Employee Compensation (Encyclopedia of Business and Finance)
In exchange for job performance and commitment, an employer offers rewards to employees. Adequate rewards and compensations potentially attract a quality work force, maintain the satisfaction of existing employees, keep quality employees from leaving, and motivate them in the workplace. A proper design of reward and compensation systems requires careful review of the labor market, thorough analysis of jobs, and a systematic study of pay structures.
There are a number of ways of classifying rewards. A commonly discussed dichotomy is intrinsic versus extrinsic rewards. Intrinsic re wards are satisfactions one gets from the job itself, such as a feeling of achievement, responsibility, or autonomy. Extrinsic rewards include monetary compensation, promotion, and tangible benefits.
Compensation frequently refers to extrinsic, monetary rewards that employees receive in ex change for their work. Usually, compensation is composed of the base wage or salary, any incentives or bonuses, and other benefits. Base wage or salary is the hourly, weekly, or monthly pay that employees receive. Incentives or bonuses are re wards offered in addition to the base wage when employees achieve a high level of performance. Benefits are rewards offered for being a member of the company and can include paid vacation, health and life insurance, and retirement pension.
A company's compensation system must include policies, procedures, and rules that provide clear and unambiguous determination and ad ministration of employee compensation. Other wise, there can be confusion, diminished employee satisfaction, and potentially costly litigation.
DETERMINANTS OF COMPENSATION
Fair and adequate compensation is critical to motivating employees attracting high-potential employees, and retaining competent employees. Compensation has to be fair and equitable among all workers in the same company (internal equity). Internal equity can be achieved when pay is proportionate to the individual employee's qualifications and contributions to a company. On the other hand, compensation also has to be fair and equitable in comparison to the external market (external equity). If a company pays its employees below the market rate, it may lose competent employees. In determining adequate pay for employees, a manager must consider the three major factors: the labor market, the nature and scope of the job, and characteristics of the individual employee.
Potential employees are recruited from a certain geographic areahe labor market. The actual boundary of a labor market varies depending on the type of job, company, and industry. For example, an opening for a systems analyst at IBM may attract candidates from across the country, whereas a secretarial position at an elementary school may attract candidates only from the immediate local area of the school.
Pay for a job even within the same labor market may vary widely because of many factors, such as the industry, type of job, cost of living, and location of the job. Compensation managers must be aware of these differences. To help compensation managers understand the market rate of labor, a compensation survey is conducted. A compensation survey obtains data regarding what other firms pay for specific jobs or job classes in a given geographic market. Large companies periodically conduct compensation surveys and review their compensation system to assure external equity. There are professional organizations that conduct compensation surveys and provide their analysis to smaller companies for a fee.
Several factors are generally considered in evaluating the market rate of a job. They include the cost of living of the area, union contracts, and broader economic conditions. Urban or metropolitan areas generally have a higher cost of living than rural areas. Usually, in calculating the real pay, a cost-of-living allowance (COLA) is added to the base wage or salary. Cost-of-living indexes are published periodically in major business journals. During an economically depressed period, the labor supply usually exceeds the demand in the labor market, resulting in lower labor rates.
The characteristics of an individual employee are also important in determining compensation. An individual's job qualifications, abilities and skills, prior experiences, and even willingness to work in hardship conditions are determining factors. Within the reasonable range of a market rate, companies offer additional compensation to attract and retain competent employees.
In principle, compensation must be designed around the job, not the person. Person-based pay frequently results in discriminatory practices, which violates Title VII of the Civil Rights Act, and job-based compensation is the employer's most powerful defense in court. For job-based compensation, management must conduct a systematic job analysis, identifying and describing what is happening on the job. Each job must be carefully examined to list the necessary tasks and actions, identify skills and abilities required, and establish desirable behaviors for successful completion of the job.
With complete and comprehensive data about all the jobs, job analysts must conduct systematic comparisons of them and determine their relative worth. Numerous techniques have been developed for the analysis of relative worth, including the simple point method, job classification method, job ranking method, and the factor comparison method.
Information resulting from the comprehensive job analysis will be used for establishing pay or wage grades. Assume that twenty-five jobs range from 10 to 50 points in their job scores based on the job point method. All twenty-five of these jobs are reviewed carefully for their relative worth and plotted on Figure 1. The x-axis represents job points and the ordinate (y-axis) represents relative worth or wage rates. Once a manager
can identify fair and realistic wages of two or more jobs, desirably top and bottom ones, then all the rest can be prorated along the wage curve in the diagram.
