1. Topic #10: Compensation Systems
Paul L. Schumann, Ph.D.
Professor of Management
MGMT 440: Human Resource Management
© 2008 by Paul L. Schumann. All rights reserved.

2. Outline Compensation System Components Compensation Equity Issues
Equity Theory
Pay Systems
Market-Based Pay
Job Evaluation Pay Systems
Job Ranking
Job Grading (Job Classification)
Factor Comparison
Point Method
Pay Policy Issues

3. Compensation System Components
Benefits
Pay
Source of figure: Fisher, Schoenfeldt, & Shaw (2006), Figure 11.1, p. 485

4. Compensation Equity Issues
Compensation equity: Is compensation judged to be fair?
3 Compensation equity issues
#1: Individual equity: compare the pay of individuals who do the same job in the same organization and judge if it is fair
Example: A retail store has 2 Assistant Store Managers (2 people doing the same job in the same organization)
If they are paid the same, is that perceived as being fair?
If they are paid differently, is the pay difference perceived as being fair?

5. Compensation Equity Issues
3 Compensation equity issues (more)
#2: Internal equity: compare the pay of different jobs in the same organization and judge if it is fair
Example: A retail store has an Assistant Store Manager and a Store Manager (2 different jobs in the same organization)
If they are paid the same, is that perceived as being fair?
If they are paid differently, is the pay difference perceived as being fair?

6. Compensation Equity Issues
3 Compensation equity issues (more)
#3: External equity: compare the pay of the same job in different organizations and judge if it is fair
Example: Retail store X has a Store Manager and retail store Y has a store manager (the same job in two different organizations)
Do the two stores pay their store managers the same or not?

7. Compensation Equity Issues
3 Compensation equity issues (more)
#3: External equity (more)
External equity pay policies:
Match the market (match the competition): the organization sets pay for some of its jobs to be about the same as what other organizations pay for the same jobs
No advantage or disadvantage in costs or in attracting and retaining employees

8. Compensation Equity Issues
3 Compensation equity issues (more)
#3: External equity (more)
External equity pay policies (more)
Lead the market: the organization sets pay for some of its jobs to be higher than what other organizations pay for the same jobs
Above average pay levels would tend to increase costs
Can the higher pay costs be offset by lower costs because of:
Lower turnover rates
Easier to recruit larger numbers of well-qualified applicants, allowing increased hiring standards (“skim the cream”)
But we need to use valid selection methods to correctly identify the well-qualified applicants
Otherwise, we’re paying more for poor performers (“duds”)

9. Compensation Equity Issues
3 Compensation equity issues (more)
#3: External equity (more)
External equity pay policies (more)
Lag the market: the organization sets pay for some of its jobs to be lower than what other organizations pay for the same jobs
Below average pay levels would tend to decrease costs
But the lower pay costs may be offset by higher costs because of:
Higher turnover rates
Harder to recruit well-qualified applicants, requiring lower hiring standards
Can we provide employees with more of other things that employees value to compensate for the below average pay?
Example: More opportunities for growth & promotions
Example: Some of pay is in the form of company stock

10. Equity Theory
Equity theory describes how an employee determines if his or her pay is fair
An employee judges if his or her pay is fair by examining 4 factors:
The employee’s pay (and other rewards)
The employee’s contributions
Other employees’ pay (and other rewards)
Other employees’ contributions

11. Equity Theory I’d feel underpaid if:
My contributions are the same as my co-workers’, but I’m paid less
I’m paid the same as my co-workers, but my contributions are greater than my co-workers’ contributions
Figure adapted from: Fisher, Schoenfeldt, & Shaw (2006), Figure 11.2, p. 487

12. Pay Systems
We want to set pay in a way that takes into consideration the 3 compensation equity issues:
We want pay t0:
Implement the organization’s external equity pay policy
Match, lead, or lag the market
Achieve internal equity
Appropriate pay differences across the jobs in the organization
Achieve individual equity
Appropriate pay differences across employees who perform the same job

13. Pay Systems
Methods of determining a range of pay for each job in an organization:
Market-Based Pay
Job Evaluation Pay Systems
Job Ranking
Job Grading (Job Classification)
Factor Comparison
Point Method
Once we have a pay range for each job, then we can figure out where inside the pay ranges each employee should fall

