Human Resource Management
10th Edition
Chapter 9
DIRECT FINANCIAL
COMPENSATION
© 2008 by Prentice Hall
9-1
HRM in Action: Are Top
Executives Paid Too Much?
• Peter Drucker recommends 20-to-1 salary
ratio between senior executives and rankand-file white-collar workers
• Ratio of chief executives’ compensation to
the pay of average production worker
jumped to 431-to-1
• 90 percent of investors think that
executives are overpaid
© 2008 by Prentice Hall
9-2
Compensation: An Overview
• Compensation - Total of all rewards provided
employees in return for services
• Direct financial compensation - Pay received in
form of wages, salaries, bonuses, and
commissions
• Indirect financial compensation (benefits) - All
financial rewards not included in direct
compensation
• Nonfinancial compensation - Satisfaction person
receives from job itself or from psychological
and/or physical environment in which person
works
© 2008 by Prentice Hall
9-3
Components of Total Compensation Program
External Environment
Internal Environment
Compensation
Financial
Direct
Indirect (Benefits)
Nonfinancial
The Job
Job Environment
Sound Policies
Wages
Legally Required Benefits
Skill Variety Task
Capable Managers
Salaries
Social Security
Identify Task
Competent Employees
Commissions Unemployment Compensation Significance
Congenial Coworkers
Bonuses
Workers’ Compensation
Autonomy
Suitable Status Symbols
Family & Medical Leave
Feedback
Working Conditions
Voluntary Benefits
Workplace Flexibility
Payment for Time Not Worked
Flextime
Health Care
Compressed Workweek
Life Insurance
Job Sharing
Retirement Plans
Customized Benefit Plans
Disability Protection
Telecommuting
Employee Stock Option Plans
Part-time Work
Supplemental Unemployment
More Work, Fewer Hours
Benefits (SUB)
Employee Services
Premium Pay
Customized Benefit Plans
© 2008 by Prentice Hall
9-4
Equity Theory
• Motivation theory that people assess their
performance and attitudes by comparing
both their contribution to work and benefits
they derive from it to contributions and
benefits of comparison others whom they
select—and who in reality may or may not
be like them
© 2008 by Prentice Hall
9-5
Equity in Financial Compensation
• Financial equity - Perception of fair pay
treatment for employees
• External equity - Employees are paid
comparably to workers who perform
similar jobs in other firms
• Internal equity - Employees are paid
according to relative value of jobs within
same organization
© 2008 by Prentice Hall
9-6
Equity in Financial Compensation
(Cont.)
• Employee equity - Individuals performing
similar jobs for same firm are paid
according to factors unique to employee,
such as performance level or seniority
• Team equity - More productive teams are
rewarded more than less productive
groups
© 2008 by Prentice Hall
9-7
Primary Determinants of Direct Financial
Compensation
Organization
Compensation Policies
Organizational Level
Ability to Pay
Employee
Job Performance
Skills
Competencies
Seniority
Experience
Organization Membership
Potential
Political Influence
Luck
Job
Direct Financial
Compensation
Pricing
Labor Market
Compensation Surveys
Expediency
Cost of Living
Labor Unions
Economy
Legislation
Job
Job Analysis
Job Descriptions
Job Evaluation
© 2008 by Prentice Hall
9-8
Organization as a Determinant of
Direct Financial Compensation
• Compensation
Policies
• Organizational Level
• Ability to Pay
© 2008 by Prentice Hall
9-9
Compensation Policies
• Pay leaders - Pay higher wages and
salaries
• Market rate, or going rate - Pay what most
employers pay for same job
• Pay followers - Pay below market rate
because poor financial condition or believe
do not require highly capable employees
© 2008 by Prentice Hall
9-10
Organizational Level
• Upper management often makes
decisions to ensure consistency
• Extreme pressure to retain top
performers may override desire to
maintain consistency in pay
structure
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9-11
Ability to Pay
Organization’s
assessment of
ability to pay is
important factor in
determining pay
levels
© 2008 by Prentice Hall
9-12
Labor Market as Determinant of
Direct Financial Compensation
• Potential employees located
within geographic area from
which employees are recruited
• Pay for same jobs in different
labor markets may vary
considerably
© 2008 by Prentice Hall
9-13
Compensation Surveys
• What are other
firms paying?
