shrmn ch11

CHAPTER 11:

COMPENSATION

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Copyright © 2005 South-Western. All rights reserved. 1–2

Importance of CompensationImportance of CompensationImportance of CompensationImportance of Compensation

• Impacts employer’s ability to attract & retain Impacts employer’s ability to attract & retain employeesemployees

• Ensure optimal levels of employee performance in Ensure optimal levels of employee performance in meeting organization’s strategic objectivesmeeting organization’s strategic objectives

• Compensation’s componentsCompensation’s components– Direct compensation in wages or salaryDirect compensation in wages or salary

• Base pay (hourly, weekly, monthly)Base pay (hourly, weekly, monthly)

• Incentives (sales bonuses &/or commissions)Incentives (sales bonuses &/or commissions)

– Indirect compensation in form of benefitsIndirect compensation in form of benefits• Legally required benefits (e.g., Social Security)Legally required benefits (e.g., Social Security)

• Optional (e.g., group health benefits)Optional (e.g., group health benefits)

• Impacts employer’s ability to attract & retain Impacts employer’s ability to attract & retain employeesemployees

• Ensure optimal levels of employee performance in Ensure optimal levels of employee performance in meeting organization’s strategic objectivesmeeting organization’s strategic objectives

• Compensation’s componentsCompensation’s components– Direct compensation in wages or salaryDirect compensation in wages or salary

• Base pay (hourly, weekly, monthly)Base pay (hourly, weekly, monthly)

• Incentives (sales bonuses &/or commissions)Incentives (sales bonuses &/or commissions)

– Indirect compensation in form of benefitsIndirect compensation in form of benefits• Legally required benefits (e.g., Social Security)Legally required benefits (e.g., Social Security)

• Optional (e.g., group health benefits)Optional (e.g., group health benefits)


Exhibit 11-1Exhibit 11-1

Compensation SystemCompensation SystemExhibit 11-1Exhibit 11-1

Compensation SystemCompensation System


Internal EquityInternal EquityInternal EquityInternal Equity

• Fairness of pay differentials Fairness of pay differentials between different jobs in between different jobs in organization organization

• Established by job ranking, job Established by job ranking, job classification, point systems or classification, point systems or factor comparisonsfactor comparisons

• Fairness of pay differentials Fairness of pay differentials between different jobs in between different jobs in organization organization

• Established by job ranking, job Established by job ranking, job classification, point systems or classification, point systems or factor comparisonsfactor comparisons


External EquityExternal EquityExternal EquityExternal Equity

• Fairness of organizational Fairness of organizational compensation levels relative to compensation levels relative to external compensation external compensation

• Assessed by collecting wage & salary Assessed by collecting wage & salary information to guide in setting information to guide in setting organization’s pay strategy to lead, organization’s pay strategy to lead, meet or lag labor market wagesmeet or lag labor market wages

• Fairness of organizational Fairness of organizational compensation levels relative to compensation levels relative to external compensation external compensation

• Assessed by collecting wage & salary Assessed by collecting wage & salary information to guide in setting information to guide in setting organization’s pay strategy to lead, organization’s pay strategy to lead, meet or lag labor market wagesmeet or lag labor market wages


Individual EquityIndividual EquityIndividual EquityIndividual Equity

• Fairness about pay differentials among individuals Fairness about pay differentials among individuals in same job in same job

• Established by usingEstablished by using– Seniority-based pay systems: Reward longevity Seniority-based pay systems: Reward longevity – Merit-based pay systems: Reward employee performanceMerit-based pay systems: Reward employee performance– Incentive plans: Employees receive part of compensation Incentive plans: Employees receive part of compensation

based on performancebased on performance– Skills-based pay systems: Compensation based on Skills-based pay systems: Compensation based on

employees possessing skills that firm valuesemployees possessing skills that firm values– Team-based pay plans: Encourage cooperation & flexibilityTeam-based pay plans: Encourage cooperation & flexibility

• Fairness about pay differentials among individuals Fairness about pay differentials among individuals in same job in same job

