Chapter 1

The Pay Model

DZA

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 Chapter Topics
• Compensation: Definition
• Forms of Pay
• A Pay Model
• Book Plan
• Caveat Emptor - Be an Informed Consumer

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 Key Questions and Issues
• How differing perspectives affect our
views of compensation
• Definition of compensation
– The meaning of compensation most
appropriate from an employee's view:
return, reward, or entitlement
• Examining “network of returns” a college
offers an instructor
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 Key Questions and Issues (cont.)

• Four policy issues in the pay model

– Objectives of the pay model
• Forms of pay received from work

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 Compensation: Definition
• Compensation does not mean the same thing to
every one.
• Your view probably differs, depending on
whether you look at compensation from the
perspective of a member of:
- a society,
- a stakeholder,
- a manager, or
- an employee
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• Compensation represents both the intrinsic
and extrinsic rewards employees receive for
performing the jobs. Intrinsic compensation
reflects employees’ psychological mind sets
that result from performing their jobs . Extrinsic
compensation includes both monetary and
non monetary rewards.

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 Contrasting Perspectives of
Compensation

Society’s Stockholders’
Views Views

Employees’ Managers’
Views Views
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 Compensation: Definition
• Society
– Some people see pay as a measure of justice. For example,
a comparison of earnings between men and women
highlights what many inequities in pay decisions
– Benefits may also be seen as a reflection of justice in society.
For example, about 20 million people in Bangladesh do not
have minimum health facilities
– Some in a society attribute job losses (or gains) to differences
in compensation. For example, people in the US complain
about losing manufacturing jobs to Mexico, China, and other
nations
– Some consumers know that pay increases often lead to price
increases. They do not believe that higher labor costs benefit
them. For example, while pay increase in our country, prices
of essentials also increase at the same time
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Exhibit 1.1: Hourly Compensation Costs for
Manufacturing Workers (in U.S. Dollars)

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 Compensation: Definition (cont.)
• Stockholders
– Stockholders are also interested in how employees are
paid
– Some believe that using stock to pay employees creates a
sense of ownership that will improve performance, which
will, in turn, increase stockholder wealth
– Others argue that granting employees too much ownership
dilutes stockholder wealth
– Stockholders have a particular interest in executive pay
– Linking executive pay to company performance is
supposed to increase stockholders' returns. Unfortunately,
this does not always happen
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 Compensation: Definition (cont.)
• Managers
– For managers, compensation influences their success in
two ways
– First, it is a major expense
– Competitive pressures (global & local) force managers to
consider the affordability of their compensation decisions
– Labor costs can account for more than 50% of total costs
– In some industries, such as financial or professional
services and in education and government, this figure is
even higher
– However, even within an industry, labor costs as a percent
of total costs vary among individual firms
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 Compensation: Definition (cont.)
– Second, a manager also uses it (compensation) to influence
employee behaviors and to improve the organization's
performance
– The way people are paid affects
• the quality of their work
• their attitude toward customers, and
• their willingness to be flexible, learn new skills, or suggest
innovations
- On the other hand, people may become interested in unions
or legal action against their employer based on how they
are paid
- This potential to influence employees’ behaviors, and
subsequently the productivity and effectiveness of the
organization, makes the study of compensation worth your
time
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 Compensation: Definition (cont.)
• Employees
– The pay individuals receive in return for the work they
perform is usually the major source of their financial security
– Hence, pay plays a vital role in person’s economic and
social well-being
– Employees may see compensation as
• a return in an exchange between their employer and themselves
• an entitlement for being an employee of the company
• a reward for a job well done
- Compensation can be all of these things
- However, whether employees see their pay as a reward
remains an open question
- Employees invest in education and training; they contribute
their time and energy at the workplace
- Compensation is their return on those investments and
contributions 13
 Compensation: Definition (cont.)
• Global Views – Vive la différence
– In English, compensation means something that
counterbalances, offsets, or makes up for something else
– We get a sense of the richness of the meaning of compensation,
which combines entitlement, return, and reward
– In China: the traditional characters for the word “compensation”
are based on the symbols for logs and water; compensation
provides the necessities in life
– In the recent past, the state owned all enterprises and
compensation was treated as an entitlement
– In today’s China, compensation takes on a more fine meaning
– A new word, dai yu, is used.
– It refers to how you are being treated – your wages, benefits,
training opportunities, and so on
– When people talk about compensation, they ask each other
about the treatment, the meaning of compensation now includes
a broader sense of return as well as entitlement 14
 Compensation: Definition (cont.)
• Global Views – Vive la différence
– In Japanese, “compensation” stands for kyuyo, which made up
of two characters (kyu and yo), both meaning “giving something”
– Traditionally, compensation is thought of as something given by
one’s superior
– Today, business consultants in Japan try to substitute the word
hou-syu, which means “reward” and has no associations with
notion of supervisors
– The many allowances that are part of Japanese compensation
systems translate as teate, which means “taking care of
something.”
– Teate is regarded as compensation that takes care of
employees’ financial needs
– This concept is consistent with family, housing, and commuting
allowances that are still used in many Japanese companies
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What Is Compensation?

