Milkovich/Newman: Compensation, Ninth Edition

Chapter 1

Compensation Management

McGrawMcGraw-Hill/Irwin

Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-

Chapter Topics
 Compensation:

Definition  Introduction to Compensation Management  Objectives of Compensation  Theories of Wage Determination  Forms of Pay  A Pay Model  Book Plan  Caveat Emptor - Be an Informed Consumer  Your Turn: Glamorous Internships, or House Elves?

1-2

Key Questions and Issues

 How

differing perspectives affect our views of compensation compensation

The meaning of compensation most appropriate from an employee's view: return, reward, or entitlement

 Definition of

 Examining

network of returns a college offers an instructor

1-3

Key Questions and Issues (cont.)

 Four policy
 Forms

issues in the pay model

Objectives of the pay model of pay received from work

1-4

Contrasting Perspectives of Compensation

Societys Views Stockholders Views

Employees Views

Managers Views
1-5

Compensation: Definition
 Society

Pay as a measure of justice Benefits as a reflection of justice in society Job losses (or gains) attributed to differences in compensation Belief that pay increases lead to price increases

1-6

Exhibit 1.1: Hourly Compensation Costs for Manufacturing Workers (in U.S. Dollars)

1-7

Compensation: Definition (cont.)

 Stockholders

Using stock to pay employees creates a sense of ownership Linking executive pay to company performance supposedly increases stockholders' returns
 Managers

A major expense Used to influence employee behaviors and to improve the organization's performance
1-8

Exhibit 1.2: The Relationship between Shareholder Return and Change in CEO Pay

1-9

Compensation: Definition (cont.)



Employees
Major source of financial security Return in an exchange between employer and themselves Entitlement for being an employee of the company Reward for a job well done

Global Views Vive la diffrence diff

China: Traditional meaning of compensation providing necessities of life replaced with dai yu Japan: Traditional word kyuyo replaced with hou-syu; very hourecently the phrase used is teate

1-10

What Is Compensation?

Compensation refers to all forms of financial returns and tangible services and benefits employees receive as part of an employment relationship
1-11

Wage Components
 BASIC WAGEWAGE-

It is the remuneration, by way of basic salary and allowances, which is paid to an employee in terms of the contract of employment work done.

 ALLOWANCES- are ALLOWANCES-

paid in addition to the basic wage to ensure that the value of basic wages does not fall over a period of time. Some are statutory and others can be voluntary.

Eg: Eg: Holiday pay, overtime, Bonus, attendance bonus, good conduct bonus etc.
1-12

Components of Compensation
 1. 2. 3. 4. 5.

Financial : Hourly and monthly rated wage and salary. Incentives ie individual plans and group plans. Fringe benefits ie PF , Gratuity, Medical care, Group Insurance. Perquisites are Company car, furnished house (Offered to retain competent executives) Non Financial -: Recognition, Growth Prospects

1-13

Compensation Objectives (cont.)

 Equity


 

Income distribution through narrowing of inequalities, increasing the wage of the lowest paid employees, protecting real wages and the concept of equal pay for work of equal values Internal Equity requires that pay be related to the relative worth of a job. External equity- means paying workers what other equityfirms are paying.

1-14

Compensation Objectives
 Efficient


allocation of laborlabor-

Employees can move to wherever they receive net gain like geographical movement or job movement. Improving performance, increasing quality, delighting customers and stockholders Controlling labor costs

 Efficiency

 Fairness

Fundamental objective of pay systems Fair treatment by recognizing both employee contributions, and employee needs
1-15

Compensation Objectives (cont.)

Other objectives can be
 

To acquire qualified personnel, compensation needs to be high to attract applicants. Retain current employees, Employees may quit when compensation levels are not competitive, resulting in higher turnover. Reward desired behavior A rational compensation system helps the organisation obtain and retain workers at a reasonable costs.

 

Compliance
Conformance to Federal and State compensation laws and regulations
1-16

Compensation Objectives (cont.)



Ethics
Organizations care about how its results are achieved

Objectives
Guide the design of the pay system Serve as the standards for judging success of the pay system Policies and techniques are means to reach objectives

1-17

Exhibit 1.6: Pay Objectives at Medtronic and Whole Foods

1-18

Factors Influencing Employee Remuneration

 1. 2. 3. 4.

External -: Labour Market Demand & Supply, Going Rate Cost of Living Escalatory clause Labour Unions Labour Laws Payment of wages act1936, Minimum wages act 1948, Payment of Bonus act 1965, Equal remuneration act 1976, Payment of gratuity act 1972. Society

5.

1-19

Factors Influencing Employee Remuneration

 Internal -:

1. 2. 3.

Business Strategy Rapid growth = High Pay Job Evaluation and Performance Appraisal Employee Performance , Experience, Seniority

1-20

Determinants of Wage Rates



Wage Rates are either the products of market forces or may be influenced by tradition, social structure and seniority.

ExamplesExamples- In US market forces, In Japan seniority and In India labor laws and other regulations determines wage rates.

