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PAY STRUCTURE DECISIONS

Learning Objectives
1. List the major decision areas and concepts in employee compensation management. 2. Describe the major administrative tools used to manage employee compensation. 3. Explain the importance of competitive labor-market and product-market forces in compensation decisions. 4. Explain the importance of process issues such as communication in compensation management. 5. Explain where the United States stands from an international perspective on pay issues. 6. Explain the reasons for the controversy over executive pay. 7. Describe the regulatory framework for employee compensation. I. IntroductionPay, of course, has a strong impact on employees standard of living. Pay is a symbol of status and success as well as important as a comparison to others. A. From the employers point of view, pay is critical in attaining strategic goals. 1. Pay has a major impact on employee attitudes and behaviors. 2. Employee compensation is typically a significant organizational cost. B. Pay decisions can be broken into two major areas: Pay Structure and Individual Pay. 1. Pay structure is composed of considerations related to both pay level and job structure. 2. Pay level is the average pay in organizations, excluding benefits. 3. Job structure is the relative pay of jobs in organizations (i.e., the range of pay often expressed by salary grades). 4. Pay policies are attached to jobs, not individuals, in order to make the process more manageable and equitable. II. Equity Theory and Fairness A. Equity theory describes a process in which people evaluate the fairness of their pay by comparing their pay to that of other people. 1. A person will compare his or her ratio of perceived outcomes (e.g., pay, benefits, etc.) to perceived inputs (e.g., education, effort, experience) to the ratio of a comparison other. 2. If the persons ratio is higher, research suggests that rationalization will occur to account for the perceived overpayment. If the comparison others ratio is higher, the person may attempt to restore equity by reducing ones inputs (e.g., working less), increasing ones outcomes (e.g., asking for a raise), or leaving the company.

3. Three types of employee social comparisons of pay are especially relevant in making pay-level and job structure decisions. a. Employees make external equity pay comparisons, which focus on what other organizations pay for roughly the same job. These comparisons influence decisions to join and remain in the organization. A market-pay survey is used by organizations to examine the level of other organizations pay. b. Internal equity pay comparisons focus on what employees within the same organization, but in different jobs, are paid. c. Employees make internal equity pay comparisons with others performing the same job. III. Developing Pay Levels A. Market pressures that create competitive market challenges are: 1. Product-market competition, which is the challenge to sell goods and services at a quantity and price that will bring a return on investment. An organization that has higher labor costs than its competitors will have to charge higher prices for products of similar quality. This will likely lead to a loss of sales to the competition. Product-market competition places an upper bound on labor costs and compensation, although productivity differences are also important. Labor costs are the average cost per employee (direct pay and indirect compensation, such as benefits) and staffing level (number of employees). Financially troubled organizations tend to focus cuts on one or both of these. 2. Labor-market competition is the amount an organization must pay to compete against other organizations that hire similar employees. Usually these are companies with similar products and those that hire similar employees. If an organization is not competitive, it will fail to attract and retain sufficient numbers of high-quality employees. Labor-market competition places a lower bound on pay levels. B. Employees as a resource is a philosophy that considers employees to be an investment that will yield valuable returns. Controlling costs through noncompetitive pay can result in low employee productivity and quality. If you pay higher than the market, this is not bad as long as productivity is also higher. Therefore, pay policies must be evaluated, not only in terms of costs, but also the returnshow they attract, retain, and motivate a high-quality work force. C. Deciding what to pay is discretionary, with a broad range. The organization has to decide whether to pay at, below, or above the market. According to efficiency wage theory, the benefits of higher wages may outweigh higher costs when the organizations technology or structure depends on highly skilled employees or when the organization has difficulty observing and monitoring employee performance. The idea with the latter is that with higher pay, employees will feel less willing to shirk.

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Benchmarking is a procedure by which an organization compares its own practices against those of the competition. Benchmarking in this situation is done by pay surveys that provide information on the going rates of pay of the competition. The following issues must be determined before pay surveys are used: a. Which employers should be included as key labor-market and productmarket competitors? b. Which jobs should be included that are representative of levels, functional areas, and product market? c. If multiple surveys are used, how are all the rates of pay weighted and combined? d. Product-market comparisons will be more important when labor costs represent a large share of total costs, product demand is elastic (it changes in response to product price changes), the supply of labor is inelastic, and employee skills are specific to the product market. e. Labor-market comparisons will be more important when attracting and retaining employees is difficult and the costs of recruiting are high. f. As well as knowing what other organizations are paying, it is necessary to know what those organizations are getting in return for their investment in employees. Ratios such as revenues to employees or revenues to labor cost could be used.

