Compensation Theory, Job Evaluation and Pay Administration

Reward Systems
Compensation Theory, Job Evaluation and
Pay Administration
• Why is compensation important to
• Need to control costs to remain solvent and
• Need to remain competitive with internal and
external labor markets
• Need to use pay to motivate employees
• The basic problem: a limited pie to divide
among all employees
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MGMT 412 | Reward Systems
Fall 2008
Information from DoL, Bureau of Labor Statistics
Compensation Costs Per Hour
Wages & Salaries
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MGMT 412 | Reward Systems
Fall 2008
What is a Job Worth?
• Market price; willing seller and willing buyer
• Issues of justice and equity
• Male/female wage differentials
• U.S. wages vs. wages in less developed countries
• Gaps between executive and rank-and-file employee pay
• Currently in US around 400x rank-and-file pay (20x for most of
20th century -- comparable to Canada & UK)
• Especially an issue in the current environment (Fall 2008)
• But....does CEO incentive pay lead to performance? Who
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MGMT 412 | Reward Systems
Fall 2008
Women’s Pay Equality
2006: 76.9%
1951: 63.9%
1964: 59.1%
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MGMT 412 | Reward Systems
Fall 2008
The Basic Pay Model
• Compensation plan efficiency based on:
• Internal consistency
• External competitiveness
• Employee contributions to the firm
• Compensation:
• “All forms of financial returns and tangible
services and benefits employees receive as
part of an employment relationship”
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MGMT 412 | Reward Systems
Fall 2008
A Basic Question
• Can we satisfy everybody?
• Perceptions of fairness come from:
• Actual pay amounts
• Relative pay amounts on internal basis
• Relative pay amounts on external basis
• Pay administration
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MGMT 412 | Reward Systems
Fall 2008
Job Evaluation
• Determining the relative value of jobs within
the organization
• General basis:
Working conditions
• Approaches
• Whole job (ranking, classification)
• Decomposed (point factor)
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MGMT 412 | Reward Systems
Fall 2008
• How to:
• Order the jobs from highest to lowest
• Pro and con
• Easy to use and to explain to employees
• Cumbersome for any but the small organization
• Very difficult to add jobs / re-evaluate jobs
• Very subjective; it is difficult to say what criteria
are being used, so difficult to justify/explain to
employees or courts
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MGMT 412 | Reward Systems
Fall 2008
• How to:
• Set up grades or categories with descriptions of
the necessary responsibility, skill, effort and
working conditions (or other factors as desired)
• Include benchmark or representative jobs to serve
as anchors; these should be
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Common and well-known
Stable content
Truly representative of grade
Can be priced on external market
MGMT 412 | Reward Systems
Fall 2008
U.S. Government General
• Used since 1923
• Includes 18 classes or grades
• Uses 9 factors to develop grades
• These factors fit into the four categories
of skill, effort, responsibility and
working conditions
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MGMT 412 | Reward Systems
Fall 2008
GS Factors
Knowledge required by the position
Nature or kind of knowledge and
skills needed
How the knowledge and skills are
used in doing the work
Supervisory controls
How the work is assigned
The employee’s responsibility for
carrying out the work
How the work is reviewed
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The nature of guidelines for
performing the work
The judgement needed to apply the
guidelines or develop new guides
The nature of the assignment
The difficulty in identifying what
needs to be done
The difficulty and originality involved
in performing the work
Scope and effort
The purpose of the work
The impact of the work product or
Personal contacts
Purpose of contacts
Physical demands
Work environment
MGMT 412 | Reward Systems
Fall 2008
Classification: Pro and Con
• Used by U.S. government (not
necessarily a positive factor, but some
evidence that it works)
• Relatively easy to develop and
• Can be difficult to write grades for jobs
from multiple job families
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MGMT 412 | Reward Systems
Fall 2008
Point-Factor Plans
• The most commonly used type of job
evaluation method
• Make the criteria for comparisons
explicit, unlike ranking and classification
• The criteria for classification (the
compensable factors) are related to the
strategy of the business; they are the
factors valued by or of high worth to
the firm
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MGMT 412 | Reward Systems
Fall 2008
Point-Factor: How it Works
Point factor plans all include three elements:
• Compensable factors are defined
• Degrees or level of each factor are given numerical rankings
• Factors weighted as to their relative value to the organization
• Job worth is measured by the total number of points
The steps to follow:
• Job analysis
• Determine compensable factors
• Scale the factors
• Weight the factors
