1 Chapter 9 Direct Financial CompensationUniversity 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 CriticismExecutive 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 OverviewCompensation: 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 EnvironmentFinancial 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 CompensationFinancial 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 CompensationOrganization 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 CompensationCompensation policies Organizational level Ability to pay 9-10
11 Compensation PoliciesPay 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 CompensationLabor 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 Dr. Mahnmood Asad 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 decisionsDepressed economy generally increases labor supply Cost of living often rises as economy expands Dr. Mahnmood Asad MGT430
20 Compensation LegislationDavis-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 Dr. Mahnmood Asad 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 Dr. Mahnmood Asad MGT430
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 Dr. Mahnmood Asad MGT430
23 Fair Labor Standards Act of 1938, as AmendedMost significant law affecting compensation Establishes minimum wage Requires overtime pay and record keeping Provides standards for child labor
24 Exempt and Nonexempt EmployeesExempt employees: Categorized as executive, administrative, professional, or outside salespersons Nonexempt employees: Those in jobs not conforming to the definition above Dr. Mahnmood Asad MGT430
25 Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010Provisions relating to executive compensation and corporate governance Impacts executives, directors, and shareholders of publicly traded companies Dr. Mahnmood Asad MGT430
26 Job as Determinant of Direct Financial CompensationJob 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 Dr. Mahnmood Asad MGT430
27 Job Analysis and Job DescriptionsBefore 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 anotherRanking Classification Factor comparison Point Hay Group Guide Chart-Profile Method Dr. Mahnmood Asad MGT430
29 Ranking Method Simplest method Raters examine description of each jobJobs arranged in order according to value
30 Classification MethodDefine 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 Method5 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 componentsSum of values gives quantitative assessment of job’s relative worth Job factors selected according to nature of specific group of jobs Dr. Mahnmood Asad MGT430
33 Hay Group Guide Chart-Profile MethodRefined version of point method Know-how Problem solving Accountability Additional compensable elements, such as working conditions Dr. Mahnmood Asad MGT430
34 Job Pricing Job evaluation results in a job hierarchyJob pricing places a dollar value on job Takes place after evaluation of a job Dr. Mahnmood Asad MGT430
35 Pay Ranges for Pay GradesScatter 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 jobsSimilar 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 Dr. Mahnmood Asad 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 RangesAverage 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 jobsBring 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 CompensationPerformance (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 PayMerit 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 produceEspecially 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 companyManagement 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 performMaterializes 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 MembershipReceive 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 realizedMany 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 timeOpportunities 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 planDr. Mahnmood Asad MGT430
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 CompensationProfessionals initially compensated for knowledge they bring to organization Maturity curves reflect relationship between professional compensation and years of experience
64 Sales Representative CompensationStraight salary Straight commission Endless variety of part-salary, part-commission combinations Dr. Mahnmood Asad MGT430
65 Contingent Worker CompensationIn 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 PoliciesThree 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 Dr. Mahnmood Asad MGT430
68 Golden Parachute ContractPerquisite 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 ProvisionProvision 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 CompensationRemember 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 CompensationBase salary Bonuses and performance-based pay Stock option plans Perquisites (perks) Severance packages
72 Base Salary Factor in determining executive’s standard of livingSalary 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 PayTrend 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 Dr. Mahnmood Asad 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 firedSEC requires companies to list all agreements for each executive Investors will see estimated total dollar value of exit packages Dr. Mahnmood Asad MGT430
77 A Global Perspective: Executive Compensation in the Global EnvironmentWhereas 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