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Human Resources Management
![Human Resource Management
13th
Edition
Chapter 9
Direct Financial Compensation
9-1Copyright © [2014] Pearson Education](https://image.slidesharecdn.com/mondyhrm13inppt09-150216192946-conversion-gate01/85/Mondy-hrm13-inppt09-ppt-1-320.jpg)
![Learning Objectives
• Discuss executive pay as a lightning rod for criticism,
define compensation, and describe the various forms of
compensation.
• Define financial equity and explain the concepts of equity
in direct financial compensation.
• Identify the determinants of direct financial compensation.
• Describe the organization as a determinant of direct
financial compensation.
• Describe the labor market as a determinant of direct
financial compensation and explain how the job is a
determinant of direct financial compensation.
9-2Copyright © [2014] Pearson Education](data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7)
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Mondy hrm13 inppt09.ppt
- 1. Human Resource Management 13th Edition Chapter 9 Direct Financial Compensation 9-1Copyright © [2014] Pearson Education
- 2. Learning Objectives • Discuss executive pay as a lightning rod for criticism, define compensation, and describe the various forms of compensation. • Define financial equity and explain the concepts of equity in direct financial compensation. • Identify the determinants of direct financial compensation. • Describe the organization as a determinant of direct financial compensation. • Describe the labor market as a determinant of direct financial compensation and explain how the job is a determinant of direct financial compensation. 9-2Copyright © [2014] Pearson Education
- 3. Learning Objectives (Cont.) • Define job evaluation and describe the four traditional job evaluation methods. • Describe job pricing and identify factors related to the employee that are essential in determining direct financial compensation. • Describe team-based pay, company-wide pay plans, professional employee compensation, sales representative compensation, and contingent worker compensation. • Explain say on pay, golden parachutes, and claw back policies. • Explain the various elements of executive compensation and discuss executive compensation in the global environment. 9-3Copyright © [2014] Pearson Education
- 4. HRM in Action: Executive Pay as a Lightning Rod for Criticism • Executive compensation averaged $11.4 million in 2011 for top 299s companies • Peter Drucker advised managers that a 20-to-1 salary ratio between senior executives and rank-and-file white-collar workers should be considered the limit • Dodd-Frank Act may have major impact on excessive executive compensation 9-4Copyright © [2014] Pearson Education
- 5. Compensation: An Overview • Compensation: Total rewards provided to employees in return for services • Direct financial compensation: Wages, salaries, bonuses, and commissions • Indirect financial compensation (benefits): All other financial rewards • Nonfinancial compensation: Satisfaction from job itself or from psychological and/or physical environment in which employee works 9-59-5Copyright © [2014] Pearson Education
- 6. Components of Total Compensation Program External Environment Internal Environment 9-6 Compensation Direct Wages Salaries Commissions Bonuses Indirect (Benefits) Legally Required Benefits Social Security Unemployment Compensation Workers’ Compensation Discretionary Benefits Payment for Time Not Worked Health Care Life Insurance Retirement Plans Disability Protection Employee Stock Option Plans Employee Services Premium Pay Voluntary Benefits The Job Meaningful Appreciated Satisfying Learning Enjoyable Challenging Job Environment Sound Policies Capable Managers Competent Employees Congenial Coworkers Appropriate Status Symbols Working Conditions Workplace Flexibility Flextime Compressed Workweek Job Sharing Telecommuting Part-time Work Financial Nonfinancial 9-6Copyright © [2014] Pearson Education
- 7. Equity Theory • Motivation is in proportion to the perceived fairness of rewards received for amount of effort exerted. • Compared to what others around the person receive for their efforts, • Equity and fairness important in compensation. 9-79-7Copyright © [2014] Pearson Education
- 8. Equity in Financial Compensation • Financial equity: Perception of fair pay • External equity: Employees paid comparably to workers who perform similar jobs in other firms • Internal equity: Employees paid according to relative value of jobs within a single organization • Employee equity: Individuals performing similar jobs for same firm paid according to factors such as performance level or seniority • Team equity: More productive teams are rewarded more than less productive groups 9-89-8Copyright © [2014] Pearson Education
- 9. Primary Determinants of Direct Financial Compensation 9-9 Organization Compensation Policies Organizational Level Ability to Pay Labor Market Compensation Surveys Expediency Cost of Living Labor Unions Economy Legislation Employee Job Performance Skills Competencies Seniority Experience Organization Membership Potential Political Influence Luck Salary Compression Job Pricing Direct Financial Compensation Job Job Analysis Job Descriptions Job Evaluation 9-9Copyright © [2014] Pearson Education
- 10. Organization as a Determinant of Direct Financial Compensation • Compensation policies • Organizational level • Ability to pay 9-109-10Copyright © [2014] Pearson Education
- 11. Compensation Policies • Pay leaders: Pay higher wages and salaries to attract high-quality, productive employees and thus achieve lower per-unit labor costs • Market rate, or going rate: Pay what most employers pay for same job • Pay followers: Pay below market rate because of firm’s poor financial condition or belief that it does not require highly capable employees 9-119-11Copyright © [2014] Pearson Education
- 12. 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 9-129-12Copyright © [2014] Pearson Education
- 13. Ability to Pay Organization’s assessment of its ability to pay is an important factor in determining pay levels. 9-139-13Copyright © [2014] Pearson Education
- 14. Labor Market as Determinant of Direct Financial Compensation • Labor market: Potential employees located within geographic area from which employees are recruited • Pay for same jobs in different labor markets may vary considerably 9-149-14Copyright © [2014] Pearson Education