• Geographic area of
survey
• Specific firms to
contact
• Jobs to include
© 2008 by Prentice Hall
9-14
Expediency
• Managers in highly technical and
specialized areas occasionally need
to utilize nontraditional means to
determine what constitutes
competitive compensation for scarce
talent and niche positions
• Need real-time information
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9-15
Cost of Living
• When prices rise
over a period of
time and pay does
not, real pay is
actually lowered
• Some firms index
pay increases to
inflation rate
© 2008 by Prentice Hall
9-16
Labor Unions
• Mandatory collective bargaining
between management and unions as
“wages, hours, and other terms and
conditions of employment.”
• Cost-of-living allowance has been
disappearing
© 2008 by Prentice Hall
9-17
The Economy
• Affects financial
compensation
decisions
• Depressed economy
generally increases
labor supply
• Cost of living often
rises as economy
expands
© 2008 by Prentice Hall
9-18
Compensation Legislation
• Davis-Bacon Act of 1931
• Walsh-Healy Act of 1936
• Fair Labor Standards Act of 1938,
as Amended
© 2008 by Prentice Hall
9-19
Davis-Bacon Act of 1931
• First national law to deal
with minimum wages
• Federal construction
contractors with projects
over $2000 to pay at least
prevailing wages in area
• Secretary of Labor sets
the prevailing wage at
union wage, regardless of
what average wage is in
affected locality
© 2008 by Prentice Hall
9-20
Walsh-Healy Act of 1936
• Companies with federal supply contracts
exceeding $10,000 pay prevailing wages
• Requires 1½ times regular pay rate for
hours over 8 per day or 40 per week
© 2008 by Prentice Hall
9-21
Fair Labor Standards Act of 1938,
as Amended
• Most significant law
affecting compensation
• Establishes minimum
wage
• Requires overtime pay
and record keeping
• Provides standards for
child labor
© 2008 by Prentice Hall
9-22
Exempt and Nonexempt
Employees
• Exempt employees - Categorized as
executive, administrative, professional
employees and outside salespersons
• Nonexempt employees - Those in jobs
not conforming to above definition
• Most employees who earn less than
$23,660 will be considered nonexempt no
matter what their duties are
© 2008 by Prentice Hall
9-23
Job as Determinant of Direct
Financial Compensation
• Job itself continues to be factor, especially
in firms that have internal pay equity as
primary consideration
• Organizations pay for value they attach to
certain duties, responsibilities, and other
job-related factors such as working
conditions
© 2008 by Prentice Hall
9-24
Job Analysis and Job Descriptions
• Before
organization can
determine relative
difficulty or value of
jobs, must first
define content
• Done by job
analysis/job
descriptions
© 2008 by Prentice Hall
9-25
Job Evaluation
• Firm determines relative value of one
job in relation to another
• Ranking
• Classification
• Factor comparison
• Point
• Hay guide chart-profile method
© 2008 by Prentice Hall
9-26
Ranking Method
• Simplest method
• Raters examine
description of
each job
• Jobs arranged in
order according
to value
© 2008 by Prentice Hall
9-27
Classification Method
• Define number of classes or grades
to describe group of jobs
• Compare job description with class
description
• Class description that most closely
agrees with job description
determines job classification
© 2008 by Prentice Hall
9-28
Factor Comparison Method
• Five universal job factors Mental requirements, skills,
physical requirements,
responsibilities, and working
conditions
• Raters need not keep entire
job in mind as they evaluate;
instead, they make decisions
on separate aspects or factors
of job
© 2008 by Prentice Hall
9-29
Point Method
• Numerical values assigned to specific
job components
• Sum of values gives quantitative
assessment of job’s relative worth
• Job factors selected according to
nature of specific group of jobs
© 2008 by Prentice Hall
9-30
Procedure for Establishing Point
Method of Job Evaluation
Select Job Cluster
Identify Compensable Factors
Determine Degrees and Define Each
Compensable Factors
Determine Factor Weights
Determine Factor Point Values
Validate Point System
© 2008 by Prentice Hall
9-31
A Point Method Example
1. Select Job Cluster - Assume we are
going to develop point system for the
administrative job cluster
2. Identify Compensable Factors - Assume
compensable factors identified are
education, job knowledge, contacts,
complexity of duties, and initiative
© 2008 by Prentice Hall
9-32
A Point Method Example (Cont.)
