiary, and back from subsidiary to home.
Provide a consistent and reasonable relationship between the pay levels of
employees at headquarters, domestic affiliates and foreign subsidiaries.
Be cost effective by reducing unnecessary expenses.
Should be easily understood and easy to administer.
Components of Compensation:
components of international compensation comprises the base salary, incentives,
benefits, allowances, foreign service inducement/ hardship premium, long term
benefits and taxes etc.
Base Salary:
Base salary is the amount of money that an expatriate normally receives in the
home country. In the united states, this was around $ 175,000 for upper-middle
managers in the late 1990s, and this rate was similar to that paid to managers in
both Japan and Germany. The exchange rates, of course, also affect the real wage.
• Expatriate salaries typically are set according to the base pay of the home
countries. Therefore, a German Manager working for a US MNC and assigned
to Spain would have a base salary that reflects the salary structure in Germany.
• The salaries usually are paid in Home currency, local currency, or a
combination of the two. The base pay also serves as the benchmarks against
which bonuses and benefits are calculated.
Benefits:
•
•
•
•
•
Alternatively known as indirect compensation,
Benefits constitute a substantial portion of international compensation (
approx. one third of compensation for regular employees is benefits).
Benefits include a suit of programmes such as:
– Entertainment, Festival celebrations, Gifts, Use of club facilities,
provision of hospitality including food and beverage, employee
welfare, use of health club, Conveyance tour and travel, Hotel Board
and Lodging, vehicles, telephone and other telecommunication
facilities, Sponsorship of children.
Basically an employee tends to join and stay with an org. which guarantees an
attractive benefits programme.
Vacation along with holidays and rest breaks help employees mitigate fatigue
and enhance productivity during the hours employees actually work.
Allowance:
It is an inevitable feature of International compensation. The most common allowance
relates to the cost of living – an adjustment for different in the cost of living between
the home country and foreign country assignment. This allowance is designed to
provide the expatriate with the same standard of living that he or she enjoyed in the
home country.
Spouse assistance, housing allowance, home leave allowance, relocation
allowance and educational allowance are the popular in expats. Compensation.
These allowances are often contingent upon tax – equalization policies and practices
in both the home and the host countries.
Incentives:
•
An additional payment (or other remuneration) to employees as a means of
increasing output. Increasingly, MNCs these days are designing special
incentive programmes for keeping expatriates motivated. In the process, a
growing number of firms have dropped the ongoing premium for overseas
assignments and replaced it with a one – time, lump-sum premium.
•
•
The lump – sum payment has at least three advantages:
First, expatriates realizes that they are paid this only once and that too when
they accept an overseas assignment. So the payment tends to retain its
motivational value.
• Second: costs to the company are less because there is only one payment and
no future financial commitment. This is so because incentive is a separate
payment, distinguishable from a regular pay, and it is more rapidly for saving
or spending.
• Third, less chances for pre mature repatriation.
Foreign Service / Hardship Premium:
This is often perceived as an inducement in the form of a salary premium to
accept an overseas assignment. Generally, salary premiums vary from 5—40% of
the base salary. Actual salaries depend upon the assignment, actual hardship, tax
consequences and length of assignment. In addition, if the work – week in the host
country is longer than in the home country , the assignee will be paid for the extra
hours worked.
Certain countries are highly hostile to foreigners staying and working. Indians
engaged in road construction work in Afghanistan, for example, face constant
threat lives. In fact, ten such emigrants got killed in recent times (2006-2007).
Expatriates in such environments are paid 2-3 times more than their domestic
salaries.
Long term Benefits:
The most common long term benefits offered to employees of MNCs are Employee
Stock Option Schemes (ESOS). Traditionally E-SOS were used as means to reward
top management or key people of the MNCs. Some of the commonly used stock
option schemes are:
-
Employee Stock Option Plan (ESOP)- a certain nos. of shares are reserved for
purchase and issuance to key employees. Such shares serve as incentive for
employees to build long term value for the company.
-
Restricted Stock Unit (RSU) – This is a plan established by a company,
wherein units of stocks are provided with restrictions on when they can be
exercised. It is usually issued as partial compensation for employees. The
restrictions generally lifts in 3-5 years when the stock vests
-
Employee Stock Purchase Plan (ESPP) – This is a plan wherein the company
sells shares to its employees usually, at a discount. Importantly, the company
deducts the purchase price of these shares every month from the employee’s
salary
Hence, the primary objective for providing stock options is to reward and
improve employee’s performance and /or attract / retain critical talent in the
Organization
Taxes:
The final component of the expatriate’s remuneration relates to taxes. MNCs
generally select one of the following approaches to handle international taxes:
1. Tax equalization: Firms withhold an amount equal to the home country tax
obligation of the expatriate, and pay all taxes in the host country.
