Chapter 12 Compensation Strategies and Practices

Copyright © 2005 Thomson Business & Professional Publishing.
All rights reserved.
ROBERT L. MATHIS
JOHN H. JACKSON
PowerPoint Presentation by Charlie Cook
The University of West Alabama
Compensation StrategiesCompensation Strategies
and Practicesand Practices
Chapter 12Chapter 12
SECTION 4SECTION 4
CompensatingCompensating
Human ResourcesHuman Resources

Copyright © 2005 Thomson Business & Professional 12–2
Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives
• After you have read this chapter, you should be
able to:
Identify the two general types of compensation and
the components of each.
Discuss four issues of strategic compensation design.
List the basic provisions of the Fair Labor Standards
Act (FLSA).
Describe the two means of valuing jobs.
Outline the process of building a base pay system.
Explain two ways individual pay increases are
determined.

Nature of CompensationNature of CompensationNature of CompensationNature of Compensation
• Types of Rewards
Intrinsic
 Intangible, psychological and social effects of compensation
Extrinsic
 Tangible, monetary and nonmonetary effects of
compensation
• Types of Compensation
Direct compensation
 The employer exchanges monetary rewards for work done.
Indirect compensation
 Employer-provided benefits—like health insurance—that are
provide employees for being a member of the organization.

Components of a Compensation SystemComponents of a Compensation SystemComponents of a Compensation SystemComponents of a Compensation System
Figure 12–1

Direct CompensationDirect CompensationDirect CompensationDirect Compensation
Base PayBase PayBase PayBase Pay
SalarySalarySalarySalary
WagesWagesWagesWages
The basic monetary compensation that an employeeThe basic monetary compensation that an employee
receives, usually as a wage or salary.receives, usually as a wage or salary.
The basic monetary compensation that an employeeThe basic monetary compensation that an employee
receives, usually as a wage or salary.receives, usually as a wage or salary.
Payments calculated on the amount of time worked.Payments calculated on the amount of time worked.Payments calculated on the amount of time worked.Payments calculated on the amount of time worked.
Consistent payments made each period regardlessConsistent payments made each period regardless
of the number of hours worked in the period.of the number of hours worked in the period.
Consistent payments made each period regardlessConsistent payments made each period regardless
of the number of hours worked in the period.of the number of hours worked in the period.
VariableVariable
PayPay
VariableVariable
PayPay
Compensation linked to individual, team, orCompensation linked to individual, team, or
organizational performance.organizational performance.
Compensation linked to individual, team, orCompensation linked to individual, team, or
organizational performance.organizational performance.

Typical Division of HR Responsibilities: CompensationTypical Division of HR Responsibilities: CompensationTypical Division of HR Responsibilities: CompensationTypical Division of HR Responsibilities: Compensation
Figure 12–2

Strategic CompensationStrategic CompensationStrategic CompensationStrategic Compensation
• Objectives of a Strategically Supportive
Compensation System:
Legal compliance with all appropriate laws and
regulations
Cost effectiveness for the organization
Internal, external, and individual equity for employees
Performance enhancement for the organization

Compensation PhilosophiesCompensation PhilosophiesCompensation PhilosophiesCompensation Philosophies
• Entitlement Philosophy
Assumes that individuals who have worked another
year are entitled to pay increases, with little regard for
performance differences.
• Pay-for-Performance Philosophy
Requires that compensation changes reflect individual
performance differences.

Continuum of Compensation PhilosophiesContinuum of Compensation PhilosophiesContinuum of Compensation PhilosophiesContinuum of Compensation Philosophies
Figure 12–3

Compensation ApproachesCompensation ApproachesCompensation ApproachesCompensation Approaches
Figure 12–4

HR Metrics for CompensationHR Metrics for CompensationHR Metrics for CompensationHR Metrics for Compensation
Figure 12–5

Compensation System Design IssuesCompensation System Design IssuesCompensation System Design IssuesCompensation System Design Issues
ExpatriatesExpatriatesExpatriatesExpatriates
Host-CountryHost-Country
NationalsNationals
Host-CountryHost-Country
NationalsNationals
Third-CountryThird-Country
NationalsNationals
Third-CountryThird-Country
NationalsNationals
GlobalGlobal
CompensationCompensation
IssuesIssues
GlobalGlobal
IssuesIssues

Typical Components of Expatriate CompensationTypical Components of Expatriate CompensationTypical Components of Expatriate CompensationTypical Components of Expatriate Compensation
Figure 12–6

Global Compensation ApproachesGlobal Compensation ApproachesGlobal Compensation ApproachesGlobal Compensation Approaches
• Balance Sheet Approach
 Compensation plan that equalizes cost differences between
identical international and home-country assignments.
• Global Market Approach
 Compensation plan that attempts to be more comprehensive in
providing base pay, incentives, benefits, and relocation
expenses regardless of the country to which the employee is
assigned.
• Tax Equalization Plan
 Compensation plan used to protect expatriates from negative tax
consequences.