3. Determine Degrees and Define Each
Compensable Factors - In administrative
job cluster, Education, Job Knowledge,
and Initiative have been determined to
have five degrees; Contacts has four;
and Complexity of Duties has three
© 2008 by Prentice Hall
9-33
A Point Method Example (Cont.)
FACTOR: CONTACTS
Level (Degrees)
Points
IV Usual purposes of contacts are to discuss problems and possible
90
solutions, to secure cooperation or coordination of efforts, and to get
agreement and action; more than ordinary tact and persuasiveness required.
III Usual purposes of contacts are to exchange information and settle
66
specific problems encountered in course of daily work.
II Contacts may be repetitive but usually are brief with little or no
42
continuity.
I Contacts normally extend to persons in immediate work unit only.
18
© 2008 by Prentice Hall
9-34
A Point Method Example (Cont.)
FACTOR: COMPLEXITY OF DUTIES
III Performs work where only general methods are available. Independent
85
action and judgment are required regularly to analyze fact, evaluate
situations, draw conclusions, make decision, and take or recommend action.
II Performs duties working from standard procedures or generally
51
understood methods. Some independent action and judgment are required
to decide what to do, determine permissible variations from standard
procedures, review facts in situations, and determine action to be taken,
within limits prescribed.
I Little or no independent action or judgment. Duties are so standardized
17
and simple as to involve little choice as to how to do them.
© 2008 by Prentice Hall
9-35
A Point Method Example (Cont.)
4. Determine Factor Weights - Assume the
committee believes that education is quite
important for administrative job cluster and
sets the weight for education at 35%. The
weights of other four factors were determined
by the committee to be:
Job Knowledge—25
Contacts—18
Complexity of Duties—17
Initiative—5
The percent total is 100%
© 2008 by Prentice Hall
9-36
A Point Method Example (Cont.)
5. Determine Factor Point Values Committee determines total number of
points for the plan. Number may vary, but
500 or 1,000 points may work well.
Committee has determined that a 500
point system will work.
© 2008 by Prentice Hall
9-37
Job Evaluation Worksheet
(500-Point System)
Degree of Factor
Job Factor
Weight
1
2
3
4
5
Education
35%
35
70 105 140 175
Job Knowledge
25%
25
50
75 100 125
Contacts
18%
18
42
66
Complexity of Duties
17%
17
51
85
5%
5
10
15
Initiative
© 2008 by Prentice Hall
90
20
25
9-38
A Point Method Example (Cont.)
6. Validate Point System - Each committee
member should take a random sample of
jobs within chosen job cluster and
calculate weights for each job selected
Point total for Administrative 2 job is
determined to be 239 points
© 2008 by Prentice Hall
9-39
Job Evaluation Worksheet for
Administrative 2 Position
Degree of Factor
Job Factor
Weight
1
2
3
4
5
Education
35%
35
70 105 140 175
Job Knowledge
25%
25
50
75 100 125
Contacts
18%
18
42
66
Complexity of Duties
17%
17
51
85
5%
5
10
15
Initiative
Total Job Value
90
20
25
239
© 2008 by Prentice Hall
9-40
Illustration of Arithmetic and Geometric
Progression
Degree of Factor
Job Factor
Experience Required
1
2
3
4
1 year
3 years
5 years
7 years
(-------------------- Arithmetic Progression---------------------)
Degree of Factor
Job Factor
Experience Required
1
2
3
4
1 year
2 years
4 years
8 years
(-------------------- Geometric Progression---------------------)
© 2008 by Prentice Hall
9-41
The Hay Guide Chart-Profile
Method
•
•
•
•
•
Refined version of the point method
Know-how
Problem Solving
Accountability
Additional compensable elements,
such as working conditions
© 2008 by Prentice Hall
9-42
Job Pricing
• Placing dollar value on worth of job
• Pay grades - Grouping of similar jobs to
simplify pricing jobs
• Wage curve - Fitting of plotted points to
create smooth progression between pay
grades
• Pay ranges - Minimum and maximum pay
rate with enough variance between to
allow for significant pay difference
© 2008 by Prentice Hall
9-43
Job Pricing (Cont.)
