Chapter 9 Compensation and Incentives Diane Bigda/Photodisc/Getty Images Learning Objectives After reading this chapter, you should be able to do the following: Discuss various psychological perspectives on pay and reward systems. Apply motivation theories to pay and reward systems' design and implementation. Link compensation with other functions within the HRM process. List and describe various pay structures and types of pay. Explain the ways HR laws and labor unions influence the design and implementation of compensation and reward systems. Discuss opportunities, challenges, and recent developments in the area of compensation. 9 Pre-Test Chapter 9 Pre-Test 1. Which of the following motivation theories is NOT based on content perspectives? a) Maslow's hierarchy of needs b) Vroom's expectancy c) Herzberg's two-factor d) McClelland's acquired needs 2. is the approach an organization utilizes to implement its value system and philosophy regarding pay. a) A job classification system b) A pay structure c) A pay range d) A pay grade 3. Why might highly qualified employees opt to work at below-market rates of pay? a) When high turnover rates make it a good choice. b) When employment rates are high. c) When they are earning nonmonetary rewards and benefits. d) When they cannot find a higher-paying first-quartile job. 4. Which of the following types of pay has the LEAST potential of being motivating or conducive to higher productivity? a) Hourly pay b) Piece-rate pay c)\tCommissions d) Team-based pay 5. What does the overtime provision of the Fair Labor Standards Act mandate? a) That exempt employees may not be asked to work more than 40 hours per week. b) That employers may not use overtime as a substitute for hiring new full-time employees. c) That employees who work more than 40 hours a week must be paid one and a half times their regular hourly wage. d) That employees must be paid double their regular salary for working on holidays, weekends, or outside of regular business hours. 6. relies on pay, benefits, or other rewards to motivate employees. a) Performance motivation b) Philosophical motivation c) Extrinsic motivation d) Intrinsic motivation Answers 1. b) Vroom's expectancy. The correct answer can be found in Section 9.1. 2. b) A pay structure. The correct answer can be found in Section 9.2. Introduction Chapter 9 3. c) When they are earning nonmonetary rewards and benefits. The correct answer can be found in Section 9.3. 4. a) Hourly pay. The correct answer can be found in Section 9.4. 5. c) That employees who work more than 40 hours a week must be paid one and a half times their regular hourly wage. The correct answer can be found in Section 9.5. 6. c) Extrinsic motivation. The correct answer can be found in Section 9.6. Introduction Pay and benefits are critical factors in the attraction, motivation, and retention of talent, and it is probably unwise to consider them as separate entities. Rather, they should be considered collectively as a package of total rewards having the power to motivate employees to consistently exhibit attitudes and behaviors that are aligned with the organization's goals, strategies, and culture. While employers should offer total rewards that are competitive with other employers' pay and benefits, employers should also clearly use total rewards to motivate employees to attain specific outcomes that the organization wants to see. There are many perspectives on motivation, and each perspective has implications for how reward systems should be designed and implemented. The next section discusses some of these perspectives' implications for compensation and incentives. These perspectives are applied to various types of benefits in the next chapter. O P E N I N G C A S E S T U DY Is There a War for Engineering Talent Driving Up Salaries? Access the following links: http://money.cnn.com/2013/07/25/news/economy/engineering-jobs-pay/index.html http://www1.salary.com/Engineering-Salaries.html Salaries ebb and flow with supply and demand. The article in the first link highlights shortages in engineering talent, which are apparently driving up salaries and benefits. However, if you scroll down to the readers' responses to the article, you realize that this information is misleading. It may be true that there are shortages in a few highly specialized engineering subfields, but the higher salaries and benefits come at a high cost, namely unfavorable locations, hours, and working conditions. Furthermore, the shortages tend to be temporary, and so do the job assignments. The second link offers a more realistic perspective on salaries in various engineering subfields. Discussion Questions 1. Browse through the various engineering subfields. Which ones seem to offer premium salaries? At what level or length of experience do salaries seem to increase exponentially? When do they seem to flatten out? 2. Look specifically for the specializations mentioned in the article (e.g., petroleum, drilling, and mechanical engineering) and the related comments. Are the salaries cited in the article realistic? 3. Try different zip codes. Do some locations seem to offer higher salaries than others? Are premium salaries related to the cost of living in these locations, the desirability of the locations, both, or neither? (continued) Perspectives on the Motivational Role of Pay and Reward Systems Chapter 9 4. Broaden your search beyond engineering, perhaps to your own field or your own city or state. What are the salary ranges in your specialization and related fields? What about your geographic location? 5. What are some opportunities that you can pursue to improve your salary prospects? 9.1 \u0007 erspectives on the Motivational Role of Pay and P Reward Systems Organizations look for ways to motivate employees in the workplace, and pay and rewards play an important role in motivation. This section offers three perspectivescontent, process and equity, and behavioral perspectiveson motivation and the ways that pay and reward systems should be designed and implemented. As shown in Figure 9.1, these motivational perspectives are central to the effective design and implementation of compensation and incentives processes. It is important to note that these are higher-level, philosophical perspectives that have guided HR research and practice for decades. While their applications may vary over the years, their classic psychological foundations remain valid and applicable to most contemporary practices. Content Perspectives Content perspectives focus on the source that triggers motivation: people's needs. When there is no need, there is no motivation. Many traditional motivation theories were developed based on content perspectives, including Maslow's hierarchy of needs, Alderfer's ERG theory, Herzberg's two-factor theory, and McClelland's acquired needs theory. Maslow's Hierarchy of Needs Maslow's Hierarchy of Needs (1943) places psychological needs in a hierarchy that starts with the simplest physiological needs and ends with the most complex psychological needs. The theory argues that lower-level needs have to be met first in order for higher-level needs to motivate people. The hierarchy starts with the simplest needs: Physiological needs include hunger and thirst. Safety needs include the need for shelter and clothing. Belongingness needs include the need for love and affiliation. Esteem needs include the need for status. Self-actualization needs include the need for achievement. For example, a regular paycheck is motivating because it can help fulfill physiological and safety needs. A supportive manager and friendly co-workers can help fulfill needs for belonging, and a promotion can help fulfill esteem and self-actualization needs. Alderfer's ERG Theory Alderfer's ERG Theory (1969) simplifies Maslow's hierarchy and divides core needs into three groups, represented by the abbreviation ERG: Existence can be compared to Maslow's physiological and safety needs. Relatedness can be compared to Maslow's belongingness, or social, needs. Perspectives on the Motivational Role of Pay and Reward Systems Chapter 9 Figure 9.1: Compensation and