1-21

THEORIES OF WAGE DETERMINAITON



Traditional theory of Wage DeterminationDeterminationThis theory assumes that market forces i.e. demand and supply determine wages. Computers programmers or IT Professional

Theory of Negotiated Wages Unionized employees can negotiate in salaries.

 Collective bargaining for unions- Unions periodically submit unionstheir memorandum to the mgmt. asking for wage raise. Wages are negotiated in collective bargaining meeting.  Individual bargaining - For non-unionized employees. non1-22

Principles of Compensation Determination



Subsistence Theory - David Ricardo (1772-1832) (1772-

Workers should be paid to enable them to subsist or perpetuate the race without
increase or diminution. AssumptionAssumption- if the workers were paid more than subsistence wage, their would increase as they would procreate more

Wages Fund Theory Adam Smith (1723-1790) (1723Wages are paid out of a predetermined fund of wealth, the surplus savings of the wealthy. This fund could be utilized for employing laboureres. laboureres. If the fund would be high, wages would be large and if it small, wages would be reduced to subsistence level.

1-23

Principles of Compensation Determination



Surplus Value Theory - Karl Marx (1818-1883) (1818Labor was an article of commerce Labor was given the payment of subsistence price The labourer was not paid according to the time spent on work but was paid much less. The price of any product was determined by the labor and the time needed for producing it.


  


 

Residual Claimant Theory Francis Walker (1840(18401897)

Assumes that there are four factors of production i.e. Land, Labor, Capital and entrepreneurship. Wages represent the amount of value created in the production, which remains after payment of all other factors.
1-24

Principles of Compensation Determination



Marginal Productivity Theory

Wages depend upon an entreprenuers estimate of the value that will probably be produced by the last or marginal workers. Wages depend upon the demand for and supply of labour. labour.

Bargaining Theory of Wages

Wages are determined by the relative bargaining power of workers, trade unions and employers.

1-25

Principles of Compensation Determination



Behavioral Theory of wages Marsh & Simon, Robert Dubin and Eliot Jacques.
 The employees acceptance of a wage level  Employees believe in employment stability  Other factors are size & prestige of an organisation, trade unions etc. organisation,  The internal Wage structure  Internal pay equity, social status

1-26

Types Of Wages

 

Minimum Rate of wages

Consists of basic rate of wages and a special allowance. A basic rate of wages with or without a cost of living allowance and the cash value of supplies of essential commodities at concessional rates.

Procedure of fixing and revising minimum wages The central govt. appoints central advisory Board to advise . Wages in Kind Minimum wages payable under this act are to be paid in cash. Payment of minimum rate of wages It is required to pay every employee, engaged in a scheduled employment, wages at a rate not less than the minimum rates.

1-27

Types Of Wages
       

Fixing hours for a normal working day Overtime Wages for 2 or more classes of work. Maintenance of registers and record Inspections Claims Penalties for offences Addition of new employments

1-28

Types Of Wages


The need-based minimum Wage needMinimum wage provides not merely for the bare sustenance of life but for the preservation of the efficiency of the worker by providing for some measure of education, medical requirements and amenities. Guidelines for calculating minimum wage given by fixing authorities, including the minimum wage committee, wage boards and adjudicators-

I. II. III. IV.

The standard working class family should be taken to consist of three consumption units for the earners. The minimum food requirements should be calculated on the basis of net intake of 2700 calories. The clothing requirements should be estimated at a per capita consumption of 18 yards per annum. The norms for housing should be the minimum rent charged by the govt under subsidized housing scheme.

1-29

Types Of Wages

1.

Living Wage
To provide for a standard of living that would ensure good health for workers and their family, a measure of decency, comfort, and education for their children; and protection against misfortunes. It is determine d by national income & industrys capacity to pay. Lowest level of minimum <living wage> highest level of fair wage. Supreme court has laid some principles for wage fixation
A. B. C. Minimum wage must be paid in any event. The wages must be fair i.e. sufficiently high to provide a standard of living. Wages must be paid on industry wise and region basis.

2. 3. 4.

1-30

Types Of Wages


Fair Wage
It represents the wage above the minimum wage but below the living wage. The upper limit is set by the capacity of industry to pay. The actual wage should depend on considerations of such factors as the:
1. 2. 3. 4. Productivity of labour. labour. Prevailing rates of wages in the same localities. Level of national income and its distribution Place of industry in the economy

1-31

WAGE BOARDS
 

In 1950s and 1960s inadequate bargaining power of unions constituted Wage boards. The Wage Boards are tripartite in character i.e. representative of workers, employers and independent members participate and finalize recommendations. All wage boards except of journalists and non-journalists newspaper ; are nonnonnon- statutory. Recommendations made by these Wage Boards are not enforceable under the law. In 1966 the concept of wage board consequently declined except of sugar industry.

  

1-32

Wage Policy


An ideally wage and salary policy shouldshouldI. II. Establish good labour relations Decide on appropriate wages

III. Decide wages based on individuals capacity IV. Develop a pre-determined scheme for payment of wages preV. Establish linkages of wage payment with performances VI. Maintain parity of wages with other organisations VII. Provide incentive payment VIII. guarantee minimum wages IX. Provide for neutralisation of price rise X. Develop wage structure that can attract talent.

