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CHAPTER 10
Compensation: An Overview
Chapter Overview
This chapter discusses the potential impact of pay on employees as well as determination
of pay level, pay structure, and individual pay. The discussion begins by stating the
objectives of compensation and explaining the multiple meanings of pay at work, external
and internal factors that influence compensation, pay levels, pay surveys, pay structures,
and their determination.
Learning Objectives
After studying this chapter, students should be able to:
1. Define compensation and be able to differentiate between direct financial
compensation, indirect financial compensation, and nonfinancial rewards.
2. Describe the strategic importance of human resource management (HRM) activities
performed in organizations.
3. Explain how compensation systems relate to employees’ motivation, productivity,
and satisfaction.
4. Explain how external factors (labor markets, the economy, the government, and
unions) and internal factors (size and age of the organization, labor budget, and who
is involved in pay decisions) relate to a firm’s compensation policy.
5. Discuss how pay surveys help managers create efficient and equitable pay systems.
6. Describe the job evaluation process.
Barriers to Student Understanding
1. One useful classroom project is to discuss indirect financial compensation approaches
that are utilized by different countries. This can be very revealing for students who
have an entitlement view of benefits.
2. Comparable worth can be illustrated by some of the recent court cases that have been
used to help define comparable worth.
3. Students may find it difficult to agree with Herzberg’s position that pay is a hygiene
factor and not simply, or often even, a motivator. One good way to illustrate this is to
ask students how much their salary to be in their first position. Then ask how long
they expect to be content with that amount before some indicator of their performance
is made?
4. Ask students if international assignments should be compensated above the cost of
reassignment and there will be sharply differing opinions. Some may view this as a
de-motivator, and a hardship assignment deserving of additional compensation, others
may view the opportunity as a perk and a reward based on performance.
5. If comparable worth and comparable pay are not issues to students, ask them why
there is still a significant salary gap between men and women in the work force.
Lecture Outline
Introduction
A Diagnostic Approach to Compensation
Objective of Compensation
External Influences on Compensation
The Labor Market and Compensation
Economic Conditions and Compensation
Government Influences and Compensation
Union Influences and Compensation
Internal Influences on Compensation
The Labor Budget
Who Makes Compensation Decisions
Compensation and Motivation
Pay and Motivation
Pay and Employees’ Satisfaction
Pay and Employees’ Productivity
Compensation Decisions
The Pay-Level Decision
Pay Surveys
The Pay Structure Decision
Delayering an Broadbanding
The Individual Pay Decision
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Key Points
1. Compensation is the HRM function that deals with every type of reward that
individuals receive in exchange for performing organizational tasks—wages, salaries,
bonuses, commissions, benefits, and nonfinancial rewards like praise.
2. The objective of the compensation function is to create a system of rewards that is
equitable to the employer and employee alike.
3. Compensation should be adequate, equitable, cost-effective, secure, incentiveproviding, and acceptable to the employee.
4. Motivation theories like the “economic man” theory, Maslow’s hierarchy of needs,
equity theory, exchange theory, and behavior modification suggest a relationship
between pay and motivation.
5. Pay satisfaction refers to an employee’s liking for, or dislike of, the employer’s
compensation package, including pay and benefits. Much research has been
conducted about the relationship, but it has not be clarified.
6. There is early evidence linking pay and productivity from the time of the Code of
Hammurabi in the 18th century B.C. However, higher performance requires more
than just understanding the relationship among pay, motivation, satisfaction, and
productivity.
7. The pay-structure decision involves comparing jobs within the organization to
determine their relative worth.
8. Determining the worth of a job is difficult because it involves measurement and
subjective decisions. Using systematic job evaluation procedures is one way to
determine net worth.
9. The four most widely used methods of job evaluation are job ranking, classification,
the point system, and factor comparison.
