CHAPTER 11

Total Rewards
and Compensation

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Learning Objectives
 Identify the three general components of total rewards and give examples of
each
 Explain the major laws governing employee compensation
 Outline the steps in developing a base pay system

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Nature of Total Rewards and Compensation

 Total
rewards: Monetary and nonmonetary rewards provided by
companies to attract, motivate, and retain employees
 Strategic decisions can guide the design of compensation practices
 Compliance with all applicable laws and regulations
 Cost-effectiveness for the organization
 Internal and external equity for employees

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Nature of Total Rewards and Compensation (continued)

 Performance enhancement for the organization

 Performance recognition and talent management for employees
 Enhanced recruitment, involvement, and retention of employees

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Elements of Total Rewards

• Tangible Direct Rewards

• Tangible Indirect Rewards

• Intangible Rewards

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 Components of Compensation
 Tangible
rewards: Elements of compensation that can be quantitatively
measured and compared between different organizations
 Intangible
rewards: Elements of compensation that cannot be as easily
measured or quantified
 Base pay: Basic compensation that an employee receives, often wages or
salary
 Wages:Payments calculated directly on the basis of time worked by
employees

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Components of Compensation (continued)
 Salary:
Consistent payments made each period regardless of the number of
hours worked
 Variable pay: Compensation linked directly to individual, team, or
organizational performance
 Benefit:
Indirect reward given to an employee or group of employees as part
of membership in the organization, regardless of performance

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Fair Labor Standards Act (F L S A)

 Primary federal law affecting compensation

 Enforced by the Wage and Hour Division of the U.S. Department of Labor
(D O L)
 Provisions focus on the following major areas:
 Minimum wage
 Limits on the use of child labor
 Overtime provisions (exempt and nonexempt status)

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Fair Labor Standards Act (F L S A) (continued 1)

 Minimum wage
 Set by F L S A to be paid to a broad spectrum of covered employees
 Congressional action is the only way to change it
 Child labor provisions
 Set the minimum age for employment with unlimited hours at 16 years
 Minimum age for hazardous occupations is 18 years
 Individuals who are 14 to 15 years old may work outside school hours with certain
limitations

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What is Exempt vs Non Exempt

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Fair Labor Standards Act (F L S A) (continued 2)

 During enactment of F L S A, limited exemptions were included that

permitted employers to restrict executives and others from receiving
overtime pay
 Exempt employees: Employees who hold positions for which they are not paid
overtime
 Nonexempt employees: Employees who must be paid overtime
 Overtime: F L S A established overtime pay requirements at 1.5 times the
regular pay rate for all hours worked over 40 in a week

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Determining Exempt Status under the F L S A

 Categories for exempt status

 Executive
 Administrative
 Professional (learned and creative)
 Computer
 Outside sales (including pharmaceutical sales)

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Determining Exempt Status under the F L S A
(continued)

 Major criteria for exempt status

 Pay level per week—minimum of $455/week
 Paid on a salary basis
 Job duties and responsibilities
 Primary duties of managing
 Decision discretion/judgment
 Requires advanced knowledge and/or training/education
 Pursuit of artistic or creative endeavors

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 Special Pay/Overtime Issues
 Compensatory time off
 Incentives for nonexempt employees
 Training time
 Security inspection time
 After-hours e-mail time
 Travel time
 Donning and doffing time

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Pay Equity Laws
 Equal Pay Act of 1963
 Prohibits companies from using different wage scales for men and women performing
substantially the same jobs
 Lilly Ledbetter Fair Pay Act
 Statute of limitations are extended for equal pay claims, and each paycheck is treated
as a new act of discrimination
 Pay practices resulting in disparate impact are also actionable

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Independent Contractor Regulations

 Employers do not have to pay Social Security, unemployment, or workers’

compensation costs
 Criteria
for independent contractor status established by the Internal
Revenue Service, or I R S
 Firms may control only the result of the work being contracted but not what or how it
will be done
 The I R S considers the amount of behavioral and financial control a company
exercises over the worker and additional relationship factors