1-33

Wage Policy


A sound wage policy should adopt a job evaluation programmes based upon differences in job content. Besides the basic factors provided by job content. description and evaluation, those that are to be taken into consideration are: are:
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. Organisations ability to pay Supply and demand of labour Prevailing market rate Cost of living Living wage Productivity Trade unions bargaining power Job requirements Managerial attitudes Psychological and sociological factors Levels of skills available in the market

1-34

Compensation Benchmarking

Unnecessary attrition enhances human resource costs due to cost of replacing manpower, it affects organisational brand image. If attrition is below than image. competitive pay i.e. less than market trend , it is because of organisations failure of compensation benchmarking. benchmarking. For successful benchmarking, we take an example of Xerox Corporation in the US who adopted benchmarking in four phases

Introduction

1.

Planning Phase - What will be benchmarked?

Who will be the benchmark companies? How will the data be collected?

2.

Analysis Phase - Are the benchmarked companies better?

If so, by how much? Why are they better? How can we apply what we have learned to our business?

3.

Integration Phase - Have the results been accepted by the mangement? mangement? Do goals have to be changes or modified based on the results? Have these new goals been communicated to all affected parties?
1-35

Compensation Benchmarking
4.

Action phase - Have the steps required to achieve the desired goals been identified?
Is progress being tracked? Is there a plan for recalibration of the benchmarks?

BROAD BAND PAY PLAN Broad banding is a pay structure form that leads to the consolidates large number of pay grades and salary ranges into much fewer but broader bands with relatively wide salary ranges. The plan simplifies the classification of positions, increases the emphasis on marketmarketbasedbased-pay, and promotes competency based human resource systems including compensation.

1-36

Total Returns for work

Total Returns

Total compensation

Relational Returns

Cash Compensation Base

Short term incentives Merit/Cost of living Long term incentives

Benefits

Recognition & Status Employment Security

Income Protections Work life focus allowances

Challenging Work Learning Opportunities 1-37

Forms Of Pay
 Relational  Total

returns

Psychological in nature

compensation

1.Cash Compensation/ transactional 1. Cash

a) Base wages
Difference between wage and salary Cash Compensation

b) Merit pay/cost-of-living adjustments pay/cost-of Merit increases given in recognition of past work behavior Periodic changes to base wages made on the basis of changes in what other employers are paying for the same work Cost-of-living adjustments same increases to everyone, regardless of Cost-ofperformance
1-38

Forms Of Pay (cont.)

1. Cash Compensation/ transactional (cont.)
c) Incentives/ Variable pay tie pay increases directly to performance
Does not increase base wage; must be reearned each pay period Potential size generally known beforehand Long-term (stock options), and short-term Longshort Incentives are based on future whereas merit based on past performance. Incentive are one-time payments, they do not have a permanent effect on onelabor costs.

2. Benefits
 Income protection- Medical insurance, retirement , life insurance etc. protection Work/life balance- Drug counseling, financial planning, referral for child care balance Allowances of whatever is in short supply,
1-39

Forms Of Pay (cont.)



Total earnings opportunities: Present value of a stream of earnings

Shifts comparison of today's initial offers to consideration of future bonuses, merit increases, and promotions

 

Relational returns from work

Nonfinancial returns

Organization as a network of returns

Created by different forms of pay, including total compensation and relational returns The network of returns more likely to be useful if bonuses, development opportunities & promotions all work together.

So the next time you walk in an employers door, look beyond the cash and health care offered to search for all the returns.
1-40

A Pay Model
 Three basic

building blocks:

Compensation objectives Policies that form the foundation of the compensation system Techniques that make up the compensation system

1-41

The Pay Model

1-42

Compensation obejectives
Objectives serve different purposespurposes    

They guide the design of the pay system. Eg- increase customer satisfaction EgServe as the standards for judging the success of the pay system. Efficiency improving performance, increasing quality, delighting customers and stockholders and controlling labor costs Fairness Compliance

1-43

Four Policy Choices

Internal alignment

Focus - Comparisons among jobs or skill levels inside a single

 Stay with the organization  Become more flexible by investing in additional training  Seek greater responsibility

organization Pay relationships within an organization affect employee decisions to:

External competitiveness
comparison with competitors Pay is market driven

Focus - Compensation relationships external to the organization:

1-44

Four Policy Choices (cont.)



External competitiveness (cont.)

Effects of decisions regarding how much and what forms:
 To ensure that pay is sufficient to attract and retain employees  To control labor costs to ensure competitive pricing of products/ services

Employee contributions
Focus - Relation emphasis placed on employee performance
 Performance based pay affects fairness

Management
Focus - Policies ensuring the right people get the right pay for achieving the right objectives in the right way

1-45

Pay System Techniques

Techniques

tie the four basic policies to the pay

objectives Many variations exist Some techniques will be discussed through the book

1-46

Caveat Emptor Be An Informed Consumer

 Is

the Research Useful?

 Does the

Study Separate Correlation from Causation? Alternative Explanations?

 Are there

1-47