10. The wave curve (or line) illustrates the average target wage for each pay class.
11. Most managers group similar jobs into pay classes or rate ranges.
12. Broadbanding is a new system for condensing rate ranges into broader classifications.
It allows an employer to create a more flexible compensation program based on
individual contributions.
13. Most managers group similar jobs into pay classes or rate ranges.
Instructor’s Manual/Chapter 10
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Key Terms
Students will be introduced to the following key terms:
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behavior modification
Individual learning through reinforcement.
broadbanding
A system for condensing compensation rate ranges into
broader classifications.
classification or
grading system
A job evaluation method that groups jobs together into a grade
or classification.
comparable worth
An issue that has been raised by women and the courts in
recent years. It means that the concept of equal pay for equal
jobs should be expanded to the notion of equal pay for
comparable jobs. If a job is comparable to other jobs as
determined by job content analysis, that job's pay should be
comparable.
compensation
Compensation is the HRM function that deals with every type
of reward that individuals receive in return for performing
organizational tasks.
delayering
Allowing workers to move among a wider range of tasks
without having to adjust pay with each move.
equal pay
Equal pay for equal work for men and women. Equal work is
defined as work requiring equal skills, effort, and
responsibility under similar working conditions.
equity theory
A motivation theory that argues that a major determinant of
employees' productivity and satisfaction arises from the
degree of fairness or unfairness that they perceive in the
workplace.
exchange theory
A theory of motivation that argues that a major determinant of
an employee's productivity and satisfaction arises from the
degree of equity in the workplace, defined in terms of a ratio
of an employee's inputs (effort, attendance, and so on) to
outcomes (pay, benefits, and so on) as compared with a
similar ratio for a relevant other.
Ivancevich, Human Resource Management, Ninth Edition
exempt employee
A person working in a job that is not subject to the provisions
of the Fair Labor Standards Act (1938) with respect to
minimum wage and overtime pay. Most professionals,
executives, administrators, and outside salespeople are
classified as exempt.
factor comparison
method
A job evaluation method that uses a factor-by-factor
comparison. A factor comparison scale, instead of a point
scale, is used. Five universal job factors used to compare jobs
are responsibility, skills, physical effort, mental effort, and
working conditions.
Fair Labor Standards
Act (FLSA)
A 1938 law that set specific minimum wage and overtime pay
rates.
indirect financial
compensation
All financial rewards (benefits and services) that are not
included in direct financial compensation.
job evaluation
The formal process by which the relative worth of various
jobs in the organization is determined for pay purposes.
minimum wage
The Fair Labor Standards Act of 1938, as amended, states that
all employers covered by the law must pay an employee at
least a minimum wage. In June 2000, the minimum was $5.15
per hour.
motivation
The attitudes that predispose a person to act in a specific goaldirected way. It is an internal state that directs a person's
behavior.
nonexempt employee
A person working in a job that is subject to the minimum
wage and overtime pay provisions of the Fair Labor Standards
Act. Blue-collar and clerical workers are two major groups of
nonexempt employees.
pay class or pay grade
A convenient grouping of a variety of jobs that are similar in
difficulty and responsibility.
pay curve
A pay graph developed from data collected from wage and
salary surveys. It graphically depicts pay rates/ranges.
pay level
Pay set relative to employees working on similar jobs in other
organizations.
Instructor’s Manual/Chapter 10
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pay range
The spread of pay in various classes. That is, a class may have
a range of $1,000 per month. One employee would be paid the
lowest rate and another employee paid the highest rate. The
range from the lowest to the highest could be $1,000 per
month.
pay structure
Pay set relative to employees working on different jobs within
the organization.
pay surveys
Surveys of the compensation paid to employees by all
employers in a geographic area, an industry, or an
occupational group.
point system
The most widely used job evaluation method. It requires
evaluators to quantify the value of the elements of a job. On
the basis of the job description or interviews with job
occupants, points are assigned to the degree of various factors
required to do the job.
ranking of jobs
A job evaluation method often used in smaller organizations,
in which the evaluator ranks jobs from the simplest to the
most challengingfor example, clerk to research scientist.