Compensation Quartile StrategiesCompensation Quartile StrategiesCompensation Quartile StrategiesCompensation Quartile Strategies
Figure 12–7

Market Competitiveness and CompensationMarket Competitiveness and CompensationMarket Competitiveness and CompensationMarket Competitiveness and Compensation
Lead theLead the
MarketMarket
Lead theLead the
MarketMarket
Lag theLag the
MarketMarket
Lag theLag the
MarketMarket
Meet theMeet the
MarketMarket
Meet theMeet the
MarketMarket
Paying for higher qualified, more productive workers.Paying for higher qualified, more productive workers.Paying for higher qualified, more productive workers.Paying for higher qualified, more productive workers.
Attempting to balance employer costs and the needAttempting to balance employer costs and the need
to attract and retain employees.to attract and retain employees.
Attempting to balance employer costs and the needAttempting to balance employer costs and the need
to attract and retain employees.to attract and retain employees.
Paying all that the firm can afford. Taking advantagePaying all that the firm can afford. Taking advantage
of the abundant supply of potential employees in aof the abundant supply of potential employees in a
loose labor market.loose labor market.
Paying all that the firm can afford. Taking advantagePaying all that the firm can afford. Taking advantage
of the abundant supply of potential employees in aof the abundant supply of potential employees in a
loose labor market.loose labor market.

Competency-Based PayCompetency-Based PayCompetency-Based PayCompetency-Based Pay
Maintenance of
Competencies
Maintenance of
Competencies
Limitations
(How many?)
Limitations
(How many?)
Pricing
Competencies
Pricing
Competencies
TrainingTraining
Competency-Competency-
Based PayBased Pay
SystemsSystems
KBP/SBPKBP/SBP
Competency-Competency-
Based PayBased Pay
SystemsSystems
KBP/SBPKBP/SBP

Individual vs. Team RewardsIndividual vs. Team RewardsIndividual vs. Team RewardsIndividual vs. Team Rewards
Distribute variable rewards at the team levelDistribute variable rewards at the team levelDistribute variable rewards at the team levelDistribute variable rewards at the team level
Make system simple and understandable.Make system simple and understandable.Make system simple and understandable.Make system simple and understandable.
Using Team-Based Reward SystemsUsing Team-Based Reward SystemsUsing Team-Based Reward SystemsUsing Team-Based Reward Systems
Use skill-based pay for the base.Use skill-based pay for the base.Use skill-based pay for the base.Use skill-based pay for the base.
Use variable pay based on business entity performanceUse variable pay based on business entity performanceUse variable pay based on business entity performanceUse variable pay based on business entity performance
Maintain a high degree of employee involvementMaintain a high degree of employee involvementMaintain a high degree of employee involvementMaintain a high degree of employee involvement

