Building Internally Consistent Compensation System

By Dr. G C Mohanta, BE, MSc (Engg.), MBA, PhD (Mgt.), Professor, Al-Qurmoshi Institute of Business Management, Hyderabad, India

Equity Theory

Equity is commonly defined as anything of value earned through providing or investing something of value. Fairness is achieved when the return on equity is equivalent to the investment made. As it relates to compensation, fairness is achieved when pay equates to the value of the work performed. Inequity, on the other hand, occurs when the value of the work performed does not match the value of the compensation received.

Early studies indicate that inequitable treatment directly affects and influences employee behavior and performance. In Equity Theory Towards a General Theory of Social Interaction (The Academic Press, 1976), J. Stacy Adams proposed that an employee continuously monitors his or her inputs and outputs on the job, and perceives an equitable situation when the ratio of his or her inputs and outputs are equal, to those of other employees. If this ratio is not equal, the employee may feel angry (as a result of not being paid enough) or guilty (as a result of being paid too much). Either feeling could result in dissatisfaction or discomfort. Fig. 1 is the schematic diagram of Equity Theory.

Internal Equity Internal equity exists when an employer pays wages commensurate with the relative internal value of each job. This is established according to the employer's perception of the importance of the work performed.

Before an organization can estimate the importance of each job, however, it must first determine the job-related factors that will be used for setting compensation levels - in short, compensable factors. Here are some typical compensable factors used for lower-level jobs:

• Education required. • Experience required. • Physical demands. • Responsibility for equipment/materials. • Responsibility for the safety of others. • Supervisory/managerial responsibility. • Working conditions. • Accident or health hazards. • Public contact. • Manual dexterity.

Determining the relative internal value of jobs in a large or complex organization can be a difficult process. Job-evaluation methods are often used to develop a job hierarchy that reflects the relative value of jobs on the basis of skill, effort, responsibility, and working conditions. A number of job-evaluation approaches have been developed. Such approaches include (1) job ranking, (2) classification, (3) point factors and (4) factor comparison.

External Equity External equity exists when an employer pays a wage rate commensurate with the wages prevailing in external labor markets. Assessing external equity requires measuring these labor markets. There is, however, no single labor market for a particular job. Supply and demand differ substantially among markets, resulting in significant variation in wages across labor markets.

The following factors contribute to these wage differences among markets: • Geographic location. • Industry sector. • Union status. • Organization size. • Product competition. • Company prestige. • Education and experience level of available work force. • Licensing or certification requirements called for by the job.

Fig.1: Schematic Diagram of Equity Theory

Individual Equity Individual equity exists when an employer compensates individuals who are in similar jobs on the basis of variations in individual performance, i.e. pay for performance. Excellent performers would receive more compensation than average performers.

Personal Equity Personal equity involves no direct comparison of one individual's compensation with another's. Personal equity exists when an employer pays a wage rate that satisfies an employee's own perception of his or her worth. The standards applied by each person relate to that particular individual's previous experiences and his or her knowledge of the market value of similar jobs.

Creating Internal Equity through Job Analysis and Job Evaluation

Job Evaluation

Job evaluation is the process of determining and quantifying the value of jobs. It is the systematic scoring and comparison of jobs along organizationally determined dimensions of job worth, such as, in the effort, responsibility, complexity, importance, skills and the working conditions of a job.

Job evaluation is a tool to compare jobs consistently and classify them into appropriate pay ranges. The worth of each job within the organization is determined through the Job Evaluation process (job analysis, job descriptions, & job evaluations). This establishes the relative worth of a job in relation to the value of other jobs in the workplace. The process can ensure that an organization’s pay system is equitable, understandable, legally defensible, and externally competitive. Job evaluations can be used to help to attract desirable job candidates and retain high performance employees due to fair and equitable pay scales.

Fig. 2: Schematic Diagram of Job Evaluation Procedures.

Methods of Job Evaluation

Job evaluation requires information to distinguish among jobs, usually on the basis of work activities and/or job required worker characteristics. The most utilized evaluation methodologies are: Ranking, Classification, Factor Comparison and Point Method.

1. Ranking involves creating a hierarchy of jobs by comparing jobs on global factors that presumably are common to all the jobs being evaluated.2. The Classification method defines categories of jobs and slots jobs into these classes.3. Factor Comparison involves job-to job comparisons on several specific factors.4. The Point Method compares jobs on rating scales which are comprised of specified factors.

Each of these methods is based on one or a combination of two general approaches:(1) an analysis of the job as a whole or (2) an analysis of the job’s individual components. Fig. 2 shows the schematic diagram of Job Evaluation Procedures.