Ivancevich, Human Resource Management, Ninth Edition
Suggested Answers to Review Questions
1. What is the difference between direct and indirect financial compensation?
Direct financial compensation consists of the pay an employee receives in the form
of wages, salary, bonuses, and commissions.
Indirect financial compensation, also known as benefits, consists of all financial
rewards that are not included in direct financial compensation. Typical benefits
include vacation, insurance, health insurance, mandatory federal requirements like
Family Medical Leave Act privileges, and retirement options.
2. Pay for each individual in the United States is set relative to three groups. Name
them and explain why each is important.
Pay for a particular position is set relative to the following groups:

Employees working on similar jobs in other companies

Employees working on different jobs within the same organization

Employees working on the same job within the same organization
The first group is important because it offers a broad look at the position while trying
to ascertain if the compensation package is competitive with regard to market rates.
The second group involves determining what the relative worth of each kind of job is
to the organization. The third group is concerned with making the individual pay
determination decision.
3. What is pay satisfaction? Why is it so difficult to measure it and relate it to a
compensation system?
Pay satisfaction refers to an employee’s like or dislike of the employer’s
compensation package, including pay and benefits. It seems intuitively logical that
satisfaction should lead to productivity, but the research to date has not been
convincing. The reasons why it is so difficult to directly relate to compensation
systems is that there are many variables to consider related to motivation and
compensation and it is hard to isolate which are the most relevant.
Instructor’s Manual/Chapter 10
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4. Linking pay and productivity has been around since the days of the
Babylonians. How much do we really know about the relationship?
Although at least 3,500 scholarly articles have been written about pay satisfaction,
research on it is not very definitive. It has failed to find convincing evidence that
worker satisfaction leads to an increase in productivity. And although it seems logical
that employees derive satisfaction from being paid well or getting desired benefits or
services, this is a very subjective conclusion. In fact, the sheer complexity of reward
systems, made up of such things as base pay, bonuses, benefits, and services, makes it
even more difficult to research employees’ satisfaction. The clearest indication of
satisfaction may be patterns of absenteeism and turnover.
5. What is the difference between equal pay and comparable worth? Why are these
concepts so important today?
Equal pay means paying two employees equally as long as their jobs are equal in these
requirements: skills, effort, responsibility, and working conditions.
Comparable worth, on the other hand, attempts to prove that employers systematically
discriminate by paying women less than their work is intrinsically worth, versus what
they pay mean who work in comparable (equally valuable positions), and to remedy
this situation. Advocates of comparable worth contend that individuals who perform
jobs that require similar skills, effort, and responsibility under similar work conditions
should be compensated equally, regardless of gender.
Both concepts are important because of the gap between men’s and women’s wages; a
gap has been closing only because men’s wages have fallen, not because women’s
wages have risen.
6. Differentiate between the high, low, and comparable pay-level strategies.
Companies determine their strategy based on external information, often surveys that
aid in determining if geographic area, industry, and occupational group should make a
difference on their philosophy or strategy.
Managers using the high pay-level strategy choose to pay higher than average pay
levels based on the assumption that you get what you pay for. Managers using the low
pay-level strategy sets pay levels at the minimum level needed to hire employees.
This strategy is usually chosen because that is what the organization can afford.
Managers using the comparable pay-level strategy set the organization’s average
pay at the going rate for the industry.
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7. How would you go about deciding if a pay survey you wanted to buy had the
necessary characteristics to be useful to your organization?
Pay surveys are surveys of the compensation paid to employees by all employers in a
geographic area and industry, or an occupational group. They are completed by large
employers, professional and consulting enterprises, trade associations, universities,
unions, city chambers, and the government. They can be conducted by personal
interviews which are accurate but expensive or by mailed questionnaires. Their
usefulness in making the pay-level decision is based on the jobs covered in the
survey, the employers contacted, and the method used together the data.