• Broadbanding - Collapses many pay
grades into few wide bands to improve
effectiveness
• Single rate system - Pay ranges not
appropriate for some workplace conditions
such as some assembly lines
• Adjusting pay rates - Overpaid and
underpaid jobs
© 2008 by Prentice Hall
9-44
Scatter Diagram of Evaluated Jobs Illustrating Wage Curve,
Pay Grades, and Pay Ranges
Average Pay per Hour (Current Rates or Market Rates)
$19.80
5
18.50
4
17.20
3
15.90
Pay Ranges for
Pay Grades
2
14.60
14.00
13.30
12.90
1
12.00
100
1
Summary
Evaluated Points
0- 99
100-199
200-299
300-399
200
300
400
500
Evaluated Points
2
3
4
5
Pay Grades
Pay Grade
1
2
3
4
5
Minimum
$12.00
13.30
14.60
© 2008 by Prentice Hall
17.20
Midpoint
$13.30
14.60
15.90
17.20
18.50
Maximum
$14.60
15.90
17.20
9-45
19.80
Broadbanding
• Technique that collapses many pay
grades (salary grades) into few wide
bands to improve organizational
effectiveness
• Lateral employee development
• Develop employee skills and
encourage team focus
• Employee attention directed away
from vertical promotional opportunities
© 2008 by Prentice Hall
9-46
Average Pay Per Hour
Broadbanding and Its Relationship to Traditional
Pay Grades and Ranges
Grade 5
Grade 4
Grade 3
Band B
Grade 2
Grade 1
Band A
Low
High
Job Worth
© 2008 by Prentice Hall
9-47
Employee as Determinant of
Direct Financial Compensation
• Performance—Performance-based Pay
• Skills—Skilled-based Pay
• Competencies—Competency-based Pay
• Seniority
• Experience
• Membership in the organization
• Potential
• Political Influence
• Luck
© 2008 by Prentice Hall
9-48
Performance-Based Pay
• Merit pay - Pay increase given to employees based on
level of performance as indicated in appraisal
• Variable Pay - Compensation based on performance
• Bonus - Most common type of variable pay for
performance. One-time financial award based on
productivity
• Spot bonuses - Relatively small, gifts to employees for
outstanding work or effort
• Piecework - Employees paid for each unit they produce
© 2008 by Prentice Hall
9-49
Skill-Based Pay
Compensates on basis of job-related skills
and knowledge
• Employees and departments benefit when
employees obtain additional skills
• Appropriate where work tends to be
routine and less varied
• Must provide adequate training
opportunities or system becomes
demotivator
© 2008 by Prentice Hall
9-50
Competency-Based Pay
• Rewards employees for capabilities
they attain
• Competencies include skills but
also involve other factors such as
motives, values, attitudes, and selfconcepts
© 2008 by Prentice Hall
9-51
Seniority
• Length of time employee has
been associated with company,
division, department, or job
• Labor unions tend to favor
seniority
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9-52
Experience
• Regardless of nature of job, very
few factors have a more significant
impact on performance than
experience
• Dot-com world has changed
attitude with regard to experience
© 2008 by Prentice Hall
9-53
Membership in Organization
• Components of individual financial
compensation are given to employees
regardless of particular job they perform or
level of productivity
• Maintains high degree of stability in
workforce and recognizes loyalty
© 2008 by Prentice Hall
9-54
Potential
• Organizations do pay some
individuals based on potential
• Many young employees are
paid well because of their
potential
© 2008 by Prentice Hall
9-55
Political Influence
• Should not be used to determine
financial compensation
• To deny its existence would be
unrealistic
• Person's pull or political influence
may sway pay and promotion
decisions
© 2008 by Prentice Hall
9-56
Luck
“It certainly helps to be
in the right place at
the right time.”