Perceptions of Pay FairnessPerceptions of Pay FairnessPerceptions of Pay FairnessPerceptions of Pay Fairness
EquityEquityEquityEquity
InternalInternal
EquityEquity
InternalInternal
EquityEquity
ExternalExternal
EquityEquity
ExternalExternal
EquityEquity
The perceived fairness between what a person doesThe perceived fairness between what a person does
(inputs) and what the person receives (outcomes).(inputs) and what the person receives (outcomes).
The perceived fairness between what a person doesThe perceived fairness between what a person does
(inputs) and what the person receives (outcomes).(inputs) and what the person receives (outcomes).
Employee compensation viewed as equitable in relation to theEmployee compensation viewed as equitable in relation to the
compensation of employees performing similar jobs in othercompensation of employees performing similar jobs in other
organizations.organizations.
Employee compensation viewed as equitable in relation to theEmployee compensation viewed as equitable in relation to the
compensation of employees performing similar jobs in othercompensation of employees performing similar jobs in other
organizations.organizations.
Employees receive compensation in relation to the knowledge,Employees receive compensation in relation to the knowledge,
skills, and abilities they use in their jobs as well as theirskills, and abilities they use in their jobs as well as their
responsibilities and accomplishments.responsibilities and accomplishments.
Employees receive compensation in relation to the knowledge,Employees receive compensation in relation to the knowledge,
skills, and abilities they use in their jobs as well as theirskills, and abilities they use in their jobs as well as their
responsibilities and accomplishments.responsibilities and accomplishments.
Procedural JusticeProcedural JusticeProcedural JusticeProcedural Justice Perceived fairness of the process and proceduresPerceived fairness of the process and procedures
used to make decisions about employees.used to make decisions about employees.
Perceived fairness of the process and proceduresPerceived fairness of the process and procedures
used to make decisions about employees.used to make decisions about employees.
Distributive JusticeDistributive JusticeDistributive JusticeDistributive Justice Perceived fairness in the distribution of outcomes.Perceived fairness in the distribution of outcomes.Perceived fairness in the distribution of outcomes.Perceived fairness in the distribution of outcomes.
Pay Openness/Pay Openness/
SecrecySecrecy
Pay Openness/Pay Openness/
SecrecySecrecy
The degree of openness or secrecy that an organizationThe degree of openness or secrecy that an organization
allows regarding its pay system.allows regarding its pay system.
The degree of openness or secrecy that an organizationThe degree of openness or secrecy that an organization
allows regarding its pay system.allows regarding its pay system.

Equity Considerations in CompensationEquity Considerations in CompensationEquity Considerations in CompensationEquity Considerations in Compensation
Figure 12–8

Fair Labor Standards Act (FSLA) of 1938Fair Labor Standards Act (FSLA) of 1938Fair Labor Standards Act (FSLA) of 1938Fair Labor Standards Act (FSLA) of 1938
Provisions of the ActProvisions of the ActProvisions of the ActProvisions of the Act
Minimum wage requirement sets wage floorMinimum wage requirement sets wage floorMinimum wage requirement sets wage floorMinimum wage requirement sets wage floor
Child labor (under 14 years old) is prohibitedChild labor (under 14 years old) is prohibitedChild labor (under 14 years old) is prohibitedChild labor (under 14 years old) is prohibited
Requires overtime payments for non-exempt employeesRequires overtime payments for non-exempt employeesRequires overtime payments for non-exempt employeesRequires overtime payments for non-exempt employees
Exempts highly-paid computer workersExempts highly-paid computer workersExempts highly-paid computer workersExempts highly-paid computer workers
Requires overtime (1Requires overtime (1½) pay for hours over 40 hours½) pay for hours over 40 hoursRequires overtime (1Requires overtime (1½) pay for hours over 40 hours½) pay for hours over 40 hours
Requires compensatory time at overtime (1Requires compensatory time at overtime (1½) pay rates½) pay ratesRequires compensatory time at overtime (1Requires compensatory time at overtime (1½) pay rates½) pay rates

FLSA Employee ClassificationsFLSA Employee ClassificationsFLSA Employee ClassificationsFLSA Employee Classifications
• Exempt Employees
Employees to whom employers are not required to
pay overtime under the Fair Labor Standards Act.
 Executives, administrators, professional (learned or creative)
employees, computer employees, outside sales persons
• Non-exempt Employees
Employees who must be paid overtime under the Fair
Labor Standards Act.
 Hourly
 Salaried non-exempt

FLSA Wage ProvisionsFLSA Wage ProvisionsFLSA Wage ProvisionsFLSA Wage Provisions
• Overtime
Non-exempt employees must be paid overtime pay
(one and one-half the regular pay rate) for all hours
worked over 40 regular hours in a workweek (168
hours—7days x 24 hours).
• Compensatory Time Off (Comp Time)
Hours off regular work time given to an employee in
lieu of payment for extra time worked.
 Compensatory hours off must be awarded at rate of one and
one-half times hours worked over 40 hours.

IRS Test for Employees and Independent ContractorsIRS Test for Employees and Independent ContractorsIRS Test for Employees and Independent ContractorsIRS Test for Employees and Independent Contractors
Figure 12–9Source: U.S. Internal Revenue Service, www.irs.gov.

Other Laws Affecting CompensationOther Laws Affecting CompensationOther Laws Affecting CompensationOther Laws Affecting Compensation
• Davis-Bacon Act of 1931
Required payment of “prevailing wage” by firms
engaged in federal construction projects.
• Walsh-Healy Public Contracts Act and the
McNamara-O’Hara Service Contract Act
Extended the payment of “prevailing wage” to service
contracts
Required overtime payment for any employee hours
worked over eight hours in one day; applies only to to
federal contracts, not the private sector.