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Rate ranges define the minimum, midpoint, and maximum rates of pay for jobs. Often, the midpoint is the market rate. Ranges are used so that individual differences in seniority and performance can be compensated differently. Ranges are used more often for white-collar jobs and less for blue-collar jobs that are unionized. Key jobs and nonkey jobsKey jobs are benchmark jobs that have relatively stable content and are common to many organizations so that market-pay survey data can be obtained. Nonkey jobs are unique to organizations and cannot be compared through the use of market surveys.

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Developing a Job StructureA job structure defines the relative worth of various jobs in the organization, based on internal comparisons. A. Job evaluation is an administrative procedure that measures a jobs worth to the organization. 1. The evaluation process is composed of compensable factors, which are the characteristics of jobs that an organization values and chooses to pay for. Examples include job complexity, working conditions, education and/or experience, and responsibility. Typically, committees are formed to do job evaluations and they use the information from job analyses. Several compensable factors are used.

2. The point-factor system is the most widely used variety of job evaluation. With this system weighted scores are generated for all compensable factors to account for the differing importance of the factors to the organization. Either a priority weight can be assigned using expert judgment about the importance of each factor or weights can be derived statistically by how important each factor seems to be in determining labor-market pay. B. Developing a pay structure includes examining and balancing both internal and external comparisons. There are significant differences in employers in terms of whether they place priority on internal or external comparisons (Table 11.4 indicates an example of both types of data for 15 jobs). Following are three pay-setting approaches: 1. The approach with the greatest emphasis on external comparisons (i.e., marketsurvey data) is achieved by directly basing pay on market surveys that cover as many key jobs as possible. A pay-policy line is generated based on key jobs; the data are plotted using a statistical (regression analysis) procedure with both internal and external data. It is not necessary to fit a straight line to the data, and nonlinearity may be appropriate if higher-level jobs are especially valuable to the organization. The second pay-setting approach combines information from internal and external comparisons to derive pay rates for both key and nonkey jobs; however, actual market rates are not used for key jobs. There is more internal consistency with this technique since pay is directly linked to job-evaluation points. The third approach is to group jobs into a smaller number of pay grades. Each job with a grade would have the same minimum, midpoint, and maximum. The advantage is that separate rates of pay for all jobs do not exist, and it permits moving employees into other jobs in the same grade without necessarily adjusting pay. The range spread (the distance between the minimum and maximum) is larger at higher levels, since these jobs are more likely to demonstrate wide performance differences and can have more of an impact on the organization. Disadvantages of using grades are that some jobs may be underpaid while others may be overpaid.

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C. Conflicts between market-pay surveys and job evaluation are typically indicated by jobs whose average pay is either below or above the pay-policy line by a significant amount. These discrepancies are likely related to market supply and demand. 1. In resolving the conflict, emphasizing the internal data would create a situation of overpaying jobs that are paid less in the market, which drives up labor costs (and creates product-market problems). If the job pays more in the market, using internal data may make it difficult to attract and retain employees (labor-market problems). 2. If external market data are emphasized and a job is paid lower internally, the comparisons that employees make internally would result in dissatisfaction. If a job is paid more than similar-level internal jobs, it makes it difficult for internal movement, since other internally equivalent jobs will be seen as a demotion.

