Module 8 - Compensation Systems

Maturity Curves

Correlate pay with time spent in the professional field. They are most frequently used for teachers and research-focused scientists, engineers, and other technical personnel.

Cost-of-Living Adjustment (COLA)

A periodic compensation payment given to all eligible employees without regard to organizational profitability, employee productivity or other performance factors.

Stock Option Plan

A right to purchase shares of a company's stock at the predetermined price which is referred to as the exercise price.

Total Company Compensation Expense

All costs associated with employment, including salaries, overtime, benefits, and bonuses. salaries + overtime + benefits + bonuses / total costs

Dual Career Ladders

Allow professionals to earn as much in senior technical positions as they would on a management track.

General Pay Increase

Given to all employees based on local competitive market requirements.

Challenges in Cross-Border Situations

Global organizations encounter some unique challenges in designing and awarding incentives.

Restricted Stock Units

Grant of these stock units are very much like phantom stock. Used to control the timing of the grantee's income.

Travel Pay

Hourly employees receive travel pay for time spent traveling to work assignments, even if the travel is outside of working hours.

Market-Based Increase

Organizations may use these increases to be competitive in attracting new talent or to keep key employees.

Geographical Differential Pay

Pay is based on where the employee works. This difference may occur between different cities or regions within the US and between countries.

Productivity-Based System

Pay is determined by the employee's output.

Green-Circle Rates

Opposite of red circle rates - employee's pay is below the minimum of the range. Examples: • Reviews and updates pay range, increases minimum as a result

Members of Boards of Directors are Compensated in a Variety of Ways

• Base pay or retainer • Fees, usually for attending meetings, chairing a committee, or other services • Benefits such as liability and life insurance • Perquisites similar to those offered to executives • Nonqualified stock options/grant plans • Nonqualified deferred compensation programs

For an Incentive Pay Plan to be Successful, Organizations Need to Have the Following in Place:

• Competitive base salaries • Fairly stable management presence and strategic direction • Good communication between management and employees • Reliable method for measuring the results linked to incentives • Commitment from the top down to communicate the plan and to provide ongoing training and coaching

Forms of Base Pay

• Hourly wage • Salary (same amount no matter how many hours worked)

Types of Incentives

• Individuals • Groups • Organization-Wide

To Counteract the Efforts of Pay Compression, Organizations Can

• Match the market in the pay rates for all employees, not just new hires • Provide other benefits to employees affected by pay compression • Continuously evaluate survey data and update pay ranges accordingly • Provide incentive plans for managers • Increase the amount of time off awarded • Provide longevity bonuses • Monitor salaries for inflation • Install a more aggressive merit pay program

Pay Variations

• Red-circle rates • Green-circle rates • Pay compression or salary compression • Cost-of-living adjustment (COLA) • General pay increase • Seniority increase • Lump-sum increase or Performance bonus • Market-based increase • Differential pay

Incentive Pay Structures

• Reward Short-Term: easy to measure but may not have a lasting impact on the overall health of the organization. • Reward Long-Term: can help keep high performers and provide long-term positive results for the organizations.

Time-Based Step Pay System Advantages/Disadvantages

+ Best suited to routine jobs where qualifications of job incumbents increase with time + Enables a company to reward long term employment - Does not reflect varying rate at which incumbents become proficient - Does not reflect performance differences, except for unsatisfactory performance - Can raise average pay levels over time even if performance is below average

Productivity-Based System Advantages/Disadvantages

+ Works best where emphasis is quantity of work and output are accurately measured + Encourages high level of employee productivity + Ties pay to the volume of work performed - May sacrifice quality of work without careful supervision - May lead to inflexibility in the workforce because employees may want to stay with the job for which they are paid the most

Performance-Based/Merit Pay System Advantages/Disadvantages

+ Works best where individual performance is valued and accurately measured + Rewards and encourages superior performance - Requires well-documented performance appraisal systems on which managers have been thoroughly trained - Bias or subjectivity in performance appraisals may lead to employee discrimination claims - Can be manipulated by supervisors to benefit certain employees

Person-Based System Advantages/Disadvantages

+ Works best where skills/knowledge levels are well defined and development of employee is valued + Encourages a flexible and better-trained workforce + May reduce need for specialists + Allows for use of work teams that are highly interdependent - Can be costly in terms of both administration and training - May result in higher pay rates - Skills/knowledge must be effectively utilized to provide the organization with an offset to higher pay rates - May be more difficult to institute cost controls

Single or Flat-Rate System Advantages/Disadvantages

+ Works well for routine, simple jobs + Implemented and administered simply - Does not reflect individual performance, seniority or skill difference

