1. Chapter 9 Direct Financial Compensation
University of Bahrain
College of Business Administration
MGT 430 Human Resource Management Global Edition
Chapter 9 Direct Financial Compensation
Copyright © 2014 Pearson Education
Dr. Mahnmood Asad
MGT430

2. Learning Objectives
Discuss executive pay as a lightning rod for criticism, define compensation, and describe the various forms of compensation.
Define financial equity and explain the concepts of equity in direct financial compensation.
Identify the determinants of direct financial compensation.
Describe the organization as a determinant of direct financial compensation.
Describe the labor market as a determinant of direct financial compensation and explain how the job is a determinant of direct financial compensation.
Dr. Mahnmood Asad
MGT430

3. Learning Objectives (Cont.)
Define job evaluation and describe the four traditional job evaluation methods.
Describe job pricing and identify factors related to the employee that are essential in determining direct financial compensation.
Describe team-based pay, company-wide pay plans, professional employee compensation, sales representative compensation, and contingent worker compensation.
Explain say on pay, golden parachutes, and clawback policies.
Explain the various elements of executive compensation and discuss executive compensation in the global environment.
Dr. Mahnmood Asad
MGT430

4. HRM in Action: Executive Pay as a Lightning Rod for Criticism
Executive compensation averaged $11.4 million in 2011 for top 299s companies
Peter Drucker advised managers that a 20-to-1 salary ratio between senior executives and rank-and-file white-collar workers should be considered limit
Dodd-Frank Act may have major impact on excessive executive compensation
Dr. Mahnmood Asad
MGT430

5. Compensation: An Overview
Compensation: Total rewards provided to employees in return for services
Direct financial compensation: Wages, salaries, bonuses, and commissions
Indirect financial compensation (benefits): All other financial rewards
Nonfinancial compensation: Satisfaction from job itself or from psychological and/or physical environment in which employee works
9-5
Dr. Mahnmood Asad
MGT430

6. Components of Total Compensation Program External Environment Internal Environment
Financial
Nonfinancial
Direct
Wages Salaries Commissions Bonuses
Indirect (Benefits)
Legally Required Benefits Social Security Unemployment Compensation Workers’ Compensation
Discretionary Benefits Payment for Time Not Worked Health Care Life Insurance Retirement Plans Disability Protection Employee Stock Option Plans Employee Services
Premium Pay
Voluntary Benefits
The Job Meaningful
Appreciated
Satisfying
Learning
Enjoyable
Challenging
Job Environment
Sound Policies
Capable Managers Competent Employees Congenial Coworkers Appropriate Status Symbols
Working Conditions
Workplace Flexibility Flextime Compressed Workweek Job Sharing Telecommuting
Part-time Work
9-6
Dr. Mahnmood Asad
MGT430

7. Equity Theory
Motivation is in proportion to the perceived fairness of rewards received for amount of effort exerted.
Compared to what others around the person receive for their efforts,
Equity and fairness important in compensation.
9-7
Dr. Mahnmood Asad
MGT430

8. Equity in Financial Compensation
Financial equity: Perception of fair pay
External equity: Employees paid comparably to workers who perform similar jobs in other firms
Internal equity: Employees paid according to relative value of jobs within a single organization
Employee equity: Individuals performing similar jobs for same firm paid according to factors such as performance level or seniority
Team equity: More productive teams are rewarded more than less productive groups
9-8
Dr. Mahnmood Asad
MGT430

9. Primary Determinants of Direct Financial Compensation
Organization Compensation Policies Organizational Level Ability to Pay
Employee Job Performance Skills Competencies Seniority Experience Organization Membership Potential Political Influence Luck
Salary Compression
Job
Pricing
Labor Market Compensation Surveys Expediency Cost of Living Labor Unions Economy Legislation
Direct Financial Compensation
Job Job Analysis Job Descriptions Job Evaluation
9-9
Dr. Mahnmood Asad
MGT430

10. Organization as a Determinant of Direct Financial Compensation
Compensation policies
Organizational level
Ability to pay
9-10

11. Compensation Policies
Pay leaders: Pay higher wages and salaries to attract high-quality, productive employees and thus achieve lower per-unit labor costs
Market rate, or going rate: Pay what most employers pay for same job
Pay followers: Pay below market rate because of firm’s poor financial condition or belief that it does not require highly capable employees
9-11
Dr. Mahnmood Asad
MGT430

12. Organizational Level
Upper management often makes decisions to ensure consistency
Extreme pressure to retain top performers may override desire to maintain consistency in pay structure
9-12

