COMPENSATION AND

PAY FOR PERFORMANCE

Jann Hidajat
School of Business and Management ITB
17th FEBRUARY 2020
 OBJECTIVES
• Understand the need to link compensation policies
and practices with an organisation’s strategic business
objectives.
• Identify the key objectives of employee
compensation.
• Explain the components of a systematic compensation
program.
• Understand the mechanics of common job evaluation
systems.
• Explain the steps in compensation planning.
• Understand current issues in executive compensation.
• Explain how to link pay to performance.
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 STRATEGIC COMPENSATION

• Compensation is one of the most important

HRM functions.
• It can help to reinforce the organisation’s culture
and key values and facilitate the achievement
of its strategic business objectives.
• If there is any significant mismatch between
compensation and organisational strategy, it is
likely to result in major barriers to the
achievement of strategic business objectives.

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 TYPES OF EMPLOYMENT REWARDS

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 COMPENSATION PHILOSOPHY

The HR manager must change the

emphasis from immediate questions:
• How much do we need to pay?

• How should it be packaged?

to more strategic questions:
• What does the organisation want in return for
its pay?

• How can compensation policies and practices

achieve these objectives?
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 COMPENSATION PHILOSOPHY

A formal compensation policy should:

• reflect the organisation’s strategic
business objectives and culture
• articulate the objectives that an
organisation wants to achieve via its
compensation programs
• be communicated to all employees
• provide the foundation for designing and
implementing compensation and benefit
programs.
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 COMPENSATION PROGRAM OBJECTIVES:
ORGANISATION

Attract and keep the desired quality and mix of

employees
Motivate employees to continually improve their
performance and to strive to achieve the
organisation’s strategic business objectives
Reinforce the key values and the desired
organisational culture
Drive and reinforce desired employee behaviour

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 COMPENSATION PROGRAM OBJECTIVES:
ORGANISATION

Ensure compensation is maintained at

the desired competitive level

Ensure optimum value for each salary

dollar spent

Comply with legal requirements

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 COMPENSATION PROGRAM OBJECTIVES:
EMPLOYEE

Give the employee equitable treatment

Accurately measure and appropriately

reward the employee’s performance and
contribution
Provide appropriate compensation
changes
Provide regular compensation and
performance reviews
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COMPENSATION PROGRAM COMPONENTS

Inadequate compensation planning:

• Failure to link compensation strategies
to the organisation’s strategic business
objectives
• A haphazard approach in the reward of
performance
• Lack of control over salary costs
• Gross overpayment or underpayment
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 COMPENSATION PROGRAM
COMPONENTS

Inadequate compensation planning:

• Disjointed internal relationships, with
junior positions being paid more than
senior positions
• The granting of salary increases on the
‘squeaky wheel’ principle
• Lack of compliance with applicable state
and federal laws and awards.
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 COMPENSATION PROGRAM
COMPONENTS

Job analysis, job description and job

specification
Job evaluation

Salary survey

Performance evaluation

Pay for performance

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 JOB EVALUATION

• Job evaluation is a systematic method of

determining the worth to the
organisation of each job in relation to the
worth of other jobs.
• It is concerned with ‘how big’ or ‘how
small’ a job is.
• The aim is to ensure that jobs of different
sizes are paid proportionately different
salaries.
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 JOB EVALUATION SYSTEMS

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 JOB RANKING

• A job evaluation method that sizes

jobs by placing them in rank order.

• Quick, easy and well-established

method

• Subject to bias

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 Ranking Method
• Orders job descriptions from highest to
lowest based on a global definition of
relative value or contribution to the
organization’s success

• Two approaches

– Alternation ranking

– Paired comparison method

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 Exercise: Paired Comparison Ranking

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 JOB RANKING

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 JOB GRADING OR CLASSIFICATION

• The first step is to use a number of

job-related factors such as
education, experience and
responsibilities to determine classes
or grades of job.

