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COMPENSATION
Job satisfaction includes challenging work, interesting job assignments, equitable rewards, competent supervision, and rewarding careers. The quality of work life and psychological rewards from employment are very important. It is doubtful, however, whether many of us would continue working were it not for the money we earn. Employees desire compensation systems that they perceive as being fair and 0 0 commensurate with their skills and expecta1 F tions. Pay, therefore, is a major consideration in HRM because it provides employees with a tangible reward for their services, as well as a source of recognition and livelihood. 0 0 Em1 F ployee compensation includes all forms of pay and rewards received by employees for the performance of their jobs. Direct compensation encompasses employee wages and salaries, incentives, bonuses, and commissions. Indirect compensation comprises the many benefits supplied by employers, and nonfinancial 0 0 compensation includes em1 F ployee recognition programs, rewarding jobs, and flexible work hours to accommodate personal needs. Both HR professionals and scholars agree that the way compensation is allocated among employees sends a message what management believes is important and the types of activities it encourages. For an employer, the payroll constitutes a sizable operating cost. In manufacturing firms compensation is seldom 0 0 as low as 20 per1 F cent of total expenditures, and in service enterprises it often exceeds 80 percent. A sound compensation program is essential so that pay can serve to motivate employee production sufficiently to keep labor costs at an acceptable level. The management of a compensation program, job evaluation systems, and pay structures for determining compensation payments is covered here. Included will 0 0 be a discussion of fed1 F eral regulations that affect wage and salary rates. Employee benefits that are part of the total compensation package are discussed later.
The Compensation Program
A significant interaction occurs between compensation management and the other functions of 0 0 the HR program. For example, in the recruitment of new em1 F ployees, the rate of pay for jobs can increase or limit the supply of applicants. Many fast-food restaurants, traditionally low-wage employers, have needed to raise their starting wages to attract a sufficient number of job applicants to meet staffing requirements. If rates of pay are high, creating a large applicant pool, then organizations may choose to raise their selection standards and hire better-qualified employees. This in turn can reduce employer training costs. 0 0 When em1 F ployees perform at exceptional levels, their performance appraisals may justify an increased pay rate. For these reasons and others, an organization should develop a formal HR program to manage employee compensation. This program should establish its intended objectives, the policies for determining compensation payments, and the methods by which the payments will be disbursed. Included as part of the program should be the communication of information concerning wages and benefits to employees.
Compensation Objectives and Policies
0 0 Compensation objectives should facilitate the effective utilization and manage1 F ment of an organization’s human resources, while also contributing to the overall objectives 0 0 of the organization. A compensation program, therefore, must be tai1 F lored to the needs of an organization and its employees. It is not uncommon for organizations to establish very specific goals for their compensation program. Formalized compensation goals serve as guidelines for managers to ensure that wage 0 0 and benefit policies achieve their intended pur1 F pose. The more common goals of compensation policy include:
- To reward employees’ past performance
- To remain competitive in the labor market
- To maintain salary equity among employees
- To motivate employees’ future performance
- To maintain the budget
- To attract new employees
- To reduce unnecessary turnover
To achieve these goals, policies must be established to guide management in making decisions. Formal statements of compensation policies typically include the following:
- The rate of pay within the organization and whether it is to be above, below, or at the prevailing community rate
- The ability of the pay program to gain employee acceptance while motivating employees to perform to the best of their abilities
- The pay level at which employees may be recruited and the pay differential between new and more senior employees
- The intervals at which pay raises are to be granted and the extent to which merit and/or seniority will influence the raises
- The pay levels needed to facilitate the achievement of a sound financial position in
Pay Equity
Equity can be defined as anything of value earned through the investment of something of value. Fairness is achieved when the return on equity is equivalent to the investment made. For
employees, pay equity is achieved when the compensation received is equal to the value of the work performed.
