HR 202 Chapter 01

1. Compensation
Chapter 01
The Pay Model
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Compensation: Does It Matter?
It Matters
Nucor Steel had high pay and
higher productivity.
TARP discourages “unnecessary
and excessive risks.”
A well-designed compensation
system can help achieve and
sustain competitive advantage.
So What?
Chrysler and General Motors had
unsustainable pay practices.
Incentive plans led to risky
behavior in the financial industry.
Poorly designed compensation
systems can undermine
organizational success.

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Compensation: Definition, Please
From the perspective of society:
• Some see pay (and benefits in general) as a measure of justice, such as
pay inequalities between men and women.
• Job losses (or gains) in a country is partly a function of labor costs.
From a shareholder perspective:
• Some stockholders say using stock to pay employees creates a sense of
ownership while others say it dilutes shareholder wealth.
• Stockholders have an interest in linking executive pay to performance.
From a manager’s perspective:
• Compensation is a major expense that must be managed.
• It is also a major determinant of employee attitudes and behaviors.
Employees may view pay as financial security, a return in an
exchange, an entitlement, an incentive, or a reward.

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Incentive and Sorting Effects
Pay influences employee motivation and behavior in two ways:
• The incentive effect is the degree to which pay influences individual
and aggregate motivation.
• The sorting effect is the effect that pay can have on the composition
of the workforce.
• How an organization pays can result in sorting effects.
Organizations must ask: Are we using the pay policy that will
attract and retain the types of employees we want?
• Focus on incentive effects of pay can miss other major mechanisms.
Compensation policies work through incentive and sorting
effects to either achieve or not achieve company objectives.

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Global Views
In the U.S., compensation refers to all forms of financial returns
and tangible services and benefits employees receive as part of
an employment relationship.
In China, the contemporary meaning of compensation includes
returns as well as entitlement.
“Compensation” in Japanese means “giving something.”
• Today, the word hou-syu, meaning “reward,” is used.
• Teate, meaning “taking care of something,” is regarded as
compensation that takes care of employees’ financial needs.
• Includes the many allowances still used in many Japanese companies.

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Forms of Pay
Total compensation are transactional returns and include pay
received directly as cash and indirectly as benefits.
• Cash payment includes base pay, merit pay, cost-of living adjustments,
and incentives.
• Benefits include pensions, medical insurance, and programs to help
balance work and life demands.
Relational returns are psychological and include:
• Recognition and status, employment security, learning opportunities,
challenging work, and so on.

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Exhibit 1.4: Total Returns for Work

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Cash Compensation: Base
Base wage is the cash compensation an employer pays for work
performed.
• Base pay reflects the value of work or skills and ignores differences in
individuals.
• In the U.S., salary refers to annual or monthly pay for employees
exempt from overtime pay.
• Nonexempts are paid on an hourly wage.

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Cash Compensation: Merit Pay and COLAs
Cost of living adjustments (COLA) to base wages may be based on:
• Changes in what other employers are paying for the same work.
• Changes in living costs.
• Changes in experience or skill.
Merit increases are given as performance-based increments to
the base pay.
Merit bonuses are also based on performance rating but are paid
in one lump sum rather than a permanent change to base pay.

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Cash Compensation: Incentives
Incentives also tie pay increases to performance but differ from
merit adjustments.
• Incentive programs use objective measures of performance.
• Incentives do not increase base wage and must be re-earned.
• Incentive payment is known beforehand – such as a commission.
• Incentives try to influence future behavior and merit rewards past
behavior – a matter of timing.
Because incentives are a one-time payment, they are frequently
referred to as variable pay.
Incentives may be short- or long-term.
• Long-term incentives are in the form of stock ownership or options.

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Benefits
Benefits, including income protection, work/life services, and
allowances, are also part of total compensation.
• Some programs are legally required in the U.S. – unemployment and
Social Security.
Programs that help employees integrate their work and life
responsibilities include:
• Time away from work, access to services to meet specific needs, and
flexible work arrangements.
Allowances often grow out of whatever is in short supply.
• Housing and transportation allowances are frequent in China.

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Total Earnings and Relational Returns
Total earnings opportunities is a present-value perspective which
considers future bonuses, merit increases, and promotions.
Non-financial returns from work affect employees’ behavior.
• Forms include recognition and status, employment security,
challenging work, and opportunities to learn.
• Other forms include personal satisfaction from facing new challenges,
teaming with great co-workers, and receiving new uniforms.
• Such factors are part of the total return, broader than total
compensation.
It is useful to view an organization as a network of returns
created by different forms of pay, including total compensation
and relational returns.

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A Pay Model
The pay model contains three basic building blocks:
• The compensation objectives, the policies, and the techniques.
The basic objectives include:
• Efficiency – improving performance, increasing quality, delighting
customers and stockholders, and controlling labor costs.
• Fairness – recognizes both employee contributions and needs.
• Procedural fairness is the process used to make pay decisions.
• Compliance – means following federal and state regulations and laws.
• Ethics – means the organization cares about how it achieves results.
Pay objectives guide the design of the pay system and serve as
the standards for judging success of the pay system.

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Exhibit 1.5:
The Pay
Model

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Four Policy Choices
Internal alignment refers to comparisons among jobs or skill
levels inside an organization.
• Pay relationships affect all three compensation objectives.
External competitiveness refers to pay comparisons with
competitors and affect objectives in two ways.
• Employees must perceive their pay as competitive or they may leave.
• Controlling labor costs keeps the company’s products competitive.
Employee contributions or nature of the pay mix is a key decision.
• Make the external competitiveness and employee contribution
decision jointly.
Management means ensuring the right people get the right pay
for achieving the right objectives in the right way.

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Pay Techniques and Book Plan
The remaining portion of the pay model show techniques that
make up the pay system, discussed later in the text.
• Techniques tie the four basic policies to the pay objectives.
• There are unlimited variations in pay techniques.
Part one of this textbook introduces the pay model and discusses
compensation strategies.
Part two focuses on internal alignment and part three examines
external competitiveness.
Part four covers employee contributions and part five covers
employee services and benefits.
Part six looks at systems tailored to special groups and part
seven discusses managing the compensation system.

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Be an Informed Research Consumer
Is the research useful?
• How useful are the variables? Does the research measure anything
useful? How well are they measured?
Does the study separate correlation from causation?
• The correlation coefficient indicated how changes in one variable
relate to changes in another.
• Many studies use regression analysis.
Are there alternative explanations?
• The best way to establish causation is to account for competing
explanations, either statistically or through control groups.
• Look at the overall pattern of evidence and judge the effects of pay.

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End of Chapter 01.