14. Market-Based Pay
Alternative names: Market-Based Pay = Market Pricing = Rank to Market
Method (for each job title):
Identify the relevant labor market
Local, regional, national, or international
Obtain market pay data in the relevant labor market
Either use pay data collected by others:

15. Market-Based Pay Method (more):
Obtain market pay data in the relevant labor market (more)
Or perform a market pay (wage & salary) survey:
Identify a sample of organizations in the relevant labor market that have the job title
Contact each organization and ask how much they pay the job title (minimum, average, maximum)
Avoid anti-trust (pay-fixing) concerns:
Use an independent consultant to collect the pay data
Collect pay data that is several months old (e.g., 3 months)
Include at least 5 employers for each job title
Have the consultant report only averages (e.g., average minimum pay for the job title, average maximum pay for the job title)

16. Market-Based Pay Method (more):
Use the market pay data on the average minimum pay and the average maximum pay directly to set the pay range (min to max) for the job title
If the external pay policy is:
Match the market, then set the pay range for the job to be about the same as the market pay range for the job
Lead the market, then set the pay range for the job to be a bit higher than the market pay range for the job
Lag the market, then set the pay range for the job to be a bit lower than the market pay range for the job

17. Market-Based Pay Strengths: Weaknesses: Not too complicated
Assumes all jobs with the same job title in different organizations are truly identical
Example: We have to assume that all Store Manager jobs in every retail store are identical
Assumes market pay differences correctly capture internal equity issues
Example: We have to assume that we want the pay difference between our Store Managers and Assistant Store Managers to be the same as in other retail stores
Hard to use with unique jobs
If the job is unique to our organization, then we can’t find comparable jobs in other organizations, so we can’t get market pay data

18. Job Evaluation Pay Systems
An alternative to market-based pay is to use a pay system based on job evaluation
Job evaluation: systematically determine the relative value of jobs with an organization to create an internal hierarchy of jobs, and then use the hierarchy to set pay ranges for the jobs
Which job has the highest value to the organization and so should be paid the most?
Which job has the second highest value and so should be paid second highest?
Etc.
There are 4 job evaluation pay systems

19. Job Evaluation Pay Systems
Source of figure: Fisher, Schoenfeldt, & Shaw (2006), Figure 11.3, p. 490

20. Job Evaluation: Job Ranking
Method:
Review the job descriptions
Rank the jobs in order of relative worth or importance to the organization
Frequently done by a committee of managers
Use the rank ordering to set pay for each job
Pay the highest ranked job the most, etc.
Weaknesses:
The rank ordering tells us that one job is worth more than another, but not how much more
While the ranking takes care of internal equity, it’s not obvious how to take into consideration external equity

21. Job Evaluation Pay Systems
Source of figure: Fisher, Schoenfeldt, & Shaw (2006), Figure 11.3, p. 490

22. Job Evaluation: Job Grading (Job Classification)
Method:
Create a sequence of job grades
Example: US Government GS system has 15 job grades: GS1 … GS15
For each job grade, define the job grade in words
Example: Define each job grade in terms of:
Skill & knowledge
Responsibilities
Physical effort
Working conditions
Use the job descriptions to classify each job into one job grade
Example (from the US Government GS pay system):
Carpenter = GS9

23. Job Evaluation: Job Grading (Job Classification)
Method (more)
Select a set of benchmark (key) jobs
Jobs with well-known, stable job content
Jobs that are common in many organizations
Jobs that represent the full range of job grades
Jobs for which market pay data is available
Collect market pay data for the benchmark jobs
Use the market pay data to set the pay range for the job grades
Example:

24. Job Evaluation: Job Grading (Job Classification)
Strengths:
The sequence of job grades allows us to deal with internal equity
The use of market pay data to set the pay range for each job grade allows us to deal with external equity
Weaknesses:
The classification of jobs into pay grades is subjective
Example: Carpenter = GS9, not GS8 or GS10 (are we sure?)
The method relies heavily on job titles in setting pay
Example: We have to assume that all Carpenter jobs are identical

25. Job Evaluation Pay Systems
Source of figure: Fisher, Schoenfeldt, & Shaw (2006), Figure 11.3, p. 490

26. Job Evaluation: Factor Comparison
Method:
Define a set of compensable factors
Compensable factors: the characteristics about jobs that are used to set pay
Example: skill, effort, responsibility, & working conditions
Select a set of benchmark (key) jobs
Jobs with well-known, stable job content
Jobs that are common in many organizations
Jobs that represent the full range of jobs being evaluated
Jobs that represent the range of each compensable factor
Example: jobs with various skill levels, effort levels, etc.
Jobs for which market pay data is available

27. Job Evaluation: Factor Comparison
Method:
Rank the benchmark jobs on the basis of each compensable factor
Example: Rank the jobs from least skilled to most skilled
Collect market pay data for the benchmark jobs
For each benchmark job, allocate market pay across the compensable factors
Example: If market pay for a benchmark job is $15, how much of that $15 is for skill, how much for effort, how much for responsibilities, and how much for working conditions?