• Communications and documentation
Compensable Factors
“Characteristics in the work
that the organization values,
that help it pursue its strategy
and achieve its objectives”
• Apply the plan
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MGMT 412 | Reward Systems
Fall 2008
Selecting Compensable Factors
These should be:
• Based on the work performed
• Based on the strategy and values of the organization
• Acceptable and considered to be fair by all concerned parties
As a result, compensable factors should be developed by each
organization, rather than using an off-the-shelf plan
• Basic group of compensable factors:
• Skill
• Effort
• Responsibility
• Working conditions
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MGMT 412 | Reward Systems
Fall 2008
The Hay Plan
A widely used plan developed by a consulting firm, Hay
Associates, and aimed toward management jobs
• It includes:
• Know-how
• Functional expertise
• Managerial skills
• Human relations
• Problem solving
• Environment
• Challenge
• Accountability
• Freedom to act
• Impact of end results
• Magnitude
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MGMT 412 | Reward Systems
Fall 2008
Other Plans
• J.C. Penney looks at:
• Decision making impact on the company’s objectives
• Communications
• Supervision and management
• Knowledge requirements
• Internal customers
• External customers
• Many firms (i.e., 3M, TRW) add a factor for
“International Responsibilities”
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MGMT 412 | Reward Systems
Fall 2008
Weighting Compensable
Each factor contributes a different amount towards the total
score for the job, depending on the importance of the factor to
the organization. These weights can be arrived at in two ways
• Committee judgments (compensation committee, which is made up
of management representatives)
• Statistical analysis: the weights are chosen so that the factor scores
for a selected group of benchmark jobs will predict market prices or
current rates for those jobs
When compensable factors are weighted and the total number
of points determined, points assigned to each level of the
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MGMT 412 | Reward Systems
Fall 2008
Point-Factor: Pro and Con
• Point-factor systems orderly, rational, and
make criteria for evaluating jobs explicit
• Time consuming to set up (and they do need
to be periodically updated), but very simple
to add new jobs
• Job evaluations may still be affected by what
the evaluator already knows or believes the
market value of the job to be
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MGMT 412 | Reward Systems
Fall 2008
Why Conduct Salary Surveys?
• To create and adjust pay structure
• Adjust actual pay in response to the market
• All jobs on scheduled basis (almost a COLA); be careful this
doesn’t become an entitlement
• Jobs for which supply or demand has changed
• Monitor other forms of pay, such as shift differentials,
bonuses, incentives, overtime practices
• Estimate competitors’ labor costs
• However, we cannot market price every job
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MGMT 412 | Reward Systems
Fall 2008
What Is The Market?
Employers who compete for the same occupations and skills
Employers who compete for employees in the same geographic area
Employers who compete with the same products
How to determine this?
Who are our competitors?
Where do we recruit?
Where are employees going?
Interaction of skill/place/product
If labor market is rich in a particular skill, may recruit/price locally
If labor market does not include skills, recruiting and pricing are on a wider
Commuting time within a market may also be a factor
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MGMT 412 | Reward Systems
Fall 2008
Guidelines for Salary Surveys (I)
• How many firms to include
• Include fewer firms if you are a major employer and make
the market
• Commercial surveys often include several hundred firms (but
they make money by getting participants and selling them
• Price fixing issues
• Under the Sherman Act, surveys can be viewed as a
conspiracy in restraint of trade
• Having a third party conduct the survey protects you, but
you lose control
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MGMT 412 | Reward Systems
Fall 2008
Guidelines for Salary Surveys (II)
Make or buy
• For national data, may need to buy from a consultant
• Some firms may be reluctant to respond to your survey, but will
participate in third-party survey
• More control with own survey
• Purchasing a survey means you get what they want to report
• Running your own survey takes more time, but may be less
• Odd jobs, local jobs may not be available commercially
Free data from Department of Labor...but you get what you pay
for (useful in general terms)
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MGMT 412 | Reward Systems
Fall 2008
Guidelines for Salary Surveys (III)
• What jobs to survey
• Benchmark jobs:
• Well-known and stable content
• Stable pricing (stable supply/demand)
• Represent entire structure
• Represent majority of covered positions
• Market sensitive jobs
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MGMT 412 | Reward Systems
Fall 2008
What Data to Collect
• Basic company information, for comparability,
weighting of results
• How closely surveyed jobs match your jobs