• Established by usingEstablished by using– Seniority-based pay systems: Reward longevity Seniority-based pay systems: Reward longevity – Merit-based pay systems: Reward employee performanceMerit-based pay systems: Reward employee performance– Incentive plans: Employees receive part of compensation Incentive plans: Employees receive part of compensation

based on performancebased on performance– Skills-based pay systems: Compensation based on Skills-based pay systems: Compensation based on

employees possessing skills that firm valuesemployees possessing skills that firm values– Team-based pay plans: Encourage cooperation & flexibilityTeam-based pay plans: Encourage cooperation & flexibility



Equity TheoryEquity TheoryExhibit 11-2Exhibit 11-2

Equity TheoryEquity Theory



Equity & Work-Related OutcomesEquity & Work-Related OutcomesExhibit 11-3Exhibit 11-3

Equity & Work-Related OutcomesEquity & Work-Related Outcomes



Classification System Classification System – Federal Government– Federal Government


Classification System Classification System – Federal Government– Federal Government



Point System Point System MethodMethod


Point System Point System MethodMethod



Comparison of Job Evaluation MethodsComparison of Job Evaluation MethodsExhibit 11-7Exhibit 11-7

Comparison of Job Evaluation MethodsComparison of Job Evaluation Methods



• Collect wage & salary information to Collect wage & salary information to determine market wage ratesdetermine market wage rates

• Also consider other forms of compensationAlso consider other forms of compensation

• Determine pay strategy relative to marketDetermine pay strategy relative to market

• Collect wage & salary information to Collect wage & salary information to determine market wage ratesdetermine market wage rates

• Also consider other forms of compensationAlso consider other forms of compensation

• Determine pay strategy relative to marketDetermine pay strategy relative to market



• Lag policy Lag policy – Lower wages than Lower wages than

competitors, competitors, compensates employees compensates employees through other meansthrough other means

• Opportunity for Opportunity for advancementadvancement

• Incentive plansIncentive plans

• Good locationGood location

• Good working Good working conditionsconditions

• Employment securityEmployment security

• Lag policy Lag policy – Lower wages than Lower wages than

competitors, competitors, compensates employees compensates employees through other meansthrough other means

• Opportunity for Opportunity for advancementadvancement

• Incentive plansIncentive plans

• Good locationGood location

• Good working Good working conditionsconditions

• Employment securityEmployment security

• Market policy Market policy – Wages equal to Wages equal to

competitorscompetitors– Neutralizes pay as factorNeutralizes pay as factor

• Lead policyLead policy– Higher wages than Higher wages than

competitors to ensure competitors to ensure organization becomes organization becomes employer of choiceemployer of choice

• Market policy Market policy – Wages equal to Wages equal to

competitorscompetitors– Neutralizes pay as factorNeutralizes pay as factor

• Lead policyLead policy– Higher wages than Higher wages than

competitors to ensure competitors to ensure organization becomes organization becomes employer of choiceemployer of choice



• Basing pay on seniorityBasing pay on seniority• Merit pay systemsMerit pay systems• Incentive payIncentive pay

– Returns financial rewards to employees responsible for Returns financial rewards to employees responsible for creating themcreating them

– Allows organizations to adjust compensation expenses Allows organizations to adjust compensation expenses based on organization performancebased on organization performance

– Variety of formsVariety of forms– Tied to employee’s, work unit’s, or organization’s resultsTied to employee’s, work unit’s, or organization’s results

• Basing pay on seniorityBasing pay on seniority• Merit pay systemsMerit pay systems• Incentive payIncentive pay

– Returns financial rewards to employees responsible for Returns financial rewards to employees responsible for creating themcreating them

– Allows organizations to adjust compensation expenses Allows organizations to adjust compensation expenses based on organization performancebased on organization performance

– Variety of formsVariety of forms– Tied to employee’s, work unit’s, or organization’s resultsTied to employee’s, work unit’s, or organization’s results



• Skill-based pay systemsSkill-based pay systems– Base compensation on acquisition & mastery of Base compensation on acquisition & mastery of

skillsskills– Give employees incentives to learnGive employees incentives to learn– Promote flexibilityPromote flexibility– Easily linked with training programs & strategic Easily linked with training programs & strategic

needsneeds

• Skill-based pay systemsSkill-based pay systems– Base compensation on acquisition & mastery of Base compensation on acquisition & mastery of

skillsskills– Give employees incentives to learnGive employees incentives to learn– Promote flexibilityPromote flexibility– Easily linked with training programs & strategic Easily linked with training programs & strategic

needsneeds



• Team-based pay plansTeam-based pay plans– Can be less time-consuming than administering individual Can be less time-consuming than administering individual

reward systemsreward systems– May impact group dynamicsMay impact group dynamics– Can adversely impact & intensify conflictCan adversely impact & intensify conflict– Need decentralized decision-making systemNeed decentralized decision-making system– Need high level of communication with employeesNeed high level of communication with employees– Employees should have voice & provide input into designEmployees should have voice & provide input into design– Team members need to feel system is fair & equitableTeam members need to feel system is fair & equitable