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Pay for Internships
 Many organizations began to pay interns only after the institution of the six-
factor test by the D O L
 Six-factor test
 Issued by the D O L in April 2010
 Narrowly permitted for-profit enterprises to utilize unpaid interns
 December 2017: The D O L issued new guidance reversing the six-factor
criteria and adopting a primary beneficiary test

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Additional Laws Affecting Compensation

 Prevailing wage: Hourly wage determined by a formula that considers the

rate paid for a job by a majority of the employers in the appropriate
geographic area
 Garnishment: Court order that directs an employer to set aside a portion
of an employee’s wages to pay a debt owed to a creditor

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Strategic Compensation Decisions
 Firms
need to manage their compensation philosophy to ensure that
employees believe they are being treated fairly
 Entitlement philosophy is at one end of the continuum, and performance philosophy is
at the other end
 Entitlement philosophy: Assumes that individuals who have worked another year with the
company are entitled to pay increases with little regard for performance differences
 Pay-for-performance philosophy: Assumes that compensation decisions reflect
performance differences

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Continuum of Compensation Philosophies
Entitlement  PayPerformance
and raises based on performance
 Pay and raises based on length of  No raises for poor-performing
service employees
 Across-the-board raises
 Pay scales increased annually  Market-adjusted pay scales
 Industry comparisons of pay only  No raises for length of service or job
 Holiday bonuses given to all
tenure
employees
 Industry comparisons of total rewards

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Strategic Compensation Decisions (continued)

 Communicating pay philosophy

 Helps employees recognize the value of the total rewards package and how their work
performance, tenure, and raises can affect their compensation
 Administrative responsibilities
 H R specialists develop and administer the compensation system and ensure that pay
practices comply with all legal requirements
 Managers help employees see the connections between their individual performance
and the expected rewards

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 Payroll Administration
 Handled in different ways:
 H R professionals may or may not do the actual processing of payroll
 If they do, payroll staff may report to H R or accounting function
 Payroll is outsourced
 Accurate
payroll processing is important for maintaining a positive
workplace and complying with various laws
 Managers are responsible for accuracy
 Recordkeeping is critical

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Motivation Theories and Compensation Philosophies

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Motivation
Theories and
Compensation
Philosophies

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Compensation Fairness and Equity
 External equity
 If an employer’s rewards are not viewed as equitable compared with other firms, the
employer is likely to experience higher turnover
 Internal equity
 Employees are compensated fairly within the organization with regard to their K S As
 Pay secrecy
 Explaining pay grades and pay decision rules can enhance employee perceptions of
fair and ethical treatment

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 Compensation
Quartile Strategies

Deciding which quartile position to target

for pay structures is a function of the
following considerations:
• Available financial resources
• Competitiveness pressures
• Market availability of employees
with different capabilities

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 Competency-Based Pay
 Rewards individuals for the capabilities they demonstrate and acquire
 Knowledge-based pay (KBP) or skill-based pay (SBP) systems
 Employees start at a base level of pay and receive increases as they learn to do other
jobs or gain additional skills and knowledge and thus become more valuable to the
employer

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 Global Compensation Issues
 Developing and managing a global compensation system is extremely
complex
 The growing world economy has led to an increase in employees working
internationally
 Laws,living costs, tax policies, currency fluctuations, and more must be
considered when designing the compensation

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Figure 11-7: Compensation Administration
Process

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Job Evaluation Methods
 Job evaluation: Formal, systematic means to determine the relative worth
of jobs within an organization
 Ranking method: Places jobs in order, from highest to lowest, by their value
to the firm
 Appropriate in small firms with relatively few jobs
 Classification method: Involves writing descriptions of job classes and then
putting each job into a grade according to the class it best matches
 Used in public-sector organizations

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Job Evaluation Methods (continued)
 Pointfactor method: Looks at compensable factors in a group of similar
jobs and assigns weights, or points, to them
 Compensable factor: Job dimension commonly present throughout a group of jobs
within an organization that can be rated for each job
 Derived from job analysis
 Reflects the nature of different types of work performed in the organization
 Most popular approach because it is relatively simple to use and considers the
components of a job rather than the total job

