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Human Resource Management 13 th Edition Chapter 9 Direct Financial Compensation 9-1 Copyright © [2014] Pearson Education

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Human Resource Management 13th Edition

Chapter 9Direct Financial Compensation

9-1 Copyright © [2014] Pearson Education

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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.

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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 claw back policies.

• Explain the various elements of executive compensation and discuss executive compensation in the global environment.

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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 the limit

• Dodd-Frank Act may have major impact on excessive executive compensation

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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

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Components of Total Compensation Program External EnvironmentInternal Environment




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 ServicesPremium Pay

Voluntary Benefits

The JobMeaningful AppreciatedSatisfying Learning EnjoyableChallenging

Job EnvironmentSound Policies Capable Managers Competent Employees Congenial Coworkers Appropriate Status Symbols Working Conditions

Workplace Flexibility Flextime Compressed Workweek Job Sharing Telecommuting Part-time Work

Financial Nonfinancial

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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.

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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

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Primary Determinants of Direct Financial Compensation


Organization Compensation Policies Organizational Level Ability to Pay

Labor Market Compensation Surveys Expediency Cost of Living Labor Unions Economy Legislation

Employee Job Performance Skills Competencies Seniority Experience Organization Membership Potential Political Influence LuckSalary Compression



Direct Financial Compensation

Job Job Analysis Job Descriptions Job Evaluation

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Organization as a Determinant of Direct Financial Compensation

• Compensation policies

• Organizational level

• Ability to pay

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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

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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

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Ability to Pay

Organization’s assessment of its ability to pay is an important factor in determining pay levels.

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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

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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.

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• 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

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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

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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

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The Economy

• Affects financial compensation decisions• Depressed economy generally increases

labor supply• Cost of living often rises as economy


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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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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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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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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

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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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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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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


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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

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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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Ranking Method

• Simplest method

• Raters examine description of each job

• Jobs arranged in order according to value

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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

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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

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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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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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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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Scatter Diagram of Evaluated Jobs Illustrating Wage Curve, Pay Grades, and Pay Ranges


100 200 300 400 500





14.60 14.00 13.30 12.90 12.00

Average Pay per Hour (Current Rates or Market Rates)

Wage Curve

Evaluated Points1 2 3 4 5 Pay Grades






Pay Ranges for Pay Grades

0- 99 1 $12.00 $13.30 $ 14.60 100-199 2 13.30 14.60 15.90 200-299 3 14.60 15.90 17.20 300-399 4 15.90 17.20 18.50 400-500 5 17.20 18.50


Evaluated Points Pay Grade Minimum Midpoint MaximumSummary

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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

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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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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

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• 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

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Broadbanding and Its Relationship to Traditional Pay Grades and Ranges





rly P


Grade 4

Grade 1

Grade 2

Grade 3

Job WorthLow High

Band I

Band II

Grade 6

Band III

Grade 5

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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

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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

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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

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Performance-Based Pay

• Merit pay• Variable pay• Bonuses• Spot bonuses• Piecework

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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

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• 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

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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

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• 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

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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

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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

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• Seniority: Length of time employee has been with company

• Management generally prefers performance as primary basis for compensation changes

• Unions tend to favor seniority

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• 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

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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

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• 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

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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

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• Helps to be in the right place at the right time

• Opportunities are continually presenting themselves

• Luck works primarily for the efficient

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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

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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

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Company-Wide Pay

• Profit sharing

• Gainsharing

• Scanlon plan

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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

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• 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

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Scanlon Plan

• Reward to employees for savings in labor costs resulting from employees’ suggestions

• Employee-management committees evaluate these suggestions

• Systems for participative management

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Professional Compensation

• Professionals initially compensated for knowledge they bring to organization

• Maturity curves reflect relationship between professional compensation and years of experience

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Sales Representative Compensation

• Straight salary

• Straight commission

• Endless variety of part-salary, part-commission combinations

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Contingent Worker Compensation

• In most cases, contingent workers earn less pay than permanent counterparts

• Far less likely to receive health or retirement benefits

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Trends & Innovations: Say on Pay, Golden Parachutes, and Clawback


• Three provisions in Dodd-Frank Act relate to:– Say on pay

– Golden parachutes

– Clawback policies

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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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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


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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

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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

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Types of Executive Compensation

• Base salary

• Bonuses and performance-based pay

• Stock option plans

• Perquisites (perks)

• Severance packages

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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

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Bonuses and Performance-Based Pay

• Trend toward more performance-based compensation packages for executives

• Payment of bonuses reflects managerial belief in their incentive value

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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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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

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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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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

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