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INTERNATIONAL HUMAN RESOURCE MANAGEMENT

Dr. Shyamal Gomes


Chapter 6:

COMPENSATION MANAGEMENT

Introduction:OneofthekeycomponentsofIHRMisthecompensation
administration in MNCs. Today, compensation and employee benefits
contribute to 4050% of the total costs. Compensation is strategically
reportedandmonitoredatthebroadlevelsandwiththeinvestorsto
assess the health of the organization. What is compensation
management?Effectiveandefficientprocessofmanagingtheearnings
financialandnonfinancialrewardsoftheemployeesinanorganization
based on their performance towards organizational goal is called
compensationmanagement.

International Compensation is an internal rate of return (monetary or


non monetary rewards / package) including base salary, benefits,
perquisites and long term & short term incentives that valued by
employees in accordance with their relative contributions to
performance towards achieving the desired goal of an organization. It
influences:

Organizationalculture
Recruitmentandselectionofcompetentemployees
Motivationandperformance

Objectivesofcompensation:

Compensation decisions are strategic decisions and play a key role in


achieving performance and sustainable competitive advantages for
nationalaswellasinternationalfirms.Thereforethekeyobjectivesare:

Attract employees who are qualified, experienced and interested


ininternationalassignments.
Facilitate the movement of expatriates from one subsidiary to
another, from home to subsidiary, and back from subsidiary to
home.

Provideaconsistentandreasonablerelationshipbetweenthepay
levels of employees at headquarters, domestic affiliates and
foreignsubsidiaries.
Becosteffectivebyreducingunnecessaryexpenses.
Shouldbeeasilyunderstoodandeasytoadminister.

ComponentsofCompensation:

components of international compensation comprises the base salary,


incentives, benefits, allowances, foreign service inducement/ hardship
premium,longtermbenefitsandtaxesetc.

BaseSalary:

Base salary is the amount of money that an expatriate normally


receivesinthehomecountry.IntheUnitedStates,thiswasaround$
175,000 for uppermiddle managers in the late 1990s, and this rate
wassimilartothatpaidtomanagersinbothJapanandGermany.The
exchangerates,ofcourse,alsoaffecttherealwage.
Expatriate salaries typically are set according to the base pay of
thehomecountries.Therefore,aGermanManagerworkingfora
US MNC and assigned to Spain would have a base salary that
reflectsthesalarystructureinGermany.
ThesalariesusuallyarepaidinHomecurrency,localcurrency,ora
combination of the two. The base pay also serves as the
benchmarksagainstwhichbonusesandbenefitsarecalculated.

Benefits:

Alternativelyknownasindirectcompensation,
Benefits constitute a substantial portion of international
compensation ( approx. one third of compensation for regular
employeesisbenefits).
Benefitsincludeasuitofprogrammessuchas:
Entertainment, Festival celebrations, Gifts, Use of club
facilities, provision of hospitality including food and
beverage, employee welfare, use of health club,
Conveyance tour and travel, Hotel Board and Lodging,

vehicles,telephoneandothertelecommunicationfacilities,
Sponsorshipofchildren.
Basically an employee tends to join and stay with an org. which
guaranteesanattractivebenefitsprogramme.
Vacation along with holidays and rest breaks help employees
mitigate fatigue and enhance productivity during the hours
employeesactuallywork.

Allowance:

It is an inevitable feature of International compensation. The most


common allowance relates to the cost of living an adjustment for
different in the cost of living between the home country and foreign
country assignment. This allowance is designed to provide the
expatriatewiththesamestandardoflivingthatheorsheenjoyedinthe
homecountry.
Spouse assistance, housing allowance, home leave allowance,
relocation allowance and educational allowance are the popular in
expats.Compensation.

These allowances are often contingent upon tax equalization policies


andpracticesinboththehomeandthehostcountries.