Pay equity An employee’s perception that compensation received is equal to the value of the work performed
Internal equity is especially important in an organization where “teamwork” is critical to success. In environments that requires a cross-section of skills and talents and interdisciplinary teamwork, coworkers need confidence in themselves and their colleagues. An important part of creating an environment in which teamwork is effective, is a pay policy that reflects the true value of work to the overall organization, and helps all members of the team respect one another’s contribution and role. Not only must pay be equitable, it must also be “perceived” as such by employees. Research clearly demonstrates that employees’ perceptions of pay equity, or inequity, can have dramatic effects on their motivation for both work 0 0 behav1 F ior and productivity. Managers must therefore develop pay practices that are both internally and externally equitable. Employees must believe that wage rates for jobs within the organization approximate the job’s worth to the organization. Also, the employer’s wage rates must correspond closely to prevailing market rates for the employee’s occupation. These two goals can sometimes be in conflict.
Pay Expectancy
0 0 The expectancy theory of motivation predicts that one’s level of motivation de1 F pends on the attractiveness of the reward sought. The theory holds that employees should exert 0 0 greater work effort if they have rea1 F son to expect that it will result in a reward that is valued. To motivate this ef0 01 F^ fort, the value of any monetary reward should be attractive. Employees also must believe that good performance is valued by their employer and will result in their receiving the expected reward. The chart below illustrates the relationship between pay-for-performance and the expectancy theory of motivation. The model predicts that high effort will lead to high performance (expectancy), and high performance in turn will lead to monetary rewards that are appreciated (valued). Since pay-for-performance leads to a feeling of pay satisfaction, this feeling should reinforce one’s high level of effort.
(insert figure 10-1)
0 0 Thus, how employees view compensation can be an important factor in de1 F termining the motivational value of compensation. Furthermore, the effective communication of pay
information together with an organizational environment that elicits employee trust in management can contribute to employees having more accurate perceptions of their pay. The 0 0 perceptions employees develop con 0 0 1 F cerning their pay are influenced by the accuracy of their knowledge and under1 F standing of the compensation program.
Pay Secrecy
0 0 Misperceptions by employees concerning the equity of their pay and its relation1 F ship to performance can be created by secrecy about the pay that others receive. There is reason to believe that secrecy can generate distrust in the compensation system, reduce employee motivation, and inhibit organizational effectiveness. Yet pay secrecy seems to be an accepted practice in many organizations in both the private and the public sector. Managers may justify secrecy on the grounds that most employees prefer to have their own pay kept secret. Probably one of the reasons for pay secrecy that managers may be unwilling to admit is that it gives them greater freedom in compensation management, since pay decisions are not disclosed and there is no need to justify or defend them. Employees who are not supposed to know what others are being paid have no objective base for pursuing grievances about their own pay. Secrecy also serves to cover up inequities existing within the pay structure. Furthermore, secrecy surrounding compensation decisions may lead employees to believe that there is no direct relationship between pay and performance.
The Bases for Compensation
Work performed in most private, public, and not-for-profit organizations has 0 0 tra1 F ditionally been compensated on an hourly basis. It is referred to as hourly or day work , in contrast to piecework , in which employees are paid according to the number of units they produce. Hourly work, however, is far more prevalent than piecework as a basis for compensating employees.
Hourly or day work Work paid on an hourly basis
Piecework Work paid according to the number of units produced
Employees compensated on an hourly basis are classified as hourly employees, or wage earners. Those whose compensation is computed on the basis of weekly, biweekly, or monthly pay periods are classified as salaried employees. 0 0 Hourly em1 F ployees are normally paid only for the time they work. Salaried employees, by contrast, are generally paid the same for each pay period, even 0 0 though they occa1 F sionally may work more hours or fewer than the regular 0 0 number of hours in a pe1 F riod. They also usually receive certain benefits not provided to hourly employees. Another basis for compensation centers on whether employees are classified
Components of the Wage Mix
A combination of external and internal factors can influence, directly or indi0 01 F rectly, the rates at which employees are paid. Through their interaction these factors constitute the wage mix, as shown below.
(insert Figure 10-2: Factors Affecting the Wage Mix)
External Factors
0 0 The major external factors that influence wage rates include labor market condi 0 0 1 F tions, area wage rates, cost of living, legal requirements, and collective bargain1 F ing if the employer is unionized.