28. Job Evaluation: Factor Comparison
Method (more)
For each benchmark job, compare the factor rankings to the pay rankings & make adjustments as needed to bring the rankings into agreement
Example: Make sure that the job ranked as having the greatest skill requirements also has the greatest amount of pay for the skill compensable factor
Construct a job comparison scale, and slot the benchmark jobs onto the pay scale for each compensable factor
Example: For the skill compensable factor, create a “skill” pay scale that shows where each benchmark job falls on the scale

29. Job Evaluation: Factor Comparison
Method (more)
Slot all the non-benchmark jobs into their proper places on the pay scale for each compensable factor
Determine the pay for each job by adding up the pay from each compensable factor
Example: Pay = pay from skill + pay from effort + pay from responsibility + pay from working conditions
Example: Fisher, Schoenfeldt, & Shaw (2006), Table 11.7, p. 498
Job 4: Pay = $3.50 for skill + $2.50 for effort + $3.75 for responsibilities + $1.25 for working conditions = $11.00

30. Job Evaluation Pay Systems
Source of figure: Fisher, Schoenfeldt, & Shaw (2006), Figure 11.3, p. 490

31. Job Evaluation: Point Method
Define a set of compensable factors
Compensable factors: the characteristics about jobs that are used to set pay
Example: 11 compensable factors: (1) Education (2) Experience (3) Knowledge (4) Physical demands (5) Mental demands (6) Responsibility for equipment & work processes (7) Responsibility for materials & products (8) Responsibility for safety (9) Responsibility for the work of others (10) Working conditions (11) Job hazards

32. Job Evaluation: Point Method
Method (more)
Define a factor scale for each compensable factor
Factor scale: define in words the different levels (or degrees) of the compensable factor
Example: Factor scale for the “Knowledge” factor:
1st Degree Knowledge: reading & writing; simple arithmetic with whole numbers only; following instructions
2nd Degree Knowledge: arithmetic with decimals & fractions; use of formulas, charts, graphs, or diagrams
3rd Degree Knowledge: mathematics with complex formulas, drawings, or diagrams; precision measuring instruments
4th Degree Knowledge: advanced trades mathematics; advanced use of complex formulas, drawings, or diagrams
5th Degree Knowledge: higher-level engineering math; advanced use of complex engineering theories & practices

33. Job Evaluation: Point Method
Method (more)
Assign points to each degree of each compensable factor
Example:
Source of table: Fisher, Schoenfeldt, & Shaw (2006), Table 11.4, p. 495

34. Job Evaluation: Point Method
Method (more)
Perform the job evaluation: evaluate each job to determine the number of points to assign to that job on each compensable factor
Usually done by a committee of managers
Use the job descriptions as the source of job information
Add up the number of points from each compensable factor to get the total points for the job
Jobs with more total points have more of the things we value in setting pay
This should take care of internal equity

35. Job Evaluation: Point Method
Method (more)
Select a set of benchmark (key) jobs:
Jobs with stable job content
Jobs that are common in lots of organizations
Jobs that can be defined with precision
Jobs that are performed similarly across different organizations
Jobs that represent the range of jobs being evaluated
Jobs for which market pay data is available
Identify the relevant labor market for each benchmark job
Local, regional, national, or international

36. Job Evaluation: Point Method
Method (more)
For each benchmark job, collect market pay data in the relevant labor market
Either use pay data collected by others, or
Collect pay data yourself by performing a pay survey (wage & salary survey):
Identify a sample of organizations in the relevant labor market that have the benchmark job
Contact each organization & collect pay data for the job title (minimum pay & maximum pay)
Avoid anti-trust (pay-fixing) concerns:
Use an independent consultant to collect the pay data
Collect pay data that is several months old (e.g., 3 months)
Include at least 5 employers for each job title
Have the consultant report only averages (e.g., average minimum pay for the job title, average maximum pay for the job title)

