3.2- Compensation Concepts

7/29/2019 3.2- Compensation Concepts

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COMPENSATIONCONCEPTSProf. John Kammeyer-Mueller

MGT 4301

Unit 4, Lecture 1: Compensation Concepts


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Plan

Where we are Understand the legal framework for compensationHave a few principles related to compensation

known Where we want to beUnderstand some of the basic ideas underlying

compensation plans

How we know how were doingHow can we figure out how much a job should be

paid?How does justice factor into the compensation

system? Unit 4, Lecture 1: Compensation Concepts


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Major Principles in SettingWages

Market pay Employees should be paid what other people in

similar jobs in the external labor market arebeing paid

Job analysisEmployees should be paid based on difficulty of

a job, the demands on workers, and the level ofqualifications required

Distributive justice and social comparisonEmployees judge how much they should be paid

based on their subjective assessment of whatother people like them are being paid



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Market Pay and Wages

Why compare to market wages? If firms are wage takers, they cannot afford

to pay less than competitors

If firms are in a highly competitive industry,they cannot afford to pay more thancompetitors

Salary surveys

Sent out (usually by consulting firms) askingemployers to tell how much they pay workers.Results are sold on the open market. If you want a raise, check out this link

http://jobstar.org/tools/salary/sal-prof.cfmhttp://jobstar.org/tools/salary/sal-prof.cfm


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Trends in Wages

Average Hourly Earnings, 1982 Dollars

7

7.2

7.4

7.6

7.8

8

8.2

8.4

8.6

8.8

9

1968

1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

2007



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Factors that Change MarketWages

Supply side changesEducation level

Demographic shifts (baby booms and busts)

Immigration Demand side changesTechnology

Market for domestic goods and services International markets for goods and services



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Technology and EmployerDemand

Complements in productionComplementary technology makes workers

more productive, and therefore increases

employer demand (MRP of labor increasesalong with MRP of capital)

Substitutes in productionSubstitute technology replaces workers

because the MRP of capital becomes greaterthan the MRP of labor



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Technology and EmployerDemand

Complements and substitutes in actionComputers complement the skills of

professionals and creative workers by makingtheir productive activities faster and lessexpensive to accomplish

Computers substitute the skills of clericalworkers by making it possible to completelyeliminate jobs like typists, filing clerks, andphone operators

Result: increasing wage gap based on skills



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International Perspectives onTechnology

Why do some countries specialize in low-wage laborand others specialize in high-skill labor? Increasing levels of industrialization increase the need for

education, which reduces birth rates Reductions in birth rates reduce the supply of labor

Drops in the supply of labor increase the MRP of laborrelative to capital

Higher capital investments favor skilled workers

The movement of low-wage manufacturing acrossAsia during industrialization shows this process atwork



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Supporting Evidence



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Efficiency Wage Theory andAbove Market Wages

Above market wages are rational for somefirms

Reduces shirking with imperfect monitoring managers cant watch you all the time to pressure you to

work harder, but the threat of firing motivates workers tonever be caught goofing off

Minimizes turnover and replacement costs

Ability to attract more qualified candidates Shown in A. Barber, 1998, Recruiting Employees; Barker

and Bretz, 2000, Compensation in Organizations



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Issues for the Market WageApproach

How do you define the market for a job?New England, California, Hawaii and Alaska have

the highest cost of living; the South andMidwestern states are lowest.

In some fields, relocation is expectedA survey of 35 compensation specialists said that

the most important factor for evaluating therelevance of a salary survey was the region of the

country where the firm was located; workingconditions, industry, or size were less important

Viswesvaran & Barrick, Journal of Applied Psychology, 1992



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How do you define the market for a job?The market of other jobs in the same industry

or from different industries?

Nonprofit industry jobs pay less Some industries require more qualifications or

work of the same job title than others As noted earlier, profitable firms do tend to pay

quite a bit more

Large firms usually pay more, and will comparethemselves to other large firms



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What if your jobs are unlike themarket?

Job titles are seldom sufficient toestablish similarityWorth of a job to a company varies

considerablyAuthority based on company structureImportance of tasks based on niche and

strategyPossibility for advancement effects

wages Unit 4, Lecture 1: Compensation Concepts


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Job Evaluation Approach

Focus is on the value of the job to thiscompanyEvaluate jobs using job analysis

Estimate the worth of various KSAOs, decisionmaking requirements, and working conditionsfor jobs

Considering the job of an employee in yourfinal project company, what does thisinternal approach add?