- 15. Compensation Surveys • A means of obtaining data regarding what other firms are paying for specific jobs or job classes within a given labor market. • Market rates remain the most important standard for determining pay. 9-159-15Copyright © [2014] Pearson Education
- 16. Expediency • Managers in highly technical and specialized areas occasionally need to use nontraditional means to determine what constitutes competitive compensation for scarce talent and niche positions. • Need real-time information 9-169-16Copyright © [2014] Pearson Education
- 17. 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 9-17Copyright © [2014] Pearson Education
- 18. Labor Unions • Mandatory collective bargaining between management and unions on: –Wages –Hours –Other terms and conditions of employment • Cost-of-living allowance has been disappearing 9-18Copyright © [2014] Pearson Education
- 19. The Economy • Affects financial compensation decisions • Depressed economy generally increases labor supply • Cost of living often rises as economy expands 9-19Copyright © [2014] Pearson Education
- 20. Compensation Legislation • Davis-Bacon Act of 1931 • Walsh-Healy Act of 1936 • Fair Labor Standards Act of 1938, as amended • Dodd-Frank Wall Street Reform and Consumer Protection Act 9-20Copyright © [2014] Pearson Education
- 21. Davis-Bacon Act of 1931 • Federal construction contractors with projects over $2,000 must pay at least prevailing wages in area • Secretary of Labor sets prevailing wage at union wage, regardless of what average wage is in affected locality • First national law to deal with minimum wages 9-21Copyright © [2014] Pearson Education
- 22. Walsh-Healy Act of 1936 • Companies with federal supply contracts exceeding $10,000 pay prevailing wages • Requires 1.5 times regular pay rate for hours over 8 per day or 40 per week 9-22Copyright © [2014] Pearson Education
- 23. 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 9-23Copyright © [2014] Pearson Education
- 24. Exempt and Nonexempt Employees • Exempt employees: Categorized as executive, administrative, professional, or outside salespersons • Nonexempt employees: Those in jobs not conforming to the definition above 9-24Copyright © [2014] Pearson Education
- 25. Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 • Provisions relating to executive compensation and corporate governance • Impacts executives, directors, and shareholders of publicly traded companies 9-25Copyright © [2014] Pearson Education
- 26. Job as Determinant of Direct Financial Compensation • Job itself is a factor, especially in firms that have internal pay equity as primary consideration • Organizations pay for value they attach to certain: – Duties – Responsibilities – Other job-related factors, such as working conditions 9-26Copyright © [2014] Pearson Education
- 27. Job Analysis and Job Descriptions • Before organization can determine relative difficulty or value of jobs, they must first define content • This is done by job analysis and job descriptions 9-27Copyright © [2014] Pearson Education
- 28. Job Evaluation • Firm determines value of one job in relation to another –Ranking –Classification –Factor comparison –Point –Hay Group Guide Chart-Profile Method 9-28Copyright © [2014] Pearson Education
- 29. Ranking Method • Simplest method • Raters examine description of each job • Jobs arranged in order according to value 9-29Copyright © [2014] Pearson Education
- 30. 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 9-30Copyright © [2014] Pearson Education
- 31. Factor Comparison Method • 5 universal job factors: – Mental requirements – Skills – Physical requirements – Responsibilities – Working conditions • Raters make decisions on separate aspects or factors of job 9-31Copyright © [2014] Pearson Education
- 32. 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 9-32Copyright © [2014] Pearson Education
- 33. Hay Group Guide Chart-Profile Method • Refined version of point method • Know-how • Problem solving • Accountability • Additional compensable elements, such as working conditions 9-33Copyright © [2014] Pearson Education
- 34. Job Pricing • Job evaluation results in a job hierarchy • Job pricing places a dollar value on job • Takes place after evaluation of a job 9-34Copyright © [2014] Pearson Education
- 35. Scatter Diagram of Evaluated Jobs Illustrating Wage Curve, Pay Grades, and Pay Ranges 9-35 100 200 300 400 500 17.20 $19.80 18.50 15.90 14.60 14.00 13.30 12.90 12.00 Average Pay per Hour (Current Rates or Market Rates) W age Curve Evaluated Points 1 2 3 4 5 Pay Grades 1 2 3 4 5 Pay Ranges for Pay Grades 0- 99 1 $12.00 $13.30 $ 14.60 100-199 2 13.30 14.60 15.90 200-299 3 14.60 15.90 17.20 300-399 4 15.90 17.20 18.50 400-500 5 17.20 18.50 19.80 Evaluated Points Pay Grade Minimum Midpoint Maximum Summary Copyright © [2014] Pearson Education
- 36. Pay Grades • Grouping of similar jobs to simplify pricing jobs • Similar to a university’s practice of grouping grades – Grades of 90–100 are an “A” – Grades of 80–89 are a “B,” etc. • Plotting jobs on a scatter diagram 9-36Copyright © [2014] Pearson Education
- 37. Wage Curve • Fitting of plotted points to create smooth progression between pay grades • Creates a smooth progression • Often uses statistical methods 9-37Copyright © [2014] Pearson Education
- 38. Pay Ranges • Minimum and maximum pay rate with enough variance between to allow for significant pay difference • Generally preferred over single pay rates • Need to develop a method to advance individuals through the range 9-38Copyright © [2014] Pearson Education
- 39. Broadbanding • Technique that collapses many pay grades (salary grades) into a few wide bands to improve organizational effectiveness • Lateral employee development • Develops employee skills and encourages team focus 9-39Copyright © [2014] Pearson Education
- 40. Broadbanding and Its Relationship to Traditional Pay Grades and Ranges 9-40 AverageHourlyPay Grade 4 Grade 1 Grade 2 Grade 3 Job Worth Low High Band I Band II Grade 6 Band III Grade 5 Copyright © [2014] Pearson Education
- 41. Single Rate Systems • Pay ranges not appropriate for some workplace conditions, such as some assembly lines • Everyone in the same job receives same base pay • May be midpoint of a range determined by compensation survey 9-41Copyright © [2014] Pearson Education
- 42. Adjusting Pay Rates • Overpaid and underpaid jobs • Bring underpaid jobs up to minimum of pay range • Promote person who is overpaid or freeze rate until across-the-board pay increases bring job into line • Bad idea to cut pay 9-42Copyright © [2014] Pearson Education