incentives Attraction and recruitment of talent Job analysis and job design Selection and job fit Performance/ appraisal management Strategic HR planning Benefits and benefits administration Training and development Compensation and incentives Pay structure Content perspectives Appropriate types of pay Motivation Process and equity perspectives Behavioral perspectives Pay grades and pay ranges f09.01_OMM618.ai Job classification system Perspectives on the Motivational Role of Pay and Reward Systems Chapter 9 Growth can be compared to Maslow's esteem and self-actualization needs. Moreover, unlike Maslow, Alderfer believed that different people may be motivated to satisfy their needs in different sequences. For example, Alderfer believed that when growth needs are frustrated, people may regress back to what Maslow would consider lower-level needs. This regression may explain situations when employees are denied promotions and ask instead for a raise, corner office, or designated parking spot. In these cases, employees may play for co-workers' sympathy by bragging about past accomplishments and complaining about managers' lack of appreciation for their past efforts. These behaviors do not help employees satisfy their growth needs; instead, they show regression to existence and relatedness needs. Herzberg's Two-Factor Theory Herzberg's Two-Factor Theory (Herzberg, Mausner, & Snyderman, 1959) describes factors that can increase and decrease employee motivation and satisfaction. According to this theory, factors that decrease motivation are likely to be extrinsicsuch as working conditions, organizational politics and policies, compensation and benefits, and co-worker relationships. These extrinsic factors are referred to as hygiene factors. On the other hand, factors that increase motivation are likely to be intrinsicsuch as nature of work, career advancement opportunities, and feelings of achievement. These intrinsic factors are referred to as motivators. Thus, hygiene factors are necessary to prevent job dissatisfaction, but they are not sufficient to motivate a person in the absence of motivators related to job content. Blend Images/SuperStock McClelland's Acquired Needs Theory McClelland's Acquired Needs Theory (1958) argues that there are two types of needs: ones that people are born with and others that are acquired through life experiences. Acquired needs include the needs for achievement, affiliation, and power, which motivate people to behave in ways they believe will help them fulfill these needs. For example, one employee may be motivated by promotion prospects that could fulfill his achievement and power needs. Another employee may be motivated to do her fair share of the work in order for her team to appreciate her efforts, which could fulfill her affiliation needs. According to Herzberg's two-factor theory, factors that increase motivation, such as feelings of achievement, are likely to be intrinsic. Process and Equity Perspectives Whereas content perspectives focus on the source of motivation, process and equity perspectives focus on the process leading to motivation. They address the reasons and mechanisms for people's actions as well as the resulting level of satisfaction. Motivation theories based on process perspectives include: Vroom's expectancy theory goal-setting theories Perspectives on the Motivational Role of Pay and Reward Systems Chapter 9 equity theories justice theories Each of those theories informs the design and implementation of compensation and incentive systems that would motivate employees. For example, compensation and incentive systems are more motivating when they are perceived to be more equitable and just. Vroom's Expectancy Theory Vroom's Expectancy Theory (1964) explains the motivation process using three dimensions: 1. Expectancy is an individual's belief that expending effort on an activity will probably lead to high performance. For example, an employee who believes that he can do a task is more likely to attempt it than an employee who feels incapable of completing the same task. Rewards for low-expectancy tasks are unlikely to motivate an employee to make additional effort. 2. Instrumentality is the perceived probability that successful performance will lead to desired outcomes. For example, an employee who views bonuses as linked to performance on a particular task is more likely to focus on that task. The more strongly performance is linked to rewards, the more motivating the rewards are. 3. Valence is the relative weight or value that an employee places on particular rewards or outcomes. For example, an employee who cares more about growth opportunities than money will be more motivated to perform the tasks that are most likely to lead to those opportunities, such as volunteering for challenging projects, even if no extra pay is involved. Goal-Setting Theories Goal-setting theories view humans as being motivated to pursue challenging goals. In particular, goals that are specific, measurable, and difficult have been found to lead to higher performance than goals that are easy or ill-defined (e.g., when people are simply encouraged to do their best). This benefit fades when goals are so difficult that they are perceived as unachievable or unrealistic (Locke & Latham, 2002). Goals with set deadlines and regular feedback on progress also tend to be more motivating. Thus, rewards for meeting deadlines and for achieving specific, measurable, challenging goals will likely motivate employees toward higher performance. In fact, those goals sometimes become their own rewards because the goals are intrinsically motivating and do not necessarily need any additional, extrinsic rewards (Amabile, Hill, Hennessey, & Tighe, 1994; Wiersma, 1992). Equity Theory According to equity theory (Adams, 1965), employees choose specific behaviors based on whether they believe they are treated fairly. Employees form this belief as a result of comparing their own inputs and outcomes with those of others. The behavior can be positive or negative, depending on the belief the employee holds. For example, one employee may believe that he or she has invested the same amount of time, effort, and resources (equal inputs) as another employee, but the other employee received more pay, incentives, or recognition (unequal outcomes). This belief generates a perception of inequity. To restore equity, the employee may reduce his or her inputs (e.g., work less) or try to increase his or her outcomes (e.g., ask for a raise or a promotion). On the other hand, if an employee worked longer or harder than another employee but also received proportionately more outcomes, then both employees will perceive the situation to be equitable. Perspectives on the Motivational Role of Pay and Reward Systems Chapter 9 Justice Theories Employees are motivated by knowing that their employer treats them with fairness, respect, and dignity. They also want to make sure that their organization is being fair and transparent in its values, its processes, and the impact it has on various stakeholders. Justice theories (Colquitt, Conlon, Wesson, Porter, & Ng, 2001; Greenberg, 1993) attribute motivation to perceptions of five forms of justice: Distributive justice is the perceived fairness of the distribution of outcomes such as pay and incentives. Procedural justice is the perceived fairness of the procedures used to determine such outcomes as pay and incentives. For example, if an organization uses objective performance criteria as the basis for raises and promotions, then employees will perceive procedural justice in this arrangement. Informational justice is the thoroughness of the information provided to explain outcomes. For example, an organization may base annual bonuses on criteria that are high in procedural and distributive justice. But the decisions may still be perceived as unfair if those criteria and their application are not explained effectively. Interactional justice is the degree of perceived respect in interactions among individuals in an organization. For example, it would be just not to give a raise or a promotion to a poor performer. However, if