3. There are no right answers. An organization should consider its strategy and what jobs and/or functions will be critical for success. The usual approach, however, is driven by a perception that external equity are critical because of increasing market competition. D. Monitoring Compensation CostsThe pay structure represents policy, but practice may not always coincide. One way to examine the difference between policy and practice is to compute a compa-ratio, which is the actual average pay for grade/midpoint pay for grade. A compa-ratio of less than one suggests that actual pay is lagging behind policy; if it is more than one, it indicates that pay and costs exceed policy . E. Globalization, Geographic Region, and Pay StructuresPay structures can differ substantially across countries both in terms of their level and in terms of the relative worth of jobs. Typically, expatriate pay and benefits continue to be linked more closely to the home country. However, this link appears to be slowly weakening and now depends more on the nature and length of the assignment. V. The Importance of Process: Communication and ParticipationSince pay decisions might be viewed in different ways by different groups in the organization and technology rarely provides a right answer, how decisions are made and communicated is critical. A. Participation should involve both those who will manage the process and those who will be affected by it (HR staff and line managers). Usually, participation comes in recommending, designing, and communicating a pay program. Typically, pay-level decisions are only made by top management. B. CommunicationThe consequences of not communicating effectively are described in a study in which a group that received pay cuts, but to which was communicated adequate information and remorse, engaged in significantly less theft after the pay cut than a group to whom communication was inadequate. The effect of communication is likely to be an impact on employees perceptions of equity. Managers must be prepared to explain to employees why the pay structure is designed the way it is and to judge whether employee concerns about the structure need to be addressed with changes to the structure. VI. Current Challenges A. Although most commonly used, job-based pay structures can create the following problems: 1. They create bureaucracy, which can encourage a lack of flexibility in employees who perceive that they should only do what is in their job descriptions. 2. They reinforce top-down decision making as well as status differentials. 3. The bureaucracy, time, and cost required to generate and update job descriptions can become a barrier to change. 4. The job-based structure may not reward desired behaviors, where the knowledge, skills, and abilities needed yesterday may not be helpful today and tomorrow.

5. The system encourages promotion-seeking behavior, but discourages lateral movement. B. Responses to problems with job-based pay structures include the following: 1. Delayering is reducing the number of job levels. This provides more flexibility in job assignments and assigning merit increases. Banding is combining several job levels into fewer job levels. There is a reduced opportunity for promotion with delayering and banding, although there are increased opportunities for training, responsibility, and pay tied to seniority or performance. 2. A second response to job-based pay structure problems has been to move away from linking pay to jobs and toward building structures on skill, knowledge, and competency. Competency-based pay is similar but usually refers to a plan that covers exempt employees (e.g., managers). a. Skill-based pay typically pays individuals for the skills they are capable of using rather than for the job they are performing at a point in time. For example, workers will not only operate a machine but take responsibility for quality control, troubleshooting, and maintenance. b. Advantages are that flexibility helps promote lower staffing levels and aids in situations where the manufacturing process demands adaptable and flexible responses (e.g., flexible manufacturing, just-in-time systems). It has also been suggested that skill-based plans contribute to a climate of learning and adaptability and give employees a broader view of how the organization functions. c. Potential disadvantages are that the organization may find it difficult to use all skills effectively (i.e., work design must also change), employees may acquire skills quickly and compensation tops out, and skill-based plans may require a larger bureaucracy (related to skills definition and measurement, training, and certification). Lastly, there is almost no market information available on how to price skills. VII. Can the U.S. Labor Force Compete? The costs for labor are high in the United States, particularly in comparison to newly industrialized and developing countries. There are several factors to consider in shifting production to other countries: A. Relative labor costs are very unstable over time because of fluctuations in currency exchange rates. B. The quality and productivity of national labor forces can vary dramatically. Lower labor costs may reflect the lower average skill level of the labor force. C. In terms of comparative productivity, unit labor costs, and gross domestic product per person, the United States is the highest in the world. D. Nonlabor ConsiderationsOperating costs may be high enough to compensate for lower labor costs. Also, product development and customer response may be faster