Steps in the Job Evaluation Process

Job evaluations typically follow these steps:1. Review the choices of job evaluation methods such as job ranking, classification, factor comparison and point factor analysis and select the method most appropriate to meet the organization’s needs.2. Gather information on each job within the organization, analyzing job content to make sure it is clear and understandable; job content can be revealed utilizing job questionnaires, job descriptions, interviews and/or work site visits.3. Ensure that each job description lists pertinent accountabilities and responsibilities; revise or expand job descriptions using the information collected.4. Evaluate each position utilizing the chosen method and link the ranked job to the organization’s existing compensation system or to a newly developed pay structure. The point system evaluates the skill, effort, responsibility and working conditions involved in the job; here, each of these factors is subdivided into sub factors to provide standards against which each job is rated to determine its relative worth.5. Create the appropriate pay grades and pay ranges in the pay structure and along with policies and procedures setting out employee progress within the range.6. Periodically review the job evaluation system itself, developing procedures for evaluating and modifying the system and the resulting compensation decisions.

Job Analysis

Job Analysis is a process to identify and determine in detail the job duties and requirements and the relative importance of these duties for a given job. Job Analysis is a process where judgments are made about data collected on a job.

The purpose of job analysis is to provide the information necessary for preparing job descriptions and evaluating jobs. This information may be obtained through workplace observation and/or interviews, questionnaires, and activity logs.

Methods of Job AnalysisThere are five main methods (employed individually or in combination) that can be used to obtain job information:

1. Observation: the researcher watches the employee perform the job, recording data on a standardized form. This method is only useful for simple, usually manual tasks for which the employee can be directly observed.2. Interviews: a sample of employees carrying out a given job and/or their supervisors are asked a series of questions about the job, the essential tasks of the job, and the abilities required to perform it well.3. Questionnaires: a standard questionnaire about the essential tasks of the job is administered to the employee and/or supervisor; these may vary as to whether they are open or closed, organization-specific.4. Activity Logs: employees identify every activity in the course of work and the time spent on it during a set period.5. Functional Job Analysis: using the generic descriptions, the analyst can choose and adapt it to the needs of the organization.

Job Descriptions

Making use of the information collected in job analysis, standardized job descriptions outline - What physical, mental, and interactional activities a job entails,

- How a worker utilizes methods, procedures, tools, and information sources to carry out a given job, and

- Why the job was developed (the necessary role it plays in the organization’s meeting its objectives).

The well written, detailed job descriptions provide the foundation of any internally consistent compensation system.

Job Evaluation Methods

The methods and practices of ordering jobs or positions with respect to their value or worth to the organization. The four most commonly used methods of job evaluation are: 1) Ranking; 2) Classification; 3) Factor Comparison; and 4) Point Method.

Ranking This method is one of the simplest to administer. Jobs are compared to each other based on the overall worth of the job to the organization. The 'worth' of a job is usually based on judgements of skill, effort (physical and mental), responsibility (supervisory and fiscal), and working conditions.

Advantages

Simple.

Very effective when there are relatively few jobs to be evaluated (less than 30).

Disadvantages

Difficult to administer as the number of jobs increases.

Rank judgements are subjective.

Since there is no standard used for comparison, new jobs would have to be compared with the existing jobs to determine its appropriate rank. In essence, the ranking process would have to be repeated each time a new

job is added to the organization.

Ranking Methods1. Ordering - Simply place job titles on 3x5 inch index cards then order the titles by

relative importance to the organization. 2. Weighting

3. Paired Comparison

GroupingAfter ranking, the jobs should be grouped to determine the appropriate salary levels.

Classification Jobs are classified into an existing grade/category structure or hierarchy. Each level in the grade/category structure has a description and associated job titles. Each job is assigned to the grade/category providing the closest match to the job. The classification of a position is decided by comparing the whole job with the appropriate job grading standard. To ensure equity in job grading and wage rates, a common set of job grading standards and instructions are used.

The standards identify and describe those key characteristics of occupations which are significant for distinguishing different levels of work. They define these key characteristics in such a way as to provide a basis for assigning the appropriate grade level to all positions in the occupation to which the standards apply.

Advantages

Simple.

The grade/category structure exists independent of the jobs. Therefore, new jobs can be classified more easily than the Ranking Method.

Disadvantages

Classification judgments are subjective.

The standard used for comparison (the grade/category structure) may have built in biases that would affect certain groups of employees (females or minorities).

Some jobs may appear to fit within more than one grade/category.

Attempt should be made to define the grades/categories so that they do not overlap one another. Overlaps in the descriptions and factors used to identify the grade would lead to problems when assigning jobs to the grades where there is overlap between them. The Grades/Categories should be examined for inherent biases against females and minorities.