- 43. Employee as Determinant of Direct Financial Compensation • Performance (performance-based pay) • Skills (skill-based pay) • Competencies (competency-based pay) • Seniority • Experience • Potential • Political influence • Luck • Salary compression 9-43Copyright © [2014] Pearson Education
- 44. Performance-Based Pay • Merit pay • Variable pay • Bonuses • Spot bonuses • Piecework 9-44Copyright © [2014] Pearson Education
- 45. Merit Pay • Pay increase given based on level of performance, as indicated in appraisal • Historically a cost-of-living increase in disguise • Increases the employee’s base pay • Some companies are freezing or cutting pay for some so as to be able to reward others 9-45Copyright © [2014] Pearson Education
- 46. Bonuses • Companies are increasingly placing higher percentage of compensation budget in bonuses • One-time financial award based on productivity • Based on productivity that is not added to base pay • Use of bonuses is a win–win situation 9-46Copyright © [2014] Pearson Education
- 47. Spot Bonuses • Relatively small gifts to employees for outstanding work or effort • For work done in relatively short period of time • $100 or $500, perhaps up to $5,000, shortly after noteworthy actions 9-47Copyright © [2014] Pearson Education
- 48. Piecework • Employees paid for each unit they produce • Especially prevalent in production/operations area • Need plan for developing output standards • Not feasible for many jobs • Have declined in their use 9-48Copyright © [2014] Pearson Education
- 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 it becomes demotivating 9-49Copyright © [2014] Pearson Education
- 50. Competency-Based Pay • Compensates employees for capabilities they attain • Type of skill-based pay plan for professional and managerial employees • Disappearance of the traditional job provides primary rationale for this change 9-50Copyright © [2014] Pearson Education
- 51. Seniority • Seniority: Length of time employee has been with company • Management generally prefers performance as primary basis for compensation changes • Unions tend to favor seniority 9-51Copyright © [2014] Pearson Education
- 52. Experience • Has potential for enhancing person’s ability to perform • Materializes only if experience acquired is positive • Today technology may have rendered experience useless unless person has kept up with the technology available 9-52Copyright © [2014] Pearson Education
- 53. Organization Membership • Receive some compensation components without regard to particular job they perform or their level of productivity • Receive them because they are members of the organization 9-53Copyright © [2014] Pearson Education
- 54. Potential • Useless if it is never realized • Many young employees are paid well because they have the potential to add future value • Used to attract talented young people to the firm 9-54Copyright © [2014] Pearson Education
- 55. Political Influence • Firms should obviously try not to permit political influence to be a factor • To deny its existence would be unrealistic • Natural for a manager to favor a friend or relative in granting a pay increase or promotion 9-55Copyright © [2014] Pearson Education
- 56. Luck • Helps to be in the right place at the right time • Opportunities are continually presenting themselves • Luck works primarily for the efficient 9-56Copyright © [2014] Pearson Education
- 57. Salary Compression • Salary compression: Occurs when less experienced employees are paid as much as or more than employees who have been with the organization a long time due to a gradual increase in starting salaries and limited salary adjustment for long-term employees 9-57Copyright © [2014] Pearson Education
- 58. Team-Based Pay • Firms should also provide rewards based on overall team performance • Firms find it easier to develop performance standards for groups • Potential disadvantage for exemplary performers 9-58Copyright © [2014] Pearson Education
- 59. Company-Wide Pay • Profit sharing • Gainsharing • Scanlon plan 9-59Copyright © [2014] Pearson Education
- 60. Profit Sharing • Distribution of predetermined percentage of firm’s profits to employees • Kinds of plans: –Current profit sharing –Deferred profit sharing –Combination plans • Vesting: Determines amount of profit employee owns 9-60Copyright © [2014] Pearson Education
- 61. Gainsharing • Binds employees to firm’s productivity and provides incentive payment based on improved company performance • Scanlon, Multicost Scanlon, Rucker, and Improshare plans are most popular • Helps align an organization’s people strategy with its business strategy 9-61Copyright © [2014] Pearson Education
- 62. Scanlon Plan • Reward to employees for savings in labor costs resulting from employees’ suggestions • Employee-management committees evaluate these suggestions • Systems for participative management 9-62Copyright © [2014] Pearson Education
- 63. Professional Compensation • Professionals initially compensated for knowledge they bring to organization • Maturity curves reflect relationship between professional compensation and years of experience 9-63Copyright © [2014] Pearson Education
- 64. Sales Representative Compensation • Straight salary • Straight commission • Endless variety of part-salary, part- commission combinations 9-64Copyright © [2014] Pearson Education
- 65. Contingent Worker Compensation • In most cases, contingent workers earn less pay than permanent counterparts • Far less likely to receive health or retirement benefits 9-65Copyright © [2014] Pearson Education
- 66. Trends & Innovations: Say on Pay, Golden Parachutes, and Clawback Policies • Three provisions in Dodd-Frank Act relate to: –Say on pay –Golden parachutes –Clawback policies 9-66Copyright © [2014] Pearson Education
- 67. Say on Pay • Gives shareholders in all but smallest companies an advisory vote on executive pay • Some expect vote will cause greater accountability on executive pay • Votes at least every 3 years 9-67Copyright © [2014] Pearson Education
- 68. Golden Parachute Contract • Perquisite protecting executives in event another company acquires firm or executive is forced to leave firm for other reasons • At times has been abused • Dodd-Frank Act has disclosure requirements • Requires shareholder advisory vote on certain arrangements 9-68Copyright © [2014] Pearson Education
- 69. Clawback Contract Provision • Provision allows company to recover compensation if subsequent review indicates payments were not calculated accurately or performance goals were not met • Dodd-Frank Act requires companies to develop Clawback policies to recover compensation later deemed excessive 9-69Copyright © [2014] Pearson Education
