PART FOUR
Compensation
Chapters 11-12
Chapter 11
Pay and Incentive Systems
McGraw-Hill/Irwin
© 2006 The McGraw-Hill Companies, Inc. All rights reserved.
Questions This Chapter Will Help Managers Answer
 How can we tie compensation strategy to general business strategy?
 What economic and legal factors should be considered in establishing pay
levels for different jobs?
 What is the best way to develop pay systems that are understandable,
workable, and acceptable to employees at all levels?
 How can we tie incentives to individual, team, or organization-wide
performance?
 In implementing a pay-for-performance system, what key traps must I avoid to
make the system work as planned?
Figure 11-1
Four Key Challenges in Planning and
Administering a Pay System
Understand economic
and legal factors that
determine pay levels
Tie compensation
strategy to general
business strategy
Pay Planning and Administration
Develop systematic pay
structures
Address key policy
issues
Organizational Reward System
… includes anything an employee
values and desires that an employer
is able and willing to offer in
exchange for employee contributions.
Organizational Reward Systems
Financial and Nonfinancial Components
Figure 11-3
REWARD SYSTEMS
Financial
Direct payments (salaries)
Indirect payments (benefits)
Nonfinancial
Protection programs
Employee involvement in decision
making
Effective supervision
Recognition
Training opportunities
Supportive, nurturing company
culture
Dimensions of Equity in Pay Systems
Internal equity
 In terms of the relative worth of individual jobs to an organization,
are pay rates fair?
External equity
 Are the wages paid by an organization “fair” in terms of
competitive market rates outside the organization?
Individual equity
 Is each individual’s pay “fair” relative to that of other individuals
doing the same or similar jobs?
Viewing Compensation From a Strategic Perspective
(Firm’s Actions)
1.
2.
3.
4.
They recognize compensation as a pivotal control and incentive
mechanism that can be used flexibly by management to attain
business objectives
They make the pay system an integral part of strategy formulation
They integrate pay considerations into strategic decision-making
processes, such as those that involve planning and control
They view the firm’s performance as the ultimate criterion of the
success of strategic pay decisions and operational compensation
programs
Collective Bargaining
Affects two key factors
1. The level of wages
2. The behavior of workers in relevant
labor markets
Figure 11-4
Traditional Job-Based Compensation Model
Important job characteristics
Pay surveys to attach pay
rates to jobs
Compensable factors
Pay structures to classify jobs
by grade levels
Job evaluation to rate the
relative worth of jobs
Assignment of individual pay
within a range for each job
Job hierarchy
Purposes of Job Descriptions
1. They identify important characteristics of each job so that
the relative worth of jobs can be determined
2. From them we can identify, define, and weight
compensable factors (common job characteristics that an organization
is willing to pay for, such as skill, effort, responsibility, and working
conditions)
Alternatives to Pay Systems Based on Job
Evaluation
Market-based pay
Competency-based
pay (skill or
knowledge based)
Figure 11-8
Requirements of Effective Incentive
Systems
Simple
Measurable
Effective
Employee
Incentive
Programs Are:
Attainable
Specific
Figure 11-9
Why Merit-Pay Systems Fail
Reasons Why Merit-Pay Systems Fail
Rewards are
too small
Merit-based
pay fails to
match union
pay scales
Supervisors
resist
performance
appraisal
Links
between
performance
and rewards
are weak
Annuity
feature
creates
problems
The “Annuity” Problem
As past “merit payments” are incorporated into
an individual’s base salary, the payments form
an annuity (a sum of money received at regular
intervals) and allow formerly productive
individuals to slack off for several years and still
earn high pay
Figure 11-10
Guidelines for Effective Merit-Pay Systems
Merit-Pay Systems That Work
Establish
high
standards of
performance
Develop
accurate
performance
appraisal
systems
Teach
supervisors
how to do
appraisals and
how to give
feedback
Link rewards
closely to
performance
Use a wide
range of
increases
Top Executive Compensation Types
 Stock options
 Restricted stock
 Common stock vests after a specified period
 Restricted stock units
 Shares awarded over time to defer taxes
 Performance shares
 Essentially stock grants awarded for meeting goals
 Performance accelerated shares
 Stocks that vest sooner if the executive meets goals ahead of
schedule
Incentives for Lower-Level Employees
Lump-sum bonus – employees receive an end-of- year
bonus (based on employee or company performance) that
does not build into base pay
Spot bonus – if an employee’s performance has been
exceptional, the employer may reward the worker with a
one-time bonus of $50, or $100, or $500 shortly after the
noteworthy actions
Reasons Why Firms Use Profit Sharing
 To provide a group incentive for increased productivity
 To provide retirement income for their employees
 To institute a flexible reward structure that reflects a company’s actual
economic position
 To enhance employees’ security and identification with the company
 To attract and retain workers more easily
 To educate individuals about the factors that underlie business success
and the capitalistic system
Gain Sharing
Focuses on achieving savings in areas
over which employees have control –
for example, reduced scrap, or lower
labor or utility costs
Elements of Gain Sharing
1. A philosophy of cooperation
2. An involvement system
3. A financial bonus
Gain Sharing vs. Profit Sharing
Gain Sharing
Profit Sharing
Based on a measure of productivity
Based on a global profitability
measure
Frequent events, distributed
monthly or quarterly
Annual measures and rewards
Current distribution plans
Deferred payments
Key Terms Discussed in the Chapter
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Trust gap
Organizational reward system
Compensation
Internal equity
External equity
Individual equity
Balance
Job descriptions
Compensable factors
Job evaluation
Benchmark jobs
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Relevant labor markets
Market-based pay
Competency-based pay
Pay compression
Annuity problem
Premium-price options
Workload standards
Motion study
Time study
Profit sharing
Gain sharing
Employee stock ownership plans