Milkovich/Newman: Compensation, Ninth Edition: The Pay Model

Milkovich/Newman: Compensation, Ninth
Edition
The Pay Model

Chapter 1
Chapter Topics
1. Compensation: Definition
2. Compensation perspectives
3. Forms of Pay
4. A Pay Model
5. Importance of effective compensation
6. Factors affecting compensation setting
7. Managerial compensation
8. Policy choices for Compensation
9. Methods for Compensation Management
1-2
Key Questions and Issues
■ How differing perspectives affect our

views of compensation
■ Definition of compensation
– The meaning of compensation most
appropriate from an employee's view:
return, reward, or entitlement
1-3
Key Questions and Issues (cont.)
■ Four policy issues in the pay model
– Objectives of the pay model
■ Forms of pay received from work
1-4
COMPENSATION
PRESPECTIVES
 How people view compensation
affects how they behave. It does not
mean the same thing to everyone.
 Your view probably differs, depending on
whether you look at compensation from
the perspective of a member of society, a
stockholder, a manager, or an employee.
Thus, we begin by recognizing different
perspectives. 1-5
Contrasting Perspectives of
Compensation
Society’s Stockholders’
Views Views
Employees’ Managers’
Views Views
1-6
Compensation: Definition
■ Society
– Pay as a measure of justice
– Benefits as a reflection of justice in society
– Job losses (or gains) attributed to differences in
compensation
– Belief that pay increases lead to price increases
1-7
Exhibit 1.1: Hourly Compensation Costs for
Manufacturing Workers (in U.S. Dollars)
1-8
Compensation: Definition (cont.)
■ Stockholders
– Using stock to pay employees creates a sense of
ownership
– Linking executive pay to company performance
supposedly increases stockholders' returns
■ Managers
– A major expense
– Used to influence employee behaviors and to
improve the organization's performance
1-9
Compensation: Definition (cont.)
■ Employees
– Major source of financial security
– Return in an exchange between employer and themselves
– Entitlement for being an employee of the company
– Reward for a job well done
1-10
What Is Compensation?
Compensation refers to all

forms of financial returns
and tangible services and
benefits employees
receive as part of an
employment relationship
1-11
Compensation is what
employees receive in exchange
for their contribution to the
organization. Generally
speaking, employees offer their
services for three types of
rewards: Base pay , Variable pay
And Benefits
1-12
The most important objective of
any pay system is fairness or
equity, generally expressed in
three forms
1-13
Internal equity: where more
difficult jobs are paid more
External equity: where jobs are
fairly compensated in comparison
to similar jobs in the labor market
Individual equity: where equal
pay is ensured for equal work
1-14
Managerial Compensation
Executive compensation is built

around three factors:
 Job complexity
 Employers’ ability to pay
 Managerial productivity
1-15
Common Strategic Compensation Goals
 To reward employees’ past performance

 To remain competitive in the labor market
 To maintain salary equity among
employees
 To network employees’ future performance
with organizational goals
 To control the compensation budget
 To attract new employees
 To reduce unnecessary turnover
1-16
What Is Reward
Management?
Reward management is concerned
with the formulation and
implementation of strategies and
policies that aim to reward people in
the organization fairly, equitably and
consistently in accordance with their
value to the organization
1-17
Exhibit 1.4: Total Returns for Work
1-18
A Pay Model
■ Three basic building blocks:
– Compensation objectives
– Policies that form the foundation of the
compensation system
– Techniques that make up the
compensation system
1-19
Exhibit 1.5: The Pay Model
1-20
Compensation Objectives (cont.)
■ Efficiency
– Improving performance, increasing quality,
delighting customers and stockholders
– Controlling labor costs
■ Fairness
– Fundamental objective of pay systems
– Fair treatment by recognizing both employee
contributions, and employee needs
■ Procedural fairness
1-21
Compensation Objectives (cont.)
■ Compliance
– Conformance to Federal and State compensation laws and
regulations
■ Ethics
– Organizations care about how its results are achieved
■ Objectives
– Guide the design of the pay system
– Serve as the standards for judging success of the pay
system
– Policies and techniques are means to reach objectives
1-22
Four Policy Choices
■Internal alignment
– Focus - Comparisons among jobs or skill levels inside
a single organization
– Pay relationships within an organization affect
employee decisions to:
▪ Stay with the organization
▪ Become more flexible by investing in additional
training
▪ Seek greater responsibility
■External competitiveness
– Focus - Compensation relationships external to the
organization: comparison with competitors
– Pay is ‘market driven’
1-23
Four Policy Choices (cont.)
■ External competitiveness (cont.)
– Effects of decisions regarding how much and what forms:
▪ To ensure that pay is sufficient to attract and retain employees
▪ To control labor costs to ensure competitive pricing of
products/ services
■ Employee contributions
– Focus - Relation emphasis placed on employee
performance
▪ Performance based pay affects fairness
■ Management
– Focus - Policies ensuring the right people get the right
pay for achieving the right objectives in the right way
1-24
Factors affecting Emp. Comp
■ Internal factors
1. Ability to pay
2. Business Strategy
3. Job evaluation
4. Performance appraisal
5. Employee
1-25
Factors affecting Emp. Comp
■ External factors
1. Labor Market
2. Productivity
3. Cost of living
4. Labor union
5. Government control
1-26
Methods of Compensation MGT
1. Base plus cost of living allowance

2. Scale plus cost of living allowance
3. Cash incentives
4. Skill based pay method
1-27
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Milkovich/Newman: Compensation, Ninth

The Pay Model

■ How differing perspectives affect our

Compensation refers to all

Executive compensation is built

 To reward employees’ past performance

1. Base plus cost of living allowance

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