Legislation on Equal Pay and Pay EquityLegislation on Equal Pay and Pay EquityLegislation on Equal Pay and Pay EquityLegislation on Equal Pay and Pay Equity
• Equal Pay Act of 1963
Requires that men and women be paid the same for
performing substantially similar jobs with limited non-
gender exceptions (e.g., merit and seniority).
• Pay Equity (or Comparable Worth)
Similarity in pay for all jobs requiring comparable level
of knowledge, skills, and abilities, even if actual duties
and market rates differ significantly.
• Garnishment
A court action in which a portion of an employee’s
wages is set aside to pay a debt owed a creditor.

AdministrationAdministration
ProcessProcess
AdministrationAdministration
ProcessProcess
Figure 12–10

Development of a Base Pay SystemDevelopment of a Base Pay SystemDevelopment of a Base Pay SystemDevelopment of a Base Pay System
• Job Evaluation
Formal, systematic means to identify the relative
worth of jobs within an organization.
Evaluating every job in the organization on:
 Knowledge, skills, and abilities required
 Nature of job tasks, duties, responsibilities, and
competencies
 Difficulty of the job, including the physical and mental
demands
• Compensable factor
Factor that identifies a job value commonly present
throughout a group of jobs.

Examples of Compensable FactorsExamples of Compensable Factors
for Different Job Familiesfor Different Job Families
Examples of Compensable FactorsExamples of Compensable Factors
for Different Job Familiesfor Different Job Families
Figure 12–11

Job EvaluationJob EvaluationJob EvaluationJob Evaluation
FactorFactor
ComparisonComparison
FactorFactor
ComparisonComparison
RankingRankingRankingRanking ClassificationClassificationClassificationClassification
PointPoint
MethodMethod
PointPoint
MethodMethod
JobJob
EvaluationEvaluation
MethodsMethods
JobJob
EvaluationEvaluation
MethodsMethods

Legal Issues and Job EvaluationLegal Issues and Job EvaluationLegal Issues and Job EvaluationLegal Issues and Job Evaluation
Americans with Disabilities ActAmericans with Disabilities Act
Job evaluations may not identify job functions related toJob evaluations may not identify job functions related to
physical demands as essentialphysical demands as essential
Americans with Disabilities ActAmericans with Disabilities Act
Job evaluations may not identify job functions related toJob evaluations may not identify job functions related to
physical demands as essentialphysical demands as essential
Gender IssuesGender Issues
Traditional job evaluations place less weight on knowledge,Traditional job evaluations place less weight on knowledge,
skills, and working conditions for female-dominated jobsskills, and working conditions for female-dominated jobs
Gender IssuesGender Issues
Traditional job evaluations place less weight on knowledge,Traditional job evaluations place less weight on knowledge,
skills, and working conditions for female-dominated jobsskills, and working conditions for female-dominated jobs
Job EvaluationJob EvaluationJob EvaluationJob Evaluation

Valuing Jobs Using Market PricingValuing Jobs Using Market PricingValuing Jobs Using Market PricingValuing Jobs Using Market Pricing
• Market Pricing
Use of pay survey data to identify the relative value of
jobs based on what other employers pay for similar
jobs.
• Advantages of Market Pricing
Ties organizational pay levels to what is actually
occurring in the market, without being distorted by
“internal” job evaluation.
Communicates to employees that the compensation
system is “market linked,” rather than distorted by
internal issues.

Valuing Jobs Using Market Pricing (cont’d)Valuing Jobs Using Market Pricing (cont’d)Valuing Jobs Using Market Pricing (cont’d)Valuing Jobs Using Market Pricing (cont’d)
• Disadvantages of Market Pricing
It relies on market survey data that is limited or may
have been gathered in methodologically sound ways.
The responsibilities of a specific job in a company
may be somewhat different from those of the
“matching” job identified in the survey.
The market data’s scope (range of sources) is
another concern.
Tying pay levels to market data can lead to wide
fluctuations based on market conditions.

Pay SurveysPay SurveysPay SurveysPay Surveys
• Pay Survey
Collection of data on compensation rates for workers
performing similar jobs in other organizations.
• Benchmark Jobs
Jobs found in many organizations.
• Internet-Based Pay Surveys
Pay survey questionnaires are distributed
electronically rather than as printed copies.