In order to simplify the administration of a wage structure, similar jobs in the approximate cluster are grouped together into a class or grade for pay purpose. Figure 2 shows how twenty-five jobs are grouped into five pay grades. Employees move up in their pay within each grade, typically by seniority. Once a person hits the top pay in the grade, he or she can only increase the pay by moving to a higher grade. Under certain unusual circumstances, it is possible for an outstanding performer in a lower grade to be paid more than a person at the bottom of the next-highest level.
INNOVATIONS IN COMPENSATION SYSTEMS
As the market becomes more dynamic and competitive, companies are trying harder to improve performance. Since companies cannot afford to continually increase wages by a certain percentage, they are introducing many innovative compensation plans tied to performance. Several of these plans are discussed in this section.
Incentive Compensation Plan. Incentive compensation pays proportionately to employee performance. Incentives are typically given in addition
to the base wage; they can be paid on the basis of individual, group, or plant-wide performance. While individual incentive plans encourage competition among employees, group or plant-wide incentive plans encourage cooperation and direct the efforts of all employees toward achieving overall company performance.
Skill-Based or Knowledge-Based Compensation. Skill-based pay is a system that pays employees based on the skills they possess or master, not for the job they hold. Some managers believe that mastery of certain sets of skills leads to higher productivity and therefore want their employees to master a series of skill sets. As employees gain one skill and then another, their wage rate goes up until they have mastered all the skills. Similar to skill-based pay is knowledge-based pay. While skill-based pay evolved in the manufacturing sector, pay-for-knowledge developed in the service sector (Henderson, 1997). For example, public school teachers with a bachelor's degree receive the lowest rate of pay, those with a master's degree receive a higher rate, and those with a doctorate receive the highest.
Team-Based Compensation. As many companies introduce team-based management practices such as self-managed work teams, they begin to offer team-based pay. Recognizing the importnace of close cooperation and mutual development in a work group, companies want to encourage employees to work as a team by offering pay based on the overall effectiveness of the team.
Performance-Based Compensation. In the traditional sense, pay is considered entitlement that employees deserve in exchange for showing up at work and doing well enough to avoid being fired. While base pay is given to employees regardless of performance, incentives and bonuses are extra rewards given in appreciation of their extra efforts. Pay-for-performance is a new movement away from this entitlement concept (Milkovich and Newman, 1996). A pay-for-performance plan increases even the base payo-called merit increaseso reflect how highly employees are rated on a performance evaluation. Other incentives and bonuses are calculated based on this new merit pay, resulting in substantially more total dollars for highly ranked employee performance. Frequently, employees also receive an end-of-year lump sum bonus that does not build into base pay.
Recently, people have been concerned with the excessively high level of executive compensation. According to Business Week 's annual executive pay survey, in 1997 Sanford Weill, CEO of Travelers Group, collected $7.5 million in salary and bonuses plus $223.2 million for long-term compensation, totaling $230.7 million. In the same year, Roberto Goizueta, CEO of Coca-Cola, earned a total of $111.8 million, including annual salary, bonuses, and long-term compensation. Compensations of the twenty highest-paid executives ranged from $28.4 million to $230 million.
Frequently, executive compensation becomes controversial. Are these compensations excessive? What justifies such a large compensation for executives? Justification of such a large sum of compensation is linked to the company's performance. In fact, a significant portion of executive compensation results from exercising stock options, which were quite valuable in the recent "bull" market. And yet ordinary working-class Americans are outraged by the shocking contrast in pay raises: Annual executive pay at large companies rose 54 percent in 1996, whereas the pay raises of most working-class people were in the 3 percent to 5 percent range during the same period.
An executive compensation package is typically composed of (1) base salary, (2) annual incentives or bonuses, (3) long-term incentives (e.g., stock options), (4) executive benefits (e.g., health insurance, life insurance, and pension plans), and (5) executive perquisites. Considering the high turnover rate of competent executives, offering a competitive salary is crucial in attracting the top candidates.
Frequently, annual bonuses play a more important role than base salary in executive compensations. They are primarily designed to motivate better performance. In order to underscore the importance of financial performance, usually measured by the company's stock price, top executives are offered stock options. Sometimes, exercising stock options yields more cash benefits to executives than do annual salaries.
In addition to monetary compensation, executives enjoy many different types of perquisites, commonly called "perks." Such executive perks include the luxurious office with lush carpets, the executive dining room, special parking, use of a company airplane, company-paid membership in high-class country clubs and associations, and executive travel arrangements. Many companies even offer executives tax-free personal perks, including such things as free access to company property, free legal counseling, free home repairs and improvements, and expenses for vacation homes or boats.
