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11
Compensation: Methods
and Policies
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Adequate
Equitable
A Compensation
system should be:
(* focus of this chapter)
Acceptable to the
employee*
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Incentiveproviding
Cost-effective*
Secure*
Balanced*
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To the individual
employee, the most
important compensation
decision is how much he
or she will earn.
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Determination of Individual Pay
Three questions need to be addressed:
1. How should one employee be paid relative
to another when they both hold the same
job in the organization?
2. Should we pay all employees doing the
same work at the same level the same?
3. If not, on what basis should we make the
distinction?
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Pay differentials are based on:
1. Individual differences in experience, skills,
and performance
2. Expectations that seniority, higher
performance (or both) deserve higher pay
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Reasons for choosing to pay employees at
different rates for the same job: (1 of 3)
 Pay
differentials allow firms to recognize that
different employees performing the same job
make substantially different contributions to
meeting organizational goals
 Differentials
allow employers to communicate a
changed emphasis on important job roles,
skills, knowledge, etc.
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Reasons for choosing to pay employees at
different rates for the same job: (2 of 3)
 Differentials
provide organizations with an
important tool for emphasizing norms of
enterprise without having employees change
jobs (i.e., promotion)
 Pay
differentials allow firms to recognize
market changes between jobs in the same
grade without requiring a major overhaul of the
whole compensation system
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Reasons for choosing to pay employees at
different rates for the same job: (3 of 3)
 Without
differentials,
 the
pay system violates the internal equity norms
of most employees,
 reducing satisfaction with pay, and
 making attraction and retention of employees
more difficult
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Methods of Payment
Flat Rates
Payment for Time
Worked
Variable Pay: Incentive
Compensation
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Payment for Time Worked
 General,
across-the-board increase for all
employees
 Merit increases paid to some employees
 based
on some indicator of job performance
 Cost-of-living
 based
adjustment (COLA)
on the consumer price index (CPI)
 Seniority
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Variable Pay
Percentage
of an employee’s paycheck is put
at risk
If business goals are not met, the pay rate will
not rise above the lower base salary
Annual raises are not guaranteed
Helps manage labor costs
Does not guarantee equitable treatment of
employees
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Variable Pay: Key Design Factors
Support by
management
Acceptance by
employees
Supportive
organizational
culture
Timing
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Types of Variable Pay
Individual Incentives
Group Incentives
Organization Incentives
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Individual Variable Pay
Merit
incentives
Individual
incentives
 piecework
 production
bonuses
 commissions
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Merit Pay Problems
1. Employees fail to make the connection
between pay and performance
2. The secrecy of the reward is perceived by
other employees as inequity
3. The size of the merit award has little effect
on performance
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Individual Incentives
Possible
only in situations where performance
can be specified in terms of output
 e.g.,
sales dollars generated
 e.g., number of items completed
Employees
must work independently of each
other so that individual incentives can be
applied equitably
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Conditions for Effective Individual
Incentive Plans
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1. The task is liked
2. The task is not boring
3. The supervisor reinforces and supports the system
4. The plan is acceptable to employees and managers
5. The incentive is financially sufficient to induce
increased output
6. Quality of work is not especially important
7. Most delays in work are under the employees’ control
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Reasons to Use Team Incentives
When
it is difficult to measure individual
output
When cooperation is needed to complete a
task or project
When management feels this is a more
appropriate measure on which to base
incentives
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Organization-wide Incentives
Usually
based on one of two performance
concepts:
 A sharing
of profits generated by all employees
altogether
 A sharing of money saved as a result of
employees’ efforts to reduce costs
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Approaches to Organization-wide Incentives
Suggestion
Systems
Gainsharing
Profit Sharing
Ownership
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Suggestion Systems: Essential Elements
1. Management commitment
2. Clear goals
3. Designated administrator
4. Structured award system
5. Regular publicity
6. Immediate response to each suggestion
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Gainsharing Plans
 Employees
earn bonuses tied to unit-wide
performance as measured by a predetermined,
gainsharing formula
 Commonly used gainsharing plans:
 Lincoln
Electric Plan
 Scanlon Plan
 Rucker Plan
 ImproShare
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Key Elements in Designing a Gainsharing
Plan
Strength
of reinforcement
Productivity
Sharing
Scope
standards
the gains
of the formula
Perceived
fairness of the formula
Production
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variability
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Newer Approaches to Gainsharing
Business Plan
Gainsharing
Winsharing
Spot Gainsharing
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Typical Profit Sharing Plans
1. Cash or current distribution plans provide full
payment to participants soon after profits have been
determined
2. Deferred plans credit a portion of current profits to
employees’ accounts with cash payments made at
the time of retirement, disability, severance, or death
3. A combination of both incorporates aspects of current
and deferred options
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Ownership
stock ownership plan (ESOP) –
employees receive stock in the company
 ESOPs are tax qualified
 Employee
 i.e.,
in return for meeting certain rules designed to
protect the interests of plan participants, ESOP
sponsors receive various tax benefits
 ESOPs
are defined contribution plans
 the
employers makes yearly contributions that
accumulate to produce a benefit that is not defined
in advance
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People-Based Pay
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Skill-Based
Pay
KnowledgeBased Pay
CredentialBased Pay
Feedback Pay
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Executive Pay
More likely to be based on comparative performance:
1. Compensation committees link CEO’s pay to
returns to shareholders
2. Variable performance-based pay is emphasized
over guarantees
3. CEOs are encouraged to invest in company stock
4. Performance yardsticks are linked to actual key
productivity indices, to the competition, or to both
5. CEOs are held responsible for the cost of capital
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Issues in Compensation Administration
Pay Secrecy or
Openness
Pay Security
Pay Compression
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Pay Security Plans
Guaranteed
Annual Wage
(GAW)
Supplementary
Unemployment
Benefits (SUB)
Cost of Living
Adjustments
(COLAS)
Severance Pay
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Solutions to the Problem of Pay
Compression (1 of 2)
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1. Reexamining how many entry-level people
are needed
2. Reassessing recruitment itself
3. Focusing on the job evaluation process,
emphasizing performance instead of salarygrade assignment
4. Basing all salaries on longevity
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Solutions to the Problem of Pay
Compression (2 of 2)
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5. Giving first-line supervisors and other
managers the authority to recommend equity
adjustments for incumbents who have been
unfairly victimized by pay compression
6. Limiting the hiring of new employees seeking
excessive salaries
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Summary
 There
is a growing realization that traditional
pay systems do not effectively link pay to
performance
 The trend is toward a total compensation
approach made up of base pay, variable pay,
and benefits
 Flexibility is an essential ingredient in any
compensation plan and can be built using a
variable pay approach
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