Using Pay SurveysUsing Pay SurveysUsing Pay SurveysUsing Pay Surveys
MethodologyMethodologyMethodologyMethodology
ParticipantsParticipantsParticipantsParticipants Broad-basedBroad-basedBroad-basedBroad-based
TimelinessTimelinessTimelinessTimelinessSurvey DataSurvey Data
RelevanceRelevance
Survey DataSurvey Data
RelevanceRelevanceJob MatchesJob MatchesJob MatchesJob Matches

Developing Pay SurveysDeveloping Pay SurveysDeveloping Pay SurveysDeveloping Pay Surveys
Select Employers with Comparable JobsSelect Employers with Comparable JobsSelect Employers with Comparable JobsSelect Employers with Comparable Jobs
Determine Jobs to be SurveyedDetermine Jobs to be SurveyedDetermine Jobs to be SurveyedDetermine Jobs to be Surveyed
Decide What Information Is NeededDecide What Information Is NeededDecide What Information Is NeededDecide What Information Is Needed
Conduct SurveyConduct SurveyConduct SurveyConduct Survey

Pay StructuresPay StructuresPay StructuresPay Structures
• Job Family
A group of jobs having common organizational
characteristics.
• Common Pay Structures
Hourly and salaried
Office, plant, technical, professional, managerial
Clerical, information technology, professional,
supervisory, management, and executive
• Pay Grades
Groupings of individual jobs having approximately the
same job worth.

EstablishingEstablishing
PayPay
StructuresStructures
EstablishingEstablishing
PayPay
StructuresStructures
Figure 12–12

Market-Banded Pay Grades for Community BankMarket-Banded Pay Grades for Community BankMarket-Banded Pay Grades for Community BankMarket-Banded Pay Grades for Community Bank
Figure 12–13
*Computed by averaging the pay survey summary data for the jobs in each pay grade.

Pay Structures (cont’d)Pay Structures (cont’d)Pay Structures (cont’d)Pay Structures (cont’d)
• Market Banding
Grouping jobs into pay grades based on similar
market survey amounts.
• Market Line
Graph line that shows the relationship between job
value as determined by job evaluation points and job
value as determined by pay survey rates.
Shows the distribution of pay for the surveyed jobs,
allowing a linear trend line to be developed by the
least-squares regression method.

Pay RangesPay RangesPay RangesPay Ranges
• Broadbanding
The practice of using fewer pay grades having
broader pay ranges that in traditional systems.
Benefits
 Encourages horizontal movement of employees
 Is consistent with trend towards flatter organizations
 Creates a more flexible organization
 Encourages competency development
 Emphasizes career development

Example ofExample of
Pay GradesPay Grades
and Payand Pay
RangesRanges
Example ofExample of
Pay GradesPay Grades
and Payand Pay
RangesRanges
Figure 12–14

Individual PayIndividual PayIndividual PayIndividual Pay
• Rates Out of Range
Red-Circled Employees
 An incumbent (current jobholder) who is paid above the
range set for the job.
Green-Circled Employees
 An incumbent who is paid below the range set for the job.
• Pay Compression
A situation in which pay differences among individuals
with different levels of experience and performance in
the organization becomes small.

Pay Adjustment MatrixPay Adjustment MatrixPay Adjustment MatrixPay Adjustment Matrix
• Compa-ratio
The pay level divided by the midpoint of the pay
range.
ratio)-(Compa110100
(midpoint)15.00
pay)(current$16.50
Employee =×=R
ratio)-(Compa87100
(midpoint)15.00
pay)(current$13.05
Employee =×=J

Pay Adjustment MatrixPay Adjustment MatrixPay Adjustment MatrixPay Adjustment Matrix
Figure 12–15

Determining Pay IncreasesDetermining Pay IncreasesDetermining Pay IncreasesDetermining Pay Increases
• Seniority
 Time spent in an organization or on a particular job that is used
to determine eligibility for organizational rewards and benefits.
• Cost-of-Living Adjustments (COLA)
 A percentage increase in wages to maintain real wages in a
period of economic inflation.
 Adjustments are tied to changes in an economic measure (e.g.,
the Consumer Price Index).
• Lump-Sum Increases (LSI)
 A one-time payment of all or part of a yearly pay increase that
does not increase base wages.

Chapter 12 Compensation Strategies and Practices

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