COMPENSATION SYSTEM:Pay, Job Pricing, Compensation: An Overview, Compensation Surveys

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BENEFITS:Total Compensation, Discretionary Benefits (Voluntary), Workplace Flexibility >>

Human Resource Management (MGT501)

Lesson 28

COMPENSATION SYSTEM

After studying this chapter, students should be able to understand the following:

A. Job Pricing & Developing a Base Pay System

B. Compensation system

LESSON OVERVIEW

We begin this chapter with an overview of compensation and an explanation of compensation equity. Next,

we discuss determinants of individual financial compensation and the organization as a determinant of

financial compensation. This is followed by a discussion of the labor market, the job, and the employee, as

determinants of financial compensation. Finally, job pricing and executive compensation are presented.

To understand the basic concepts of compensation first of all we will define the pay

Pay:

Pay is a statement of an employee's worth by an employer.

Pay is a perception of worth by an employee

HR Management Strategy Model:

Human resource department uses different

strategies to mange the workforce so that the

HR Management Strategy Model

desired results can be attained. These desired

result as stated in earlier chapters as well, can be

attained if organization is able to attract, select,

develop and retain workforce in successful

Attract

Select

manner in short, the effective hiring and

retaining workforce can be helpful in achieving

organizational goals. This purpose can be

Desired

Rewards

Strategy

attained through fair and effective rewards

Results

systems in the organization. Rewards are used as

Retain

Engage

basic motivational tools in the organization so

that performance of the employees can be

Develop

influenced in desirable way. So to be more

successful organizations need attractive and fair

compensation and reward systems to be paid to

the workforce.

A. Job Pricing

Job pricing means placing a dollar value on the worth of a job.

I. Pay Grades--The grouping of similar jobs together to simplify the job pricing process. Plotting

jobs on a scatter diagram is often useful in determining the appropriate number of pay grades.

II. Wage Curve--The fitting of plotted points in order to create a smooth progression between pay

grades.

III. Pay Ranges--Includes a minimum and maximum pay rate with enough variance between the

two to allow some significant pay difference.

IV. Broad Banding--A technique that collapses many pay grades (salary grades) into a few wide

bands in order to improve organizational effectiveness.

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V. Single-Rate System--Pay ranges are not appropriate for some workplace conditions. When

single rates are used, everyone in the same job receives the same base pay, regardless of seniority

or productivity. This rate may correspond to the midpoint of a range determined by a

compensation survey.

VI. Adjusting Pay Rates--when pay ranges have been determined and jobs assigned to pay grades,

it may become obvious that some jobs are overpaid and others underpaid. Underpaid jobs

normally are brought to the minimum of the pay range as soon as possible.

B. Compensation: An Overview

i. Compensation--The total of all rewards provided employees in return for their services.

ii. Direct Financial Compensation--Consists of the pay that a person receives in the form of

wages, salaries, bonuses, and commissions.

iii. Indirect Financial Compensation--All financial rewards that are not included in direct

compensation.

iv. Non-financial Compensation--Consists of the satisfaction that a person receives from the job

itself or from the psychological and/or physical environment in which the person works. All such

rewards comprise a total compensation program.

I. Equity in financial compensation :

Organizations must attract, motivate, and retain competent employees. Because achievement of these goals

is largely accomplished through a firm's compensation system, organizations must strive for compensation

equity.

Equity--Workers' perceptions that they are being treated fairly. Compensation must be

fair to all parties concerned and be perceived as fair.

b. External Equity--Exists when a firm's employees are paid comparably to workers who

perform similar jobs in other firms.

Internal Equity--Exists when employees are paid according to the relative value of their

jobs within an organization.

d. Employee Equity--Exists when individuals performing similar jobs for the same firm are

paid according to factors unique to the employee, such as performance level or seniority.

Team Equity--Achieved when more productive teams are rewarded more than less-

productive teams.

II. Determinants of individual financial compensation:

Compensation theory has never been able to provide a completely satisfactory answer to what an individual

is worth for performing jobs.

· The Organization,

· The Labor Market,

· The Job, and

· The Employee

These all have an impact on job pricing and the ultimate determination of an individual's financial

compensation.