Labor Market Conditions
The labor market reflects the forces of supply and demand for qualified labor within an area. These forces help to influence the wage rates required to recruit or retain competent employees. It must be recognized, however, that counter-forces can reduce the full impact of supply and demand on the labor market. The economic power of unions, for example, may prevent employers from lowering wage rates even when unemployment is high among union 0 0 members. Govern1 F ment regulations also may prevent an employer from paying at a market rate less than an established minimum.
Area Wage Rates
A formal wage structure should provide rates that are in line with those being paid by other employers for comparable jobs within the area. Data pertaining to area wage rates may be obtained from local wage surveys. Wage-survey data may be obtained from a variety of sources, often available on the Internet, including the American Management Association, 0 0 Administrative Management Society, U.S. Depart1 F ment of Labor, and Federal Reserve Banks. Data from area wage surveys can be used to prevent the rates for certain jobs from drifting too far above or below those of other employers in the region. When rates rise above existing area levels, an employer’s labor costs may become excessive. Conversely, if they drop too far below area levels, it may be difficult to recruit and retain competent personnel. Wage-survey data must also take into account indirect wages paid in the form of benefits.
Cost of Living
Because of inflation, compensation rates have had to be adjusted upward periodically to help employees maintain their purchasing power. This can be achieved through escalator clauses found in various labor agreements. These clauses provide for quarterly cost-of-living adjustments (COLA) in wages based on changes in the consumer price index (CPI). The CPI is
a measure of the average change in prices over time in a fixed “market basket” of goods and
services.
Escalator clauses
Clauses in labor agreements that provide for quarterly cost-of-living adjustments in wages, basing the adjustments upon changes in the consumer price index
Consumer price index (CPI)
Measure of the average change in prices over time in a fixed “market basket” of goods and services
The CPI is largely used to set wages. The index is based on prices of food, clothing, shelter, and fuels; transportation fares; charges for medical services; and prices of other goods and services that people buy for day-to-day living. The Bureau of Labor Statistics collects price information on a monthly basis and 0 0 cal1 F culates the CPI for the nation as a whole and various U.S. city averages. Separate indexes are also published by size of city and by region of the country. Employers in a number of communities monitor changes in the CPI as a basis for compensation decisions.
Collective Bargaining
One of the primary functions of a labor union is to bargain collectively over conditions of employment, the most important of which is compensation. The union’s goal in each new agreement is to achieve increases in real wages --wage increases larger than the increase in the CPI--thereby improving the purchasing power and standard of living of its members. This goal includes gaining wage settlements that equal if not exceed the pattern established by other unions within the area.
Real wages Wage increases larger than rises in the consumer price index; that is, the real earning power of wages
The agreements negotiated by unions tend to establish rate patterns within the labor 0 0 market. As a result, wages are generally higher in areas where orga1 F nized labor is strong. To recruit and retain competent personnel and avoid unionization, nonunion employers must either meet or exceed these rates. The “union scale” also becomes the prevailing rate that all employers must pay for work performed under government contract. The impact of collective bargaining therefore extends beyond that segment of the labor force that is unionized.
not uncommon for employers in the trades to seek to retain their most competent employees by paying them more than the union scale. In industrial and office jobs, differences in employee performance can be recognized and rewarded through promotion and with various incentive systems. Superior performance can be rewarded by granting merit raises on the basis of steps within a rate range established for a job class. If merit raises are to have their intended value, however, they must be determined by an effective performance appraisal system that differentiates between those employees who deserve the raises and those who do not. This system, moreover, must provide a visible and credible relationship between performance and any raises received. Unfortunately, too many so-called 0 0 merit systems provide for raises to be granted auto1 F matically. As a result, employees tend to be rewarded more for merely being present than for being productive on the job.
Employer’s Ability to Pay
0 0 In the public sector, the amount of pay and benefits employees can receive is lim1 F ited by the funds budgeted for this purpose and by the willingness of taxpayers to provide them. In the 0 0 private sector, pay levels are limited by profits and other fi1 F nancial resources available to employers. Thus an organization's ability to pay is determined in part by the productivity of its employees. Increased productivity is a result not only of their performance, but also of the amount of 0 0 capital the orga1 F nization has invested in labor-saving equipment. Generally, increases in capital 0 0 investment reduce the number of employees required to perform the work and in1 F crease an
employer's ability to provide higher pay for those it employs. 0 0 Economic conditions and competition faced by employers can also signifi1 F cantly affect the rates they are able to pay. Competition and recessions can force prices down and reduce the income from which compensation payments are derived. In such situations, employers have little choice but to reduce wages and/or lay off employees, or, even worse, to go out of business.