37. Job Evaluation: Point Method
Method (more)
Estimate the market pay lines
Estimate 2 simple regressions using the benchmark jobs as the data points
Minimum pay line: regress minimum pay (dependent variable) on points (independent variable)
Maximum pay line: regress maximum pay (dependent variable) on points (independent variable)
Use the market pay lines to determine the pay ranges for each job (both benchmark & non-benchmark jobs)
This takes care of external equity
Optional: create pay grades

38. Job Evaluation: Point Method
Example of a website that implements the Point Method (this website would be a good resource to use for the Compensation element of your Team Project):
Important note: The website uses pop-ups, so change your browser setting to allow pop-ups from this website before starting
In Box 1, select the area based on the relevant labor market for the job title
In Box 2, select the occupation that includes the job title
In Box 3, click the “Get help choosing a Work Level” button
This will pop open a new window where you perform the job evaluation using 9 compensable factors: Knowledge, Supervision Received, Guidelines, Complexity, Scope and Effect, Personal Contacts, Purpose of Contacts, Physical Demands, & Work Environment
Perform the job evaluation, then click “Accept Level” (this will pop you back to the other page); suggestion: use a committee to do the job evaluation
In Box 4, click “Get Data” (this will pop open a new window with the results)

39. Job Evaluation Pay Systems
Source of figure: Fisher, Schoenfeldt, & Shaw (2006), Figure 11.3, p. 490

40. Pay Policy Issues Periodically update the pay ranges
Jobs above or below the desired pay range:
Green circle jobs: jobs whose current pay is below the pay range for the job
Develop & implement a plan to give these jobs slightly larger pay increases to catch the job up with the pay range
Red circle jobs: jobs whose current pay is above the pay range for the job
Develop & implement a plan to give these jobs slightly smaller pay increases to allow the pay range to catch up with the job
Compression: the pay differences across jobs shrink over time
Can mess up internal equity because the pay differences across jobs gets too small

41. Pay Policy Issues
Broadbanding: combine adjacent pay ranges to create a smaller number of pay ranges in which each pay range is wider
May help with red & green circle jobs & with compression
Frequently implemented as part of restructuring & downsizing
Source of figure: Fisher, Schoenfeldt, & Shaw (2006), Figure 11.7, p. 511

42. Pay Policy Issues
Set the pay for each employee doing each job (where the employee falls inside the pay range for the employee’s job)
Methods:
Seniority: Each employee moves up their pay range by the same amount (usually determined as a percentage pay increase)
Creates incentives for a stable, experienced workforce
Typically used with unionized jobs, when merit pay isn’t accepted by employees, when it is hard to measure job performance, or when there are very minor differences in job performance across employees (e.g., assembly line)
Merit Pay: Each employee moves up their pay range based on their job performance (creates incentives for improved job performance)
Skill-based Pay: Each employee moves up their pay range based on the skills & knowledge mastered by the employee (incentives to add skills)

43. Pay Policy Issues Legal issues in pay Fair Labor Standards Act (FLSA)
4 Primary provisions:
Minimum wage:
9/1/97: $5.15
7/24/07: $5.85
7/24/08: $6.55
7/24/09: $7.25
Overtime pay
Restrictions on employment of children
Recordkeeping requirements
Minimum wage set by state laws
Example: Minnesota (for large employers): $6.15

44. Pay Policy Issues Equal Pay Act: “equal pay for equal work”
Forbids sex discrimination in pay when the employees perform the same job in the same organization
If a man and a woman are both doing the same job in the same organization, don’t pay them differently because of their sexes
Pay differences based on other factors is okay (e.g., seniority, job performance, etc.)
Comparable worth: “equal pay for equal worth”
If a man and a women are doing different jobs, but the company evaluates that both jobs are of equal value to the company, then they should be paid the same
Example: If a company’s job evaluation determines that a secretarial job (held mostly by women) and a maintenance job (held mostly by men) make contributions of equal value to the company, then the two jobs should be paid the same

45. Outline Compensation System Components Compensation Equity Issues
Equity Theory
Pay Systems
Market-Based Pay
Job Evaluation Pay Systems
Job Ranking
Job Grading (Job Classification)
Factor Comparison
Point Method
Pay Policy Issues