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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 2 Ivancevich, Human Resource Management, Ninth Edition 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 3 Key Terms Students will be introduced to the following key terms: 4 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 5 6 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 challengingfor 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 7 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. 8 Ivancevich, Human Resource Management, Ninth Edition 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 9 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. 10 Ivancevich, Human Resource Management, Ninth Edition 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 11 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. 12 Ivancevich, Human Resource Management, Ninth Edition