- 70. Executive Compensation • Remember the skills possessed by company executives largely determine whether firm will prosper, survive, or fail • Compensation programs need to be developed which motivates these executives to strive to achieve long term success for firm 9-70Copyright © [2014] Pearson Education
- 71. Types of Executive Compensation • Base salary • Bonuses and performance-based pay • Stock option plans • Perquisites (perks) • Severance packages 9-71Copyright © [2014] Pearson Education
- 72. Base Salary • Factor in determining executive’s standard of living • Salary provides basis for other forms of compensation; may determine amount of bonuses and certain benefits • U.S. tax law does not allow companies to deduct more than $1 million of executive’s salary 9-72Copyright © [2014] Pearson Education
- 73. Bonuses and Performance-Based Pay • Trend toward more performance- based compensation packages for executives • Payment of bonuses reflects managerial belief in their incentive value 9-73Copyright © [2014] Pearson Education
- 74. Stock Option Plans • Options for managers to buy specified amount of stock in 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 require companies to expense stock options, thereby making them less attractive 9-74Copyright © [2014] Pearson Education
- 75. Perquisites (Perks) • Special benefits provided by firm to small group of key executives • Designed to give executives something extra • Securities and Exchange Commission lowered threshold for disclosure of executive perks from $50,000 to $10,000 9-75Copyright © [2014] Pearson Education
- 76. Severance Packages • Not set up after CEO has quit or been fired • SEC requires companies to list all agreements for each executive • Investors will see estimated total dollar value of exit packages 9-76Copyright © [2014] Pearson Education
- 77. A Global Perspective: Executive Compensation in the Global Environment • Whereas people in United States derive great status from high pay, nations in large parts of Europe and Asia shun conspicuous wealth • Governance of executive pay varies from country to country • Investors in some countries can cast binding vote on executive pay 9-77Copyright © [2014] Pearson Education
- 78. 9-78
Hinweis der Redaktion
- For some time now, executive pay for the nation’s highest-paid chief executives, including salary, bonuses, perks and the value of exercised stock options, has been a lightning rod for criticism and debate. According to one site, CEO’s of the top 299s companies in the Standard & Poor’s 500 Index received, on average, $11.4 million in total compensation in 2011. That is 343 times the average worker’s median pay of $33,190It is difficult for workers who make $12 to $18 an hour to appreciate why these executives merit such large salaries. This obvious disparity has caused considerable discussion regarding the proper ratio of CEO compensation to that of the average worker. Peter Drucker, the famous management author, once said, “I have often advised managers that a 20-to-1 salary ratio between senior executives and rank-and-file white-collar workers is the limit beyond which they cannot go if they don’t want resentment and falling morale to hit their companies.”
- Compensation is the total of all rewards provided to employees in return for their services. The overall purposes of providing compensation are to attract, retain, and motivate employees. We will review the three major types of compensation in this chapter. Direct financial compensation consists of the pay that an employee receives in the form of wages, salaries, commissions, and bonuses. Indirect financial compensation (or benefits) consists of all financial rewards that are not included in direct financial compensation, such as health care insurance. Nonfinancial compensation consists of the satisfaction that an employee receives from the job itself or from environment in which he or she works.
- This figure shows the components of a total compensation program.
- Equity theory states that a person’s motivation is in proportion to the perceived fairness of the rewards he or she receives for the amount of effort he or she exerts, and that this is also compared with what others receive. According to the theory, individuals are motivated to reduce any perceived inequity and will strive to make the ratios of outcomes to inputs equal. As such, equity is a very important factor in compensation.
- Financial equity is the perception that there is fair pay for employees. Firms and individuals view fairness from several perspectives. Ideally, compensation will be evenhanded to all parties concerned and employees will perceive it as such. However, this is a very elusive goal. External equity exists when a firm’s employees receive pay comparable to workers who perform similar jobs in other firms. Compensation surveys help organizations determine the extent to which external equity is present. Internal equity exists when employees receive pay according to the relative value of their jobs within a single organization. Employee equity exists when individuals performing similar jobs for the same firm receive pay according to factors unique to the employee, such as performance level or seniority. Team equity is achieved when teams are rewarded based on their productivity. However, achieving equity may be a problem because not all team members contribute equally to the outcomes.
- Compensation theory alone has never been able to provide a completely satisfactory answer as to what an individual’s job is worth. Therefore, organizations typically use a number of factors entailing the organization, the labor market, the job, and the employee to determine any given individual’s financial compensation.
- Managers tend to view financial compensation as both an expense and an asset. It is an expense in the sense that it reflects the cost of labor. However, financial compensation is clearly an asset when it helps recruit good people and encourages them to put forth their best efforts and to remain in their jobs.
- A compensation policy provides general guidelines for making compensation decisions. An organization often establishes compensation policies that determine whether it will be a pay leader, a pay follower, or strive for an average position in the labor market.
- The organizational level in which compensation decisions are made can also have an impact on pay. Upper management often makes these decisions to ensure consistency. However, organizations are increasingly pushing these decisions to lower levels in an effort to retain top performers.