Another perk that became popular recently is the so-called golden parachute protection plan for executives in the event that they are forced out of the organization. Such severance frequently results from a merger or hostile take over of the company. The golden parachute provides either a significant one-time sum to the departing executive or a guaranteed executive position in the newly merged company.
Henderson, Richard I. (1997). Compensation Management in a Knowledge-Based World, 7th ed. New York: Prentice-Hall.
Henderson, Richard I. (1994). Compensation Management: Rewarding Performance, 6th ed. New York: Prentice Hall.
Klein, Andrew L. (1996). "Validity and Reliability for Competency-Based Systems: Reducing Litigation Risks." Compensation and Benefits Review 28(4): 31-37.
Milkovich, George T., and Newman, Jerry M. (1996). Compensation, 5th ed. Chicago: Irwin.
Pauline, George B. (1997). "Executive Compensation and Changes in Control: A Search for Fairness." Compensation and Benefits Review 29 (March/April): 30-40.
Reingold, Jennifer, and Borrus, Amy. (1997). "Even Executives Are Wincing at Executive Pay." Business Week, May 12: 40-41.
Reingold, Jennifer, and Melcher, Richard A. (1998). "Executive Pay." Business Week, April 20: 64-68.
Employee Compensation (Encyclopedia of Management)
Employees receive compensation from a company in return for work performed. While most people think compensation and pay are the same, the fact is that compensation is much more than just the monetary rewards provided by an employer. According to Milkovitch and Newman in Compensation, it is "all forms of financial returns and tangible services and benefits employees receive as part of an employment relationship" The phrase "financial returns" refers to an individual's base salary, as well as short- and long-term incentives. "Tangible services and benefits" are such things as insurance, paid vacation and sick days, pension plans, and employee discounts.
An organization's compensation practices can have far-reaching effects on its competitive advantage. As compensation expert Richard Henderson notes, "To develop a competitive advantage in a global economy, the compensation program of the organization must support totally the strategic plans and actions of the organization." Labor costs greatly affect competitive advantage because they represent a large portion of a company's operating budget. By effectively controlling these costs, a firm can achieve cost leadership. The impact of labor costs on competitive advantage is particularly strong in service and other labor-intensive organizations, where employers spend between 40 and 80 cents of each revenue dollar on such costs. This means that for each dollar of revenue generated, as much as 80 cents may go to employee pay and benefits.
Compensation costs have risen sharply in recent years, primarily because of escalating benefit costs. Employers now spend more than $1 trillion on employee benefits. In 2003 the Society for Human Resource Management reported that benefit costs averaged 39 percent of total payroll in 2001, up from 37.5 percent in 2000. This means that, on average, employers provide about $18,000 in benefits to each employee annually. The biggest cost increases have been in health benefits, which have been rising at an average of 12 percent annually for the past several years.
An organization must contain these spiraling costs if it is to get a proper return on its human resource investment, and thus gain a competitive advantage. When compensation-related costs escalate, the organization must find a way to offset them. In the past, companies passed along these increases in costs to the customer in the form of higher prices. However, most U.S. companies now find it very difficult to raise prices. Thus, to remain competitive in light of fierce domestic and foreign competition, unfavorable exchange rates, and cheaper foreign labor costs, it is imperative that companies find ways to control labor costs. Unless this can be done, organizations may be forced to implement such adverse actions as pay freezes, outsourcing/offshoring, and/or massive layoffs.
A host of laws such as the Equal Pay Act, Fair Labor Standards Act, and the Employment Retirement Income Security Act, regulate corporate compensation practices. Some pertain to pay issues such as discrimination, minimum wages, and overtime pay; others pertain to benefits, such as pensions, unemployment compensation, and compensation for work-related injuries. Organizations must understand and fully follow these laws in order to avoid costly lawsuits and/or government fines.
Pay and benefits are extremely important to both new applicants and existing employees. The compensation received from work is a major reason that most people seek employment. Compensation not only provides a means of sustenance and allows people to satisfy their materialistic and recreational needs, it also serves their ego or self-esteem needs. Consequently, if a firm's compensation system is viewed as inadequate, top applicants may reject that company's employment offers, and current employees may choose to leave the organization. With the aging of the U.S. workforce and the impending retirement of the "baby boomers," employers must be more concerned than ever before about retaining skilled, productive workers. Moreover, disgruntled employees choosing to remain with the organization may begin to behave unproductively (e.g., become less motivated, helpful, or cooperative).