Metrics for Compensation Costs

- Compensation Ratio - Total Company Compensation Expense

Guideline for Effective Use of Merit Pay

- Gain executive buy-in - Train supervisors in the mechanics of performance appraisal system and in the art of giving back - Align the merit pay system with organizational goals and culture - Tie meaningful rewards closely to performance - Develop accurate performance appraisal systems that recognize proficiency. Proficiency at a job should dictate value and awards (not just longevity or tenure or other subjective measures) - Use wide range of increases to differentiate between performance levels. - Implement accountability measures

Difficulties in Using Merit Pay

- Incentive value of reward offered may be too small to motivate performance - Managers may be reluctant to distinguish between performance levels - Link between performance and rewards may be weak - Performance appraisal definitions and guidelines may lack precision - Merit raises are permanent increases in payroll cost - People may think their own performance is above average - Union contract limit pay-for-performance decisions - Merit pay runs contrary to intrinsic motivation in the work itself - Managers may have limited personal control over organizational performance

Long-Term Incentives that Most Executives Receive

- Stock Option Plan - Stock Purchase Plans - Phantom Stock - Restricted stock grants - Restricted Stock Units - Performance Grants

Straight Commission Plans are Appropriate When

- The organization's objectives are to motivate sales volume. - Holding down the cost of sales is important. - Competitors also compensate through commission-only systems.

Straight Salary Plans are Appropriate Under These Circumstances

- The sales staff spends a significant amount of time servicing customers rather than securing sales. - Measuring sales performance is difficult. - The nature of the sales process makes it impossible to separate one individual's efforts from those of the support people who also help secure the sale. - There is a long cycle.

Three Basic Approaches of Tying Base Pay to Peoples' Qualification

1) Knowledge-Based System: pay is based on the level of knowledge the employee has in a field. 2) Skill-Based System: base pay on the number of different skills an employee is qualified to perform 3) Competency-Based System: set pay to the level at which employee can operate in defined competencies.

Reasons for Geographical Differential Pay

1) Labor cost - employers change their base-pay structure to reflect different wage rates or factors that impact the cost of living in different geographic areas. 2)To attract workers to certain locations - employers pay more to employees who accept work in remote locations or in places where the climate or quality living is a deterrent. An offshore oil platform is a good example. 3) For foreign pay - employers offer based pay plus allowance to reflect factors that affect the economics of employee who work in foreign countries. These factors may include differences in culture, education, technology, climate, and taxes Global compensation is quite complex, It is country and region specific, and it is also subject to numerous compliance issues.

Performance Grants

Avoids the deduction limitation that can be imposed under some legislation. Such arrangement can motivate recipients to achieve goals that are valuable to the organization and its shareholders.

Direct Sales Personnel

The main purpose of a sales compensation plan is to motivate sales professionals to achieve specific objectives that directly translate to the organization's bottom line.

Stock Purchase Plans

Broad-based plans available to most or all of the public company's employees. The require broad-based I they are intended to qualify for favorable tax treatment.

Emergency-Shift Pay

Certain types of industries pay emergency-shift pay when employees work in response to an emergency.

Differential Pay (Variable Pay)

Depends on performance and is not added to employees' base pay. This practice allows organizations to better control their labor cost and to tie performance and pay together.

Pay Compression or Salary Compression

Describes situations where there is only a small difference in pay between employees regardless of their experience, skills, level or seniority.

Restricted Stock Grants

Does not require an employee or executive to actually purchase the stock. It is essentially a transfer or gift of stock with forfeiture provision that result in ta possible loss of the share if certain requirements are not met.

Single-Rate Pay or Flat-Rate Pay System

Each incumbent of a job has the same rate of pay, regardless of performance or seniority. Flat rate is often set to correspond to target market survey data related to the job..

Person-Based Pay

Employee characteristics, rather than how the job is performed, determine pay.

Straight Piece-Rate System

Employee receives a base wage and is awarded additional compensation for the amount of output produced.

Reporting Pay

Employees are paid for reporting to work as scheduled even if upon arrival no work is available.

Red-Circle Rates

Employees pay rates above the range maximum. Examples: • Long-term employees who reach max rate in their job range • Employees who are bumped down to lower-level but salary is not reduced

Shift Pay

Employees receive extra pay when they work less-desirable hours, such as 2nd or 3rd shift. Shift pay may be flat rate or percentage of base pay.

Combination Step-Rate and Performance Structure

Employees receive increases on a step-rate basis up to the job rate. Above the job rate, increases to higher steps are granted only for above standard performance. This system requires adequate resources to develop and administer a performance appraisal system and communicate it to employees so that they understand how they can earn performance-based increases

Call-Back Pay

Extra pay when they are called back for an extra shift in the same work day.