when manufacturing is closer to staff groups. The discussion below provides some other considerations. VIII. Executive pay has been given widespread attention in the press. However, executive pay accounts for a small proportion of the labor costs of an organization, and executives have a disproportionate ability to influence organizational performance. They also help set the culture, so if their pay seems unrelated to organizational performance, employees may not understand why their pay should be at risk depending on the organizations performance. A. Some executives are very highly paid, such as the CEO of Walt Disney over $600 million. However, these figures reflect participation in a stock plan. B. Executives in the United States are the best paid in the world. C. Often, the ratio of executive pay to average worker pay is cited as creating a trust gap in which workers do not trust executives intentions and resent their pay. The issue becomes even more salient when companies are engaging in layoffs but are not cutting executive pay. IX. Government Regulation of Employee Compensation A. Equal Employment Opportunity (EEO) (Title VII) prohibits discrimination in all employment outcomes, including pay, unless business necessity can be proven. Two trends related to EEO are the increasing participation of women and nonwhites in the labor force. 1. The proportion of wages that women earn compared to men was 75 percent in 1997, and black to white earnings was 77 percent. There are legitimate explanations such as education, experience, and occupation, although even when these are controlled, differences remain. 2. Although the rates have risen in recent years, in the case of women, the gap may be related to the fact that womens work may be undervalued. Another hypothesis is related to crowding, which argues that women have been restricted to entering only a few (low-paid) occupations. 3. Comparable worth (or pay equity) is a public policy that advocates remedies for any underevaluation of womens jobs. The idea of comparable worth is not just to pay equivalently for equal work (this is mandated by the Equal Pay Act of 1963), but also to pay equivalently for jobs of equivalent worth. a. Typically, comparable worth becomes an issue when comparisons between internal (job evaluation) and external (market surveys) data suggest that there is conflict in which jobs predominantly occupied by women are evaluated more highly internally than in terms of the market data.

b. One problem is that job evaluation is most often used to help apply marketpay policy and not replace the market. There is also concern that EEO regulations will attempt to replace market forces (although there are no regulations related to comparable worth) and that using only internal

comparisons would result in overpayment and underpayment in several instances in relationship to the market, which would create a market disadvantage. c. More than half of the states have begun or completed comparable-worth adjustments to public-sector employees pay, and in 1988, the Canadian province of Ontario mandated comparable worth in both the private and public sectors. d. Another approach has been to suggest that organizations should examine, when womens pay falls behind that of men, entry and access to promotions, and so on. Programs such as mentoring might improve the ability of women to access higher-level jobs. B. Minimum Wage, Overtime, and Prevailing Wage Laws 1. The Fair Labor Standards Act (FLSA) of 1938 established a minimum wage that was raised to $5.15 an hour. It also requires that employees be paid one and one-half their wage rate when they work overtime, more than 40 hours a week. If the employer knows the employee is working overtime but neither stops the overtime nor pays time and a half, a violation of FLSA could have occurred. Executive, professional, administrative, and outside sales are exempt from FLSA coverage (the estimate is that about 20 percent of jobs fall in this category). Nonexempt occupations include most hourly jobs. 2. The Davis-Bacon Act (1931) and Walsh-Healy Public Contracts Act (1936) require federal contractors to pay employees no less than the prevailing wages in the area. The prevailing wage is set by the Secretary of Labor and is greatly influenced by relevant union contracts in the area. Chapter Vocabulary: Pay Structure, Pay Level, Job Structure, Equity Theory, Product-Market Competition, Labor-Market Competition, Efficiency Wage Theory, Benchmarking, Pay Surveys, Rate Ranges, Key Jobs, Nonkey Jobs, Job Structure, Job Evaluation, Compensable Factors, Point-Factor System, Pay-Policy Line, Pay Grades, Range Spread, Compa-Ratio, Delayering, Banding, Skill-based Pay, Comparable Worth, Fair Labor Standards Act (FLSA), Minimum Wage, Exempt, Nonexempt

Recognizing Employee Contributions with Pay


Learning Objectives
After studying this chapter, the student should be able to: 1. Describe the fundamental pay programs for recognizing employees contributions to the organizations success. 2. List the advantages and disadvantages of the pay programs. 3. List the major factors to consider in matching the pay strategy to the organizations strategy.