Job Evaluation Systems
One important component of the wage mix is the worth of the job. Organizations formally 0 0 determine the value of jobs through the pro1 F cess of job evaluation. Job evaluation is the systematic process of determining the relative worth of jobs in order to establish which jobs should be paid more than others within the organization. Job evaluation helps to establish internal equity between various jobs.
Job evaluation Systematic process of determining the relative worth of jobs in order to establish which jobs should be paid more than others within an organization
0 0 The relative worth of a job may be determined by compar1 F ing it with others within the organization or by comparing it with a scale that has been constructed for this purpose. Each method of comparison, furthermore, may be made on the basis of the jobs as a whole or on the basis of the parts that constitute the jobs. Four methods of comparison are listed below. They provide the basis for the principal systems of job evaluation. Regardless of the methodology used, it is important to remember that all job evaluation methods require varying degrees of managerial judgment.
- Job Ranking Systems
- Job Classification Systems
- Point Systems
- Factor Comparison Systems
Job Ranking System
The simplest and oldest system of job evaluation is the job ranking system , which arrays jobs on the basis of their relative worth. One technique used to rank jobs consists of having the raters 0 0 arrange cards listing the duties and re1 F sponsibilities of each job in order of the importance of the jobs. Job ranking can be done by a single individual knowledgeable of all jobs or by a committee composed of management and employee representatives.
Job ranking system Simplest and oldest system of job evaluation by which jobs are arrayed on the basis of their relative worth
0 0 After jobs are evaluated, wage rates can be as1 F signed to them through use of the salary survey discussed later in the chapter. The basic weakness of the job ranking system is that it does not provide a very refined measure of each job's worth. Since the comparisons are normally made on the basis of the job as a whole, it is quite easy for one or more of the factors of a job to bias the ranking given to a job,
The point system is a quantitative job evaluation procedure that determines a job’s relative value 0 0 by calculating the total points assigned to it. It has been suc 0 0 1 F cessfully used by high-visibility organizations such as Digital Equipment Com1 F pany, TRW, Johnson Wax Company, Boeing,
TransAmerica, and many other public and private organizations, both large and small.
Point system Quantitative job evaluation procedure that determines the relative value of a job by the total points assigned to it
Although point systems are rather complicated to establish, once in place they are relatively 0 0 simple to understand and use. The principal advantage of the point system is that it pro 0 0 1 F vides a more refined basis for making judgments than either the ranking or clas1 F sification systems and
thereby can produce results that are more valid and less easy to manipulate. The point system permits jobs to be evaluated quantitatively on the basis of factors or elements--commonly called compensable factors --that constitute the job. The skills, efforts, responsibilities, and working conditions that a job usually entails are the more common major compensable factors that serve to rank one job as more or less important than another. The number of compensable factors an organization uses depends on the nature of the organization and the jobs to be evaluated. Once selected, 0 0 compensable factors will be assigned weights accord1 F ing to their relative importance to the organization. For example, if responsibility is considered extremely important to the organization, it could be assigned a weight of 40 percent. Next, each factor will be divided into a number of degrees. Degrees represent different levels of difficulty associated with each factor. The point system requires the use of a point manual. The point manual is a handbook that contains a description of the compensable factors and the degrees to which these factors may exist within the jobs. A manual also will indicate--usually by means of a table--the number of 0 0 points allocated to each factor and to each of the degrees into which these fac 0 0 1 F tors are divided. The point value assigned to a job represents the sum of the nu1 F merical degree values of each compensable factor that the job possesses.