• Salary range
• Actual pay (individuals, range or average); may
include actual pay and tenure/experience
• Other forms of compensation
• Benefits (optional)
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MGMT 412 | Reward Systems
Fall 2008
How to Survey
• Mail surveys cheapest, but may not be as
• Interviews are more accurate (allow you to
verify content) but are very time consuming
• Compromises may be phone verification or
interviews every second or third year (DoL
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MGMT 412 | Reward Systems
Fall 2008
Putting it Together: The Pay
Regression Line
• Job evaluation (internal equity) gives us
relative value of jobs within the
• Salary surveys (external equity) gives us
dollar value of selected jobs outside the
• The pay regression line combines the two
sources of information
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MGMT 412 | Reward Systems
Fall 2008
Basic Information
File Clerk
Mail Clerk
Accounting Clerk
Insurance Clerk
Customer Service Rep
Senior Accounting Clerk
Word Processor
Telephone Operator
Department Secretary
HR Assistant
Legal Secretary
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MGMT 412 | Reward Systems
Fall 2008
The Pay Regression Line
Legal Sect’y
Dept. Sect’y
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MGMT 412 | Reward Systems
Fall 2008
Developing Pay Grades
• Pay grades are “convenient groupings of a wide
variety of jobs...similar in work difficulty and
responsibility requirements but possibly having
nothing else in common”
• Pay grades allow compensation to be administered
for a group of jobs that are worth approximately the
• A pay grade can be a single rate or a range of rates
• An administrative convenience
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MGMT 412 | Reward Systems
Fall 2008
Basic Characteristics of Pay
Grades normally provide for a range of pay rates, though single
rates are possible
Pay grades contain a minimum, midpoint and maximum
The range from minimum to maximum can be from 20% to
100%, with 30% to 35% being most common
The midpoint of pay grades increase in a constant percentage,
normally 5% to 15%. However, the percentage increase may
be larger at the top of the pay structure
There is normally some overlap between pay grades. If there is
a 30% range within a pay grade and there is a 10% difference
between midpoints, there will be a 67% overlap
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MGMT 412 | Reward Systems
Fall 2008
Developing Pay Grades
How many grades? Differences between grades? Grade width?
The range of jobs included in the structure is an influence. A wider range
of jobs requires more grades, possibly wider grades (to cover a wider range
of pay) or less overlap between grades
Fewer pay grades will normally be wider pay grades, allowing the
organization to place more emphasis on recognizing time in job
Can be argued that differences between grades should increase as one
advances through the pay structure; the value of incumbents in higher level
jobs increases more with time and wider variation in performance is
possible. In lower level jobs, the learning curve levels off much sooner and
there is less scope for harming or contributing to the organization
Small increments between pay grades reduces the effect of an error in
assigning a job to a pay grade
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MGMT 412 | Reward Systems
Fall 2008
Other Issues
• Single rate pay grade?
• Is there a single “market rate” for the job, or are there a
variety of rates?
• How do you then reward seniority or performance?
• Often found in union settings
• What is the midpoint?
• Midpoint is the market rate for the job
• However, firm may determine their “market rate” as being
higher or lower than the survey average
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MGMT 412 | Reward Systems
Fall 2008
Other Pay Plan Issues
• Who evaluates jobs?
• Moving individuals through pay structures
• Merit vs. seniority
• Special situations
• Pay differentials
• Compression between employees and supervisors
• Compression between old and new employees
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MGMT 412 | Reward Systems
Fall 2008
Moving Individuals Through
Pay Structures
• Merit vs. seniority
• Faster progression to the midpoint, then slow
• Grade maximum; what then?
• Special situations
• Red circled jobs
• Green circled jobs
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MGMT 412 | Reward Systems
Fall 2008
Pay Compression
Between employees and supervisors
May occur if employees are very senior and supervisors brought in from
Also possible if employees work significant overtime or have shift pay
May also happen with commission sales and sales management
• Ensure sufficient distance between pay ranges for employees and supervisors
(10%) and watch actual pay
• Pay commissions to sales managers or select sales management staff who are
motivated by security rather than money
Compression between current and newly hired employees
Happens when market rates change faster than employees move through
What happens if an employee can quit and be rehired at a higher salary?
Solution: Adjust rate of progression through grade
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MGMT 412 | Reward Systems
Fall 2008