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Market Pricing
 Uses market pay data to identify the relative value of jobs based on what
other employers pay for similar jobs
 Key to market pricing is identifying relevant market pay data for jobs that
are good matches with the employer’s:
 Jobs
 Geographic considerations
 Company strategies and philosophies about desired market competitiveness levels

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Market Pricing (continued)
 Advantages

 Ties organizational pay levels to the external job market, without internal job evaluation
distortion
 Allows an employer to communicate to employees that the compensation system is
truly market linked
 Disadvantages

 Pay survey data may be limited or may not be gathered in methodologically sound
ways
 Tying pay levels to market data can lead to wide fluctuations on the basis of market
conditions

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 Pay Surveys
 Collection of data on compensation rates for workers performing similar
jobs in other organizations
 Using benchmark jobs to anchor the survey data is helpful
 Benchmark jobs: Jobs that are found in many other organizations that can be used
for the purposes of comparison
 Internet-based pay information is prevalent

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Using Pay Surveys
 Involves evaluating many factors to determine if the data are relevant and
valid
 Is the participant sample realistic?
 Is the survey broad based?
 How established is the survey, and how qualified are those who conducted it?
 Does it include required elements of compensation to allow comparison of the reward
mix?
 Does the survey contain job summaries so that appropriate matches to job
descriptions can be made?
 Timeliness: How current are the data?

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Pay Surveys and Legal Issues
 Employers use outside sources for pay surveys to avoid charges that they
are attempting to “price fix” wages
 Companies must safeguard employee privacy and provide only de-
identified data so that specific employee pay rates and names are not
shared
 Care must also be taken to avoid violating the N L R A provisions that apply to
disclosing wage and benefit information

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Pay Grades
 Groupings of individual jobs that have approximately the same value to
the organization
 Market line: Graph line that shows the relationship between job value as
determined by job evaluation points and job value as determined by pay
survey rates
 Market banding: Grouping jobs into pay grades based on similar market
survey amounts

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Pay Ranges
 Jobswithin a point range are classified into job grades using the point
factor method
 Market data are then used to determine the minimum and maximum pay rates for each
job grade, and midpoint is computed by averaging the range of minimum and
maximum pay rates
 Current pay of employees is compared with the proposed ranges
 Broadbanding: Practice of using fewer pay grades with much broader
ranges than in traditional compensation systems

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 Individual Pay
 Manyorganizations use compa-ratio to determine each individual
employee’s standing in relationship to the midpoint
 Compa-ratio: Pay level divided by the midpoint of the pay range
 Red-circled employee: Incumbent who is paid above the range set for a job
 Green-circled employee: Incumbent who is paid below the range set for a
job

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Individual Pay (continued)
 Pay compression: Occurs when the pay differences among individuals
with different levels of experience and performance become small
 Salary inversion: Occurs when the pay given to new hires is higher than
the compensation provided to more senior employees

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Performance-Based Increases
 Targeting high performers
 Focuses on providing the top-performing employees with significantly higher pay
raises, while providing standard increases to the remaining satisfactory performers
 Pay adjustment matrix
 Reflects an employee’s eligibility for pay increase
 Factors considered:
 Employee’s level of performance as rated in an appraisal
 Employee’s position in the pay range

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Figure 11-10: Pay Adjustment Matrix

Source: Adapted from Payscale’s 2012 Compensation Best Practices Report.

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Standardized Pay Adjustments
 Methods used
 Seniority can be used as the basis for pay increases
 Cost-of-living adjustments (C O L A): Every employee’s pay is increased to
compensate for inflation and rising prices
 Across-the-board increases: Given as a percentage raise based on standard market or
financial budgeting determinations
 Lump-sum increases (L S I): One-time payment of all or part of a yearly pay
increase

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Compensation Challenges
 Economic recessions
 Organizations address shortfalls in revenue by reducing employment-related expenses
 Should be used sparingly because such strategies may result in employee job dissatisfaction
and turnover
 Gender pay gap
 Wider in some industries than others
 Continued monitoring of organizational pay levels and properly managing women’s
career progress are important