the performance deficiencies are communicated to the employee in a berating, demeaning, or belittling way, then that communication process is high on informational justice but low on interactional justice. Organizational justice is the overall perceived fairness of the organization's processes and outcomes. For example, an organization may base its pay and incentives on a specific, clearly communicated set of criteria. But organizational justice will be perceived as low if the performance appraisal system used to assess the criteria is too subjective, or if the managers evaluating performance are biased or discriminating. Behavioral Perspectives Generally speaking, behavioral perspectives are concerned with how behaviors are learned and reinforced. The foundations of those perspectives date back to Pavlov's nineteenth-century experiments, in which he conditioned dogs to salivate at the sound of a bell they associated with the presence of food. These perspectives can also be traced to Skinner's early twentieth-century operant conditioning experiments, in which he manipulated the Science Source/Photo Researchers/Getty Images behavior of lab rats and pigeons by varyThe foundation for behavioral perspectives is based on Dr. Ivan ing the consequences he administered for Pavlov's canine behavioral experiments during the nineteenth various types of behavior. Thorndike's century. Law of Effect captures the essence of behavioral perspectivesthat is, behaviors followed by positive consequences tend to increase in frequency, while behaviors followed by negative consequences tend to decrease in frequency. Perspectives on the Motivational Role of Pay and Reward Systems Chapter 9 Based on those behavioral perspectives, pay, incentives, and other workplace rewards should be directly linked to the workplace behaviors believed to lead to the desired performance. This linkage improves performance by making rewards contingent on performance. For example, sales representatives receive commissions that are proportionate to their sales volume, which promotes selling behaviors. On the other hand, a fixed paycheck, while important and desirable, does not necessarily motivate employees to work harder. In fact, this reward may become an expectation and promote a sense of entitlement. In some situations, a fixed paycheck is necessarye.g., in managerial jobs that do not lend themselves to commissions or unit-based pay. In these situations, it is best to use other incentives that can be administered contingently. Examples include regular feedback and recognition (Luthans & Stajkovic, 1999; Stajkovic & Luthans, 1997). A MOMENT IN THE LIFE OF AN HR MANAGER You Get What You Pay For How would you train a pet to behave in a certain way? You'd reward the desired behavior to reinforce it and punish the undesirable behavior until it disappears. The same behavioral management foundations have been applied to motivation in human beings. Unlike the process theories of motivation, behavioral management is not too concerned with why people are motivated by certain rewards or the mental processes that explain their motivation. Behavioral management emphasizes observable behavior and how it can be predicted, using specific environmental cues and tangible or measurable reward systems. Steven Kerr wrote a classic article about this perspective, entitled \"On the folly of rewarding A, while hoping for B,\" in which he illustrates how reward systems can fail to promote performance if they are not linked to the right behaviors. It is one of the most read and appreciated resources on applying a behavioral perspective to reward systems. It is widely available online. To answer the following questions, access the article by conducting an internet search. Discussion Questions 1. Apply this article to your own workplace. Which behaviors are desired and encouraged? Which behaviors are rewarded? Are there discrepancies? 2. Based on this article, how can these discrepancies be resolved in a practical and effective way? 3. What are your recommendations for redesigning the reward system in your organization to promote more productive behaviors and/or reduce counterproductive behaviors? SPOTLIGHT ON EVIDENCE-BASED HRM Organizational Behavior Modification Can we shape people's behavior in the workplace by managing the consequences of that behavior? Studies suggest that this process is indeed possible and can yield many desirable outcomes in many settings, including the workplace. In fact, behavioral management principles are the foundation for many reward systems today. This has become known as organizational behavior modification. In the workplace, this behavioral modification can be achieved in five steps: (continued) Perspectives on the Motivational Role of Pay and Reward Systems Chapter 9 1. Identify critical performance-related behaviors. 2. Measure the current frequency of those behaviors. 3. Analyze the existing antecedents and consequences of the behaviors. 4. Intervene with contingent reinforcers for the desired behaviors. 5. Evaluate the results. Three decades of extensive research studies consistently support this approach (Stajkovic & Luthans, 1997, 2003). Specifically, three types of reinforcers have consistently emerged as effective in the workplace (Luthans & Stajkovic, 1999). These powerful motivators are: money feedback recognition Interestingly, although feedback and recognition can be used at no cost to the organization or the manager, they have been found to result in similar (and sometimes higher) performance outcomes than money. However, the key to the motivational potential of those rewards is that they must be linked directly to the desired behaviors, and they must not be: given randomly (e.g., by managers who praise or berate their employees depending on whether they are having a good day or a bad day) spread equally (e.g., through companywide bonuses or layoffs) allowed to become an entitlement (e.g., through the fixed paycheck or seniority-based promotion, versus merit-based pay) Meta-analytical research has shown that behavioral modification and management interventions in the workplace, comparable to the five-step process described above, can increase performance by about 17% on average, and it can have a success rate of about 63% (Stajkovic & Luthans, 1997, 2003). People are unique in their needs and what they find motivating. Yet the motivational potential of money, feedback, and recognition, when administered contingently, seems to generalize across most worker populations. This generalization is true not only in the United States but in other cultures as well (Welsh, Luthans, & Sommer, 1993). Discussion Questions 1. Follow the steps of organizational behavior modification outlined above to try to change the behavior of someone you know. You can choose a co-worker, roommate, friend, or family member. Identify the specific behavior(s) you would like to change. -- Example: \"My co-worker does not clean the microwave after using it.\" Measure and record the current frequency of the behavior(s). -- Example: \"Three out of five days a week, my co-worker leaves the microwave messy after lunch.\" Analyze and record the existing antecedents and consequences of the behaviors. -- Example: \"My co-worker always eats lunch early and leaves before everyone else is in the lunchroom. When the next microwave user arrives, the cleaning chore automatically gets taken care of by that next person.\" Intervene with contingent reinforcers for the desired behaviors. (continued) Pay Structures Chapter 9 -- Examples: Make it a point to eat lunch early with your co-worker and be next in line to use the microwave to instill a sense of obligation to leave it clean. Then thank your co-worker for leaving behind a clean microwave. Or, for several days, agree with others not to clean the microwave and to bring a cold lunch instead so that the co-worker has to clean it the next day; the negative behavior then will not be reinforced. Remind others to praise your co-worker for a job well done if the co-worker gives the microwave a good scrubbing the next day. Evaluate and record the results. -- Examples: \"Now the co-worker only occasionally leaves a messy microwave behind.