• Team-based pay plansTeam-based pay plans– Can be less time-consuming than administering individual Can be less time-consuming than administering individual

reward systemsreward systems– May impact group dynamicsMay impact group dynamics– Can adversely impact & intensify conflictCan adversely impact & intensify conflict– Need decentralized decision-making systemNeed decentralized decision-making system– Need high level of communication with employeesNeed high level of communication with employees– Employees should have voice & provide input into designEmployees should have voice & provide input into design– Team members need to feel system is fair & equitableTeam members need to feel system is fair & equitable


Legal Issues in CompensationLegal Issues in CompensationLegal Issues in CompensationLegal Issues in Compensation

• Title VII of Civil Rights Act of 1964Title VII of Civil Rights Act of 1964– Protects workers rights to fair treatmentProtects workers rights to fair treatment

• Equal Pay Act of 1963Equal Pay Act of 1963– Requires equal pay for equal workRequires equal pay for equal work

• Comparable worthComparable worth– Argues that standards of equal pay for equal work should be Argues that standards of equal pay for equal work should be

replaced with doctrine of equal pay for equal valuereplaced with doctrine of equal pay for equal value– Objective, measurable data to support assessment of value Objective, measurable data to support assessment of value

of different jobs is lackingof different jobs is lacking– No basis in current law for arguments of comparable worthNo basis in current law for arguments of comparable worth

• Title VII of Civil Rights Act of 1964Title VII of Civil Rights Act of 1964– Protects workers rights to fair treatmentProtects workers rights to fair treatment

• Equal Pay Act of 1963Equal Pay Act of 1963– Requires equal pay for equal workRequires equal pay for equal work

• Comparable worthComparable worth– Argues that standards of equal pay for equal work should be Argues that standards of equal pay for equal work should be

replaced with doctrine of equal pay for equal valuereplaced with doctrine of equal pay for equal value– Objective, measurable data to support assessment of value Objective, measurable data to support assessment of value

of different jobs is lackingof different jobs is lacking– No basis in current law for arguments of comparable worthNo basis in current law for arguments of comparable worth


Legal Issues in CompensationLegal Issues in CompensationLegal Issues in CompensationLegal Issues in Compensation

• Fair Labor Standards Act of 1938Fair Labor Standards Act of 1938– Regulates minimum wageRegulates minimum wage– Sets overtime policy Sets overtime policy – Establishes exempt classes for managers & Establishes exempt classes for managers &

other professional employeesother professional employees

• Fair Labor Standards Act of 1938Fair Labor Standards Act of 1938– Regulates minimum wageRegulates minimum wage– Sets overtime policy Sets overtime policy – Establishes exempt classes for managers & Establishes exempt classes for managers &

other professional employeesother professional employees


Executive CompensationExecutive CompensationExecutive CompensationExecutive Compensation

• No real average or standardNo real average or standard

• Typical annual compensation for senior Typical annual compensation for senior executivesexecutives– 20% salary20% salary– 30% annual incentives30% annual incentives– 50% long-term incentives50% long-term incentives

• No real average or standardNo real average or standard

• Typical annual compensation for senior Typical annual compensation for senior executivesexecutives– 20% salary20% salary– 30% annual incentives30% annual incentives– 50% long-term incentives50% long-term incentives


Executive CompensationExecutive CompensationExecutive CompensationExecutive Compensation

• Stock Grants Stock Grants – Require organization meet specific financial goalsRequire organization meet specific financial goals

