6 Compensation Management

Compensation Management
1. Pay and Incentive Systems

2. Indirect Compensation: Employee Benefit Plans
Pay and Incentive Systems
Questions This Chapter Will Help Managers Answer
• How can we tie compensation strategy to general business

strategy?
• What economic and legal factors should we consider in
establishing pay levels for different jobs?
• What is the best way to develop pay systems that are
understandable, workable, and acceptable to employees at all
levels?
• How can we tie incentives to individual, team, or
organizationwide performance?
• In implementing a pay-for-performance system, what key
traps must we avoid to make the system work as planned?
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Changes in Company Philosophies Concerning Pay and Benefits
Increased willingness to:
• Reduce the size of the workforce

• Outsource jobs overseas
• Restrict pay to control the costs of wages, salaries, and benefits
Less concern with pay position relative to that of competitors

and more concern with what the company can afford
Implementation of programs to encourage and reward

performance
• Makes pay more variable
Organizational Reward System
Includes anything an employee values and desires that an

employer is able and willing to offer in exchange for employee
contributions
Compensation: Includes both financial and nonfinancial rewards
Should provide the following in order to be effective:
• Sufficient level of rewards to fulfill basic needs

• Equity with the external labor market and within the organization
• Treatment of each member of the organization in terms of his or
her individual needs
Dimensions of Equity in Pay Systems
Internal equity
• In terms of the relative worth of individual jobs to an organization,
are pay rates fair?
External equity
• Are the wages paid by an organization fair in terms of competitive
market rates outside the organization?
Individual equity
• Is each individual’s pay fair relative to that of other individuals doing
the same or similar jobs?
Bases for Determining Equitable Payment: Common Points in Theories
Employees perceive a fair return for what they contribute to

their jobs
Employees determine what their equitable return should be

after comparing their inputs and outcomes with those of their
peers or coworkers
• Better known as social comparison
Employees who perceive themselves to be in an inequitable

situation will seek to reduce that inequity
• May mentally distort their inputs or outcomes, directly alter their
inputs or outcomes, or leave the organization
Viewing Compensation from a Strategic Perspective: Firm’s Actions
• Compensation is recognized as a pivotal control and incentive

mechanism that can be used flexibly by management to attain
business objectives
• Pay system is made an integral part of strategy formulation
• Pay considerations are integrated into strategic decision-
making processes, such as those that involve planning and
control
• Firm’s performance is viewed as the ultimate criterion of the
success of strategic pay decisions and operational
compensation programs
Determinants of Pay Structure and Level
Labor market conditions
Legislation
Collective bargaining
• Affects the following key factors:
• The level of wages
• The behavior of workers in relevant labor markets
Managerial attitudes
An organization’s ability to pay
Purposes of Job Descriptions
Identify important characteristics of each job, so that the relative

worth of jobs can be determined
Help identify, define, and weight compensable factors

• Compensable factors: Common job characteristics that an
organization is willing to pay for, such as skill, effort, responsibility,
and working conditions
Job Evaluation
• Provides a work-related and business-related rationale to
support decisions about pay
• Objective: To rank jobs in terms of their relative worth to the
organization, so that an equitable rate of pay can be
determined for each job
• Different job evaluation methods yield different rank-orders of
jobs, and therefore different pay structures
Developing a Pay Structure: Rules of Thumb
• Jobs of the same general value should be clustered into the

same pay grade
• Jobs that clearly differ in value should be in different pay
grades
• There should be a smooth progression of point groupings
• New system should fit realistically into the existing allocation
of pay within a company
• Pay grades should conform reasonably well to pay patterns in
the relevant labor markets
Alternatives to Pay Systems Based on Job Evaluation
Market-based pay system

• Uses a direct market-pricing approach for all of a firm’s jobs
• Feasible if all jobs are benchmark jobs and direct matches can be
found in the market
• Benchmark jobs: Characterized by stable tasks and stable job
specifications
Competency-based pay system

• Workers are paid on the basis of their skills or on their depth of
knowledge, both of which are termed “competencies”
• In such learning environments, the more workers learn, the more
they earn
Incentives for Executives, 1
Companies, with a history of outperforming their rivals, have the

following characteristics:
• Long-term strategic view of their executives

• Stability in their executive groups
Elements of executive reward systems

• Base salary; annual, or short-term, incentives; long-term incentives;
employee benefits; and perquisites
Annual, or short-term, incentive plans