Factor Comparison A set of compensable factors are identified as determining the worth of jobs. Typically the number of compensable factors is small (4 or 5). Examples of compensable factors are:

1. Skill 2. Responsibilities

3. Effort

4. Working Conditions

Next, benchmark jobs are identified. Benchmark jobs should be selected as having certain characteristics.

1. equitable pay (not overpaid or underpaid) 2. range of the factors (for each factor, some jobs would be at the low end of the factor

while others would be at the high end of the factor).

The jobs are then priced and the total pay for each job is divided into pay for each factor. See example matrix below:

Job Evaluation: Factor Comparison

The hourly rate is divided into pay for each of the following factors:

JobHourly Rate

.Pay for Skill

Pay for Effort

Pay for Responsibility

Pay for Working Conditions

Secretary 90.00 45.00 20.00 20.00 5.00

Admin Assistant

110.00 55.00 25.00 25.00 5.00

Supervisor 150.00 60.00 35.00 40.00 15.00

Manager 210.00 90.00 35.00 70.00 15.00

This process establishes the rate of pay for each factor for each benchmark job. Slight adjustments may need to be made to the matrix to ensure equitable weighting of the factors.

The other jobs in the organization are then compared with the benchmark jobs and rates of pay for each factor are summed to determine the rates of pay for each of the other jobs.

Advantages

The value of the job is expressed in monetary terms.

Can be applied to a wide range of jobs.

Can be applied to newly created jobs.

Disadvantages

The pay for each factor is based on judgements that are subjective.

The standard used for determining the pay for each factor may have build in biases that would affect certain groups of employees (females or minorities).

Point Method A set of compensable factors are identified as determining the worth of jobs. Typically the compensable factors include the major categories of:

1. Skill 2. Responsibilities

3. Effort

4. Working Conditions

These factors can then be further defined. 1. Skill

1. Experience

2. Education

3. Ability

2. Responsibilities

1. Fiscal

2. Supervisory

3. Effort

1. Mental

2. Physical

4. Working Conditions

1. Location

2. Hazards

3. Extremes in Environment

Each factor is then divided into levels or degrees which are then assigned points. Each job is rated using the job evaluation instrument. The points for each factor are summed to form a total point score for the job.

Jobs are then grouped by total point score and assigned to wage/salary grades so that similarly rated jobs would be placed in the same wage/salary grade.

An example is given below, where Skills is the factor, knowledge is the sub-factor. This sub-factor measures the level of experience, formal education and basic skills necessary to meet the requirements of the job. Skills and knowledge may be learned from both on-the-job or off-the-job experiences and/or education.

• Level 1: Job calls for little or no acquired knowledge. Job tasks may require knowledge in one area …

• Level 2: Job tasks call for some acquired knowledge. Understanding of the job tasks may be acquired through some specific courses …• Level 3: Job tasks call for a higher level of acquired knowledge obtained through higher levels of required schooling or self-study …• Level 4: Job tasks call for some specialized acquired knowledge. Understanding of the tasks is acquired progressively through required schooling …• Level 5: Job tasks call for specialized acquired knowledge. Understanding of the tasks may be acquired progressively through highest levels of required schooling

A Basic Weighting Formula

The formula is based on a total of 100% (1000 points). The 100% (1000 points) are divided among the four factors.

Factor Formula (100% divided between four factors)

Factors Percentages Points

Skill 35% 350Effort 20% 200Responsibility 35% 350Working Conditions 10% 100Total Value for the System 100% 1000

The basic formula is expanded by dividing the percentage given to each factor between its sub-factors. For example:

Sub-Factor Formula (100% divided between ten sub-factors)

Factors Percentages Points

Skill 35% 350Knowledge 15% 150Interpersonal skills/Contacts 12% 120Problem solving/Judgement 8% 80Effort 20% 200Mental Effort 12% 120Physical Effort 8% 80Responsibility 35% 350Personnel, Policies and Practices 12% 120Information Resources 10% 100Financial Resources 8% 80Material Resources 5% 50Working Conditions 10% 100Environment 10% 100Total Value for the System 100% 1000

Levels Formula (Percentages divided among four to six levels)

Skill (35% divided between three sub-factors)

Sub-factors Weight Points Points for Levels 1 2 3 4 5Knowledge 15% 150 30 60 90 120 150Interpersonal skills/Contacts 12% 120 24 48 72 96 120Problem solving/Judgement 8% 80 16 32 48 64 80

Advantages

The value of the job is expressed in monetary terms.

Can be applied to a wide range of jobs.

Can be applied to newly created jobs.

Disadvantages

The pay for each factor is based on judgments that are subjective.

The standard used for determining the pay for each factor may have built-in biases that would affect certain groups of employees (females or minorities).