• Stock Options Stock Options – Provide opportunity to purchase shares at some future date, Provide opportunity to purchase shares at some future date,

at price determined when options are awardedat price determined when options are awarded– Focus employee attention on creating shareholder valueFocus employee attention on creating shareholder value– Do not have to be reported as expensesDo not have to be reported as expenses– Can create culture obsessed with improving stock Can create culture obsessed with improving stock

performance at expense of other concernsperformance at expense of other concerns– Can prompt executives to engage in creative accounting Can prompt executives to engage in creative accounting

practicespractices

• Stock Grants Stock Grants – Require organization meet specific financial goalsRequire organization meet specific financial goals

• Stock Options Stock Options – Provide opportunity to purchase shares at some future date, Provide opportunity to purchase shares at some future date,

at price determined when options are awardedat price determined when options are awarded– Focus employee attention on creating shareholder valueFocus employee attention on creating shareholder value– Do not have to be reported as expensesDo not have to be reported as expenses– Can create culture obsessed with improving stock Can create culture obsessed with improving stock

performance at expense of other concernsperformance at expense of other concerns– Can prompt executives to engage in creative accounting Can prompt executives to engage in creative accounting

practicespractices


Key Strategic Issues in Key Strategic Issues in CompensationCompensation

Key Strategic Issues in Key Strategic Issues in CompensationCompensation

• Determining compensation relative to marketDetermining compensation relative to market• Balance between fixed & variable compensationBalance between fixed & variable compensation• Deciding whether or not to utilize team-based Deciding whether or not to utilize team-based

versus individual payversus individual pay• Creating appropriate mix of financial & non-Creating appropriate mix of financial & non-

financial compensationfinancial compensation• Developing cost-effective compensation program Developing cost-effective compensation program

resulting in high performanceresulting in high performance

• Determining compensation relative to marketDetermining compensation relative to market• Balance between fixed & variable compensationBalance between fixed & variable compensation• Deciding whether or not to utilize team-based Deciding whether or not to utilize team-based

versus individual payversus individual pay• Creating appropriate mix of financial & non-Creating appropriate mix of financial & non-

financial compensationfinancial compensation• Developing cost-effective compensation program Developing cost-effective compensation program

resulting in high performanceresulting in high performance


Reading 11.1Reading 11.1

Compensating TeamsCompensating TeamsReading 11.1Reading 11.1

Compensating TeamsCompensating Teams

• Reasons for tailoring compensation to Reasons for tailoring compensation to individualsindividuals– Motivation comes from within individual as opposed Motivation comes from within individual as opposed

to groupto group– Development of skills & behaviors is individual Development of skills & behaviors is individual

undertakingundertaking– Fairness in dealing with teams does not mean equal Fairness in dealing with teams does not mean equal

pay for allpay for all– Team compensation is not payoff but means of Team compensation is not payoff but means of

nurturing behavior that benefits teamnurturing behavior that benefits team

• Reasons for tailoring compensation to Reasons for tailoring compensation to individualsindividuals– Motivation comes from within individual as opposed Motivation comes from within individual as opposed

to groupto group– Development of skills & behaviors is individual Development of skills & behaviors is individual

undertakingundertaking– Fairness in dealing with teams does not mean equal Fairness in dealing with teams does not mean equal

pay for allpay for all– Team compensation is not payoff but means of Team compensation is not payoff but means of

nurturing behavior that benefits teamnurturing behavior that benefits team





• Look for ways to add on incentives & recognition Look for ways to add on incentives & recognition for team participationfor team participation

• Reward behaviors & activities rather than resultsReward behaviors & activities rather than results• Other ways of saying “thank you” constitute best Other ways of saying “thank you” constitute best

incentive over long runincentive over long run– Nonmonetary recognitionNonmonetary recognition– Gifts of appreciation after factGifts of appreciation after fact

• Be careful about anything that may be viewed as Be careful about anything that may be viewed as “buying”“buying”

• Look for ways to add on incentives & recognition Look for ways to add on incentives & recognition for team participationfor team participation

• Reward behaviors & activities rather than resultsReward behaviors & activities rather than results• Other ways of saying “thank you” constitute best Other ways of saying “thank you” constitute best

incentive over long runincentive over long run– Nonmonetary recognitionNonmonetary recognition– Gifts of appreciation after factGifts of appreciation after fact

• Be careful about anything that may be viewed as Be careful about anything that may be viewed as “buying”“buying”