The Organization as a Determinant of Financial Compensation:

Compensation Policies--An organization often establishes--formally or informally--

compensation policies that determine whether it will be a pay leader, a pay follower, or

strive for an average position in the labor market.

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1. Pay Leaders: Those organizations that pay higher wages and salaries than competing firms.

2. Market Rate or Going Rate: The average pay that most employers provide for the same job in a

particular area or industry.

3. Pay Followers: Companies that choose to pay below the market rate because of poor financial

condition or a belief that they simply do not require highly capable employees.

Organizational Politics--Political considerations may also enter into the equation. A

sound, objective compensation system can be destroyed by organizational politics.

Managers should become aware of this possibility and take appropriate action.

Ability to Pay--An organization's assessment of its ability to pay is also an important

factor in determining pay levels. Financially successful firms tend to provide higher-than-

average compensation. However, an organization's financial strength establishes only the

upper limit of what it will pay.

b. The labor market as a determinant of financial compensation:

Potential employees located within the geographical area from which employees are recruited comprise the

labor market.

Compensation Surveys--Large organizations routinely conduct compensation surveys to

determine prevailing pay rates within labor markets.

1. Compensation surveys: Provide information for establishing both direct and indirect compensation.

2. Benchmark job: A job that is well known in the company and industry, one that represents the

entire job structure, and one in which a large percentage of the workforce is employed.

Cost of Living--A pay increase must be roughly the equivalent to the cost of living

increase if a person is to maintain a previous level of real wages.

Labor Unions--When a union uses comparable pay as a standard for making

compensation demands, the employer must obtain accurate labor market data. When a

union emphasizes cost of living, management may be pressured to include a cost-of-living

allowance (COLA). This is an escalator clause in the labor agreement that automatically

increases wages as the U.S Bureau of Labor Statistics' cost-of-living index rises.

Society--Compensation paid to employees often affects a firm's pricing of its goods

and/or services. Consumers may also be interested in compensation decisions.

Economy--In most cases, the cost of living will rise in an expanding economy. Thus, the

economy's health exerts a major impact on pay decisions.

Legislation--The amount of compensation a person receives can also be affected by

certain federal and state legislation.

c. The job as a determinant of financial compensation:

Organizations pay for the value they attach to certain duties, responsibilities, and other job-related factors.

Techniques used to determine a job's relative worth include job analysis, job descriptions, and job

evaluation.

Job Analysis and Job Descriptions--Before an organization can determine the relative difficulty or

value of its jobs, it must first define their content, which it normally does by analyzing jobs. Job analysis

is the systematic process of determining the skills and knowledge required for performing jobs. The job

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description is the primary by-product of job analysis, consisting of a written document that describes

job duties and responsibilities. Job descriptions are used for many different purposes, including job

evaluation.

Job Evaluation--That part of a compensation system in which a firm determines the relative value of

one job compared with that of another.

d. The employee as a determinant of financial compensation:

In addition to the organization, the labor market, and the job, factors related to the employee are also

essential in determining pay and employee equity.

I. Performance Based Pay--PA data provide the input for such approaches as merit pay, variable

pay, skill-based pay, and competency-based pay.

1. Merit Pay: A pay increase given to employees based on their level of performance as indicated in

the appraisal.

2. Bonus: The most common type of variable pay for performance and is a one-time award that is

not added to employees' base pay.

3. Skill-based Pay: A system that compensates employees on the basis of job-related skills and

knowledge they possess, not for their job titles.

4. Competency-Based Pay: A compensation plan that rewards employees for their demonstrated

expertise.

II. Seniority--The length of time an employee has been associated with the company, division,

department, or job is referred to as seniority.

III. Experience--Regardless of the nature of the task, very few factors has a more significant impact

on performance than experience.

IV. Membership in the Organization--Some components of individual financial compensation

are given to employees without regard to the particular job they perform or their level of

productivity.

V. Potential--Organizations do pay some individuals based on their potential.

Political Influence--Political influence is a factor that obviously should not be used as a determinant

of financial compensation. However, to deny that it exists would be unrealistic.