- An organization’s assessment of its ability to pay is also an important factor in determining pay levels. Financially successful firms tend to provide higher-than-average compensation.
- Potential employees located within the geographic area from which employees are recruited comprise the labor market. Labor markets for some jobs extend far beyond the location of a firm’s operations. An aerospace firm in St. Louis, for example, may be concerned about the labor market for engineers in Fort Worth or Orlando, where competitors are located. As global economics increasingly sets the cost of labor, the global labor market grows in importance as a determinant of financial compensation for individuals.
- A compensation survey is a means of obtaining data regarding what other firms are paying for specific jobs or job classes within a given labor market. Virtually all compensation professionals use compensation surveys that are purchased, outsourced to a consulting firm, or conducted by the organization itself. Of all the wage criteria, market rates remain the most important standard for determining pay. In a competitive environment, the marketplace determines economic worth, and this is the critical factor. During the recent recession, pay raises were nonexistent in many organizations. As the country has moved out of the recession, firms were racing to conduct compensation surveys to determine what the competition was doing with regard to salary increases.
- Although standard compensation surveys are generally useful, managers in highly technical and specialized areas occasionally need to use nontraditional means to determine what constitutes competitive compensation for scarce talent and niche positions. They need real-time information and must rely on recruiters and hiring managers on the front lines to let them know what is happening in the job market.
- The logic for using cost of living as a pay determinant is both simple and sound: When prices rise over time and pay does not, real pay is actually lowered. A pay increase must be roughly equivalent to the increased cost of living if a person is to maintain his or her previous level of real wages.
- The National Labor Relations Act (Wagner Act) declared legislative support, on a broad scale, for the right of employees to organize and engage in collective bargaining. Unions normally prefer to determine compensation through the process of collective bargaining. An excerpt from the Wagner Act prescribes the areas of mandatory collective bargaining between management and unions as “wages, hours, and other terms and conditions of employment.” These broad bargaining areas obviously have great potential to impact compensation decisions. When a union uses comparable pay as a standard in making compensation demands, the employer needs accurate labor market data. When a union emphasizes cost of living, it may try to pressure management into including a cost-of-living allowance. Recently, cost-of-living allowances in union contracts have been disappearing.
- The economy definitely affects financial compensation decisions. For example, a depressed economy generally increases the labor supply, and this serves to lower the market rate. A booming economy, on the other hand, results in greater competition for workers and the price of labor is driven upward. In addition, the cost of living typically rises as the economy expands.
- Federal and state laws can also affect the amount of compensation a person receives. Our focus here is on the federal legislation that provides broad coverage and specifically deals with compensation issues.
- The Davis-Bacon Act of 1931 was the first national law to deal with minimum wages. It mandates a prevailing wage for all federally financed or assisted construction projects exceeding $2,000. The Secretary of Labor sets the prevailing wage at the union wage, regardless of what the average wage is in the local market.
- The Walsh–Healy Act of 1936 requires companies with federal supply contracts exceeding $10,000 to pay prevailing wages. This legislation also requires one-and-a-half times the regular pay rate for hours over 8 per day or 40 per week.
- The most significant law affecting compensation is the Fair Labor Standards Act of 1938. The purpose of the Act was to establish minimum national labor standards, eliminate low wages, and reduce long working hours. To accomplish these goals, the Act sets a minimum wage, requires record keeping, establishes regulations for overtime pay, and provides standards for child labor.
- Exempt employees are categorized as executive, administrative, professional, or outside salespersons. Executives are basically any managers with broad authority over subordinates. An administrative employee, although not a manager, occupies an important staff position in an organization, such as account executive or market researcher. A professional employee performs work requiring advanced knowledge in a field, normally acquired through a prolonged course of specialized instruction, such as company physician or corporate attorney. These employees are considered “exempt” from the Fair Labor Standards Act overtime rules, whereas nonexempt employees are eligible for overtime pay.
- The Dodd-Frank Act was signed into law in 2010 and has provisions relating to executive compensation and corporate governance that impact the executives, directors, and shareholders of publicly traded companies. Specific provisions of the Act will be covered later under topics on “Say on Pay,” “Golden Parachutes,” and the “Claw back Provision.”
- The individual employee and market forces are the most prominent wage criteria. However, the job itself continues to be a factor, as organizations pay for the value they attach to certain duties, responsibilities, and working conditions. Management techniques used for determining a job’s relative worth include job analysis, job descriptions, and job evaluation.
- Before an organization can determine the relative value of its jobs, it must first define their content. This is done through job analysis, which is the systematic process of determining the skills and knowledge required for performing jobs. The primary by-product of job analysis is the job description, a written document that describes job duties and responsibilities.
- Job evaluation is a process that determines the value of one job in relation to another and to the company. The primary purpose of job evaluation is to eliminate internal pay inequities. The four traditional job evaluation methods are the ranking, classification, factor comparison, and point methods. Another option is to purchase a proprietary method such as the Hay Plan. The ranking and classification methods are not quantitative approaches, whereas the factor comparison and point methods are quantitative approaches.
- The ranking method is the simplest approach. Raters examine the description of each job being evaluated and arrange the jobs in order according to their value to the company.
- The classification method involves defining a number of classes or grades to describe a group of jobs. In evaluating jobs by this method, the raters compare the job description with the class description, and the closest match determines the classification for that job.
- The factor comparison method assumes that there are five universal job factors: mental requirements, skills, physical requirements, responsibilities, and working conditions. The evaluator makes decisions on these factors independently. An evaluation committee creates a monetary scale, containing each of the five universal factors, and ranks jobs according to their assessed value for each factor.