\" Or, \"Now the co-worker eats lunch at a different time and still does not clean the microwave.\" Or, \"Now my co-worker is in the habit of cleaning the microwave but forgets to pick up after himself (which may need another intervention).\" 2. How effective was your intervention? 3. Before learning about organizational behavior modification, what would have been your most likely reaction to the undesirable behaviors you encountered? Ignore them? Complain about them? Be annoyed by them? Try to punish the offender? Report them? 4. What have you learned from this exercise? References Luthans, F., & Stajkovic, A. (1999). Reinforce (not necessarily pay) for performance. Academy of Management Executive, 13, 49-57. Stajkovic, A., & Luthans, F. (1997). A meta-analysis of the effects of organizational behavior modification on task performance, 1975-1995. Academy of Management Journal, 40, 1122-1149. Stajkovic, A., & Luthans, F. (2003). Behavioral management and task performance in organizations: Conceptual background, meta-analysis, and test of alternative models. Personnel Psychology, 56, 155-194. Welsh, D. H. B., Luthans, F., & Sommer, S. M. (1993). Managing Russian factory workers: The impact of U.S.-based behavioral and participative techniques. Academy of Management Journal, 36, 58-79. 9.2 Pay Structures An organization's pay structure is the way it implements its philosophy and value system through its compensation system. In this section,we discuss three pay structures: market pricing structures, internally equitable structures, and the job component model, which is considered a hybrid of the first two. We also present key concepts related to pay structures, namely pay grades, broadbanding, and pay compression. Market Pricing Structures Also referred to as externally equitable structures, market pricing structures assess the pay of each job in relation to prevailing market rates. For example, in a market pricing structure, it would be acceptable for an employee with a rare capability or unique experience to make much more than his or her co-workers, since the much higher pay reflects the prevailing market rate for this caliber of capability or experience. \"To hire great people, only 'market rate' matters, and if you are weighted down with any other considerations unrelated to 'market rate,' you are giving an artificial and unfair advantage to your competition,\" claimed Bob Pay Structures Chapter 9 Corlett (2012), a consultant based in Washington, D.C. Advocates of market pricing strategies argue that the only thing that needs to be done to build a pay structure is to price all of a firm's jobs in the labor market, array them from top to bottom (Heaps, 2011), and make frequent updates to reflect competitive market positions (McGrory-Dixon, 2012). Lawler (1981) argued that in most cases it makes sense to focus on external criteria for determining total compensation levels because the consequences for external inequity are most severe for an organization. With a market pricing strategy, strategies can be developed to lead the market (i.e., pay above market wages in order to gain a competitive edge in the labor market), meet the midpoint or average of market wages (i.e., remain competitive, on average), or lag behind market wages (i.e., wait a specific amount of time before adjusting pay upward to reflect the market midpoint). Today, most employers base their pay structure on market pricing alone (Woodward, 2012), with the justification that failure to at least match the market average or midpoint will lead to a decline in employee morale and productivity. Adopting a lag strategy is argued to hinder a firm's ability to secure human capital, and the prevailing perception is that management is morally obligated to match prevailing wages (Romanoff et al., 1986). The market pricing strategy is not without criticism. For instance, three factors are generally used to determine a relevant labor market: 1) skills, knowledge, and abilities required, 2) geography (willingness to relocate or commute), and 3) competitors in the same product or service industry and labor markets (Milkovich et al., 2011). Unfortunately, there is no single labor market for any specific job, and because supply and demand differ substantially among markets there is significant variation in wages across labor markets. Rynes and Milkovich (1986) noted a spread in wages of as much as 100% for some jobs across industries, different localities, and within geographic areas. Further, while there are many consulting firms offering to sell salary surveys to employers, there are few standards for evaluating the reliability and validity of these surveys and few systematic studies of the effects of differences in market definition, participating firms, type of data collected, and quality of data (Milkovich et al., 2011). Now, it is prudent to consider that a pay strategy capable of being a source of sustainable competitive advantage must align with the larger business strategy of the firm, differentiate itself from the pay strategies of competitors, and add value by increasing a firm's access to human capital (Milkovich et al., 2011). A market pricing strategy often dismisses the issue of alignment by arguing that if the \"invisible hand\" metaphor suggested by Adam Smith in 1759 acts to efficiently regulate the free markets in which a firm operates (Sullivan & Sheffrin, 2003), why would anyone question that pay rates in the competitive market for labor operate any differently? However, it is much more difficult to dismiss the fact that if a pay strategy is simple and easily copied (e.g., a strategy of simply matching or leading market wages), then it is unlikely to be the source of competitive advantage or enable a firm to differentiate itself. The often-heard counter argument is that differentiation occurs in the management of the system, but the empirical evidence is less than convincing on this account (McAffee, 2005). Finally, the assumption that paying whatever the labor market demands is necessary to secure human capital appears somewhat nave in that the highest priced jobs would be considered representative of the greatest potential for securing human capital, and the potential for human capital decreases in proportion to the reduction in the market price associated with particular jobs. Internally Equitable Structures Internally equitable structures emphasize equity of pay within and across jobs in the organization rather than a concern with external equity or rates of pay for similar jobs in the external market. An example of an internally equitable pay structure is strategic centrality (Weinberger, 1992). The underlying assumption of this perspective is that pay rates for jobs represent an Pay Structures Chapter 9 expenditure incurred with the expectation that the services rendered in performing the job will create economic value by contributing to achievement of strategic objectives that generate a competitive advantage. That is, some jobs possess greater strategic centrality because they will be more instrumental in achieving particular strategies. Thus, reflecting differences in strategic centrality when determining the pay rates among jobs ensures alignment of the compensation strategy with the business strategy. Determining pay differentials between jobs requires interpretation and quantification of the role a job plays in achieving strategic business goals. Unlike simply paying market rates for a job, however, it enables a firm to achieve value when allocating pay structure dollars while producing a pay structure that would be difficult for competitors to copy. Finally, human capital does not create a competitive advantage until it is leveraged and put into productive service at the business or unit level (Ployhart et al., 2011). According to Ployhart and Moliterno (2011), the explicit differences in knowledge, skills, abilities, and other characteristics necessary for a given job to fulfill its role of strategic centrality in a business unit can constitute a unique and often