Question : a) How would you change the pay structure to encourage performance, especially for red-lined employees?

b) In terms of expectancy and equity theories, describe how the red line policy will affect the motivation of employees.

Case : Compensation Management

Just behind Wal-Mart, CVS Caremark is the second largest drugstore chain in US. Employing 286,000 people in 45 states under the CVS logo, they operate more than 7,600 drug stores. In 2013, CVS' sales exceeded $126 billion, but their net income was only around $4.6 billion, for about a 3.6% profit, about the median profit for the industry.

Similar to any other public corporation, CVS wanted to increase their profitability for their stockholders and regain their position as the industry leader. One method of increasing profits is to cut operational costs and CVS decided to do just that. They adjusted the employee annual pay raises by placing an earnings ceiling on salaries - any employee earning the highest hourly wage amongst their job classification became ineligible for a raise. Besides the obvious cost savings, why put a "red line" on wages?

The main goal was to adjust the highest paid employees' compensation to the job market average and with these savings provide raises to the employees that were paid below that average. The philosophy was that as a CVS employee, one should expect lower raises (or none at all) if he or she is earning much more higher than his or her colleagues. Once the employee reached the red line, he or she received no additional compensation.

CVS executives knew that the new compensation policy would negatively impact some of their most loyal employees, yet the executives felt that they needed to draw a line on salaries in order to make the most of their limited compensation dollars. What they did not figure was that the policy mostly hurt the employees that have been working there the longest. Worse, these same employees feared retaliation if they publicly criticized the new policy. How would it look to the

other lower paid employees (and worse the public at large) if the highest paid employees complained about their lack of raises?

Nationwide, minimum wage is set to $7.25 per hour but a fast-food industry employee would usually receive $9 on average in the US. The Wage Management Guidelines of CVS are different in most regions - depending on the minimum wage in each state. Lowest-ranked employees with exceptional skills would receive 4.75% raise on an annual basis if they were making minimum wage. However, if an employee with exceptional skills, in the same position was already earning $12.50 an hour, he or she would not receive a raise since they had already crossed the red line. With employment at will, the possibility of being laid off, and a tough job market where would these employees get such high paying jobs in the US retail and service industries? It was better for them to keep quiet about their pay and stay in a company that they were comfortable with.

Wage rates depend on employees' rank and it is no secret that the CEO is going to be paid much more than the company's average worker; the job simply requires a more demanding set of skills compared to a cash registrar. It is obvious that a CEO will receive higher pay than the average store employee because the workload is much more demanding but if the range of compensation is so great it may discourage employees who are lower paid.

Some ethical and legal concerns arose when these same red lined employees found out that this new compensation policy did not seem to apply to the top-level executives. The CEO of CVS was paid a total of $23 million in 2013 including bonuses and additional perks. He earned a 26% raise from the previous year and that was almost 800 times more than the median income of a CVS employee. These red lined employees saw an inequitable pay situation - "the rich are getting richer" because they are allowed a raise while the in store employees have a cap on their income. Yet the CEO's salary package was tied to the company's performance and according to CVS spokeswoman Carolyn Castel "last year, CVS Caremark had an outstanding year, and continued to deliver strong financial results and enhanced returns to shareholders in a challenging economic environment, performing favorably against our peer group in several key areas."