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9-57
Team-Based Pay
If team is to
function effectively,
firms should
provide reward
based on overall
team performance
© 2008 by Prentice Hall
9-58
Company-Wide Pay
• Profit sharing - Distribution of
predetermined percentage of firm’s profits
to employees
• Gainsharing - Bind employees to firm’s
productivity and provide incentive payment
based on improved company performance
• Scanlon plan - Reward to employees for
savings in labor costs resulting from
employees’ suggestions
© 2008 by Prentice Hall
9-59
Professionals Compensation
• Initially compensated for
knowledge they bring to
organization
• Maturity curves reflect
relationship between
professional compensation
and years of experience
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9-60
Sales Representative
Compensation
• Straight salary
• Straight
commission
• Endless variety of
part-salary, partcommission
combinations
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9-61
Contingent Workers Compensation
• In most cases, contingency
workers earn less pay than
permanent counterparts
• Far less likely to receive health or
retirement benefits
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9-62
Executive Compensation
Critical factor in
attracting and
retaining best
managers
© 2008 by Prentice Hall
9-63
Determining Executive Compensation
Firms typically prefer
to relate salary growth
for the highest-level
managers to overall
corporate
performance
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9-64
Types of Executive Compensation
• Base salary
• Short-Term Incentives or
Bonuses
• Stock option plans
• Performance-Based Pay
• Executive benefits (Perks)
• Golden parachutes
© 2008 by Prentice Hall
9-65
Base Salary
• Factor in determining the executive’s
standard of living
• Salary provides basis for other forms of
compensation; it may determine amount of
bonuses and certain benefits
• U.S. tax law does not allow companies to
deduct more than $1 million of an
executive’s salary
© 2008 by Prentice Hall
9-66
Short-Term Incentives or Bonuses
• Payment of
bonuses reflects a
managerial belief in
their incentive value
• 90% of executives
receive bonuses
© 2008 by Prentice Hall
9-67
Stock Option Plans
• Gives manager option to buy a specified
amount of stock in the future at or below
current market price
• Some boards of directors require their top
executives to hold some of firm’s stock
• Financial Accounting Standards Boards
requires companies to expense stock
options thereby making them not as
attractive
© 2008 by Prentice Hall
9-68
Performance-Based Pay
• Trend toward more performance-based
compensation packages for executives
• Shareholders become increasingly
disenchanted with high levels of executive
compensation - performance-based pay
may gain in popularity
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9-69
Executive Benefits (Perks)
• Any special benefits provided by a firm to
small group of key executives and
designed to give executives something
extra
• Conveys status
• Personal use of corporate jet is soaring
among Corporate America’s elite as an
executive perk
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9-70
Golden Parachutes
• Perquisite that protects
executives in event another
company acquires firm or
executive is forced to leave
firm for other reasons
• Attempts to rein in obscene
golden parachute plans
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9-71
Trends & Innovations: Outrageous
Severance Pay Examples?
•
•
•
•
•
•
•
•
Philip Purcell, Morgan Stanley, $113 million
Stephen Crawford, Morgan Stanley, $32 million
Harry Stonecipher, Boeing $600,000/year
Carly Fiorina, Hewlett-Packard, $21 million
Franklin Raines, Fannie Mae, $1.4 million/year
Scott Livengood, Krispy Kreme, $46,000/month
James Kilts, Gillette, $100 million
Jack Welch, GE corporate $9 million annual pension plan
payout, plus perks such as lifetime use of GE’s $80,000per-month Manhattan apartment with free food and free
maid service; lifetime use of GE fleet of corporate jets,
including Boeing 737 jet; new Mercedes plus limousine
and driver; and assorted free sports and opera box tickets
© 2008 by Prentice Hall
9-72
A Global Perspective: Costs of
Expatriates
• Employers today know
that it is more expensive
to send workers abroad
• Tokyo ranks as most
expensive city for
expatriates, followed by
London, Moscow and
Osaka, Japan
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9-73
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9-74