• Management often overlooks powerful Management often overlooks powerful intrinsic rewards that come from intrinsic rewards that come from – Team participation Team participation – Being part of corporate decision-making processBeing part of corporate decision-making process

• Let team decide who gets what from Let team decide who gets what from awards basketawards basket

• Management often overlooks powerful Management often overlooks powerful intrinsic rewards that come from intrinsic rewards that come from – Team participation Team participation – Being part of corporate decision-making processBeing part of corporate decision-making process

• Let team decide who gets what from Let team decide who gets what from awards basketawards basket



Executive Compensation: New Executive Compensation: New PerspectivesPerspectives



• CEOs in larger firms generally earn CEOs in larger firms generally earn moremore

• Mixed empirical evidence on Mixed empirical evidence on relationship between executive relationship between executive compensation & firm performancecompensation & firm performance

• CEOs in larger firms generally earn CEOs in larger firms generally earn moremore

• Mixed empirical evidence on Mixed empirical evidence on relationship between executive relationship between executive compensation & firm performancecompensation & firm performance






• Classifications of firm strategy:Classifications of firm strategy:– Prospector firms emphasize long-term incentivesProspector firms emphasize long-term incentives– Defender firms are more likely to emphasize fixed payDefender firms are more likely to emphasize fixed pay– AnalyzerAnalyzer– ReactorReactor

• Significant relationship between organizational Significant relationship between organizational strategy & executive compensationstrategy & executive compensation

• Firm size continues to be major determinant of Firm size continues to be major determinant of executive compensationexecutive compensation

• Classifications of firm strategy:Classifications of firm strategy:– Prospector firms emphasize long-term incentivesProspector firms emphasize long-term incentives– Defender firms are more likely to emphasize fixed payDefender firms are more likely to emphasize fixed pay– AnalyzerAnalyzer– ReactorReactor

• Significant relationship between organizational Significant relationship between organizational strategy & executive compensationstrategy & executive compensation

• Firm size continues to be major determinant of Firm size continues to be major determinant of executive compensationexecutive compensation






• Earnings per share is significant predictor Earnings per share is significant predictor of short-term executive compensation of short-term executive compensation earned as annual bonusesearned as annual bonuses

• Predictors of long-term executive Predictors of long-term executive compensation earned through stock option compensation earned through stock option exercise exercise – Share price growthShare price growth– Return on stocksReturn on stocks– Market measures of firm performanceMarket measures of firm performance

• Earnings per share is significant predictor Earnings per share is significant predictor of short-term executive compensation of short-term executive compensation earned as annual bonusesearned as annual bonuses

• Predictors of long-term executive Predictors of long-term executive compensation earned through stock option compensation earned through stock option exercise exercise – Share price growthShare price growth– Return on stocksReturn on stocks– Market measures of firm performanceMarket measures of firm performance


Reading 11.3:Reading 11.3:New Thinking for New MillenniumNew Thinking for New Millennium

Reading 11.3:Reading 11.3:New Thinking for New MillenniumNew Thinking for New Millennium

• Strategic approaches to make compensation Strategic approaches to make compensation systems more effectivesystems more effective

– Pay personPay person for individual worth (knowledge, skills and for individual worth (knowledge, skills and competencies) rather than for value of job they perform competencies) rather than for value of job they perform

– Reward excellenceReward excellence through pay for performance through pay for performance compensation that establishes clear relationship between compensation that establishes clear relationship between significant amount of pay & attainment of organizational significant amount of pay & attainment of organizational objectivesobjectives

– Individualize pay systemIndividualize pay system to give employees choices in how to give employees choices in how they are rewarded & what reward they receivethey are rewarded & what reward they receive

• Strategic approaches to make compensation Strategic approaches to make compensation systems more effectivesystems more effective

– Pay personPay person for individual worth (knowledge, skills and for individual worth (knowledge, skills and competencies) rather than for value of job they perform competencies) rather than for value of job they perform

– Reward excellenceReward excellence through pay for performance through pay for performance compensation that establishes clear relationship between compensation that establishes clear relationship between significant amount of pay & attainment of organizational significant amount of pay & attainment of organizational objectivesobjectives

– Individualize pay systemIndividualize pay system to give employees choices in how to give employees choices in how they are rewarded & what reward they receivethey are rewarded & what reward they receive

shrmn ch11

Leadership & Management