(insert Highlights in HRM 3)
Developing a Point Manual
0 0 A variety of point manuals have been developed by organizations, trade associa1 F tions, and management consultants. An organization that seeks to use one of these existing manuals should 0 0 make certain that the manual is suited to its par1 F ticular jobs and conditions of operation. If necessary, the organization should modify the manual or develop its own to suit its needs. The job factors that are illustrated in represent those covered by the American Association of Industrial Management point manual. Each of the factors listed in this manual has been divided into five degrees. The number of degrees into which the factors in a manual are to be divided, however, can be greater or smaller than this number, depending on the relative weight 0 0 1 F
0 0 as signed to each factor and the ease with which the individual degrees can be de1 F fined or
distinguished.
After the job factors in the point manual have been divided into degrees, a statement must be prepared defining each of these degrees, as well as each factor as a whole. The definitions should be concise and yet distinguish the factors and each of their degrees. These definitions represent another portion of the point manual used by the American Association of Industrial Management to describe each of the degrees for the job knowledge factor. These descriptions 0 0 1 F
0 0 en able those conducting a job evaluation to determine the degree to which the fac1 F tors exist in each job being evaluated.
(insert Highlights in HRM 4)
The final step in developing a point manual is to determine the number of points to be 0 0 assigned to each factor and to each degree within these factors. Al1 F though the total number of points is arbitrary, 500 points is often the maximum.
Using the Point Manual
0 0 Job evaluation under the point system is accomplished by comparing the job de1 F scriptions and job specifications, factor by factor, against the various factor-degree descriptions contained in the manual. Each factor within the job being evaluated is then assigned the number of points specified in the manual. When the points for each factor have been determined from the manual, the total point value for the job as a whole can be calculated. The relative worth of the job is then determined from the total points that have been assigned to that job.
Factor Comparison System
The factor comparison system , like the point system, permits the job evaluation process to be accomplished on a factor-by-factor basis. It differs from the point system, however, in that the compensable factors of the jobs to be evaluated are compared against the compensable factors of key jobs within the organization that serve as the job evaluation scale. Thus, instead of beginning 0 0 with an estab1 F lished point scale, the factor comparison system requires a “scale” to be developed as part of the job evaluation process.
Factor comparison system Job evaluation system that permits the evaluation process to be accomplished on a factor-by-factor basis by developing a factor comparison scale
Developing a Factor Comparison Scale
There are four basic steps in developing and using a factor comparison scale: (1) selecting and ranking “key” jobs, (2) allocating wage rates for “key jobs” across compensable factors, (3) 0 0 setting up the factor comparison scale, and (4) evaluat1 F ing nonkey jobs.
Step 1. Select and rank key jobs on the basis of compensable factors. Key jobs can be defined as
Skill $5. Mental effort 1. Physical effort 0. Responsibility 0. Working conditions 1. $9.
Job Evaluation for Management Positions
Because management positions are more difficult to evaluate and involve certain demands not found in jobs at the lower levels, some organizations do not attempt to include them in their job evaluation programs. Those employers that do evaluate these positions, however, may extend their regular system of evaluation to include such positions, or they may develop a separate evaluation system for management positions. 0 0 Several systems have been developed especially for the evaluation of execu1 F tive, managerial, and professional positions. One of the better known is the Hay profile method, developed by Edward N. Hay. The three broad factors that constitute the evaluation in the “profile” include knowledge (or know-how), mental activity (or problem solving), and accountability.
Hay profile method
Job evaluation technique using three factors—knowledge, mental activity, and accountability—to evaluate executive and managerial positions
The Hay method uses only three factors because it is assumed that these factors represent 0 0 the most impor 0 0 1 F tant aspects of all executive and managerial positions. The profile for each posi1 F tion is developed by determining the percentage value to be assigned to each of the three factors. Jobs are then ranked on the basis of each factor, and point values that make up the profile are assigned to each job on the basis of the percentage-value level at which the job is ranked.
The Compensation Structure
Job evaluation systems provide for internal equity and serve as the basis for wage-rate
determination. They do not in themselves determine the wage rate. The evaluated worth of each job in terms of its rank, class, points, or monetary worth must be converted into an hourly, daily, weekly, or monthly wage rate. The compensation tool used to help set wages is the wage and salary survey.
