Compensation

Importance of Compensation
• Impacts employer’s ability to attract & retain
employees
• Ensure optimal levels of employee
performance in meeting organization’s
strategic objectives
• Compensation’s components
– Direct compensation in wages or salary
• Base pay (hourly, weekly, monthly)
• Incentives (sales bonuses &/or commissions)
– Indirect compensation in form of benefits
• Legally required benefits (e.g., Social Security)
• Optional (e.g., group health benefits)
Compensation System
 Internal Equity

• Fairness of pay differentials

between different jobs in
organization
• Established by job ranking, job
classification, point systems or
factor comparisons
 External Equity
• Fairness of organizational
compensation levels relative to
external compensation
• Assessed by collecting wage & salary
information to guide in setting
organization’s pay strategy to lead,
meet or lag labor market wages
 Individual Equity
• Fairness about pay differentials among
individuals in same job
• Established by using
• Seniority-based pay systems: Reward longevity
• Merit-based pay systems: Reward employee
performance
• Incentive plans: Employees receive part of
compensation based on performance
• Skills-based pay systems: Compensation based on
employees possessing skills that firm values
• Team-based pay plans: Encourage cooperation &
flexibility
Equity Theory
Equity & Work-Related Outcomes
Point System
Method
 External Equity

• Collect wage & salary information to

determine market wage rates
• Also consider other forms of compensation
• Determine pay strategy relative to market
 External Equity
• Lag policy • Market policy
– Lower wages than – Wages equal to
competitors, competitors
compensates – Neutralizes pay as
employees through factor
other means
• Opportunity for
• Lead policy
advancement – Higher wages than
• Incentive plans competitors to ensure
• Good location organization becomes
• Good working employer of choice
conditions
• Employment security
 Individual Equity
• Basing pay on seniority
• Merit pay systems
• Incentive pay
– Returns financial rewards to employees
responsible for creating them
– Allows organizations to adjust compensation
expenses based on organization performance
– Variety of forms
– Tied to employee’s, work unit’s, or
organization’s results
 Individual Equity
• Skill-based pay systems
– Base compensation on acquisition & mastery
of skills
– Give employees incentives to learn
– Promote flexibility
– Easily linked with training programs &
strategic needs
 Individual Equity
• Team-based pay plans
– Can be less time-consuming than
administering individual reward systems
– May impact group dynamics
– Can adversely impact & intensify conflict
– Need decentralized decision-making system
– Need high level of communication with
employees
– Employees should have voice & provide
input into design
– Team members need to feel system is fair &
equitable
 Executive Compensation
• No real average or standard
• Typical annual compensation for senior
executives
– 20% salary
– 30% annual incentives
– 50% long-term incentives
 Executive Compensation
• Stock Grants
– Require organization meet specific financial
goals
• Stock Options
– Provide opportunity to purchase shares at some
future date, at price determined when options are
awarded
– Focus employee attention on creating
shareholder value
– Do not have to be reported as expenses
– Can create culture obsessed with improving
stock performance at expense of other concerns
– Can prompt executives to engage in creative
accounting practices
Key Strategic Issues in Compensation
• Determining compensation relative to
market
• Balance between fixed & variable
compensation
• Deciding whether or not to utilize team-
based versus individual pay
• Creating appropriate mix of financial &
non-financial compensation
• Developing cost-effective
compensation program resulting in
high performance
 Compensating Teams
• Reasons for tailoring compensation to
individuals
– Motivation comes from within individual as
opposed to group
– Development of skills & behaviors is individual
undertaking
– Fairness in dealing with teams does not mean
equal pay for all
– Team compensation is not payoff but means
of nurturing behavior that benefits team
 Compensating Teams
• Look for ways to add on incentives &
recognition for team participation
• Reward behaviors & activities rather
than results
• Other ways of saying “thank you”
constitute best incentive over long run
– Nonmonetary recognition
– Gifts of appreciation after fact
• Be careful about anything that may be
viewed as “buying”
 Compensating Teams
• Management often overlooks powerful
intrinsic rewards that come from
– Team participation
– Being part of corporate decision-making
process
• Let team decide who gets what from
awards basket
Executive Compensation: New Perspectives
• CEOs in larger firms generally earn
more
• Mixed empirical evidence on
relationship between executive
compensation & firm performance
Executive Compensation: New Perspectives
• Classifications of firm strategy:
– Prospector firms emphasize long-term
incentives
– Defender firms are more likely to
emphasize fixed pay
– Analyzer
– Reactor
• Significant relationship between
organizational strategy & executive
compensation
• Firm size continues to be major
determinant of executive compensation
Executive Compensation: New Perspectives
• Earnings per share is significant predictor
of short-term executive compensation
earned as annual bonuses
• Predictors of long-term executive
compensation earned through stock option
exercise
– Share price growth
– Return on stocks
– Market measures of firm performance
New Thinking for New Millennium
• Strategic approaches to make
compensation systems more effective
– Pay person for individual worth
(knowledge, skills and competencies) rather
than for value of job they perform
– Reward excellence through pay for
performance compensation that establishes
clear relationship between significant
amount of pay & attainment of
organizational objectives
– Individualize pay system to give
employees choices in how they are
rewarded & what reward they receive