13. Ability to Pay
Organization’s assessment of its ability to pay is an important factor in determining pay levels.
9-13

14. Labor Market as Determinant of Direct Financial Compensation
Labor market: Potential employees located within geographic area from which employees are recruited
Pay for same jobs in different labor markets may vary considerably
9-14
Dr. Mahnmood Asad
MGT430

15. Compensation Surveys
A means of obtaining data regarding what other firms are paying for specific jobs or job classes within a given labor market.
Market rates remain the most important standard for determining pay.
9-15

16. Expediency
Managers in highly technical and specialized areas occasionally need to use nontraditional means to determine what constitutes competitive compensation for scarce talent and niche positions.
Need real-time information
9-16
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MGT430

17. Cost of Living
When prices rise over a period of time and pay does not, real pay is actually lowered
Some firms index pay increases to inflation rate

18. Labor Unions
Mandatory collective bargaining between management and unions on:
Wages
Hours
Other terms and conditions of employment
Cost-of-living allowance has been disappearing
Dr. Mahnmood Asad
MGT430

19. The Economy Affects financial compensation decisions
Depressed economy generally increases labor supply
Cost of living often rises as economy expands
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20. Compensation Legislation
Davis-Bacon Act of 1931
Walsh-Healy Act of 1936
Fair Labor Standards Act of 1938, as amended
Dodd-Frank Wall Street Reform and Consumer Protection Act
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MGT430

21. Davis-Bacon Act of 1931
Federal construction contractors with projects over $2,000 must pay at least prevailing wages in area
Secretary of Labor sets prevailing wage at union wage, regardless of what average wage is in affected locality
First national law to deal with minimum wages
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22. Walsh-Healy Act of 1936
Companies with federal supply contracts exceeding $10,000 pay prevailing wages
Requires 1.5 times regular pay rate for hours over 8 per day or 40 per week
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23. Fair Labor Standards Act of 1938, as Amended
Most significant law affecting compensation
Establishes minimum wage
Requires overtime pay and record keeping
Provides standards for child labor

24. Exempt and Nonexempt Employees
Exempt employees: Categorized as executive, administrative, professional, or outside salespersons
Nonexempt employees: Those in jobs not conforming to the definition above
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MGT430

25. Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
Provisions relating to executive compensation and corporate governance
Impacts executives, directors, and shareholders of publicly traded companies
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MGT430

26. Job as Determinant of Direct Financial Compensation
Job itself is a factor, especially in firms that have internal pay equity as primary consideration
Organizations pay for value they attach to certain:
Duties
Responsibilities
Other job-related factors, such as working conditions
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MGT430

27. Job Analysis and Job Descriptions
Before organization can determine relative difficulty or value of jobs, they must first define content
This is done by job analysis and job descriptions

28. Job Evaluation Firm determines value of one job in relation to another
Ranking
Classification
Factor comparison
Point
Hay Group Guide Chart-Profile Method
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MGT430

29. Ranking Method Simplest method Raters examine description of each job
Jobs arranged in order according to value

30. Classification Method
Define number of classes or grades to describe group of jobs
Compare job description with class description
Class description that most closely agrees with job description determines job classification
Dr. Mahnmood Asad
MGT430

31. Factor Comparison Method
5 universal job factors:
Mental requirements
Skills
Physical requirements
Responsibilities
Working conditions
Raters make decisions on separate aspects or factors of job

32. Point Method Numerical values assigned to specific job components
Sum of values gives quantitative assessment of job’s relative worth
Job factors selected according to nature of specific group of jobs
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MGT430

33. Hay Group Guide Chart-Profile Method
Refined version of point method
Know-how
Problem solving
Accountability
Additional compensable elements, such as working conditions
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MGT430

34. Job Pricing Job evaluation results in a job hierarchy
Job pricing places a dollar value on job
Takes place after evaluation of a job
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MGT430

35. Pay Ranges for Pay Grades
Scatter Diagram of Evaluated Jobs Illustrating Wage Curve, Pay Grades, and Pay Ranges
Average Pay per Hour (Current Rates or Market Rates)
$19.80 5
18.50 4
17.20 3
Pay Ranges for Pay Grades
15.90 2
14.60
Wage Curve
14.00 1
13.30
12.90
12.00
100
200
300
400
500
Evaluated Points 1 2 3 4 5
Pay Grades
Summary
Evaluated Points Pay Grade Minimum Midpoint Maximum
$ $ $
Dr. Mahnmood Asad
MGT430 35