2. Tax protection: The employee pays up to the amount of taxes he or she would
pay on remuneration in the home country. In such a situation, the employee is
entitled to any windfall received if total taxes are less in the foreign country
than in the home country.
Taxes
Salary
International
Compensation
Benefits
Incentives
Allowances
Long term Benefits
Fig. components of International compensation
Factors influencing these components :
Remuneration or compensation varies country to country and
one MNC to another. Mainly based on two factors: External and
Internal.
External Factors
Domestic
-
Labour Market
Cost of living
Labour Union
Govt. Legislation
Society
Economy
Internal Factors
-
Remuneration/
Compensation
International
-
-
Parent Nationality
Labour
market
characteristics
Local Culture
Home and Host
Countries
Government’s
Roles
Industry Types
Competitors
Strategy
-
Business
strategy
Job Evaluation
and
Performance
Appraisal
The employee
Goal orientation
Capacity to pay
Competitive
Strategy
Org. Culture
Int. Workforce
composition
Lab. Relations
Subsidiary role
However, these factors can be classified in five categories:
1. Prosperity & Spending Power Of the company (a related factor is the
different Tax and social security System in the country.
2. Cultural Difference
3. Policy & Strategies (in productivity and Performance evaluation)
4. Situations on the relevant Labour market & Labour capital ratios
5. Institutional Frameworks within which wage Bargaining takes place
Compensation Philosophy:
Since compensation is a crucial factor, having its bearing on performance and
satisfaction, it is advisable that international business should have a clear cut
compensation philosophy
Now the question comes what is Compensation Philosophy?
Compensation philosophy is the set of values and beliefs that an organization has with
regard to monetary and non monetary benefits payable to employees.
Any compensation philosophy should cover the following aspects:
•
Goals of the organizational compensation system
•
Percentage of compensation linked to individual performance
and base salary.
•
Role of performance appraisal in disbursing compensation
•
The positioning of compensation of employees relative to
market
Therefore, Compensation philosophy or the set of values and beliefs Combined
with a set of guidelines that further assist in compensation administration of
MNCs.
Theories of compensation:
There are (generally) 4 theories in the context of international compensation:
1. Contingency theory.
2. Resource – based theory.
3. The Agency theory and
4. Equity theory
1. Contingency theory (most popular) : Expats compensation should be based
on particular contingencies or situation prevailing in a host country. The
compensation Phil. In every organization is normally de centralized and
allows units to localize the compensation structure
2. Resources based theory: Human resource is the greatest asset of the MNCs in
its competitive advantage needs good pay and st. salary band for cont.
motivation. The organizations follow this theory, remain market – sensitive
and are constantly reviewing compensation to retain their position in the
hiring and retaining the talents
3. The Agency Theory: This theory focused on the divergent interests and goals
of org.’s stakeholders and the way that employees compensation can be used
to align these interests & goals. According to this theory, there exists a
principle – agency relationship between the MNCs HQ and its Subsidiaries
for Expats Compensation.
4. Equity Theory: Equity theory suggests that there should be a fair balance
between an expatriate’s contribution to an MNC and what he / she receives as
compensation. Of late, the equity principle is sought to be compromised with a
new approach to compensation – “ Person based rather job centric” .
Compensation practices in different countries: The overall compensation
package often varies from country to country due to legally mandated benefits,
taxes, cost of living, cultures and employee expectations.
What is Cost of living?
An inflationary indicator that measures the change in the cost of a fixed basket
of products and services, including housing, electricity, food, and transportation.
The cost-of-living index is published monthly. also called cost-of-living index.
also called Consumer Price Index (CPI).
Hourly Wages in Different Countries*
COUNTRY
$/HOUR
Norway
Germany (former West)
Switzerland
Belgium
Sweden
United States
France
Britain
Japan
Australia
Canada
Italy
Spain
Israel
Korea
Portugal
Taiwan
Brazil
Mexico
China
Sri Lanka
31.5 5
31.25
27.87
27.73
25.18
21.97
21.13
20.37
20.09
20.05
19.28
18.35
14.96
11.73
10.28
6.23
5.84
2.67
2.48
0.63
0.49
However, As we observed, there are , some common elements in compensation
package including base salary, benefits, allowances, incentives and taxes; let see the
compensation systems in the different countries:
Criterion
America
Japan
Russia
Middle East
Orientation
Performance
oriented
Components
BS,VB,LTI,
VBC
- Seniority - based
Influencing
Cultural
variables
Nationality group and
job level
CBC, MW ( BA+OT), VB BS,
NMB
Link
with Excellent linkage
performance
Basis
Increase
Job – level
based
Moderate linkage
FB, BS,
HA,AA,
FA,
AF/VT,
SF,
VB
Incentives.