Incentive Type that Has Most Significant Impact on Productivity

Individual incentives typically have the most significant impact of productivity. However, a primary disadvantage is that they may be counterproductive to teamwork.

Global Differences in P4P

Many factors contribute to establishing and maintaining a meaningful effective pay for performance program. Basic questions such as how incentivize individual performance, how to set appropriate performance goals while managing risk, and what forms of remuneration to offer are all mitigating factors.

Organization-Wide Incentives

Many organizations use these incentive plans to reward overall results. • Profit sharing and stock ownership are the most common organization-wide incentive plans. Another example is a bonus program that is tied to organizational goals.

Lump-Sum Increase (LSI) or Performance Bonus

Method to reward employees, is an advantage to organizations because other wages and benefits linked to the base rate, such as overtime, shift premium, sick pay and life insurance are not impacted.

Compensation Ratio

Relationship of current salaries to the midpoints of the salary ranges. employee's pay rate / pay range midpoint

Step Rate with Variability-Based Performance Consideration

Similar to the automatic system, but the size or timing of increases may vary if performance is substantially above or below standard.

Premium Pay

Some employers pay premium pay (extra pay) or overtime at a higher rate for working: - Holidays - Sixth or seventh day of straight time - After 8 hours in a day

Differential Piece-Rate System

The employee receives one piece rate up to standard and then a higher-rate one standard has been exceeded.

Time-Based Step-Rate Pay System

The employee's pay rate is based on longevity in the job. Pay increases occur on a predetermined schedule

Performance-Based Pay System

The individual employee's performance is the basis for the amount and timing of pay increases. A performance-based pay system is commonly called merit pay or pay-for-performance. There are several ways to structure pay for performance, but a common feature is that a form of measurement is established, goals are set, and compensation is linked to the measure of work quality or goals.

Straight Salary

The least used compensation packages for direct salespeople.

HR Role in Executive Compensation

The most basic, but critical, role an HR professional plays is communication regarding the benefits, costs, and array of options in launching or improving an executive compensation program. Communications typically are directed to management, the executives at issue, the board of directors, other compensation professionals, consultants, and possibly the media and government agencies. HR professional's role encompasses ongoing assessment of the existing program's effectiveness.

Automatic Step-Rate Pay Structure

The pay scale is usually divided into a number of steps that are 3% - 7% apart.

Individual Incentives

The purpose of these incentive plans is to improve individual performance. • The piece-rate system is the most basic individual incentive system. Workers who produce more produce more earn more. •A commission is another example of an individual incentive. A commission is generally a percentage of sales. • Another type of incentive is non cash reward programs. Gifts, awards, trips, prizes, and other forms of merit awards are used to recognize individuals for their performance, special contributions, pr length of services.

Phantom Stock

These arrangements are generally used when a company does not view ownership of real equity as desirable but seeks to create some of the incentive that go along with having participants feel aligned with company's owners.

Group Incentives

These incentives are used when measuring individual performance is difficult or when performance requires cooperation of the group. • In gainsharing plans, an organization shares portion of the gains from a successful group effort. • Team bonuses can also be used and are based on achieving group goals and objectives.

Strategic Value of Compensation Ratio

Tracking individual salaries in comparison to the pay range midpoint allows managers to consider if employees are being paid appropriately on the basis of their skills, experience, and performance.

Strategic Value of Total Company Compensation Expense

Tracking total compensation as a percentage of total costs helps an organization manage the costs associated with human capital, including evaluating the use of fixed versus variable compensation.

Incentive Pay

Used to motivate employees to perform at a higher level by paying for performance that exceeds base-pay expectations. Incentive pay programs stem from the theory that rewards drive behavior.

Overtime Pay

Various countries the minimum amount to be paid for overtime is dictated by legislation.

Seniority Increase

When the time spent in an organization is sometimes the basis for pay adjustments.

On-Call Pay

When they are on call, even if they are not called in to work.

Salary Plus Commission and/or Bonus

• Salespeople are thought to be motivated by financial gain • Salary-plus-commission systems allow organizations to directly reward those behaviors that best support their organizational strategy • Such systems are adaptable and allow organizations to readjust the plan to fit current conditions • Competitors usually use salary-plus-commission/bonus sales strategies.

Time-Based Differential Pay

• Shift pay • Emergency-shift pay • Premium pay • On-call pay • Call-back pay • Reporting pay • Travel pay • Overtime pay

Two Ways to Determine Differential Pay

• Time-based (when the employee works) • Geographic (where the employee works)

In Assembly Line Work, a Productivity-Based System Works Best If

• Units of output can be measured • A clear relationship between employee effort and quantity of output exists • Job is standardized, the work flow is regular and delays are few or consistent • Quality is less important than quantity • Costs are known and precise