INFLUENCE OF PAY ON EMPLOYEE ATTITUDES AND BEHAVIOR
Because compensation practices heavily influence recruitment, turnover, and employee productivity, it is important that applicants and employees view these practices in a favorable light. In the following section, we discuss how people form perceptions about a firm's compensation system and how these perceptions ultimately affect their behavior.
One would expect that an individual's satisfaction with his or her compensation would simply be a function of the amount of compensation received: the higher the compensation rate, the greater the satisfaction. However, in reality things are not that simple. In fact, the amount of pay is less important than its perceived fairness or equity. To put this finding in perspective, consider the behavior of many professional athletes when negotiating a new contract. The average NBA salary in 2003 was $4.9 million; the average baseball salary was $2.4 million; the average NFL salary was $1.3 million. Yet, ball players continue to ask for more money. In many instances, these demands stem from neither need nor greed. Rather, the demand for greater salaries often stems from perceptions of inequity. For instance, despite a $15 million salary, a player may feel that his pay is inequitable because a less capable player (or someone he perceives as being less capable) is earning an equal or greater salary.
Because equity is such an important concern, individuals responsible for developing a firm's compensation system need to understand how perceptions of equity are formed. Equity theory, formulated by J. Stacy Adams, attempts to provide such an understanding. The theory states that people form equity beliefs based on two factors: inputs and outcomes. Inputs (I) refer to the perceptions that people have concerning what they contribute to the job (e.g., skill and effort). Outcomes (O) refer to the perceptions that people have regarding the returns they get (e.g., pay) for the work they perform. People judge the equity of their pay by comparing their outcome-to-input ratio (O/I) with another person's ratio. This comparison person is referred to as one's "referent other." People feel equity when the O/I ratios of the individual and his or her referent other are perceived as being equal. A feeling of inequity occurs when the two ratios are perceived as being unequal. For example, inequity occurs if a person feels that he or she contributes the same input as a referent other, but earns a lower salary.
A person's referent other could be any one of several people. People may compare themselves to others:
- Doing the same job within the same organization
- Working in the same organization, but performing different jobs
- Doing the same job in other organizations
For example, an assistant manager at a Wal-Mart department store might compare her pay to other assistant managers at Wal-Mart, to Wal-Mart employees in other positions (either above or below her in the organizational hierarchy), or to assistant managers at Kmart department stores.
While the mechanism for choosing a referent other is largely unknown, one study found that people do not limit their comparisons to just one person; they have several referent others. Thus, people make several comparisons when they assess the fairness of their pay; perceived fairness is achieved only when all comparisons are viewed as equitable. When employees' O/I ratios are less than that of their referent others, they feel they are being underpaid; when greater, they feel they are being overpaid. According to equity theory, both conditions produce feelings of tension that employees will attempt to reduce in one of the following ways:
- Decrease inputs by reducing effort or performance.
- Attempt to increase outcomes by seeking a raise in salary.
- Distort perceptions of inputs and/or outcomes by convincing themselves that their O/I ratio already is equal to that of their referent other.
- Attempt to change the inputs and/or outcomes of their referent other(s). For example, they may try to convince their referent other(s) to increase inputs (e.g., work harder for their pay).
- Choose a new referent other whose O/I ratio already is equal to their own.
- Escape the situation. This response may be manifested by a variety of behaviors, such as absenteeism, tardiness, excessive work-breaks, or quitting.
While equity theory poses six possible responses to inequity, only two of them typically occur (namely, numbers 1 and 6). Research findings, for example, have linked underpayment to increases in absenteeism and turnover and to decreases in the amount of effort exerted on the job. These linkages are especially strong among individuals earning low salaries.
Contrary to equity theory's predictions, these responses occur only when employees believe they are underpaid. Overpaid individuals do not respond because they feel little, if any tension, and thus have no need to reduce it. (The research findings on the issue of overpayment find overpayment to be either just as satisfying as equity, or somewhat dissatisfying but not nearly as dissatisfying as underpayment.) When feeling underpaid, why do some people choose to decrease their inputs, while others choose to escape the situation? A recent study sheds some light on this issue. The study found that reaction to inequity depends on the source of the comparison; people react differently depending on whether they judge equity on the basis of external (referents outside of the organization) or internal (referents employed by the individual's own organization) comparisons. When perceptions of inequity are based on external comparisons, people are more likely to quit their jobs. For instance, a nurse working for Hospital A may move to Hospital B if the latter pays a higher salary. When based on internal comparisons, people are more likely to remain at work, but reduce their inputs (e.g., become less willing to help others with problems, meet deadlines, and/or take initiative).