Luck--The expression has often been stated, "It certainly helps to be in the right place at the right

time." There is more than a little truth in this statement as it relates to the determination of a person's

compensation.

g. Special Employee Classes--These include pay for executives, which are discussed in a later section,

and pay for professionals and sales employees.

III. Executive Compensation:

Executive skill largely determines whether a firm will prosper, survive, or fail. Therefore, providing adequate

compensation for these managers is vital. A critical factor in attracting and retaining the best managers is a

company's program for compensating executives.

a) Determining Executive Compensation--In determining executive compensation, firms

typically prefer to relate salary growth for the highest-level managers to overall corporate

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performance. In general, the higher the managerial position, the greater the flexibility

managers have in designing their jobs.

b) Types of Executive Compensation--Executive compensation often has five basic

elements: (1) Base Salary, (2) Short-Term Incentives or Bonuses, (3) Long-Term Incentives

and Capital Appreciation Plans, (4) Executive Benefits, and (5) Perquisites. The way an

executive compensation package is designed is partially dependent on the ever-changing

tax legislation.

Base Salary: Salary is obviously important. It is a factor in determining standard

of living. Salary also provides the basis for other forms of compensation.

Short-Term Incentives or bonuses: Payment of bonuses reflects a managerial

belief in their incentive value. Today, virtually all top executives receive bonuses

that are tied to base salary.

Long-Term Incentives and Capital Appreciation: The stock option is a

long-term incentive designed to integrate further the interests of management

with those of the organization. The typical stock option plan gives the manager the

option to buy a specified amount of stock in the future at or below the current

market price.

Executive Benefits: Executive benefits are generally more generous than those

received by other employees because the benefits are tied to their higher salaries.

However, current legislation (ERISA) does restrict the value of executive

benefits to a certain level above those of other workers.

Perquisites (Perks): Any special benefits provided by a firm to a small group

of key executives that are designed to give the executives something extra. A

"golden parachute" contract is a perquisite that protects executives in the event that

their firm is acquired by another.

IV. Compensation for professionals:

People in professional jobs are initially compensated primarily for the knowledge they bring to the

organization. Because of this, the administration of compensation programs for professionals is somewhat

different than for managers. Many professional employees eventually become managers. For those who do

not desire this form of career progression, some organizations have created a dual track of compensation.

The dual track provides a separate pay structure for professionals, which may overlap a portion of the

managerial pay structure.

V. Sales Compensation:

Designing compensation programs for sales employees involves unique considerations. For example, job

content, relative job worth, and job market value should be determined. The straight salary approach is at

one extreme in sales compensation. In this method, salespersons receive a fixed salary regardless of their

sales levels. At the other extreme, the person whose pay is totally determined as a percentage of sales is on

straight commission. Between these extremes, there are endless part salarypart commission combinations.

The possibilities increase when various types of bonuses are added to the basic compensation package. In

addition to salary, commissions, and bonuses, salespersons often receive other forms of compensation that

are intended to serve as added incentives.

Role of Line managers and HRM Department in Compensation:

Line managers perform the function of job evaluation that is base for the compensation systems, according

to the worth of the job negotiation regarding the salaries and other benefits is negotiated with potential

employees through line mangers. Basic compensation packages are mostly recommended by the line

managers in the organizations. All these information is communicated to the employees by HRM

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department beside communicating this information HRM department also facilitates the departments in

establishing rates of pay, monitoring in job evaluation process, and Conducting salary surveys in order to

establish procedures for administering pay plans, and to ensure compliance with antidiscrimination laws.

Key Terms

Merit Pay: A pay increase given to employees based on their level of performance as indicated in the

appraisal.

Equity: Workers' perceptions that they are being treated fairly. Compensation must be fair to all parties

concerned and be perceived as fair

External Equity: Exists when a firm's employees are paid comparably to workers who perform similar

jobs in other firms.

Internal Equity: Exists when employees are paid according to the relative value of their jobs within an

organization.

Compensation: The total of all rewards provided employees in return for their services.

Job Pricing: Job pricing means placing a dollar value on the worth of a job.

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