inimitable form of human capital. The cornerstone of developing any internally equitable pay system is the process of job evaluation. Job evaluation is the process of establishing the relative worth of jobs within a single organization based on job content, which has been determined by prior job analysis and defined in in job descriptions, and the value added to the organization's pursuit of strategic goals and objectives while disregarding such extraneous factors as market pricing (Dulebohn & Werling, 2007). The three most common job evaluation methods are ranking, classification, and point-factor. Ranking simply orders the job descriptions from highest to lowest based on some overarching definition of relative value or contribution to organizational success. Job classification involves using taxonomies (i.e., methods of arranging or categorizing) to group work, functions, duties, tasks, knowledge, skills, abilities, and behaviors within jobs in a manner that is rational and logical from the organization's point of view in relation to the achievement of its strategic goals and objectives. The end result is a hierarchical series of classes with a number of jobs in each based on the organization strategy. Jobs within each class, also referred to as a job family, are considered similar and paid equally (Milkovich, et al., 2011). The point-factor method is by far the most widely used approach to job evaluation. The process begins with selection of compensable factors to represent what the organization values based on the strategic direction of the business and how work contributes to its strategic goals and objectives. The Equal Pay Act of 1963 identifies four generic compensable factorsskill, effort, responsibility, and working conditionsbut Kovac (2004) recommends eight to twelve total factors. Once the factors are determined, factor scales are constructed reflecting the differing degrees within each factor (i.e., how much each factor can vary); most factor scales consist of four to eight degrees (Milkovich et al., 2011). Once degrees have been assigned to each factor, factor weights are determined. Factor weights reflect the relative importance of the factor to the total job, and typically factor weights are determined by allocating 100 points among the various factors. A job evaluation form is constructed that reflects the compensable factors, factor scales, and factors weights, and the form is then applied to a representative sample of benchmark jobs (e.g., administrative, production, support, managerial, etc.). A benchmark job is one in which the content is well known and relatively stable over time, is common across a large number of employers, and represents a reasonable portion of the total workforce. Once the benchmark jobs are assigned, factor points and corrections are made in instances where the system is considered to have been incorrectly applied, and all remaining jobs are evaluated and assigned factor points. A hierarchy of job families is established that translates the firm's internal alignment policy into a consistent compensation system by ensuring that individual jobs are placed within job families having similar factor points. The links below provide examples of the point-factor method. Pay Structures Chapter 9 Web Links An Example of the Point-factor Method http://classcomp.hr.wvu.edu/r/download/70146 Another Example of the Point-factor Method https://www.uoguelph.ca/hr/managers-job-design-job-evaluation/job-evaluation-plan These two links provide examples of the point-factor method of job evaluation. Discussion Questions 1. Compare and contrast the two examples. 2. Apply the point-factor method to your own job. What additional information do you need to make an accurate assessment of the internal equity of your own compensation? The process of establishing internal equity pay structures has its share of critics. One often heard criticism is that the process of job evaluation assumes a static organizational state, but in reality there is no \"organizational steady state\" in today's global economy (Biswas, 2011). Another criticism is that internal equity was designed for labor markets during a time when the objective was long-term attachment of employees to a firm, but that environment no longer exists. Finally, after an extensive review of the empirical literature, Dulebohn and Werling (2007) concluded that job evaluation is often unreliable and invalid in determining the actual worth of a job because of unreliability in job analysis, job descriptions, and compensable factors related to non-benchmark jobs. The Job Component Model The job component model is a hybrid approach promising the potential for combining the positive points of both market pricing and internal equity pay structures. This method uses multiple regression analysis to explain the market rate of a firm's compensable factors by producing a market line (i.e., least squares line of regression) that links compensable factors within benchmark jobs with market rates paid by competitors. This market line is a regression equation that summarizes the relationship between the going rates paid by competitors in the market for labor and the compensable factors deemed important to the internal equity of an employer's pay structure (Novac, 2004); the stronger the relationship, the more valid one assumes to be the internal equity of the system. Using the market line as the best representation of what the market is willing to pay for compensable factors valued by an employer, a pay policy line is created to specify a percentage above or below the market line where the employer intends to strategically place itself when translating pay-level policy into practicefor example, the employer might decide to lead the market by being 10% above the market line. Pay Grade Often, each job is assigned to a pay grade that determines how much the job incumbent should be paid. Pay grades offer flexibility to deal with pressures from external markets and differences in organizations. In addition to offering flexibility, pay grades provide opportunities for managers to recognize differences in employee performance with adjustments in pay and also to meet employee expectations that their pay will increase over time (Milkovich et al., 2011). When using a market pricing approach, jobs that have similar market survey pricing are Linking Compensation to the HRM Process Chapter 9 grouped into pay grades through a process of market banding. When using a job evaluation method such as the point-factor method, jobs with similar compensable factors are grouped around benchmark jobs into job families, and job families of relative similar compensable worth are grouped into pay grades having a minimum and maximum pay for each grade. Broadbanding It is possible to reduce the number of pay grades by combining some of them and widening the ranges. This practice is called broadbanding. Broadbanding is currently a popular practice due to the increasing frequency of lateral movement in organizations; this movement leads to employees gaining more skills, which a wider pay range allows an organization to reward. Furthermore, with broadbanding, employees can now excel in their areas of expertise and be financially rewarded for their excellence without having to move to a management position in order to jump to the next pay grade, which is related to the concept of dual career paths, discussed in Chapter 4. Advantages of broadbanding include encouraging and rewarding a broader range of competencies and career development directions. However, broadbanding's effects should be carefully observed, since they have a significant impact on salary levels as well as costs (Fay, Schulz, Gross, & Van De Voort, 2004). Traditionally, promotion means moving to a higher grade and getting a pay raise. But this is not always the case with broadbanding. In fact, many organizations will offer more lateral opportunities than upward opportunities, which may not meet the needs and expectations of all employees. Pay Compression In contrast to broadbanding, pay compression is a serious issue that employers often face. McNatt