From the previous discussion, one may conclude that employees will believe their pay is equitable when they perceive that it:
- Is fair relative to the pay received by coworkers in the same organization (internal consistency)
- Is fair relative to the pay received by workers in other organizations who hold similar positions (external competitiveness)
- Fairly reflects their input to the organization (employee contributions)
ACHIEVING INTERNAL CONSISTENCY
To achieve internal consistency, a firm's employees must believe that all jobs are paid what they are "worth." In other words, they must be confident that company pay rates reflect the overall importance of each person's job to the success of the organization. Because some jobs afford a greater opportunity than others to contribute, those holding such jobs should receive greater pay. For instance, most would agree that nurses should be paid more than orderlies because their work is more important; that is, it contributes more to patient care, which is a primary goal of hospitals.
For pay rates to be internally consistent, an organization first must determine the overall importance or worth of each job. A job's worth typically is assessed through a systematic process known as job evaluation. In general, the evaluation is based on "informed judgments" regarding such things as the amount of skill and effort required to perform the job, the difficulty of the job, and the amount of responsibility assumed by the jobholder.
Job evaluation judgments must be accurate and fair, given that the pay each employee receives is so heavily influenced by them. Most firms create a committee of individuals, called a job evaluation committee, for the purpose of making the evaluations. Because those serving on the committee represent the organization's various functional areas, collectively they are familiar will all the jobs being evaluated. Such individuals typically include department managers, vice presidents, plant managers, and HR professionals (e.g., employee relations specialists and compensation managers). The committee chair usually is an HR professional or an outside consultant.
Perhaps the two most serious problems with job evaluation ratings are subjectivity and the rapidity with which jobs fundamentally change, both of which can cause inaccurate and unreliable ratings. In order to minimize subjectivity, the rating scales used to evaluate jobs must be clearly defined, and evaluators should be thoroughly trained on how to use them. Moreover, the evaluators should be provided with complete, accurate, and up-to-date job descriptions. The second issue is more difficult to address. Due largely to changes in technology, jobs now change so rapidly and so fundamentally that evaluation results quickly become out of date.
Job evaluation process is analogous to performance appraisal in that evaluators are asked to provide certain ratings on a form. Job evaluation ratings, however, focus on the requirements of the job rather than on the performance of the individual jobholder. Although several methods may be used to evaluate jobs, the most common approach is the point-factor method. Using this method, jobs are evaluated separately on several criteria, called compensable factors. These factors represent the most important determinants of a job's worth. A list of some commonly used factors and the criteria upon which they are judged appear in Exhibit 1.
The development of a point-factor rating scale consists of the following steps:
- Select and carefully define the compensable factors that will be used to determine job worth.
- Determine the number of levels or degrees for each factor. The only rule for establishing the number of degrees is that some jobs should fall at each level.
- Carefully define each degree level. Each adjacent level must be clearly distinguishable.
- Weight each compensable factor in terms of its relative importance for determining job worth.
- Assign point values to the degrees associated with each compensable factor. Factors assigned greater weights in Step 4 would be allotted a greater number of possible points for each degree level.
When completing the job evaluation ratings, the evaluators use job descriptions to rate each job, one factor at a time until all jobs have been evaluated on all factors. They then calculate a total point value for a job by summing the points earned on each compensable factor.
|COMPENSABLE FACTOR||RATING CRITERIA|
Internal business contacts
Consequence of error
Degree of influence
Responsibility for independent action
Responsibility for machinery/equipment
Responsibility for confidential information
This approach to job evaluation is difficult and time-consuming. However, most organizations believe that it is well worth the effort. If properly conducted, the overall score for each job should reflect its relative worth to the organization, thus enabling the firm to establish internal consistency.
When job evaluations have been completed, jobs are grouped into pay grades based on the total number of points received. Jobs with the same or similar point values are placed in the same grade. For example, consider jobs that are rated on a scale from one to one thousand. All jobs earning up to one hundred points could be assigned to pay grade one, jobs earning 101-200 to pay grade two, and so forth.
Administrators use pay grades because, without them, firms would need to establish separate pay rates for each job evaluation point score. Once jobs are classified into grades, all jobs within the same grade are treated alike for pay purposes; that is, the same range of pay applies to each job in a grade.