4. Explain the importance of process issues such as communication in compensation management. 5. Describe how U.S. pay practices compare with those of other countries. I. IntroductionTypically, individuals working in an organization and having the same job do not receive the same rate of pay (unless there is a single-rate system, as in many unionized environments). Differences in performance (by an individual, group, or the organization), seniority, or skills determine the pay. In determining a pay program relative to individual reward, an employer must consider the cost, expected return on employee motivation, and whether the incentive plan fits with the overall human resource strategy. How Does Pay Influence Individual Employees? Besides the equity theory, described in the previous chapter, there are other theories that influence compensations effects. A. Reinforcement TheoryIn Thorndikes Law of Effect, a response followed by a reward is more likely to recur in the future. The importance of a persons actual experience in receiving the reward is critical. If high performance is followed by a reward, high performance is likely to be repeated. B. Expectancy TheoryCompensation has an impact mostly on instrumentality, the perceived link between performance and pay. C. Agency TheoryThis theory focuses on divergent interests and goals of the organizations stakeholders and the ways that compensation can be used to align these interests and goals. Today, most stockholders are removed from the day-to-day operations of the organization. This separation has many advantages, but it also creates coststhe interests of the principals (owners) and their agents (managers) may not converge. Agency costs are as follows: 1. Management may be spending money on perquisites (e.g., executive perks) or empire building (enhancing the image or power of the executive without adding value to the business). 2. Managers are more averse to risk since they cannot diversify their holdings as shareholders can. 3. Decision-making horizons may differ, since managers will likely emphasize short-term gains to ensure promotion and visibility, perhaps at the cost of longterm success. 4. Agency costs may be minimized by the principal choosing a contracting scheme that helps align the interests of the agent with the interests of the principals. These approaches can be behavior oriented (e.g., merit pay) or outcome oriented (e.g., stock options, profit sharing, commissions). Outcome-oriented approaches link the rewards of the organization and individual. However, agents are often risk-aversive and may demand a compensating wage differential. Behaviororiented contracts do not transfer risk and therefore do not require a compensating wage differential. Deciding what to use is based on the following: (a) Risk aversion among agents makes outcome-oriented contracts less likely.

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(b) Outcome UncertaintyIf risks are high for desired outcomes, such as profits, agents will be less willing to have outcome-oriented contracts. (c) Job ProgrammabilityAs jobs become less programmable (i.e., less routine) outcome-oriented contracts are more likely. (d) Measurable Job OutcomesWhen outcomes are more measurable, outcomeoriented contracts are more likely. (e) Ability to PayOutcome-oriented contracts compensation costs because of the risk premium. contribute to higher

(f) TraditionA tradition of using (or not using) a certain type of contract will make it more likely (or less likely) that it will continue. III. How does pay influence Labor Force Composition? It is hypothesized that different pay systems will have an effect on a work force (e.g., organizations that link pay and performance will have higher performers). Also, organizations that link pay to individual performance will have more individualistic employees, and organizations that rely on team rewards attract more team-oriented employees. Programs The text provides an overview of some programs and potential consequences. Programs differ by payment method, frequency of payout, ways of measuring performance, and choice of which employees are covered. Contingencies that may influence whether a pay program fits the situation are organization structure, management style, and type of work. A. Merit pay programs link performance-appraisal ratings to annual pay increases. The focus is on identifying individual differences in performance. The majority of information on performance is collected from the immediate supervisor. There is then a process of linking pay to performance results. Feedback tends to occur infrequently and the flow of feedback is unidirectional, from supervisor to subordinate.

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1. The size and frequency of pay increases are most often determined by performance rating (since better-performing employees should be rewarded more than low performers) and position in range (compa-ratio). Compa-ratio is used to control compensation costs and maintain the integrity of the pay structure. 2. A disproportionate number of high-performance ratings can inflate compensation costs as well as allow a high compa-ratio. Many organizations limit the percentage of employees who can be placed in top categories. 3. Critics of merit pay include Deming, who argues that it is unfair to rate individual performance because apparent differences between people arise almost entirely from the system that they work in, not the people themselves. Examples are co-workers, the job, materials, customers, management, and supervision. These factors are the responsibility of management. a. Deming also argues that the focus on merit pay discourages teamwork.

b. Deming suggests that the link between individual performance and pay should be eliminated. The consequence of this might be that high performers would leave the organization. An appropriate balance between group and individual incentives should be designed. c. Another criticism is the way performance is measured. If this is not done fairly and accurately, employees will perceive the whole process to be unfair. Some of the most important aspects of justice that employees assess are distributive (based on how much they receive) and procedural (what process was used to decide how much). d. A last criticism is that merit pay may not really exist. In the late 1980s and early 1990s, merit budgets were approximately 4 to 5 percent. The difference between a high performers pay increase (e.g., 6 percent) and a moderate performers (3 to 4 percent) might mean little dollar difference in the paycheck. In fact, many employees do not believe that there is any payoff to higher levels of performance. Communication should be used to indicate that small differences can equate to large differences over time. B. Individual incentives reward individual performance, but payments are not rolled into base pay, and performance is usually measured as physical output rather than by subjective ratings. Monetary incentives increased production by 30 percent in a study by Locke, et al. Individual incentives are, however, relatively rare because:

1. Most jobs have no physical output measure. 2. There are many potential administrative problems (e.g., setting and maintaining acceptable standards). 3. Individual incentives may do such a good job of motivating employees that they do whatever they get paid for and nothing else. 4. Individual incentives typically do not fit in with the team approach. 5. They may be inconsistent with goals of acquiring multiple skills and proactive problem solving. 6. Some incentive plans reward output at the expense of quality. C. Profit Sharing and Ownership 1. Under profit sharing, payments are based on a measure of organization performance (profits), and payments do not become a part of base pay. a. Advantages are that profit sharing may encourage employees to think more like owners and take a broad view of what needs to be done, labor costs are reduced in difficult economic times, and organizations may not have to rely on layoffs. There is a downside risk in that there may be no profits in a given period.

b. Whether profit sharing contributes to better organization performance is not yet clear. For example, profits at Ford were much higher over several years than profits at General Motors, although their plans were identical. It is likely that something else besides the profit sharing caused Fords profitability. c. The drawback is that workers may perceive their performance has little to do with profit but is more related to top management decisions over which they have little control. Therefore, most employees are unlikely to see a strong connection between what they do and what they earn under profit sharing (instrumentality perceptions are not likely to be reinforced). They may also be disturbed when plans do not pay out when no profit is made. d. Another motivational problem is that most plans are deferred (paid to employees in some future time period). Dupont eliminated a profit-sharing plan when employees in some divisions received less than those in comparable divisions and returned to a system of fixed base salaries with no variable (risk) component. An alternate solution is to have plans that contain upside, but not downside, risk (i.e., base salaries are not reduced when a plan is implemented). When profits are high, employees share, but when profits are low, they are not penalized. This, of course, eliminates the advantage of controlling labor costs in difficult economic times. e. In summary, profit sharing may be useful to enhance identification with broad organizational goals, but it may need a supplement of incentives that are individually oriented. 2. Ownership also encourages employees to focus on the success of the organization as a whole, but, like profit sharing, may not result in motivation for high individual performance. Employees may not realize gain until they sell their stock, often when they are leaving. Reinforcement theory suggests, since rewards may not be directly experienced, that motivation would not be greatly increased. a. One method to achieve employee ownership is through stock options, which give employees the opportunity to buy company stock at a fixed price. For example, if a share is offered to employees at $10 a share and a few years later the value is $30, an employee can exercise his or her options and sell the stock at a profit (if stock goes down, there is no financial gain). Stock options are typically reserved for executives, although more companies have offered options to all employees, such as Pepsi-Cola and Hewlett-Packard. Some studies suggest that higher organization performance occurs when executives are eligible for long-term incentives, although results are not clear relative to lower-level employees. 3. Employee stock ownership plans (ESOPs), under which employers provide employees with stock in the company, are the most common form of employee ownership. The number of employees in such plans increased from 4 million in 1980 to over 10 million in 1999. a. On the negative side, ESOPs can carry significant risk for employees. ESOPs must, by law, invest at least 51 percent of their assets in the companys stock.