Compensation refers to all

forms of financial returns
and tangible services and
benefits employees receive
as part of an employment
relationship

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Exhibit 1.4: Total Returns for Work

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 Forms of Pay
• Exhibit 1.4 shows the variety of returns people receive
from work
• They are categorized as total compensation and
relational returns
• Relational returns (learning opportunities, status,
challenging work, and so on) are psychological in
nature
• Total compensation returns are cash compensation or
more transactional in nature
• They include pay received directly as cash (e.g. base,
merit, incentives, cost of living adjustments) and
indirectly as benefits (e.g. pensions, medical
insurance, brightly colored uniforms)
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 Forms of Pay (cont.)
• Cash Compensation
– Base wage is the cash compensation that an employer pays
for the work performed. For example, the base wage for
machine operators may be $20 an hour in the USA.
– Some individual operators may receive more because of their
experience and/or performance
– Some pay systems set base wage as a function of the skill or
education an employee possesses; this is common for
physicians, engineers, and schoolteachers in the USA/UK
– There is a difference between wage and salary
– Managers and professionals usually receive salary
– Their pay is calculated at an annual or monthly rate rather
than hourly, because hours worked do not need to be
recorded
– In contrast, workers who are covered by overtime and have
their pay calculated as an hourly wage
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 Forms of Pay (cont.)
• Cash Compensation
– Merit pay/cost-of-living adjustments
– Merit increases are given as increments to the base
pay in recognition of past work behavior.
– Many US firms use merit pay increases
– Outstanding performers could receive such type of
merit increases. For example, s/he could receive a 6
to 8 percent merit increase 8 months after their last
increase
– Cost-of-living adjustments give the same increases
to everyone, regardless of performance

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 Forms of Pay (cont.)
– Cash Compensation/ transactional (cont.)
• Incentives/ Variable pay tie pay increases directly to
performance
• Incentives differ from merit adjustments
• Incentive
– Does not increase base wage; must be reearned each pay period
– Potential size of the incentive payment will generally be known
beforehand
– Long-term (stock options), and short-term
• Incentives can be tied to the performance of an individual
employee, a team of employees, a total business unit, or
some combination of individual, team, and unit

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 Forms of Pay (cont.)
• Incentives/ Variable pay (cont.)
– The performance objective may be expense
reduction, volume increases, customer satisfaction,
revenue growth, return on investments, increase in
stock value – the possibilities are endless
– Incentives are one-time payments
– When performance declines, incentive pay
automatically declines, too
– Incentives are frequently referred as variable pay

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 Forms of Pay (cont.)

• Benefits - income protection, work/life balance, and

allowances – are also part of total compensation
1. Income protection programs are legally required
- Employers must pay (half of the contributions) into
a fund that provides income replacement for
workers who become disabled or unemployed
- (Employees pay the other half)
- Medical insurance, retirement programs, life
insurance, and savings plans are common
benefits
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 Forms of Pay (cont.)
• Benefits (cont.)
2. Work/life balance programs that help employees
better integrate their work and life responsibilities
include
- time away from work (e.g. vacations)
- access to services to meet specific needs (e.g.
drug counseling & financial planning), and
- flexible work arrangements (e.g. nontraditional
schedules & nonpaid time off)

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 Forms of Pay (cont.)
• Benefits (cont.)
3. Allowances often grow out of whatever is in short supply
- In Vietnam and China, housing (dormitories and
apartments) and transportation allowances are frequently
part of the pay package
- Sixty years after the end of World War II, some Japanese
companies still continue to offer a “rice allowance” based on
the number of an employee’s dependents
- Companies that resist these allowances must come up with
other ways to attract and retain employees
- In Bangladesh, teachers/officers of the public universities
normally receive house rent and medical benefits as
allowances in addition to their basic salary
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 Forms of Pay (cont.)
• Total earnings opportunities: Present value of a
stream of earnings
– A present-value perspective shifts the comparison
of today's initial offers to consideration of future
bonuses, merit increases, and promotions
– Sometimes a company will tell students that its
relatively low starting offers will be overcome by
larger future pay increase
– In effect, the company is selling the present value of
the future stream of earnings

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 Forms of Pay (cont.)
• Relational returns from work
– Nonfinancial returns from work have a substantial
effect on employees’ behavior
– Examples of relational returns from work are
recognition and status, employment security,
challenging work, and opportunities to learn
– Other relational forms might include personal
satisfaction from successfully facing new challenges,
teaming with great co-workers, receiving new
uniforms, and the like
– Such factors are part of the total return, which is a
broader umbrella than total compensation
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 Forms of Pay (cont.)
• Organization as a network of returns
– Sometimes it is useful to think of an organization
as a network of returns created by all these
different forms of pay, including total compensation
and relational returns
– The challenge is to design this network so that it
helps the organization to succeed
– Let’s not forget that compensation is only one of
many factors affecting people’s decisions about
work