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Determining compensiblefactors

Compensible factor: a feature of a job thatyou believe should be compensated

What sorts of things lead to increased payfor most workers?KSAOs

Decision making authority

Working conditions



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Compensible Factors From anEconomic Angle

Employees and employers derive equal utility from any point alongthe indifference curve

The equilibrium stress/wage level is s* and q*

Workers with different indifference curves will not work at this

company Unit 4, Lecture 1: Compensation Concepts

employee

indifference curve

employer

indifference curve

wages

stresss*

q*


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A Small Danger in Doing JobEvaluations



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Determining compensiblefactors

Concerns with compensible factorsEvidence suggests that compensation

committees can stereotype jobsPolitical processesManagers argue to increase wages for their

division

Desire to increase average qualifications Powerful divisions of a company may be overpaid



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look like in the market

overall

Unstandardized

Coefficients

Percentage

ImportanceWeight

Control variables

Percent female -.004 ** 9.84%Percent unemployed -.025 ** 23.65%

Percent unionized .006 ** 2.81%

Jobcharacteristics

Physical Demands -0.065 ** 4.11%CognitiveDemands 0.326 ** 56.59%Emotional Labor Demands -0.078 ** 3.01%

Model R 2 0.777 **


Source: Glomb, T.M., Kammeyer-Mueller, J.D., & Rotundo, M. (2005).Emotional labor and compensating wage differentials.Journal of Applied

Psychology


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Distributive justice concepts

Equity: a persons perceptions that they are paidcomparable to individuals in other similar jobs

OS/IS:OO/IO

Example: dollars per hour workedThis is robust across species:

Monkeys and distributive justice

This appears to be robust across cultures: Ancient Israel examples

!Kung people divide their hunt Concepts of justice in Ancient Greece Indian concept of karma is related



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Distributive Justice Concepts:Conceptual Difficulties

Simplest Case

Hours Pay Ratio Result

Chris 8 $80 1 : 1 Fair

Gene 8 $80 1 : 1 Fair

Relatively Simple Case

Hours Pay Ratio Result

Chris 8 $80 1 : 2 Underpaid; reducehours

Gene 4 $80 2 : 1 Overpaid; changecomparitor

Complicated Case # 2

Educ. Pay Ratio Result

Chris 12 yrs. $12/hr 12 : 16 (money) Fair?

Gene 16 yrs. $16/hr 1 : 1 (money & educ.) Fair


Complicated Case # 1

Hours Pay Production Ratio Result

Chris 8 $80 50 units 6 : 8 (hours) Unfair

Gene 6 $80 50 units 50 : 50 (output) Fair


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A Humorous Perspective onDistributive Justice



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External Equity

Comparisons


Regents Hospital

Dr. Worrell

Nurse DeVoid

Director Clinton

Dr. Collins

internal

internal

internal

Mount Sinai Hospital

St. James Hospital

Dr. Hayes

Dr. Brownexternal

external

i ib i j i d


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Distributive justice andcompensation systems

External equity: employeeperceptions that they are paid

comparable to individuals inother similar jobs Results of underpaymentinequity?Results of overpayment

inequity?Unit 4, Lecture 1: Compensation Concepts

i ib i j i d


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Distributive justice andcompensation systems

Internal equity: employeeperceptions that they are paid

comparable to individuals inother jobs in the sameorganizationResults of underpaymentinequity?

Results of overpaymentUnit 4, Lecture 1: Compensation Concepts

en ar ng us ce an


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en ar ng, us ce, anWages: Implications for Payand Firm Profit

Consider a highly profitable pharmaceuticalcompany like MerckThey need to pay their research scientists a high

wage because they lead directly to firmprofitability and having an above-average base ofscientists is directly related to how profitable theycan be

An accountant at Merck may receive more thanthe market wage simply because the desire tocreate an internally consistent wage policy leadsthe firm to pay everyone commensurate withother above-market wages



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Trends in Wage Dispersion (fromSocial Security data)


P t ti l E l ti f


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Potential Explanations forWage Dispersion

Declines in unionization

Increased need for skilled workers becauseof computerization (as noted earlier)

The service sector tends to generate lowskilled jobs with short duration ofemployment

The increased dispersion is seen both acrossand within organizationsCappelli, Bassi, Katz, Knoke, Osterman, and