- In the point method, raters assign numerical values to specific job factors, such as knowledge required, and the sum of these values provides a quantitative assessment of a job’s relative worth. Only when job factors change, or when for some reason the weights assigned become inappropriate, does the plan become obsolete. Historically, some variation of the point plan has been the most popular option.
- The Hay Group Guide Chart-Profile Method is a widely used refined version of the point method used by public and private-sector organizations worldwide to evaluate clerical, trade, technical, professional, managerial, and/or executive-level jobs. It uses the factors of know-how, problem solving, accountability, and other job-related elements. It uses the compensable factors of know-how, problem solving, accountability, and additional compensable elements. Point values are assigned to these factors to determine the final point profile for any job.
- Job pricing results in placing a dollar value on a job. It takes place after a job has been evaluated and the relative value of each job in the organization has been determined. Firms often use pay grades and pay ranges in the job-pricing process.
- This illustration depicts the concepts to be covered in forthcoming slides. Looking at the figure, notice that each dot on the scatter diagram represents one job. The location of the dot reflects the job’s relationship to pay and evaluated points, which reflect its worth. When this procedure is used, a certain point spread determines the width of the pay grade (which is 100 points in this illustration). Although each dot represents one job, it may involve dozens of individuals who have positions in that one job. The large dot at the lower left represents the job of receptionist, evaluated at 75 points. The receptionist’s hourly rate of $12.90 represents either the average wage currently paid for the job or its market rate.
- A pay grade is the grouping of similar jobs to simplify pricing jobs. For example, it is much more convenient for organizations to price 15 pay grades than 200 separate jobs.
- A wage curve is the fitting of plotted points to create a smooth progression between pay grades. The line drawn minimizes the distance between all dots and the line. Although the line of best fit may be straight or curved, a straight line is often the result when the point system is used.
- A pay range includes a minimum and maximum pay rate with enough variance between the two to allow for a significant pay difference. Pay ranges are generally preferred over single pay rates because they allow a firm to compensate employees according to performance and length of service. Pay then serves as a positive incentive for individuals to advance through the range.
- Broadbanding is a technique that collapses many pay or salary grades into a few wide bands to improve organizational effectiveness. Organizational downsizing and restructuring of jobs have created broader job descriptions, with the result that employees perform more diverse tasks than they previously did. Broadbanding creates the basis for a simpler compensation system that de-emphasizes structure and places greater importance on flexible decision making. Bands may also promote lateral development of employees and reduce demand for scarce vertical promotions.
- The decreased emphasis on job levels should encourage employees to make cross-functional moves to jobs that are on the same or an even lower level because their pay rate would remain unchanged. Broadbanding allows for more flexibility within ranges, allows more movement of employees within the ranges, and can reduce the need for promotions. The use of broadbanding has declined in recent years because each band consists of a broad range of jobs and the market value of these jobs may vary considerably. Unless carefully monitored, employees in jobs at the lower end of the band could progress to the top of the range and become overpaid.
- Pay ranges are not appropriate for some workplace conditions, such as assembly-line operations. For instance, when all jobs within a unit are routine, with little opportunity for employees to vary their productivity, a single-rate system may be more appropriate. When single rates are used, everyone in the same job receives the same base pay, regardless of productivity.
- Good management practice is to correct pay inequities for underpaid employees as rapidly as possible. Overpaid jobs present a different problem. Promotion is a possibility if the employee is qualified for a higher-rated job and a job opening is available. Another possibility is to freeze the rate until across-the-board pay increases bring the job into line. Finally, the employee’s pay could be cut, but this is generally not a good idea because it punishes the employee for a situation he or she did not create.
- In addition to the organization, the labor market, and the job itself, factors related to the employee are also essential in determining an individual’s compensation. These factors include job performance, skills, competencies, seniority, experience, potential, political influence, and luck.
- The goal of performance-based pay is to link pay and performance. It recognizes that some workers are just better than other workers at performing the same job.
- Merit pay is a pay increase added to employees’ base pay based on their level of performance. In practice, however, it has historically been merely a cost-of-living increase in disguise. The recent recession may have created a compensation revolution with regard to merit pay. Pay increases where everyone is treated essentially the same, with only small differences between the best performers and mediocre ones, are a thing of the past. Although many companies continue with traditional merit pay plans, some companies are starting to quietly freeze or cut pay for some so as to be able to reward others.
- Companies are increasingly placing a higher percentage of their compensation budget in bonuses, a one-time annual financial award, based on productivity that is not added to base pay, as more and more companies embrace the concept of pay for performance. The use of bonuses helped employers manage their cash outlay in a tough business environment while laying the foundation to share success with top producers. Managers commonly contend that the use of bonuses is a win–win situation because it boosts production and efficiency and gives employees some control over their earning power. A positive side effect of using bonuses to reward high performance is that it may encourage coworkers to increase their productivity so that they can also receive the bonuses.
- Spot bonuses are relatively small monetary gifts provided to employees for outstanding work or effort during a reasonably short period of time. If an employee’s performance has been exceptional, the employer may reward the worker with a one-time bonus ranging from $100 or $500 to perhaps as much as $5,000.
- Piecework is an incentive pay plan in which employees are paid for each unit they produce. For example, if a worker is paid $8 a unit and produces 10 units a day, the worker earns $80. Sometimes a guaranteed base is included in a piece-rate plan, meaning that a worker would receive this base amount no matter what the output. Piecework is especially prevalent in the production/operations area. Piecework pay plans have declined in use somewhat because the plan requires constant monitoring. For instance, if on day one the worker produced 8 units and on day two the worker produced 12 units, each day must be counted separately. Also professionals such as industrial engineers are needed to maintain the system.