Poor linkage Moderate Linkage
of Annual
increase
merit Seniority and age, Seniority in Job Level
performance
Job level
ratings, spring wage
negotiation
Achievement
– Hierarchy; Patience Material
Material Possessions
orientation
Possessions Status seniority
Material possession
BS- Basic Salary, VB – Variable bonus, LTI – Long tern incentives, CBC –
Compulsory benefit contributions, VBC-Voluntary benefit contribution, MW –
Monthly wage, BA – Basic Allowance, OT – Overtime, FB – Fixed Bonus, NMB
– Non monetary benefits)
Approaches to expatriate are compensation:
Working within the components described above, MNCs seek to tailor remuneration
packages to fit with the specific siuation. For example, senior level managers, in
Japan are paid four times more than their juniors staff members. This is sharp contrast
to the US, where the gap is much higher. Many senior – level managers in Europe
are paid much less than their US counterparts.
In designing an expatriate’s remuneration, firms generally follow a number of
approaches. The most common are two:
1. The Balance-sheet or Home – net system
2. The local Going rate system or localization system
Balance-Sheet Approach:
Which involves ensuring that the expatriate’s is ‘ made whole’ and does
not lose money by taking the foreign assignment. The basic objective is
to maintain the home – country living standard, plus offer some financial
inducement
Thus, it links the salary of expatriates and TCNs to home country salary
structure.
The key assumption is that foreign assignees should not suffer financially
due to transfers. The salary package is divided into four parts:
• GOODS AND SERVICES – FOOD, PERSONAL CARE,
CLOTHING, HOUSEHOLD FURNISHING, RECREATION
• HOUSING: Major cost associated with host country
• INCOME TAXES – Parent country and Host country income taxes
• RESERVE – CONTRIBUTIONS TO SAVINGS, PAYMENTS
FOR
BENEFITS,
PENSION
CONTRIBUTIONS,
INVESTMENTS,
EDUCATION
EXPENSES,
SOCIAL
SECURITY TAXES…
When costs associated with the host country assignment exceed
equivalent costs in the parent country, the firm and expatriates,
together meet these costs to ensure that parent country equivalent
purchasing power is achieved.
For example, if US national is posted in India and suppose the dollar
exchange rate is $ 1 = Rs. 50/- and COLA Index is 5, then the break
up of the annual pay will be :
Item
Base pay
Cost of
allowance
Overseas
allowance
Hardship
allowance
Housing
deduction
Income
deduction
Total pay
living
Amount in $ per
year in US
Paid in
India
$
in
1,00,000
10,000
60,000
Nil
20,000,00
5,00,000
20,000
20,000
Nil
5,000
5,000
Nil
-10,000
-
Nil
-30,000
$ 95,000
- 30,000
$ 45,000
10,000
Paid in Rs. In
India
tax
Nil
Rs. 25,00,000
Advantages:
• Expatriate is guaranteed his home country spending power.
• Easy to communicate to employees
Disadvantages:
Three problems faced in applying this system are:
1. Recalculating the salary from gross to net and vice versa.
2. In grossing up the net income in the host country, there should be strictly
identical items (same car and housing). This is the difficulty.
3. Can result in disparities between expatriates of different countries
2. Going Rate Approach:
In this, expatriates are paid according to the host country salary structures.
• Based on local market rates – the base salary is linked to the salary structure in
the host country.
• Base pay and benefits may be supplemented by additional payments for lowpay countries.
Advantages
• Equality with local nationals
• Simplicity
• Identification with the host country
• Equity among different nationalities
Disadvantages
• Variation between assignments for same employees
• Variation between expats of same nationality in different locations (
Indian expatriated to the US may be compensated better than those
assigned to a developing country)Potential re-entry problems ( on
return to home country, the expats. finds that his or her compensation
is lower than that of the host country.
The Standard Policy of Compensation management required:
A)
The knowledge of employment and taxation laws: customs, cost of living
index, environment, employment practices of various countries.
B)
The knowledge of labour markets and industry norms regarding benefits and
compensations.
C)
The knowledge of foreign exchange rate fluctuations and monitoring rate of
inflation or cost of living Index in different countries.
D)
The knowledge and clear conception about the vision and mission of the
company, its corporate philosophy regarding managing human resources, its
corporate strategy of growth or stability and strategy of its business units
regarding cost, leadership, differentiation and innovation
Conclusion:
•
•
•
•
•
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Higher basic salary with lower benefits and incentives or
Lower salary with higher level of benefits and incentives , may not motivated
the expatriates and therefore, required high degree of expertise / standard
policies for MNCs specially in the field of compensation management.
The policy decisions should be consistent with the overall strategy structure
and business needs of the multinationals.
The policy should be attract and retain the best staff in those areas where the
firm has greatest needs and opportunities and where its core competencies.
The policy must facilitate the transfer of international employees in a cost
effective manner.
The policy should give due consideration to equity case of administration.
Prepared by Dr. Shyamal Gomes
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