et al. (2007) suggest that 48% of HRM professionals deal with problems related to pay compression. The term refers to a small difference in pay among employees, regardless of their level of skill or experience, which many employees may see as unfair. Research by Heyman (2008) suggests that wage compression is related to job turnover, particularly in the manufacturing sector, and there are legal ramifications if protected classes are disproportionately impacted by pay compression (Kovac, 2005). The main factor that leads to pay compression is the failure to adjust internal salaries promptly as labor market pay levels increase (Ladika, 2005). Pay compression can occur when an employer experiences a specific skill shortage and tries to fill the job by offering higher salaries in an attempt to be competitive and attract top talent, but it can also result from inefficient merit-pay programs lacking significant differences in the pay awarded to top performers (Kovac, 2005). One way to tackle the challenge of pay compression is to keep an eye on market changes and adjust pay ranges accordingly (Klein, Keating, & Ruggerio, 2002). As a rule of thumb, top-level management positions generally have ranges of 30 to 60% above and below the midpoint, mid-level professional and managerial positions between 15 and 30%, and office and production workers between 5 and 15% (Milkovich et al., 2011). 9.3 Linking Compensation to the HRM Process Decisions regarding pay level and structures can influence organizational performance. Putting together a compensation plan for local, domestic, or international employees is no easy task. Employers often find it challenging to provide competitive compensation to employees across Linking Compensation to the HRM Process Chapter 9 geographic locations (Brown et al., 2003; Reilly & Audi, 2006). Organizations use the job market as a source of information when they put together compensation plans for employees. This job market information is usually collected through the HR planning processes discussed in Chapter 2. Based on that information, organizations may position themselves in the labor market using below-, middle-, or above-market strategies. Below-Market Strategy Using a below-market strategy, or first-quartile strategy, means offering salaries below the market rateusually in the lowest quartile (25%) of employers in its market. An organization may pursue this strategy if it is experiencing a shortage of funds or has a sufficient number of workers, or if unemployment rates are high. A below-market strategy can increase turnover rates, making it challenging to attract and retain talent. However, some organizations that use a below-market strategy may be able to attract and retain talent by offering additional nonmonetary rewards and benefits. As discussed later in this chapter, examples of those nonmonetary rewards are stock options and employee stock ownership plans (ESOPs), which have lower short-term costs for the organization but which increase in value over timerewarding employees for their long-term commitment. Other important nonmonetary rewards are employee benefits. As discussed in the next chapter, benefits have a significant value for employees, so talented employees may choose to work at below-market pay rates because these benefits can save them substantial amounts of their income that they would have spent to obtain those benefits independently. Moreover, employees now look for organizations that grant opportunities for learning, growth, and career advancement. Organizational training and development programs can serve this purpose and can therefore be used as nonmonetary rewards (Hansen, 2010). Middle-Market Strategy In a middle-market strategy, or second-quartile strategy, an organization positions itself at about the average market rate. Although they will not make the organization stand out for its compensation package, middle-market strategies are often used by organizations with established reputations. These organizations are attractive to talented employees for other reasons, such as stability and opportunities for advancement. On the other hand, an abovemarket strategy, or fourth-quartile strategy, puts an organization above 75% of employers in terms of pay rates and gives it the advantages of being able to attract and retain top talent and being more selective during the hiring process. There are a number of factors, some external and some internal, to be considered when choosing a compensation strategy. For instance, competitive pressures and unemployment rates are among the external factors. Among the internal factors for an organization are its goals, strategies, financial strength, nonmonetary benefits, and the learning and development opportunities it offers its employees. As discussed earlier, job analysis and job design are also fundamental to sound compensation decisions. Job analysis and job design can help an organization determine not only the compensation level for each job but also its pay philosophy and the various types of pay and rewards it will use to motivate employees. In turn, the organization's value system for pay and incentives can help determine the characteristics of employees who would best fit the organization and inform selection and placement decisions. Types of Pay Finally, compensation can be based on employee performance. It establishes perceptions of equity and justice to associate employees' compensation with their performance and their contributions to organizational goals. This association also motivates employees to be more productive and effective, and it accords with the motivational perspectives discussed earlier. Performance-based compensation can take many forms, such as profit sharing, bonuses, and gain sharing. However, in order for compensation to be legal and to be effective in motivating performance, an objective performance appraisal system (discussed in Chapter 7) must be in place, and regular feedback and performance reviews must be conducted. 9.4 Types of Pay Chapter 9 Fotosearch Illustration/Fotosearch/SuperStock Employees under performance-based compensation plans may be more motivated to be productive. After pay structures, grades, and ranges have been established, an organization can choose among many different types of pay. Besides legal requirements (e.g., minimum wage), as discussed earlier in this chapter, the most important consideration in selecting the type of pay to use is its motivational power, which is directly linked to the needs it satisfies, the behaviors it reinforces, and equity and justice of pay distribution. The most frequently used types of pay are discussed in this section. Hourly Pay Hourly pay is the simplest and most frequently used type of pay. Employees are paid a set rate for each hour worked. This type of pay is common for many types of jobs, including bluecollar and clerical positions. The advantages of hourly pay are its predictability and ease of calculation, both for employers and employees. What an employer is guaranteed when paying an employee by the hour is an hour of the employee's time. Any expectations beyond that are dependent upon factors such as management and leadership. The primary disadvantage is that this type of pay is not very motivating or conducive to higher productivity. It rewards employees for showing up and staying longer, but not for working harder. Since pay is not contingent on performance, it does not promote effective work behaviors (except for being present). Piece-Rate Pay Piece-rate pay is another common type of pay. Unlike hourly pay, piece-rate pay is not stated in terms of a rate per hour. Instead, it is based on the number of units or \"pieces\" produced. Piece-rate pay is common in production jobs. Another very common example of piece-rate pay is commission-based compensation for sales jobs. Types of Pay Chapter 9 Since piece-rate pay is based on the amount of work done, it is aligned with the process and behavioral perspectives discussed earlier, which makes it motivating and conducive to high productivity. However, external factors beyond the employee's control