• Encourage the efficient use of existing assets
• Usually based on indicators of corporate performance
Incentives for Executives, 2
Long-term plans
• Encourage the development of new processes, plants, and products
that open new markets and restore old ones
• Designed to reward strategic gains rather than short-term
contributions to profits
• Examples
• Performance shares: Stock grants awarded for meeting goals
• Performance-accelerated shares: Stock that vests sooner if the
executive meets goals ahead of schedule
• Restricted stock: Common stock that vests after a specified period
• Restricted stock units: Shares awarded over time to defer taxes
Incentives for Lower-Level Employees
Employees’ pay is supplemented with additions related to

improvements in job performance
• Lump-sum bonus: Employees receive an end-of-year bonus that
does not build into base pay
• Spot bonus: Awarded if an employee’s performance has been
exceptional
Individual incentive plans have a baseline, or normal,

performance standard
• Productivity above this standard is rewarded
Performance Standards
Provide a relatively objective definition of the job
Give employees targets to shoot for
Make it easier for supervisors to assign work equitably
In setting performance standards for production work, the ideal

job should:
• Be highly repetitive
• Have a short job cycle
• Produce a clear, measurable output
Incentive System: Union Attitudes
• Incentive systems set up by unionized employers are subject
to negotiation through collective bargaining
• Unions may wish to participate in the day-to-day management
of the incentive system
• Union attitudes toward incentives vary with the type of
incentive offered
Team Incentives, 1
Appropriate when jobs are highly interrelated
Provide an opportunity for each team member to receive a

bonus based on the output of the team as a whole
Aim to increase productivity and improve morale
Advantages
• Make it possible to reward workers who provide essential services
to line workers
• Encourage cooperation, not competition, among workers
Team Incentives, 2
Disadvantages
• Competition between teams
• Inability of workers to see their individual contributions to the
output of the team
• Top performers who grow disenchanted with having to carry “free
riders”
Organization wide Incentives: Profit-Sharing
Paid out if a firm meets its profitability target
Reasons for use

• To provide a group incentive for increased productivity
• To provide retirement income for employees
• To institute a flexible reward structure that reflects a company’s
actual economic position
• To enhance employees’ security and identification with the
company
• To attract and retain workers more easily
• To educate individuals about the factors that underlie business
success and the capitalistic system
Organization wide Incentives: Gain-Sharing
Results-based program that links pay to performance at the

facility level
Comprises the following elements:
• Philosophy of cooperation
• Involvement system
• Financial bonus
Gain-Sharing versus Profit-Sharing
Gain-sharing Profit-sharing
• Based on a measure of • Based on a global profitability
productivity measure
• Frequent events, distributed • Annual measure and reward
monthly or quarterly
• Current distribution plan • Deferred payment
Key Terms, 2
• Consumer-driven health
plan, or C D H P
• Pension
• Vested
• Defined-benefit plans
• Defined-contribution plan
• Cash-balance plan
• Cost shifting
• Cafeteria benefits
• Flexible-spending accounts
• Money purchase plan

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Compensation Management

1. Pay and Incentive Systems

• How can we tie compensation strategy to general business

Increased willingness to:

• Reduce the size of the workforce

Less concern with pay position relative to that of competitors

Implementation of programs to encourage and reward

Includes anything an employee values and desires that an

Compensation: Includes both financial and nonfinancial rewards

Should provide the following in order to be effective:

• Sufficient level of rewards to fulfill basic needs

Employees perceive a fair return for what they contribute to

Employees determine what their equitable return should be

Employees who perceive themselves to be in an inequitable

• Compensation is recognized as a pivotal control and incentive

Labor market conditions

An organization’s ability to pay

Identify important characteristics of each job, so that the relative

Help identify, define, and weight compensable factors

• Jobs of the same general value should be clustered into the

Market-based pay system

Competency-based pay system

Companies, with a history of outperforming their rivals, have the

• Long-term strategic view of their executives

Elements of executive reward systems

Annual, or short-term, incentive plans

Employees’ pay is supplemented with additions related to

Individual incentive plans have a baseline, or normal,

Provide a relatively objective definition of the job

Give employees targets to shoot for

Make it easier for supervisors to assign work equitably

In setting performance standards for production work, the ideal

Appropriate when jobs are highly interrelated

Provide an opportunity for each team member to receive a

Aim to increase productivity and improve morale

Paid out if a firm meets its profitability target

Reasons for use

Results-based program that links pay to performance at the

Comprises the following elements:

• Current distribution plan • Deferred payment

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