• The next step is to create generic or

‘benchmark’ job descriptions for
each grade or class.
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 Classification Method
• Uses class descriptions that serve as the standard for
comparing job descriptions
• Classes include benchmark jobs
• Outcome
–Series of classes with a number of jobs in each
• Examples
–Exhibit 5.7: Classifications
for Engineering Work
–Exhibit 5.8: General
Schedule Descriptions
for Federal Government
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 THE POINT SYSTEM

• This system involves quantifying a set of

job factors by allocating points to each
factor – education, experience,
responsibility, wk conditions, etc.
• Typically, each factor is divided into a
number of levels, each with a specific
definition.
• Can be time consuming, expensive and
difficult – subjective considerations
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 Point Method
• Three common characteristics of point methods
– Compensable factors
– Factor degrees numerically scaled
– Weights reflect relative
importance of each factor
• Most commonly used approach
to establish pay structures in U.S.
• Differ from other methods by making explicit
the criteria for evaluating jobs -- compensable
factors
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 Designing a Point Plan: Six Steps

1. Conduct job analysis

2. Determine compensable factors.

3. Scale the factors.

4. Weight the factors according to importance.

5. Communicate the plan, train users, prepare

manual.

6. Apply to nonbenchmark jobs.

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 FACTOR COMPARISON SYSTEM

• Like the point system, it uses job

factors and allocates points to
quantify these factors.
• The basic principle is that all jobs
should be compared and evaluated
independently against each of the job
factors.
• This is a refinement of the ranking
system, where jobs are ranked as
whole jobs.
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 PRE-PACKAGED SYSTEMS

• Hay Group
• Cullen Egan Dell
• Watson Wyatt
• Weighted job questionnaire
• Expensive, so rare….

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 WHICH SYSTEM?

Objectives – link pay plan to objectives

Size of the organisation - $$
Organisational resources - $, expertise
Plan users – use info’ from elsewhere ($,
acceptance, consistency, accuracy, after..
Corporate culture – fit/appropriateness
Employee attitudes – fair, equitable,
understood
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 JOB DESCRIPTION

• A necessary prerequisite to the

introduction of any job
evaluation scheme is a
comprehensive job description.
• They are used as pseudo-scientific
means of saying that this job is
worth relatively more than that
job.
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 PAY SURVEYS
Salary surveys are a key plank in the design
of an organisation’s compensation program.
Does the organisation want to compare itself
with:
• organisations in the same or related
industries?
• organisations in the same geographic
area?
• ‘best practice’ companies?
• domestic companies?
• multinationals?
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 JOB EVALUATION AND
THE PAY SURVEY

• Job evaluation determines the relative

worth of each job to the organisation

• The pay survey makes it possible to

assign appropriate salary ranges to
each job

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 PAY STRUCTURE

• Job size is established by job

evaluation and performance is
measured by employee appraisal.
• Once job sizes have been established,
each job level is given a pay range
showing the minimum and maximum
salary to be paid.

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 PAY LINE OR CURVE

• The purpose of the pay line is

to show the relationship
between the size of a job and
the average salary paid for
it.

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 Price Each Pay Grade -Wage Curves

• Developing a wage curve involves the

following:
– Find the average pay for each pay grade
– Plot the pay rates for each pay grade
– Fit the line called a wage line through the
points just plotted
– Price the jobs

Wage curve
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 PAY TREND LINE

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 Fine Tune Pay Rates

• Pay ranges are a series of

steps or levels in a pay
grade, usually based on
years of service
Sample pay grade schedule

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 PAY RANGES

Standard Range
• The most generally accepted pay range
for professional and managerial positions
is plus or minus 20 per cent from the
midpoint.
• Sets the minimum and maximum
scheduled amounts paid for a job at a
particular job size.
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 PAY RANGES

Broadbanding
• The clustering of numerous individual pay
grades into a few broad pay grades.

• An attractive pay system for

organisations wanting to restructure
and flatten, redefine career paths and
encourage personal growth through
lateral job movement – it can support
both the new strategy and culture.
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 PAY RANGES

Market Posture
An organisation can adopt one of the
three market postures:
• Pay above market average
• Pay market average
• Pay below market average

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 SELECTING A PAY
POLICY LINE

• A graphical representation of the

organisation’s predicted pay
midpoints for 12-month period
ahead.
• Its purpose is to ensure that the
organisation’s stated market
position is achieved and
maintained.
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 SELECTING A PAY POLICY LINE

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 Correcting Out-of-Line Rates

Correct Too high – lower by

Too low – raise pay
pay for
grade Freezing
wages,
transferring or
promoting
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 EQUITABLE COMPENSATION

Pay Secrecy
• Where inequities are perceived to exist,
the impact on morale and motivation
can be devastating.
• Management can try to avoid this
problem by maintaining pay secrecy
• Can generate mistrust of the
compensation program
• Reduce employee motivation
• Inhibit the organisation’s effectiveness
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 PAY COMPRESSION

• Pay compression occurs when employees

feel that the difference is too small
between their pay and that of other
employees in jobs above or below them.
• Generates dissatisfaction and makes
employees reluctant to acquire new
skills, competencies or knowledge or to
strive for promotion.