36. Pay Grades Grouping of similar jobs to simplify pricing jobs
Similar to a university’s practice of grouping grades
Grades of 90–100 are an “A”
Grades of 80–89 are a “B,” etc.
Plotting jobs on a scatter diagram
Dr. Mahnmood Asad
MGT430

37. Wage Curve
Fitting of plotted points to create smooth progression between pay grades
Creates a smooth progression
Often uses statistical methods
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MGT430

38. Pay Ranges
Minimum and maximum pay rate with enough variance between to allow for significant pay difference
Generally preferred over single pay rates
Need to develop a method to advance individuals through the range
Dr. Mahnmood Asad
MGT430

39. Broadbanding
Technique that collapses many pay grades (salary grades) into a few wide bands to improve organizational effectiveness
Lateral employee development
Develops employee skills and encourages team focus
Dr. Mahnmood Asad
MGT430 39

40. Broadbanding and Its Relationship to Traditional Pay Grades and Ranges
Average Hourly Pay
Grade 4
Grade 3
Band III
Grade 2
Band II
Grade 1
Band I
Low
High
Job Worth
Dr. Mahnmood Asad
MGT430 40

41. Single Rate Systems
Pay ranges not appropriate for some workplace conditions, such as some assembly lines
Everyone in the same job receives same base pay
May be midpoint of a range determined by compensation survey
Dr. Mahnmood Asad
MGT430

42. Adjusting Pay Rates Overpaid and underpaid jobs
Bring underpaid jobs up to minimum of pay range
Promote person who is overpaid or freeze rate until across-the-board pay increases bring job into line
Bad idea to cut pay
Dr. Mahnmood Asad
MGT430

43. Employee as Determinant of Direct Financial Compensation
Performance (performance-based pay)
Skills (skill-based pay)
Competencies (competency-based pay)
Seniority
Experience
Potential
Political influence
Luck
Salary compression
Dr. Mahnmood Asad
MGT430

44. Performance-Based Pay
Merit pay
Variable pay
Bonuses
Spot bonuses
Piecework
Dr. Mahnmood Asad
MGT430

45. Merit Pay
Pay increase given based on level of performance, as indicated in appraisal
Historically a cost-of-living increase in disguise
Increases the employee’s base pay
Some companies are freezing or cutting pay for some so as to be able to reward others
Dr. Mahnmood Asad
MGT430

46. Bonuses
Companies are increasingly placing higher percentage of compensation budget in bonuses
One-time financial award based on productivity
Based on productivity that is not added to base pay
Use of bonuses is a win–win situation
Dr. Mahnmood Asad
MGT430

47. Spot Bonuses
Relatively small gifts to employees for outstanding work or effort
For work done in relatively short period of time
$100 or $500, perhaps up to $5,000, shortly after noteworthy actions
Dr. Mahnmood Asad
MGT430

48. Piecework Employees paid for each unit they produce
Especially prevalent in production/operations area
Need plan for developing output standards
Not feasible for many jobs
Have declined in their use
Dr. Mahnmood Asad
MGT430

49. Skill-Based Pay
Compensates on basis of job-related skills and knowledge
Employees and departments benefit when employees obtain additional skills
Appropriate where work tends to be routine and less varied
Must provide adequate training opportunities or it becomes demotivating
Dr. Mahnmood Asad
MGT430

50. Competency-Based Pay
Compensates employees for capabilities they attain
Type of skill-based pay plan for professional and managerial employees
Disappearance of the traditional job provides primary rationale for this change
Dr. Mahnmood Asad
MGT430

51. Seniority Seniority: Length of time employee has been with company
Management generally prefers performance as primary basis for compensation changes
Unions tend to favor seniority
Dr. Mahnmood Asad
MGT430

52. Experience Has potential for enhancing person’s ability to perform
Materializes only if experience acquired is positive
Today technology may have rendered experience useless unless person has kept up with the technology available
Dr. Mahnmood Asad
MGT430

53. Organization Membership
Receive some compensation components without regard to particular job they perform or their level of productivity
Receive them because they are members of the organization
Dr. Mahnmood Asad
MGT430

54. Potential Useless if it is never realized
Many young employees are paid well because they have the potential to add future value
Used to attract talented young people to the firm
Dr. Mahnmood Asad
MGT430

55. Political Influence
Firms should obviously try not to permit political influence to be a factor
To deny its existence would be unrealistic
Natural for a manager to favor a friend or relative in granting a pay increase or promotion
Dr. Mahnmood Asad
MGT430

56. Luck Helps to be in the right place at the right time
Opportunities are continually presenting themselves
Luck works primarily for the efficient
Dr. Mahnmood Asad
MGT430