- Skill-based pay is a system that compensates employees for their job-related skills and knowledge, rather than the present job. Essentially, job descriptions, job evaluation plans, and job-based salary surveys are replaced by skill profiles, skill evaluation plans, and skill-based salary surveys. The system assumes that employees who know more are more valuable to the firm and, therefore, they deserve a reward for their efforts to acquire new skills. This presents some challenges for management because the firm must provide adequate training opportunities or else the system can become demotivating.
- Competency-based pay is a compensation plan that rewards employees for the capabilities they attain. It is a type of skill-based pay plan for professional and managerial employees. Today, there are many alternatives from which to choose—core, organizational, behavioral, and technical competencies. This approach requires that considerable time be spent determining the specific competencies needed for the different jobs. Blocks of competencies are then priced, and management must invest considerable time in developing, implementing, and continuing such a system.
- Seniority is the length of time an employee has been associated with the company, division, department, or job. Although management generally prefers performance as the primary basis for compensation changes, unions tend to favor seniority. They believe the use of seniority provides an objective and fair basis for pay increases. Many union leaders consider performance evaluation systems to be too subjective, permitting management to reward favorite employees arbitrarily.
- Regardless of the nature of the task, experience has the potential for enhancing a person’s ability to perform. However, this possibility materializes only if the experience acquired is positive. Knowledge of the basics is usually a prerequisite for effective use of a person’s experience. This is true for a person starting to play golf, learn a foreign language, or manage people in organizations. People who express pride in their many years of managerial experience may be justified in their sentiments, but only if their experience has been beneficial. Today, it is possible that experience is becoming somewhat irrelevant. In fact technology may have rendered experience useless unless the person with the experience has kept up with the technology available.
- Employees receive some compensation components without regard to the particular job they perform or their level of productivity. They receive them because they are members of the organization. For example, an average performer occupying a job in pay grade 1 may receive the same number of vacation days, the same amount of group life insurance, and the same reimbursement for educational expenses as a superior employee working in a job classified in pay grade 10. In fact, the worker in pay grade 1 may get more vacation time if he or she has been with the firm longer. The purpose of rewards based on organizational membership is to maintain a high degree of stability in the workforce and to recognize loyalty.
- Potential is useless if it is never realized. However, organizations do pay some individuals based on their potential. In order to attract talented young people to the firm, for example, the overall compensation program must appeal to those with no experience or any immediate ability to perform difficult tasks. Many young employees are paid well, perhaps not because of their ability to make an immediate contribution, but because they have the potential to add future value to the firm as a professional, first-line supervisor, manager of compensation, vice president of marketing, or possibly even chief executive officer.
- Firms should obviously try not to permit political influence to be a factor in determining financial compensation. However, to deny its existence would be unrealistic. There is an unfortunate element of truth in the statement, “It’s not what you know, it’s who you know.” To varying degrees in business, government, and not-for-profit organizations, a person’s pull or political influence may sway pay and promotion decisions. It may be natural for a manager to favor a friend or relative in granting a pay increase or promotion. Nevertheless, if the person receiving the reward is not deserving of it, the work group will soon know about it. The result will probably be devastating to employee morale.
- You have undoubtedly heard the expression, “It helps to be in the right place at the right time.” There is more than a little truth in this statement as it relates to compensation. Opportunities are continually presenting themselves in firms. Realistically, there is no way for managers to foresee many of the changes that occur. Experiences lend support to the idea that luck works primarily for the efficient
- Salary compression typically occurs when there is only a minimum pay differential with various skills and responsibility levels. Salary compression can cause people in jobs of less responsibility to make more than workers in jobs that have more responsible. Salary compression continues to be a major challenge for compensation managers even in a recession when pay cuts and freezes were the focus of the daily news. As workers discover inequities in their pay, resentment and lower productivity may follow with the employees ultimately leaving the company when the economy improves.
- Changing a firm’s compensation structure from an individual-based system to one that involves team-based pay can improve efficiency, productivity, and profitability. Team incentives have both advantages and disadvantages. On the positive side, firms find it easier to develop performance standards for groups than for individuals. A potential disadvantage for team incentives is that exemplary performers may feel unrecognized and under-rewarded.
- In sports, you do not judge the team based on one player, but on its overall win–loss record. In business, company-wide pay plans based on the firm’s productivity, cost savings, or profitability offer a possible alternative to the incentive plans previously discussed.
- Profit sharing is a compensation plan that results in the distribution of a predetermined percentage of the firm’s profits to employees. The three basic kinds of plans used today are as follows: Current plans provide payment to employees in cash or stock as soon as profits have been determined. Deferred plans involve placing company contributions in a trust that is available to the employee (or his or her survivors) at retirement, termination, or death. Combination plans permit employees to receive a partial share of profits on a current basis, while deferring payment of the rest. Normally, most full-time employees are included in a company’s profit-sharing plan after a specified waiting period. Vesting determines the amount of profit an employee owns in his or her account.
- Gainsharing plans are designed to bind employees to the firm’s productivity and to provide an incentive payment based on improved company performance. The goal of gainsharing is improving efficiency, reducing costs, and improving profitability. Gainsharing helps align employees with the organization’s strategy.
- The Scanlon plan provides a financial reward to employees for savings in labor costs resulting from their suggestions. Employee-management committees evaluate these suggestions. If the company is able to reduce payroll costs through increased operating efficiency, it shares the savings with its employees. Scanlon plans are not only financial incentive systems, but also systems for participative management that encourage cooperation between management and employees.
- Professional employees perform work requiring advanced knowledge in a field, normally acquired through a prolonged course of specialized instruction. Their pay, initially, is for the knowledge they bring to the organization. Gradually, however, some of this knowledge becomes obsolete. Maturity curves are used to reflect the relationship between professional compensation and years of experience. These curves are used primarily to establish rates of pay for scientists and engineers involved in technical work. Such maturity curves reveal a rapid increase in pay for roughly five to seven years, and then a more gradual rise as technical obsolescence erodes the value of these jobs.
