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Compensation: Methods Compensation: Methods and Policiesand PoliciesCompensation: Methods Compensation: Methods and Policiesand Policies
chapterchapter
11
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A Compensation system should
be:(* focus of this chapter)
AdequateEquitable
Balanced*
Cost-effective*
Secure*
Incentive-providing
Acceptable to the employee*
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To the individual
employee, the most
important
compensation decision
is how much he or she
will earn.
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Determination of Individual PayDetermination of Individual Pay
Three questions need to be addressed:
1. How should one employee be paid relative to another when they both hold the same job in the organization?
2. Should we pay all employees doing the same work at the same level the same?
3. If not, on what basis should we make the distinction?
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Pay differentials are based on:Pay differentials are based on:
1. Individual differences in experience, skills, and performance
2. Expectations that seniority, higher performance (or both) deserve higher pay
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Reasons for choosing to pay employees at Reasons for choosing to pay employees at different rates for the same job: different rates for the same job: (1 of 3)(1 of 3)
Pay differentials allow firms to recognize that different employees performing the same job make substantially different contributions to meeting organizational goals
Differentials allow employers to communicate a changed emphasis on important job roles, skills, knowledge, etc.
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Reasons for choosing to pay employees at Reasons for choosing to pay employees at different rates for the same job: different rates for the same job: (2 of 3)(2 of 3)
Differentials provide organizations with an important tool for emphasizing norms of enterprise without having employees change jobs (i.e., promotion)
Pay differentials allow firms to recognize market changes between jobs in the same grade without requiring a major overhaul of the whole compensation system
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Reasons for choosing to pay employees at Reasons for choosing to pay employees at different rates for the same job: different rates for the same job: (3 of 3)(3 of 3)
Without differentials,the pay system violates the internal equity norms
of most employees,reducing satisfaction with pay, andmaking attraction and retention of employees
more difficult
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Methods of PaymentMethods of Payment
Flat Rates
Payment for Time Worked
Variable Pay: Incentive Compensation
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Payment for Time WorkedPayment for Time Worked
General, across-the-board increase for all employees
Merit increases paid to some employeesbased on some indicator of job performance
Cost-of-living adjustment (COLA)based on the consumer price index (CPI)
Seniority
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Variable PayVariable Pay
Percentage of an employee’s paycheck is put at risk
If business goals are not met, the pay rate will not rise above the lower base salary
Annual raises are not guaranteedHelps manage labor costsDoes not guarantee equitable treatment of
employees
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Support bymanagement
Acceptance byemployees
Supportiveorganizational
cultureTiming
Variable Pay: Key Design FactorsVariable Pay: Key Design Factors
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Types of Variable PayTypes of Variable Pay
Individual Incentives
Group Incentives
Organization Incentives
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Individual Variable PayIndividual Variable Pay
Merit incentives
Individual incentivespieceworkproduction bonusescommissions
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Merit Pay ProblemsMerit Pay Problems
1. Employees fail to make the connection between pay and performance
2. The secrecy of the reward is perceived by other employees as inequity
3. The size of the merit award has little effect on performance
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Individual IncentivesIndividual Incentives
Possible only in situations where performance can be specified in terms of outpute.g., sales dollars generatede.g., number of items completed
Employees must work independently of each other so that individual incentives can be applied equitably
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Conditions for Effective Individual Conditions for Effective Individual Incentive PlansIncentive Plans
1. The task is liked2. The task is not boring3. The supervisor reinforces and supports the system4. The plan is acceptable to employees and managers5. The incentive is financially sufficient to induce
increased output6. Quality of work is not especially important7. Most delays in work are under the employees’ control
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Reasons to Use Team IncentivesReasons to Use Team Incentives
When it is difficult to measure individual output
When cooperation is needed to complete a task or project
When management feels this is a more appropriate measure on which to base incentives
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Organization-wide IncentivesOrganization-wide Incentives
Usually based on one of two performance concepts:A sharing of profits generated by all employees
altogetherA sharing of money saved as a result of
employees’ efforts to reduce costs
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Approaches to Organization-wide IncentivesApproaches to Organization-wide Incentives
SuggestionSystems
Gainsharing
Profit Sharing Ownership
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Suggestion Systems: Essential ElementsSuggestion Systems: Essential Elements
1. Management commitment
2. Clear goals
3. Designated administrator
4. Structured award system
5. Regular publicity
6. Immediate response to each suggestion
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Gainsharing PlansGainsharing Plans
Employees earn bonuses tied to unit-wide performance as measured by a predetermined, gainsharing formula
Commonly used gainsharing plans:Lincoln Electric PlanScanlon PlanRucker PlanImproShare
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Key Elements in Designing a Gainsharing Key Elements in Designing a Gainsharing PlanPlanStrength of reinforcement
Productivity standards
Sharing the gains
Scope of the formula
Perceived fairness of the formula
Production variability
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Newer Approaches to GainsharingNewer Approaches to Gainsharing
Business Plan Gainsharing
Winsharing
Spot Gainsharing
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Typical Profit Sharing PlansTypical Profit Sharing Plans
1. Cash or current distribution plans provide full payment to participants soon after profits have been determined
2. Deferred plans credit a portion of current profits to employees’ accounts with cash payments made at the time of retirement, disability, severance, or death
3. A combination of both incorporates aspects of current and deferred options
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OwnershipOwnership
Employee stock ownership plan (ESOP) – employees receive stock in the company
ESOPs are tax qualifiedi.e., in return for meeting certain rules designed to
protect the interests of plan participants, ESOP sponsors receive various tax benefits
ESOPs are defined contribution plansthe employers makes yearly contributions that
accumulate to produce a benefit that is not defined in advance
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People-Based PayPeople-Based Pay
Skill-BasedPay
Knowledge-Based Pay
Credential-Based Pay
Feedback Pay
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Executive PayExecutive Pay
More likely to be based on More likely to be based on comparative performancecomparative performance::
1. Compensation committees link CEO’s pay to returns to shareholders
2. Variable performance-based pay is emphasized over guarantees
3. CEOs are encouraged to invest in company stock
4. Performance yardsticks are linked to actual key productivity indices, to the competition, or to both
5. CEOs are held responsible for the cost of capital
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Issues in Compensation AdministrationIssues in Compensation Administration
Pay Secrecy or Openness
Pay Security
Pay Compression
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GuaranteedAnnual Wage
(GAW)
SupplementaryUnemploymentBenefits (SUB)
Cost of LivingAdjustments
(COLAS)Severance Pay
Pay Security PlansPay Security Plans
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Solutions to the Problem of Pay Solutions to the Problem of Pay Compression Compression (1 of 2)(1 of 2)
1. Reexamining how many entry-level people are needed
2. Reassessing recruitment itself
3. Focusing on the job evaluation process, emphasizing performance instead of salary-grade assignment
4. Basing all salaries on longevity
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Solutions to the Problem of Pay Solutions to the Problem of Pay Compression Compression (2 of 2)(2 of 2)
5. Giving first-line supervisors and other managers the authority to recommend equity adjustments for incumbents who have been unfairly victimized by pay compression
6. Limiting the hiring of new employees seeking excessive salaries
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SummarySummary
There is a growing realization that traditional pay systems do not effectively link pay to performance
The trend is toward a total compensation approach made up of base pay, variable pay, and benefits
Flexibility is an essential ingredient in any compensation plan and can be built using a variable pay approach