As companies develop pay grade systems, they must decide how many pay grades to establish. Most firms use thirty to fifty pay grades. However, some use as many as one hundred or more, while others use as few as five or six. The practice of limiting the number of pay grades eases the firm's administrative burdens. However, using a limited number of grades creates a situation in which jobs of significantly different worth fall into the same grade and receive the same pay. This outcome could lead to equity problems. For instance, registered nurses may feel underpaid if classified in the same pay grade as nursing aids.
ACHIEVING EXTERNAL COMPETITIVENESS
A firm achieves external competitiveness when employees perceive that their pay is fair in relation to what their counterparts in other organizations earn. To become externally competitive, organizations must first learn what other employers are paying and then make a decision regarding just how competitive they want to be. They then establish pay rates consistent with this decision. Following is an examination of how these steps are carried out.
The firm begins by conducting or acquiring a salary survey. This survey provides information on pay rates offered by a firm's competitors for certain benchmark jobs (i.e., jobs that are performed in a similar manner in all companies and can thus serve as a basis for making meaningful comparisons). Some firms gather this information from existing surveys already conducted by others, such as those produced by the Bureau of Labor Statistics. Trade associations also conduct surveys routinely for their members, or companies may hire consulting firms to gather such information. Salary surveys conducted by others should be used when they contain all the information needed by the company in question. When no such surveys exist, companies generally conduct their own.
After the pay practices of other companies have been identified, the organization must determine how competitive it wants to be (or can afford to be). Specifically, it must set a pay policy stipulating how well it will pay its employees relative to the market (i.e., what competitors pay for similar jobs). The determination of a pay policy is a crucial step in the design of a pay system. If pay rates are set too low, the organization is likely to experience recruitment and turnover problems. If set too high, however, the organization is likely to experience budget problems that ultimately may lead to higher prices, pay freezes, and layoffs.
The majority of firms pay at the market rate, which is the rate offered by most of the competitors for labor. Those paying above market are referred to as "market leaders." These typically are companies with the ability to pay and the desire to attract and retain top-notch employees (e.g., "cream of the crop"). Those paying below market ("market laggards") generally do so because they are unable to pay higher salaries. Such companies often attempt to attract employees by linking pay to productivity or profits so that the employees can earn more if the company does well.
When setting its pay policy, a company must consider its strategic plan. For example, if long-term employee commitment is a strategic goal, then the organization should attempt to develop compensation strategies that will enhance retention, such as establishing a generous retirement plan for long-service employees or adopting a profit-sharing system tied to tenure.
Once market rates for jobs are determined and a pay policy is established, an organization must price each of its jobs. Since market rates identified by a salary survey usually are restricted to benchmark jobs, how do organizations determine these rates for their non-benchmark jobs? Using the data collected on the benchmark jobs, an organization would determine the statistical relationship (i.e., simple linear regression) between job evaluation points and prevailing market rates. This regression line is referred to as the pay policy line. The appropriate pay rates for non-benchmark jobs are set based on this line.
ACHIEVING EMPLOYEE CONTRIBUTIONS EQUITY
Employee contributions equity is achieved when employees believe their pay fairly reflects their level of contribution to the organization. To achieve this aim, an organization must first establish a range of pay for each pay grade; it must then place each employee within that range based on his or her contribution to the organization.
A pay range specifies the minimum and maximum pay rates for all jobs within a grade. When establishing pay ranges, most employers set the market rate at the midpoint of the range. The spread from the midpoint usually varies, becoming larger as one progresses to higher pay grades. Most organizations establish a range spread of 10-25 percent for office and production work, 35-60 percent for professional and lower-level management positions, and 60-120 percent for top-level management positions.
The mechanism for recognizing employee contributions differs for new and existing employees. Contributions made by new employees are recognized by varying the level of starting pay they receive. New employees usually are paid at the minimum rate unless their qualifications exceed the minimum qualifications of the job. Those exceeding minimum qualifications are paid more because they can make a greater contribution, at least initially. Existing employees' contributions usually are recognized in the form of pay raises, typically granted on the basis of seniority and performance.
CONTEMPORARY COMPENSATION ISSUES
Modern organizations are making very significant changes in their compensation systems in order to better fit the dynamic, highly competitive business environment. Firms increasingly are using things such as skill-based pay, which compensates employees for the number and types of skills they possess instead of the type of job they have. Similarly, there is a strong movement to "at-risk" compensation, where employee pay is tied to performance. Under this system, the employee's bonus does not become part of his or her base pay. Instead, the bonus must be re-earned each year. These changes, and numerous others, are designed to help offset compensation costs by gains in productivity, and to develop more flexible workforces.