may affect productivity and, consequently, pay. These factors include machinery breakdowns and supply and delivery problems, which may cause employees to perceive this type of pay as unfair. Furthermore, only a limited number of behaviors can be rewarded through piece-rate pay. Employees are likely to focus on behaviors for which they are rewarded, compromising overall effectiveness. For example, commission-based sales representatives are often pushy, and once they sell a product they may ignore customers' calls or requests for after-sale service because they are not rewarded for responsiveness once the sale is complete. Finally, piece-rate pay may have unintended consequences. That is, the incentive to increase pay may cause workers, particularly men and manual laborers, to take increasing risks ultimately resulting Eyecandy Images/Eyecandy Images/Thinkstock in injury. A cross-country study in Europe Piece-rate pay is based on the number of units produced. reported that controlling for workplace hazards, job characteristics, and worker effort, piece-rate workers suffered a 5% greater likelihood of injury. This increase in worker injury is often ignored when speaking about increased productivity associated with piece-rate pay (Bender et al., 2012). Competency-Based Pay Competency-based pay is different from other compensation pay programs in that an employee is not being rewarded for his or her ability to perform the tasks and duties required for a job. There are two types of competency-based pay, namely, knowledge-based pay (KBP) and skill-based pay (SBP). The heart of the plan is that employees get paid for relevant knowledge, skills, or competencies they possess or develop, whether or not those skills are ever used in the job that is being done (Milkovich et al., 2011). Training is often used as a method to help employees obtain competencies in specific areas that will help the organization achieve its goals and objectives (Heneman & LeBlanc, 2002; Lokshin, Gils, & Bauer, 2009). For example, McDonnell Douglas Helicopter Systems has been known for years to give its employees pay raises upon demonstrating the successful completion of specific learning modules, rather than automatic raises based on seniority or job title. One of the criticisms leveled against competency-based pay is that competencies cannot be translated into a measureable and objective basis for pay, and little empirical evidence exists in support of the concept (Giancola, 2011). Given that organizational effectiveness is about task performance, why try to measure and pay for something that is below the surface and difficult to measure and relate to actual task performance (Lawler, III, 1996)? For instance, how should an employer go about certifying that an employee possesses a particular competency given that the job being done may not call for that competency? Besides requiring extensive investment of resources to development and implement, if not properly controlled Types of Pay Chapter 9 a competency-based pay plan can result in pay drift without performance improvement (Neathey & Reilly, 2003). That is, employee pay will increase with newly developed competencies, but actual job performance may be unaffected. The basic question about competencybased pay remains: Is it appropriate to pay an employee for what an employer believes he or she is capable of doing instead of what is actually being done (Milkovich et al., 2011)? Outcome-Based Incentives Recent compensation surveys indicate that nearly all organizations use some form of outcomebased incentives (Snaghee & Sturman, 2012). Outcome-based incentives are sometimes also referred to as merit pay, bonuses, and incentives. They are usually offered in addition to wages and salaries and are linked to predetermined, quantifiable outcomes. Merit pay leads to a permanent increase in base pay, but both end-of-the-year bonuses and long-term incentives (i.e., options that can be realized at a later date) result in a one-time payment. The purpose of each is to energize and motivate employees to be more effective and productive through rewards when they achieve desirable outcomes. For example, an employee or a team of employees may receive a bonus for meeting a certain sales volume or customersatisfaction score. When employees know that they are going to be rewarded for their extra work, this motivates them to try their best and produce more. There is a wealth of empirical evidence suggesting that linking pay to performance does increase employee motivation and lead to improved productivity, sometimes by an average improvement of 30% in performance (Milkovich et al., 2011). However, while the effects of outcome-based incentives are positive, they are not equal. A recent study suggests that merit pay has the strongest impact, likely because on a dollar-per-dollar basis an equal increase in base pay is worth more than the onetime payment associated with bonuses or long-term incentives. That is, a 1% raise in base pay through merit was observed to be 27% stronger in predicting future performance than a bonus of 1% of base pay and 10 times more effective than a 1% increase in long-term incentives; a 1% bonus was observed as being 8.5 times stronger than the effects of a 1% increase in long-term benefits (Sanghee & Sturman, 2012). Thus, the effects of outcome-based incentives are not only explained by the strength of the link between pay and performance, but also by the financial nature of the awards of each plan. Furthermore, organizations that offer outcome-based incentives are able to attract high performers and are therefore able to recruit and retain top talent (Cadsby, Song, & Tapon, 2007; Salamin & Horm, 2005; Trevor, Gerhart, & Boudreau, 1997). A case in point for outcomebased incentives is the Teacher Advancement Program (TAP). Created in 1999, the program provides teachers with financial incentives based on objectively measured outcomes such as student performance. These incentives include salary raises and bonuses, as well as nonfinancial incentives such as development and advancement opportunities. The program has been successful in enhancing learning outcomes in numerous schools across the United States. It has also been instrumental in attracting, motivating, and retaining talented teachers in disadvantaged areas and in difficult-to-teach subjects. Over the years, these results have led to an increased scope and funding for this program. Because different types of incentives attract different kinds of employees, outcome-based incentives are part of the compensation process but should also be considered for other HR decisions such as job analysis and job design. For example, incentive systems designed around team-based outcomes will attract employees who are team-oriented and prefer to work as part of a team (Bretz, Ash, & Dreher, 1989; Cable & Judge, 1994; Judge & Bretz, 1992). However, the evidence regarding a relationship between pay incentives and group Types of Pay Chapter 9 performance is unclear, prompting Milkovich et al. (2011) to conclude that team-based pay incentives lead to smaller productivity increases in comparison to individual pay-forperformance plans. Many factors determine the effectiveness of outcome-based incentives: one factor is that performance measures must be associated with organizational goals. Performance standards should be attainable, and employees should be provided with the resources needed to achieve those standards. These guidelines accord with the content, process, equity, and behavioral perspectives discussed earlier. Furthermore, employees should view the reward system as fair and see the rewards as valuable. Finally, organizations should consider the fact that unrewarded goals may possibly be ignored. Salaries and Exempt Positions A salary is fixed pay that is stated in terms of a rate per week, month, or year. Salaries are offered to both exempt and nonexempt employees. However, employees who hold exempt positions do not receive overtime pay according to the Fair Labor Standards Acts (FLSA) regulations. Exempt positions include executive, administrative, knowledge, service, and professional jobs in general. These positions are expected to come with responsibilities that the employee should fulfill, regardless of how much time it takes. Thus, overtime is not offered. Factors that should exist in order for a position to be considered exempt are regulated by FLSA, although many employers try to cut overtime costs by reclassifying some of their positions as exempt. This practice is illegal and has lately come under great scrutiny, causing substantial penalties for employers that engage in this false reclassification. The website below offers more detailed classification guidelines and examples of exempt and nonexempt positions. Web Links Handy Reference Guide to Fair Labor Standards Act http://www.dol.gov/whd/regs/compliance/hrg.htm This website offers detailed classification guidelines and examples of exempt and nonexempt positions. Discussion Questions 1. According to the guidelines provided, should your current position (or a position that you held in the past) be considered exempt or nonexempt? 