Wage and Salary Surveys
The wage and salary survey is a survey of the wages paid by employers in an or0 01 F ganization’s
relevant labor market--local, regional, or national, depending on the job. The labor market is 0 0 frequently defined as that area from which employ1 F ers obtain certain types of workers. The labor market for office personnel would be local, whereas the labor market for engineers would be national.
Wage and salary survey
Survey of the wages paid to employees of other employers in the surveying organization’s relevant labor market
It is the wage and salary survey that permits an organization to maintain external equity, that is, to pay its employees wages equivalent to the wages similar employees earn in other 0 0 establishments. Although surveys are primarily conducted to gather com 0 0 1 F petitive wage data, they can also collect information on employee benefits or or1 F ganizational pay practices (e.g., overtime rates or shift differentials).
Collecting Survey Data
While many organizations conduct their own wage and salary surveys, a variety of “preconducted” pay surveys are available to satisfy the requirements of most public and not-for- profit or private employers. The Bureau of Labor Statistics (BLS) is the major publisher of wage 0 0 and salary data, putting out three major sur 0 0 1 F veys: area wage surveys, industry wage surveys, and the National Survey of Pro1 F fessional, Administrative, Technical, and Clerical Pay (PATC). The BLS also publishes the Employee Benefits Survey and the Employment Cost Index (ECI), which reports changes in employee compensation costs. Employers use the ECI as a 0 0 cross-check on other compensation surveys and to track geographical differ1 F entials for various
nonexempt jobs. Many states conduct surveys on either a municipal or county basis and make them available to employers. Besides these government surveys, trade groups such as the Dallas Personnel
worth of jobs and wage rates
A curve may be constructed graphically by preparing a scattergram consisting of a series of dots that represent the current wage rates. As shown below, a freehand curve is then drawn through the cluster of dots in such a manner as to leave approximately an equal number of dots above and below the curve. The wage curve can be relatively straight or curved. This curve can then be used to determine the relationship between the value of a job and its wage rate at any given point on the line.
(Insert Figure 10-8: Freehand Wage Curve – increase the left scale by $10 everywhere)
Pay Grades
From an administrative standpoint, it is generally preferable to group jobs into pay grades and to pay all jobs within a particular grade the same rate or rate range. When the classification system of job evaluation is used, jobs are grouped into grades as part of the 0 0 evaluation process. When the point and factor com 0 0 1 F parison systems are used, however, pay grades must be established at selected in1 F tervals that represent either the point or the evaluated monetary value of these jobs. The graph below illustrates a series of pay grades designated along the horizontal axis at fifty-point intervals.
Pay grades Groups of jobs within a particular class that are paid the same rate or rate range
Insert figure 10-9 here
0 0 The grades within a wage structure may vary in number. The number is de 0 0 1 F termined by such factors as the slope of the wage curve, the number and distribu1 F tion of the jobs within the structure, and the organization’s wage administration and promotion policies. The number 0 0 utilized should be sufficient to permit diffi 0 0 1 F culty levels to be distinguished, but not so great as to make the distinction be1 F tween two adjoining grades insignificant.
Rate Ranges
Although a single rate may be created for each pay grade, it is more common to provide a range
of rates for each pay grade. The rate ranges may be the same for each grade or proportionately 0 0 greater for each successive grade, as shown below. Rate ranges constructed on the lat1 F ter basis provide a greater incentive for employees to accept a promotion to a job in a higher grade.
(Insert Figure 10-10: Wage Structure with Increasing Rate Ranges – Very important table to scan-in at this point.)
Rate ranges generally are divided into a series of steps that permit employees to receive increases up to the maximum rate for the range on the basis of merit or seniority or a combination of the two. Most salary structures provide for the ranges of adjoining pay grades to overlap. The purpose of the overlap is to permit an employee with experience to earn as much as or more than a person with less experience in the next-higher job classification.
Classification of Jobs
The final step in setting up a wage structure is to determine the appropriate pay grade into which
each job should be placed on the basis of its evaluated worth. Traditionally, this worth is determined on the basis of job requirements without regard to the performance of the person in 0 0 that job. Under this system, the per1 F formance of those who exceed the requirements of a job may be acknowledged by merit increases within the grade range or by promotion to a job in the next-higher pay grade.