- The straight salary approach is one extreme in sales compensation. In this method, salespersons receive a fixed salary regardless of their sales levels. At the other extreme is straight commission, in which the salesperson’s pay is entirely determined as a percentage of sales. If the salesperson working on straight commission makes no sales, this salesperson receives no pay. Between these extremes are endless varieties of part-salary, part-commission combinations.
- Contingent workers are employed through an employment agency or on an on-call basis and often earn less than traditional, permanent employees. Flexibility and lower costs for the employer are key reasons for the increased use of contingent workers. In most cases, contingents earn less pay and are far less likely to receive health or retirement benefits than their permanent counterparts.
- The say on pay provision gives shareholders in all but the smallest companies an advisory vote on executive pay, something governance advocates have long wanted. Those who support the concept of say-on-pay believe the vote will cause greater accountability on executive pay decisions. The Dodd-Frank Act requires 5,000 companies to hold nonbinding shareholder “say on pay” votes at least every three years. Companies must also hold shareholders votes on the frequency of say-on-pay with the option of one, two, or three years, or to abstain. Frequency votes are required to be held every six years.
- A golden parachute contract is a perquisite that protects executives in the event that another company acquires their firm or if the executive is forced to leave the firm for other reasons. To hire and retain talented individuals, some corporations negotiate employment agreements that include golden parachutes. At times golden parachute contracts have been abused. As an extreme example, CEO Robert Nardelli left Home Depot with a golden parachute worth $210 million even though Home Depot’s stock performed poorly. The Dodd-Frank Act has disclosure requirements for golden parachute arrangements between the companies and their executive officers. It requires a shareholder advisory vote on certain parachute arrangements where shareholder approval of the business combination itself is sought. Legally, a “no” vote has little effect because the vote is advisory, and the vote cannot bind a company or its board, to overrule any company or board decision or change or add to the company’s or Board’s duties. But from a shareholder relations viewpoint, the answer is more problematic. A “no” vote may indicate future shareholder involvement.
- A Clawback policy allows the company to recover compensation if a later review indicates that payments were not calculated accurately or performance goals were not met. The Dodd-Frank Act requires companies to develop Clawback policies to recover compensation later deemed excessive. The Clawback is a procedure included in an executive’s employment contract that allows the company to recover payments made through performance-based incentives under certain circumstances. It requires executives to return incentive pay if the results on which it was granted are later adjusted downward for any reason.
- The pay gap between the most affluent executives and the average worker has become enormous. It is difficult for workers who make $12 to $18 an hour to appreciate why these executives are making such outrageous salaries. On the other hand, the skills possessed by executives largely determine whether a firm will survive or fail. Thus, a company’s program for compensating executives is a critical factor in attracting and retaining the best available talent. Organizations typically tie salary growth for executives to market rates and overall corporate performance, including the firm’s market value.
- We will now review the basic elements of executive compensation.
- Although it may not represent the largest portion of the executive’s compensation package, the base salary provided is obviously important. It is a factor in determining the executive’s standard of living and may also determine the 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; therefore, most firms keep it below that amount. It is because of the million dollar deduction maximum that bonuses and performance-based pay have become so popular.
- As shareholders become increasingly disenchanted with the high levels of executive compensation for less-than-stellar accomplishments, performance-based pay is gaining in popularity. While the Dodd–Frank Act has influenced executive pay, it appears that the greater influence has been the initiative to link pay to performance. If pay for performance is appropriate for lower-level employees, should top executives be exempt from the same practice? The true superstars can still have huge earnings if their targets are met.
- Stock option plans give executives the option to buy a specified amount of stock in the future at or below the current market price. The stock option is a long-term incentive designed to integrate the interests of management with those of the organization. Stock options have lost some of their appeal because of accounting rule changes that require companies to expense these options as they are granted.
- Perquisites (perks) are any special benefits provided by a firm to a small group of key executives and designed to give the executives “something extra.” Possible executive’s perks might include a company-provided car, limousine service, and the use of company plane and yacht. The Securities and Exchange Commission has lowered the threshold for disclosure of executive perks from $50,000 to $10,000. Once-hidden information regarding perks must now be disclosed. Compensation committees are now focusing more on core incentives such as salaries, bonuses and long-term incentives, and cutting perks and severance pay. Perks such as having a corporate jet or yacht are things that upset the public and legislators.
- What most people may not understand is that massive severance payments are not set up by a board of directors after a CEO has quit or been fired. These payments were negotiated prior to being hired. Not only should CEO pay be considered but CEO pay contracts should also be examined. But hopefully the environment is changing. The Securities and Exchange Commission has adopted far-reaching executive compensation disclosure rules that apply to publicly traded companies. The new rules require companies to list all the agreements for each executive, to disclose the payment triggers, and, most importantly, to give an estimated dollar value of potential payments and benefits and the specific factors used to determine them. For the first time, investors will see the estimated total dollar value of the exit packages. No longer will these agreements become exposed only at the time of a merger and acquisition deal or when the board removes a CEO.
- The pay gap between the most affluent executives and the average worker in the U.S. remains wide. Earlier it was reported that the ratio between CEO and the average worker was 343 to 1. In yet another survey conducted by the Economic Policy Institute, Deloitte, Census Bureau, an American CEO’s paycheck is 475 times as large as that of the average worker’s. By contrast, the ratio is 50 in Venezuela, 22 in Britain, 20 in Canada, and 11 in Japan. Whereas people in the United States derive great status from high pay, nations in large parts of Europe and Asia shun conspicuous wealth.