2. Which positions in your organization clearly fit the exempt classification? Why? 3. Which positions in your organization clearly fit the nonexempt classification? Why? 4. Which positions in your organization can be considered gray areas in terms of exempt/nonexempt classification? What changes can be made to make the classification of these positions clearer and thus legally defensible? Team-Based Pay There is significant support in the literature that individual pay incentives yield higher productivity gains than group incentives (Milkovich et al., 2011), and a recent study in Europe reported that where individual piece-rates and other productivity payments were associated with employee pay satisfaction, team-based rewards demonstrated no such relationship (Godeanu, 2012). However, where team coordination is the issue, team-based pay is an Types of Pay Chapter 9 effective way to motivate teams by compensating them based on overall team performance instead of individual performance. It is based on the notion that cooperation and interaction among team members make the team effective. Team-based pay encourages team members to collaborate, which can enhance team productivity, efficiency, and effectiveness, but less understood is whether the distribution of team-based pay should be on the basis of equality (i.e., all members receiving identical pay) or equity (i.e., members receiving pay in proportion to their individual contributions to the team's performance). Results of a laboratory experiment by Bramberger and Levi (2009) suggest that when team-based pay is allocated on an equity basis rather than equality norms, team members respond to significantly fewer requests for assistance and collaboration. More specifically, the study suggests that as the degree of performance-based team pay increases, the total help given by employees when the team is rewarded on an equity basis will decrease accordingly, but when the team is rewarded on equality-basis, total help will increase. Nevertheless, high-performing team members should also be rewarded for their individual accomplishments to help avoid complacency (Merriman, 2009) and the free-rider problem that plagues all group compensation plans. Free riders are team members who contribute as little as possible to the team's output but expect to share equally in the allocation of teambased pay. The problem with free riders can be lessened through use of good performance measures with clear performance standards. For instance, asking free riders to deliver specific levels of performance at specific times makes it more difficult for them to shirk their contribution to the team (Milkovich et al., 2011). The organization's goals and priorities as well as the tasks at hand should determine the balance between individual and team-based pay. In other words, it is important to link organizational strategy to pay and incentives and strategic HR processes such as planning, job analysis, and job design. For example, Honeywell, a leader in safety, security, and energy technologies, regularly recognizes and rewards teams that deliver exceptional results that support its major initiatives. These rewards are offered in addition to individual rewards and incentives. Compensating Independent Contractors Independent contractors are not employees of the organization. They are self-employed individuals or entities that provide a product or a service to the organization for a contracted fee. Independent contractors are different from employees in that their employers do not have to contribute to their Social Security, Medicare, and unemployment taxes or to their workers' compensation costs. Employers usually share those costs with regular employees, but independent contractors have to pay their own costs. If an organization offers additional benefits, such as the benefits discussed in the next chapter, then independent contractors are not usually eligible for them. This ineligibility significantly reduces the cost of hiring independent contractors. Monkey Business/Thinkstock Independent contractors, or freelancers, are self-employed individuals who provide a service or product for an organization for a contracted fee. Types of Pay Chapter 9 However, in order for an employee to be classified as an independent contractor, a number of criteria have to be met. For example, independent contractors usually use their own tools, design their own schedules, and perform their roles as they see fit. The website below provides more details and examples of classification criteria for independent contractors. Similar to using exempt classification to reduce overtime costs, many employers try to reclassify their employees as independent contractors to avoid paying the additional taxes and offering them benefits. Unless justified by the nature of the job, this practice is illegal and subject to substantial penalties. Web Links Independent Contractor (Self-Employed) or Employee? http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/ Independent-Contractor-Self-Employed-or-Employee This website offers detailed guidelines for distinguishing between independent contractors and employees. Discussion Questions 1. According to the guidelines provided, under what conditions could your current position qualify you as an independent contractor? As an employee? 2. Which positions in your organization clearly fit the independent contractor classification? Why? 3. Which positions in your organization clearly fit the employee classification? Why? Which positions in your organization can be considered gray areas in terms of independent contractor or employee classification? What changes can be made to make the classification of these positions clearer and thus legally defensible? Executive Pay Executives are paid salaries like all other employees, but they also receive bonuses and stock as forms of compensation based, of course, on their performance. Generally speaking, top executives receive very high pay, especially in the United States compared to all other countries (Lawler, 2009). The difference in pay between CEOs and lowest-level employees in the United States has been increasing during the past 20 years or more. Prior to the recent recession, when adjusted for inflation the average worker's pay rose 8% from 1995 to 2005 whereas the median (midpoint) CEO pay at the 350 largest U.S. firms rose about 150% during the same period (Congressional Research Service, 2007), and for every $1 made by the average U.S. worker in the year prior to the beginning of the recession, the average CEO made $411 (Strier, 2010). After a temporary scaling back during the recession, median CEO pay jumped 27% in 2010 (the largest increase in recent history), even though corporate profits remained roughly flat, and most of that was due to cost-cutting measures and layoffs rather than creation of business and growth (Anderson et al., 2013). The disparity from top to bottom in U.S. corporations has been even greater since the recession and vastly greater than in other countries, particularly Europe and Asia (Azar, 2012). Many people comp