Adams, J.S. "Injustices in Social Exchange." In Advances in Experimental Social Psychology. 2nd ed., ed. Berkowitz. New York: Academic Press, 1965.
Henderson, Richard I. Compensation Management in a Knowledge-Based World. 9th ed. Upper Saddle River, NJ: Prentice Hall, 2003.
Kleiman, Lawrence S. Human Resource Management: A Tool for Competitive Advantage. Cincinnati, OH: South-Western College Publishing, 2000.
Mathis, Robert L., and John H. Jackson. Human Resource Management. 11th ed. Mason, OH: Thomson/South-Western, 2006.
Milkovich, George T., and Jerry M. Newman. Compensation. 8th ed. New York: McGraw-Hill/Irwin, 2005.
U.S. Department of Labor, Bureau of Labor Statistics. "Compensation and Working Conditions." Available from <<a href="http://bls.gov/opub/cwc" target="_blank">http://bls.gov/opub/cwc>.
Employee Compensation (Encyclopedia of Small Business)
Compensation is a primary motivator for employees. People look for jobs that not only suit their creativity and talents, but compensate themoth in terms of salary and other benefitsccordingly. Compensation is also one of the fastest changing fields in Human Resources, as companies continue to investigate various ways of rewarding employees for performance.
DETERMINING WAGES AND SALARIES
It is important for small business owners to understand the difference between wages and salaries. A wage is based on hours worked. Employees who receive a wage are often called "non-exempt." A salary is an amount paid for a particular job, regardless of hours worked, and these employees are called "exempt." The difference between the two is carefully defined by the type of position and the kinds of tasks that employees perform. In general, exempt employees include executives, administrative and professional employees, and others as defined by the Fair Labor Standards Act of 1938. These groups are not covered by minimum wage provisions. Non-exempt employees are covered by minimum wage as well as other provisions.
It is important to pay careful attention to these definitions when determining whether an individual is to receive a wage or a salary. Improper classification of a position can not only pose legal problems, but often results in employee dissatisfaction, especially if the employee believes that execution of the responsibilities and duties of the position warrant greater compensation than is currently awarded.
When setting the level of an employee's monetary compensation, several factors must be considered. First and foremost, wages must be set high enough to motivate and attract good employees. They must also be equitablehat is, the wage must accurately reflect the value of the labor performed. In order to determine salaries or wages that are both equitable for employees and sustainable for companies, businesses must first make certain that they understand the responsibilities and requirements of the position under review. The next step is to review prevailing rates and classifications for similar jobs. This process requires research of the competitive rate for a particular job within a given geographical area. Wage surveys can be helpful in defining wage and salary structures, but these should be undertaken by a professional (when possible) to achieve the most accurate results. In addition, professional wage surveys can sometimes be found through local employment bureaus or in the pages of trade publications. Job analysis not only helps to set wages and salaries, but ties into several other Human Resource functions such as hiring, training, and performance appraisal. As the job is defined, a wage can be determined and the needs for hiring and training can be evaluated. The evaluation criteria for performance appraisal can also be constructed as the specific responsibilities of a position are defined.
Other factors to consider when settling on a salary for a position include:
- Availability of people capable of fulfilling the obligations and responsibilities of the job
- Level of demand elsewhere in the community and/or industry for prospective employees
- Cost of living in the area
- Attractiveness of the community in which the company operates
- Compensation levels already in existence elsewhere in the company
There are many federal, state, and local employment and tax laws that impact compensation. These laws define certain aspects of pay, influence how much pay a person may receive, and shape general benefits plans.
The Fair Labor Standards Act (FLSA) is probably the most important piece of compensation legislation. Small business owners should be thoroughly familiar with it. This act contains five major compensation laws governing minimum wage, overtime pay, equal pay, recordkeeping requirement, and child labor, and it has been amended on several occasions over the years. Most of the regulations set out in the FLSA impact non-exempt employees, but this is not true across the board.
The Equal Pay Act of 1963 is an amendment to FLSA, which prohibits differences in compensation based on sex for men and women in the same workplace whose jobs are similar. It does not prohibit seniority systems, merit systems, or systems that pay for performance, and it does not consider exempt or non-exempt status.
In addition, the United States government has passed several other laws that have had an impact, in one way or another, on compensation issues. These include the Consumer Credit Protection Act of 1968, which deals with wage garnishments; the Employee Retirement Income Security Act of 1974 (ERISA), which regulates pension programs; the Old Age, Survivors, Disability and Health Insurance Program (OASDHI), which forms the basis for most benefits programs; and implementation of unemployment insurance, equal employment, worker's comp, Social Security, Medicare, and Medicaid programs and laws.