Useem, Change at Work, 1997



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Compensation and Internal

Equity I think it is unconscionable when the guy who is the head ofCountrywide and his co-conspirators make huge amounts ofmoney when Americans face the threat of losing their homes.If there's ways we can motivate shareholders and boards ofdirectors to punish these people we should do it. John McCain

I cannot imagine a position more selfish and greedy at a timeof national crisis. So, I would like to speak directly to thoseCEOs right now: Do not make that mistake. The enormousrewards that you've reaped come with serious responsibilitiesto your workers, to your shareholders, to the American people.And we expect and demand that you live up to thoseresponsibilities. Barack Obama


i h ll


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HR in the News: College SportsCoach Salaries

QUESTION- Do coaches deserve such large salaries? EXAMPLE- At least 23 college football coaches now earn $1 million. REASON- The rapid increase of bowl money and television contracts

has powered the escalation in salaries. Is it wrong to pay a coach more than the president of the university? YES!-

Hurts the integrity of the American university. A person coaching football makes more than professors teaching future

doctors and lawyers

NO!- Programs generate lots of money. Must pay coaches top dollar to keep them from going to the NFL. Students and Alumni love athletics. Coaches work many hours and there are intense expectations.



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Compensation and Internal

Equity Why are CEOs popular targets?They have a lot of money and power

Beliefs that markets should be consistent withprinciples of justice and fairness

They are a psychological outgroup Few people personally know CEOs

Their background and life stories are atypical Few people really know quite what they do



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Variations in Job Structure:Executive Compensation

CEO compensation as a

proportion of log annual

salary of factory workers

10

100

1000

1980

1985

1990

1995

2000

From BusinessWeek The average CEO of a

major corporation made42 times the pay of anaverage American factory

worker in 1980. By 2000 the ratio was 458times the typical factoryworkers pay.

This is clearly exponentialgrowth (because the chart

has a log transformationon the outcome axis) Why is this happening?


Th P C t Vi


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Those Poor Corporate VicePresidents


ompar son o xecu ve


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ompar son o xecu veCompensation (not just largecorporations)

0

10

20

30

40

50

60

Brazil

Mexico

Brita

in

Cana

da Italy

Spain

Fran

ce

Taiw

an

Germ

any

SouthKo

rea

Japa

n

CEO

CompensationasaMultipleofLo

westPaidEmployee

Salary


xecu ve ompensa on n


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xecu ve ompensa on nBad Times: An EmployeePerspective


n e ews:


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n e ews:Shareholders Perspective onInternal Inequity

Proposal- Limit the Chiefs pay at seven companies to a figure that is100 times that of the average worker. Proposed by- Daniel J. Steininger, chairman of the Catholic Funds, a $30

million fund company

Idea- Shareholders be allowed to vote on the compensation

If the C.E.O. is making more than 100 times the salary of the averageworker, then the C.E.O. must be able to justify this salary.

"We're trying to get at the notion of economic injustice in what theC.E.O. is making compared to the average worker," he said.

Similar proposals are before congress currently



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Who Sticks up for CEO Pay?

Compensation analysts and someeconomists argue Fairness and efficiency are sometimes opposed

Some economists (e.g., Kevin Murphy) even arguethat CEO pay is insufficientto serve as amotivator

Murphy also has argued that regulating CEO pay

seldom works because they find other waysaround the system

CEOs manage an enormous amount of financialrisk and most compensation is based directly onfirm value

Determinin how much is enou h becomesUnit 4, Lecture 1: Compensation Concepts

Tournament Theory and


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Tournament Theory andCEO Pay

Top executives earn extraordinary wagepremiums at the expense of other executivesReaching the CEO post is like winning the

Superbowl or the Masters Golf TournamentThe huge incentive to come in first (and the fact

that second place is the first loser in a very realsense) means that everyone works extremelyhard to get the job

Ongoing competition keeps a constant threat onthe CEO, who constantly risks being knocked offthe top post

Lazear, Personnel Economics, 1998Unit 4, Lecture 1: Compensation Concepts


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Wrap Up

Where we are Understand the basics of organizational socialization Understand performance appraisal processes

Where we want to be Understand some of the basic ideas underlying

compensation plans

How we know how were doing What is the Fair Labor Standards Act and how does it apply

to compensation? How does justice factor into the compensation system? How can we figure out how much a job should be paid?

U it 4 L t 1 C ti C t

Documents

3.2- Compensation Concepts