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 CHAPTER 12
Variable Pay &
Executive
Compensation

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Learning Objectives
 Define variable pay and identify three aspects of effective pay-for-performance
plans
 Explain three levels of incentives and give one example at each level
 Identify four measures used to determine the effectiveness of compensation
systems

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Variable Pay

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Variable Pay (continued)
 Basic assumptions that underlie the philosophical foundation of variable
pay:
 Some people or groups contribute more to organizational success than do others
 Some people perform better and are more productive than are others
 Employees or groups who perform better or contribute more should receive greater
compensation

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Variety of Possible Incentives

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 Effective Variable Pay
 The effectiveness of any variable pay program relies on its consistency with
the organization’s culture
 Many companies find that variable pay plans make performance results a higher priority
for employees
 Variable pay systems should be tied to desired performance
 Line of sight: Idea that employees can clearly see how their actions and decisions lead
to desired outcomes

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Factors for Effective Variable Pay Plans

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Effective Variable Pay (continued)
 Establishment involves determining appropriate performance measures to
evaluate performance and the resulting rewards
 Most firms have a number of important targets to track results related to critical
success factors
 Criticalsuccess factors: Variables that have a strong influence on the results of the
organization
 Key performance indicators (K P I’s): Scorecard measures that tell managers how well
the organization is performing relative to critical success factors

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Levels of Variable Pay

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Individual Incentive Systems
 Tie personal effort to additional rewards for the individual employee
 Necessary conditions to be considered when using individual incentive
plans
 Individual performance must be identifiable
 Individual competitiveness must be desirable
 Individualism must be stressed in the organizational culture
 Individuals must be in control of the pace of production

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Individual Incentive Systems (continued)
 Piece-rate system
 Pay system in which wages are determined by multiplying the number of units
produced by the piece rate for one unit
 Results in inequality in pay, which can lead to dysfunction within a work group
 Training managers in the program specifics is helpful

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Individual Incentives
 Bonus: One-time payment that does not become part of the employee’s base
pay
 Factors leading to success in utilizing bonuses include:
 Establishing clear, metric-based reviews
 Ensuring that employees who have not met performance criteria do not receive a payout
 Educating managers and employees about the incentive plan details
 Other types of bonuses: spot, referral, hiring, retention, and project completion

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Individual Incentives (continued)
 Nonmonetary Incentives
 Performance awards
 Incentive rewards for performance
 Recognition awards
 Recognizes individual employees for their work
 Service awards
 Recognizes and rewards longevity with the company

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Team Incentives
 When employees participate in team-level incentives, they share more
information among the team members
 Concernsare how and when to distribute the incentives and who will
determine the incentive amounts
 Primary ways for distributing those rewards are as follows:
 Same size reward for each member
 Different size reward for each member

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Team Incentives (continued)
 Challenges with team incentives
 Rewards distributed in equal amounts to all members may be perceived as unfair by
some employees
 Some individuals who are performing poorly may prevent the team from meeting the
goals needed to trigger the incentive payment
 Free rider: Member of the group who contributes little
 Gainsharing: Sharing with employees greater than expected gains in
profits and/or productivity

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Organizational Incentives
 Profit
sharing: System to distribute a portion of an organization’s profits
to employees
 Stock option plan: Gives employees the right to purchase a fixed number
of shares of company stock at a specified price for a limited period of time
 Employee stock ownership plan (E S O P): Gives employees significant
stock ownership in their organizations

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Types of Sales Compensation Plans

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Executive Compensation Packages
What is
expected
• Establish strategic
direction for the
organization
• Create shareholder value
• Ensure the sustainability
of the enterprise

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Executive Compensation
 Handled differently from employee pay in various types of organizations
 Determined by the board of directors
 Subject
to shareholder approval via a say-on-pay provision in the Dodd-
Frank Act
 Contracts with executives include a clawback provision
 Clawback provision: Permits the organization to require an employee to return rewards
obtained through unethical or negligent actions

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© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 HR
Metri
cs for
Comp
ensati
on

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