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 SENIOR EXECUTIVE
PAY RATES

• Global concern about the levels of

senior executive compensation.

• Senior managers may be able to

distort the goals and indicators of
performance-based pay.

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 SETTING PAY RATES

SENIORITY
• Pay increases based on seniority are
determined not by performance but by
the employee’s length of time on the
job.

• Organisational membership, not

individual achievement, is the prime
criterion for the allocation of pay
increases.
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 PAY FOR PERFORMANCE

• The objective of merit pay is to develop a

productive, efficient, effective
organisation that enhances employee
motivation and performance.
• A problem is that merit increases
for outstanding performance traditionally
have not been much greater than those
for poor performance.

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 Merit Pay vs. Incentive Pay

Merit Pay Incentive Pay

1. Annual salary increase. 1. One time bonus.
2. Based on supervisor 2. Based on objective
ratings. outcomes.
3. Rewards are indirectly 3. Rewards are directly
linked to organization linked to targeted
success. outcomes through a
bonus formula.
4. Employees compete for a 4. Employees receive
share of the merit pool. equal percentage
bonuses.
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 FACTORS AFFECTING MERIT PAY

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 Factors Related to Effectiveness
of Merit Pay

1. Link merit raises to relevant organizational

goals.
2. Use effective performance appraisal
methods (i.e., behaviorally based).
3. Empower employees through participation
and direct feedback.
4. Establish fair differences in merit rewards.

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 EFFECTIVE MERIT PLAN

Creates a link between reward and performance

Provides fair and equitable compensation

Reflects the organisation’s strategic business

objectives and culture
Cost is consistent with the financial state of the
business
Based on universally accepted criteria that
motivate employees to contribute
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 EFFECTIVE MERIT PLAN

Uses accurate performance appraisals

There is a minimum time lapse between
performance appraisal and the pay increase
Effective feedback
Managers are trained in performance appraisal
and the administration of the merit plan
Has top management and employee support
Employee reward needs are compatible with the
plan
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 SKILL-BASED PAY

• Skill-based pay compensates employees

on the basis of the job-related skills,
competencies and knowledge they
possess.
• The purpose of this system is to motivate
employees to gain additional attributes
that will increase their personal
satisfaction and value to the
organisation.
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 SKILL-BASED PAY

• Fits the strategic business focus on core

competencies
• Gives management greater flexibility
in rostering
• Gives employees additional job security,
job mobility, and the chance
to increase earnings
• Allows for multiskilling, which reinforces a
high-involvement management style
• Results in a better trained workforce
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 TRADITIONAL vs
COMPETENCY-BASED PAY

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 RELATING PAY TO PERFORMANCE

Compa Ratio or The ratio between the

Salary Index average pay rates and the
midpoint of the pay range
Performance A pay administration
Index technique used to better
align performance with
rewards
The Merit Grid Allocates rewards linked to
performance

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 PAY INCREASES

• Pay increases [usually annually]

recognise the employee’s
contributions to the achievement
of the organisation’s objectives.

• In most organisations, merit

increases are a composite of
payments for merit, cost of living
and inflation.
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 PROMOTIONAL INCREASES

• The movement of a person to a

higher level position in the company.
• A promotion involves a change to a
bigger job with a higher salary
range.
• Represents a significant increase in
purchasing power.
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General If pay for performance is a
adjustments compensation objective, then
across-the-board increases
should be avoided.

Automatic Automatic progression or

incremental salary scales are not
Progression concerned with relating salary
increases to performance and
should be avoided.

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 BLUE AND RED CIRCLE
PAY RATES

• Blue circle salaries are individual

anomalies which are adjusted because
the salary is below the minimum of the
salary range
• Red circle salaries are those above the
range maximum for the job.
• Generally, organisations do not cut such
salaries but rather freeze them until the
salary range moves up and can
accommodateCompensation
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 PAY REVIEWS

There are three main types of salary review:

Fixed-date reviews

Anniversary reviews

Flexible-date reviews
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 SUMMARY

• Compensation is a critical part of

strategic HRM.
• Compensation policies and practices
should reinforce employee behaviours
that help achieve the organisation’s
strategic business objectives and
reinforce its desired culture. In short,
money must match the message.
• No system for compensating employees is
perfect.
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