This results in less diversification and more risk, so if the company does not do well and pensions are funded by an ESOP, employees risk significant loss. b. ESOPs can be attractive to organizations since they have tax and financing advantages and can serve as a takeover defense, assuming that employee owners are friendly to management. c. Some degree of participation is mandatory on certain decisions, but there appears to be a great deal of range in employee decision making between plans. Some studies suggest that more participation will lead to more perceived ownership in the company. d. Costs of ESOPs have received surprisingly little attention. If stock is distributed and the real value of the company remains the same, then the value of a share of stock is reduced. D. Gainsharing programs offer a means for sharing productivity gains with employees. They differ from profit sharing in that instead of using an organization-level performance measure (profits), they measure group or plant performance. This is likely to be seen as more controllable by employees, and it is therefore more motivating. Also more motivating is that payouts are distributed more frequently and are not deferred. Studies indicate positive results on performance. 1. The Scanlon plan provides a monetary bonus to employees (and to the organization) if the ratio of labor costs to the sales value of production is kept below a certain standard. The example indicates that the standard is $240,000 (20 percent of $1.2 million). Because actual labor costs were $210,000, there is a savings of $30,000. The organization receives half and employees receive the other half. 2. Gainsharing often includes more than monetary reward. There is a strong emphasis on employee participation in problem solving through meetings, teams, and suggestion plans to improve the production process. 3. Conditions that should be in place for gainsharing to be effective include management commitment, the need to change or a process of continuous improvement, managements acceptance and encouragement of employee input, high levels of cooperation and interaction, employment security, information sharing on productivity and costs, goal setting, commitment of all involved parties to change and improvement, agreement on a performance standard, and a calculation that is understandable and perceived as fair and closely related to managerial objectives. 4. Group incentives and team awards typically pertain to a smaller work group than plantwide (which is used in gainsharing). While gainsharing measures physical output, group incentives tend to measure performance in terms of a broader array, such as cost savings, successful completion of product design, and meeting deadlines. Drawbacks are that individual competition may be replaced by competition between teams. In addition, dimensions must be perceived as fair by employees and include all important factors, such as quality.

E. Balanced ScorecardSome companies design plans that combine various elements of the above programs that are appropriate to the situation. If only merit pay/individual incentives are used, there may be high motivation but too much individualistic competition and a lack of focus on organizational goals. If only profit sharing and gainsharing are used, on the other hand, there may be more cooperation and attention to organizational goals, but individual work motivation might be low. V. Managerial and Executive PayBecause of their significant ability to influence organization performance, top managers and executives are a strategically important group whose compensation warrants special attention. The previous chapter focused on what the pay level is for this group, while this chapter focuses on how executive pay is determined. One concern appears to be that in some companies rewards for executives are high regardless of organizational performance.

A. Executive pay can be linked to organizational performance (from agency theory) by making some portion of executive pay contingent on company profitability or stock performance. This means less emphasis on non-contingent pay (e.g., base salary) and more emphasis on outcome-oriented contracts, both short-term and long-term. In the Business Week survey, average base salary plus a short-term bonus of $2.2 million accounts for less than 28 percent of average total executive compensation of $7.8 million. The remainder includes stock options and other long-term compensation. B. Organizations vary a great deal in the extent to which they use both short-term and long-term incentive programs. Greater use among top-and middle-level managers was associated with higher levels of profitability. C. There has been increased attention to executive pay from regulators. The Securities and Exchange Commission (SEC) recently required companies to more clearly report executive compensation levels and the companys performance relative to that of competitors over a five-year period. The Omnibus Budget Reconciliation Act of 1993 eliminated the deductibility of executive pay that exceeds $1 million. Table 12.9 shows how the balanced scorecard can be used to balance shareholder, customer, and employee satisfaction. VI. Process and Context IssuesThese issues represent areas of significant company discretion and pose opportunities to compete effectively. A. Employee participation in decision making relative to design and implementation of pay policies has been linked to higher pay satisfaction and job satisfaction. Agency theory suggests that employees may set goals in their own favor; however, monitoring would be less costly and more effective since employees know their workplace best. B. Communication is critical since any change will engender anxiety and rumors. Videotapes from officers are used frequently, as are brochures and focus group sessions where small groups of employees are interviewed about communication (and the programs).

C. Pay and Process: Intertwined EffectsIt is suggested that changing the way workers are treated may boost productivity more than the way they are paid; that is, using participation with a particular pay plan may increase nonpay rewards as well as productivity and profitability. VII. Organization Strategy and Compensation Strategy: A Question of FitOne should consider how the pay strategy will enhance organizational strategy. Some matches of strategies; for example, a prospector organizations (see Chapter 2) emphasis on innovation, risk taking, and growth is linked to a pay strategy that shares risk with employees but also provides them with the opportunity for high future earnings by having them share in whatever success the organization has. Fixed compensation is low, but the use of bonuses and stock options can pay extremely well. Defender organizations will use a very different pay plan.

Chapter Vocabulary
Reinforcement Theory; Expectancy Theory; Agency Theory; Principals; Agents; Merit Pay Programs; Merit Increase Grid; Individual Incentives; Profit Sharing; Ownership; Stock Options; Employee Stock Ownership Plans (ESOPs); Gainsharing; Group Incentives Source Internet

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