57. Salary Compression
Salary compression: Occurs when less experienced employees are paid as much as or more than employees who have been with the organization a long time due to a gradual increase in starting salaries and limited salary adjustment for long-term employees
Dr. Mahnmood Asad
MGT430

58. Team-Based Pay
Firms should also provide rewards based on overall team performance
Firms find it easier to develop performance standards for groups
Potential disadvantage for exemplary performers
Dr. Mahnmood Asad
MGT430

59. Company-Wide Pay Profit sharing Gainsharing Scanlon plan
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60. Profit Sharing
Distribution of predetermined percentage of firm’s profits to employees
Kinds of plans:
Current profit sharing
Deferred profit sharing
Combination plans
Vesting: Determines amount of profit employee owns
Dr. Mahnmood Asad
MGT430

61. Gainsharing
Binds employees to firm’s productivity and provides incentive payment based on improved company performance
Scanlon, Multicost Scanlon, Rucker, and Improshare plans are most popular
Helps align an organization’s people strategy with its business strategy
Dr. Mahnmood Asad
MGT430

62. Scanlon Plan
Reward to employees for savings in labor costs resulting from employees’ suggestions
Employee-management committees evaluate these suggestions
Systems for participative management
Dr. Mahnmood Asad
MGT430

63. Professional Compensation
Professionals initially compensated for knowledge they bring to organization
Maturity curves reflect relationship between professional compensation and years of experience

64. Sales Representative Compensation
Straight salary
Straight commission
Endless variety of part-salary, part-commission combinations
Dr. Mahnmood Asad
MGT430

65. Contingent Worker Compensation
In most cases, contingent workers earn less pay than permanent counterparts
Far less likely to receive health or retirement benefits
Dr. Mahnmood Asad
MGT430

66. Trends & Innovations: Say on Pay, Golden Parachutes, and Clawback Policies
Three provisions in Dodd-Frank Act relate to:
Say on pay
Golden parachutes
Clawback policies
Dr. Mahnmood Asad
MGT430

67. Say on Pay
Gives shareholders in all but smallest companies an advisory vote on executive pay
Some expect vote will cause greater accountability on executive pay
Votes at least every 3 years
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MGT430

68. Golden Parachute Contract
Perquisite protecting executives in event another company acquires firm or executive is forced to leave firm for other reasons
At times has been abused
Dodd-Frank Act has disclosure requirements
Requires shareholder advisory vote on certain arrangements
Dr. Mahnmood Asad
MGT430

69. Clawback Contract Provision
Provision allows company to recover compensation if subsequent review indicates payments were not calculated accurately or performance goals were not met
Dodd-Frank Act requires companies to develop clawback policies to recover compensation later deemed excessive
Dr. Mahnmood Asad
MGT430

70. Executive Compensation
Remember the skills possessed by company executives largely determine whether firm will prosper, survive, or fail
Compensation programs need to be developed which motivates these executives to strive to achieve long term success for firm
Dr. Mahnmood Asad
MGT430

71. Types of Executive Compensation
Base salary
Bonuses and performance-based pay
Stock option plans
Perquisites (perks)
Severance packages

72. Base Salary Factor in determining executive’s standard of living
Salary provides basis for other forms of compensation; may determine amount of bonuses and certain benefits
U.S. tax law does not allow companies to deduct more than $1 million of executive’s salary
Dr. Mahnmood Asad
MGT430

73. Bonuses and Performance-Based Pay
Trend toward more performance-based compensation packages for executives
Payment of bonuses reflects managerial belief in their incentive value
Dr. Mahnmood Asad
MGT430

74. Stock Option Plans
Options for managers to buy specified amount of stock in future at or below current market price
Some boards of directors require their top executives to hold some of firm’s stock
Financial Accounting Standards Boards require companies to expense stock options, thereby making them less attractive
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MGT430

75. Perquisites (Perks)
Special benefits provided by firm to small group of key executives
Designed to give executives something extra
Securities and Exchange Commission lowered threshold for disclosure of executive perks from $50,000 to $10,000
Dr. Mahnmood Asad
MGT430

76. Severance Packages Not set up after CEO has quit or been fired
SEC requires companies to list all agreements for each executive
Investors will see estimated total dollar value of exit packages
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MGT430

77. A Global Perspective: Executive Compensation in the Global Environment
Whereas people in United States derive great status from high pay, nations in large parts of Europe and Asia shun conspicuous wealth
Governance of executive pay varies from country to country
Investors in some countries can cast binding vote on executive pay
Dr. Mahnmood Asad
MGT430