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 A Pay Model
• Three basic building blocks of a pay model are:
– The compensation objectives
– The policies that form the foundation of the
compensation system
– The techniques that make up the compensation
system

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Exhibit 1.5: The Pay Model

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 Compensation Objectives (cont.)
• Pay systems are designed to achieve the following
objectives:
• Efficiency can be stated more specifically:
– Improving performance, increasing quality, delighting
customers and stockholders; and
– Controlling labor costs
• Fairness is a:
– Fundamental objective of pay systems
– Fair treatment by recognizing both employee
contributions (e.g. higher pay for greater performance,
experience, or training), and
– employee needs (e.g. a fair wage as well as fair
procedures) 31
 Compensation Objectives (cont.)
• Procedural fairness
- Refers to the process used to make pay decisions
- Suggests that the way a pay decision is made may be as
important to employees as the results of the decision
• Compliance means
– Conformance to the government compensation laws and
regulations
– If the laws change, pay systems may need to change, too, to
ensure continued compliance
– As the companies go global, they must comply with the laws
of all the countries in which they operate

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 Compensation Objectives (cont.)
• Ethics means
– Organizations care about how its results are achieved
– If you scan the websites or lobby walls of corporate
headquarters, you will inevitably find statements of “Key
Behaviors”, “Our Values”, and “Codes of Conduct”
• Objectives
– Guide the design of the pay system
– Serve as the standards for judging success of the pay system
– Policies and techniques are means to reach objectives

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Exhibit 1.6: Pay Objectives at Medtronic
and Whole Foods

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 Four Policy Choices
• Internal alignment
– Refers to comparisons among jobs or skill levels inside a
single organization
– Jobs and people’s skills are compared in terms of their relative
contributions to the organization’s business objectives
– For example, does the work of the programmer compare with
the work of the systems analyst?
– Pay relationships within an organization affect employee
decisions to:
• Stay with the organization
• Become more flexible by investing in additional training
• Seek greater responsibility

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 Four Policy Choices
• External competitiveness
– Refers to pay comparisons with competitors, i.e. focus on
compensation relationships external to the organization:
comparison with competitors
– For example, how much do we wish to pay in comparison
to what other employers pay?
– In addition to how much to pay, external competitiveness
also includes pay mix
– Pay mix includes base, incentives, stock, benefits that
competitors use to pay employees
– Many organizations claim their pay systems are ‘market
driven’, that is, based almost exclusively on what
competitors pay
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 Four Policy Choices (cont.)
• External competitiveness (cont.)
– Effects of decisions regarding how much and what forms:
• To ensure that pay is sufficient to attract and retain employees
• To control labor costs to ensure competitive pricing of products/
services
• Employee contributions
– The emphasis to place on employee contributions is an
important policy decision since it directly affects employees’
attitudes and work behavior
• Performance based pay affects fairness
• Management
– Means ensuring that the right people get the right pay for
achieving the right objectives in the right way
– The greatest system design in the world is useless without
competent management
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 Pay System Techniques

• Techniques tie the four basic policies to the

pay objectives
• Uncounted variations in pay techniques exist
• Some techniques will be discussed through the
book

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 Caveat Emptor -
Be An Informed Consumer
• Is the Research Useful?
• Does the Study Separate Correlation from
Causation?
• Are there Alternative Explanations?

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 Historical perspective On
compensation
• The early personnel(compensation) function
emphasized labor cost control and
management control over labor . Many
employers instituted scientific management to
control labor cost as well as well welfare
practices to maintain control over labor. Thus,
scientific management gave rise to individual
incentive pay systems. Scientific management
practices promoted labor cost control by
replacing inefficient production method 40
• S with efficient ones.
• Factory owners used time and motion studies
and job analysis to meet the that objective .
• Time and motion studies focused employees
movements and identification of the most
efficient steps to complete jobs in the least
amount of time . Job analysis is a systematic
process for collecting, documenting and
analyzing information in order to describe jobs.
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• How did scientific management influence
compensation practices ? Scientific
management gave rise to the use of
piecework . What is it? Piecework plans, an
employee compensation depends on the
number of units she or he produces over a
given period. Specially these plans reward
employees on the basis of their individual
hourly production against an objective output
standard 42
• For each hour, workers receive piecework
incentives for every item produced over the
designed production standard.
• 1960s, us government instituted major
legislation that aimed was protecting individual
rights to fair treatment in the work place .
• Personnel administration was transformed
from a purely administrative function to a
competitive resource in many companies
during the 1980s. 43
• At that time technology transformed the work
place and pressures from global competitors
.Employers recognition that employees
represent an important resource that led to the
view of employees as human resource . In this
regards , companies design human resource
management practices to promote
competitive advantage .--- refers to a
company’s ability to maintain market share
and profitability over it’s competitors . 44
• Increased global competition has forced
companies to become more productive ,
Compensation practices contribute to
competitive advantage by developing more
productive and highly skilled workforces. Well
designed merit pay programs reinforce
excellent performance by awarding pay rises
commensurate with performance attainment .

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