8. Define the pay-structure decision. What is the job evaluation and how does it help
managers build a pay structure?
The pay structure decision is concerned with determining what the organization
should pay for different jobs within the same organization.
Job evaluation is a special kind of job analysis that is intended to determine the
relative worth of a job. A systematic comparison of the worth of one job to another
eventually results in the creation of a wage or salary hierarchy.
9. Name and discuss four techniques of job evaluation. Include advantages and
disadvantages of each.
1. Job ranking—The evaluator rank orders whole jobs from the simplest to the most
challenging. The advantage to this approach is that it is useful for smaller
organizations. The disadvantage is that it is clumsy to use when rating many jobs
and rating reliability is not high.
2. Classification or grading system—The evaluator groups a set of jobs together into
a grade or classification. These sets are then ranked by level of difficulty or
sophistication. The advantage of this methods is that it provides a specific
standard for compensation and accommodates any changes in the value of
individual jobs. It can be constructed easily and is easy to communicate to
employees. It is also more detailed than job ranking. The disadvantage is that it
assumes a rigid relationship between job factors and value, so jobs may be forced
into categories that are not a true fit. Determining how many classifications are
needed can also be a problem.
3. Point system—Evaluators quantify the value of the elements of a job by assigning
points to the various compensable factors, such as skill required. The advantage to
the system is that it can be easily interpreted and explained to employees.
Unfortunately, developing the system is time consuming.
4. Factor comparison—Job evaluation is done on a factor-by-factor basis against a
“benchmark” or key points. The advantage is that it provides a step-by-step formal
method and translates factors into dollar values. The disadvantage is that it is very
complex.
Instructor’s Manual/Chapter 10
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10. Define the term broadbanding. How does it relate to traditional job evaluation
outcomes like pay ranges and classes?
Broadbanding is a new system for condensing rate ranges into broader classifications.
Its use allows employers to create a more flexible compensation program based on
individual contributions to the bottom line. Entry level employees with minimal
qualifications start at the minimum range within the band. Instead of annual raises,
movement through these ranges is dependent on performance. With fewer, broader
salary ranges, organizations de-emphasize traditional job evaluation and
organizational hierarchy.
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Suggested Answers for Application Case 10-1
The Comparable Worth Debate
1. In your view, is comparable worth a legitimate strategy for determining job
compensation?
Student opinions will vary. This writer’s opinion that that it is not a legitimate strategy
because it is a method used by far too few companies. Wages should be set by market
conditions, such as what competitors are paying for similar jobs, availability of
workforce, and so on.
2. Are the director of Twin Oak’s HR department, what recommendations would
you make to James Bledsoe?
Student responses will vary, based on their personal opinion and/or experiences.
Sample answer: If I were the direction of Twin Oak’s HR department, I would
recommend implementing an immediate 6 percent across-the-board pay increase,
which would keep employees from defecting to Lexington Memorial Hospital, reduce
the attractiveness of unionization, and be less costly than implementing a comparableworth system or finding replacement employees. However, I would also recommend a
quiet review of the pay scales in order to determine if there is a pay inequity between
men and women holding the same or similar jobs. If there is, it should be corrected
quickly in order to shield the company from potential discrimination lawsuits.
Instructor’s Manual/Chapter 10
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3. From an HRM perspective, what are the challenges of implementing comparable
worth?
From an HRM perspective, this would be a huge, costly, and time-consuming process.
First, every job would have to be identified, evaluated, and documented. Then,
representatives from each functional area would have to determine the weights for all
factors related to the job, such as knowledge, experience, accountability, and
judgment. Next, a comparison of all the jobs and the weights would have to be
reviewed by management to determine if the system was fair and acceptable. Before
implementation, the system would have to be explained to employees. Then, followups would likely have to be held with employees who received a cut in pay rather than
an increase. Pay cuts might also lead to employee loss and/or claims of
discrimination.
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Ivancevich, Human Resource Management, Ninth Edition