For the most part, traditional methods of compensation involve set pay levels (wage or salary) with regular increases. Increases can be given for a variety of reasons, but are typically given for promotions, merit increases, or cost of living increases. The Hay Group points out that there is less distinction today between merit increases and cost of living increases: "Because of the low levels (3 to 4 percent) of salary budget funding, most merit raises are perceived as little more than cost of living increases. Employees have come to expect them." This "base pay" system is one that most people are familiar with. Often, it includes a set salary or wage, a set schedule for merit increases, and a set benefits package.
Benefits are an important part of an employee's total compensation package. Benefits packages became popular after World War II, when wage controls made it more difficult to give competitive salaries. Benefits were added to monetary compensation to attract, retain, and motivate employees, and they still perform that function today. They are not cash rewards, but they do have monetary value (for example, spiraling health care costs make health benefits particularly essential to today's families). Many of these benefits are nontaxable to the employee and deductible by the employer.
Many benefits are not required by law, but are nonetheless common in total compensation packages. These include health insurance, accidental death and dismemberment insurance, some form of retirement plan (including profit-sharing, stock option programs, 401(k) and employee stock ownership plans), vacation and holiday pay, and sick leave. Companies may also offer various services, such as day care, to employees, either free or at a reduced cost. It is also common to provide employees with discounted services or products offered by the company itself. In addition, there are also certain benefits that are required by either state or federal law. Federal law, for example, requires the employer to pay into Social Security, and unemployment insurance is mandated under OASDHI. State laws govern worker's compensation.
CHANGES IN COMPENSATION SYSTEMS
As businesses change their focus, their approach to compensation must change as well. Traditional compensation methods may hold a company back from adequately rewarding its best workers. When compensation is tied to a base salary and a position, there is little flexibility in the reward system. Some new compensation systems, on the other hand, focus on reward for skills and performance, with the work force sharing in company profit or loss. One core belief of new compensation policies is that as employees become employee owners, they are likely to work harder to ensure the success of the company. Indeed, programs that promote employee ownershipnd thus employee responsibility and emotional investmentre becoming increasingly popular. Examples of these types of programs include gain sharing, in which employees earn bonuses by finding ways to save the company money; pay for knowledge, in which compensation is based on job knowledge and skill rather than on position (and in which employees can increase base pay by learning a variety of jobs); and incentive plans such as employee stock options plans (ESOPs).
PAY FOR PERFORMANCE Probably the most popular of the newer concepts in compensation is the easiest to understandompensation based on performance. These programs, sometimes referred to as variable pay programs, generally offer compensation incentives based on employee performance or on the performance of a team. Pay for performance rewards high performance and does not reward mediocre or low performance, and is the definition of the "merit" system.
In a true merit based system, there are a few conditions which must be satisfied for it to be meaningful:
- Employees must have control over their performance. If employees are overly dependent on the actions and output of other employees or processes, they may have little control over their own performance.
- Differences in performance must mean something to the business. If there is little difference between a high performer and a mediocre one, merit pay won't work.
- Performance must be measured regularly and reliably. A clear system of performance appraisal, with defined criteria that are understood by the employee and regularly scheduled meetings must be in place.
ADMINISTERING COMPENSATION PROGRAMS
Compensation programs and policies must be communicated clearly and thoroughly to employees. Employees naturally want to have a clear understanding of what they can reasonably expect in terms of compensation (both in terms of monetary compensation and benefits) and performance appraisal. To ensure that this takes place, consultants urge business owners to detail all aspects of their compensation programs in writing. Taking this step not only helps reassure employees, but also provides the owner with additional legal protection from unfair labor practices accusations.
Boyett, Joseph H., and Henry P. Conn. Workplace 2000: The Revolution Reshaping American Business.
Dauten, Dale A. The Gifted Boss: How to Find, Create and Keep Great Employees. Morrow, 1999.
Hay Group. People, Performance, & Pay: Dynamic Compensation for Changing Organizations.
Kinne, David W. "Employee Compensation: What Gets Rewarded is What Gets Done." Compensation and Benefits Management. Spring 2000.
Milkovich, George T., and Alexandra K. Wigdor. Pay for Performance: Evaluating Performance Appraisal and Merit Pay.
Parrott, Mark D. "Employee Compensation." Do-It-Yourself Retailing. January 2000.
SEE ALSO: Employee Motivation; Employee Reward Systems