Incentives:
Anadditionalpayment(orotherremuneration)toemployeesasa
means of increasing output. Increasingly, MNCs these days are
designing special incentive programmes for keeping expatriates
motivated. In the process, a growing number of firms have
dropped the ongoing premium for overseas assignments and
replaceditwithaonetime,lumpsumpremium.

Thelumpsumpaymenthasatleastthreeadvantages:
First,expatriatesrealizesthattheyarepaidthisonlyonceandthat
too when they accept an overseas assignment. So the payment
tendstoretainitsmotivationalvalue.
Second: costs to the company are less because there is only one
payment and nofuture financialcommitment.This issobecause
incentive is a separate payment, distinguishable from a regular
pay,anditismorerapidlyforsavingorspending.

Third,lesschancesforprematurerepatriation.

ForeignService/HardshipPremium:

This is often perceived as an inducement in the form of a salary


premium to accept an overseas assignment. Generally, salary
premiums vary from 540% of the base salary. Actual salaries
dependupontheassignment,actualhardship,taxconsequencesand
length of assignment. In addition, if the work week in the host
countryislongerthaninthehomecountry,theassigneewillbepaid
fortheextrahoursworked.

Certaincountriesarehighlyhostiletoforeignersstayingandworking.
Indians engaged in road construction work in Afghanistan, for
example, face constant threat lives. In fact, ten such emigrants got
killedinrecenttimes(20062007).Expatriatesinsuchenvironments
arepaid23timesmorethantheirdomesticsalaries.

LongtermBenefits:

ThemostcommonlongtermbenefitsofferedtoemployeesofMNCsare
EmployeeStock OptionSchemes(ESOS).TraditionallyESOSwere used
asmeanstorewardtopmanagementorkeypeopleoftheMNCs.Some
ofthecommonlyusedstockoptionschemesare:

Employee Stock Option Plan (ESOP) a certain nos. of shares are


reservedforpurchaseandissuancetokeyemployees.Suchshares
serveasincentiveforemployeestobuildlongtermvalueforthe
company.

Restricted Stock Unit (RSU) This is a plan established by a


company, wherein units of stocks are provided with restrictions
on when they can be exercised. It is usually issued as partial
compensationforemployees.Therestrictionsgenerallyliftsin35
yearswhenthestockvests

EmployeeStockPurchasePlan(ESPP)Thisisaplanwhereinthe
company sells shares to its employees usually, at a discount.
Importantly, the company deducts the purchase price of these
shareseverymonthfromtheemployeessalary

Hence, the primary objective for providing stock options is to reward


andimproveemployeesperformanceand/orattract/retaincritical
talentintheOrganization

Taxes:

The final component of the expatriates remuneration relates to taxes.


MNCs generally select one of the following approaches to handle
internationaltaxes:
1. Tax equalization: Firms withhold an amount equal to the home
country tax obligation of the expatriate, and pay all taxes in the
hostcountry.
2. Taxprotection:Theemployeepaysuptotheamountoftaxeshe
orshewouldpayonremunerationinthehomecountry.Insucha
situation,theemployeeisentitledtoanywindfallreceivediftotal
taxesarelessintheforeigncountrythaninthehomecountry.

Taxes

Salary

International
Compensation
Incentives

Allowances

Long term Benefits

Fig. components of International compensation

Benefits

Factorsinfluencingthesecomponents:

RemunerationorcompensationvariescountrytocountryandoneMNC
toanother.Mainlybasedontwofactors:ExternalandInternal.

Domestic

Remuneration

/
CompensationInternational

ExternalFactors

InternalFactors

LabourMarket
Costofliving
LabourUnion
Govt.Legislation
Society
Economy

Businessstrategy
Job Evaluation
and Performance
Appraisal
Theemployee

ParentNationality
Labour
market
characteristics
LocalCulture
Home and Host
Countries
GovernmentsRoles
IndustryTypes
Competitors
Strategy

Goalorientation
Capacitytopay
Competitive
Strategy
Org.Culture
Int. Workforce
composition
Lab.Relations
Subsidiaryrole

However,thesefactorscanbeclassifiedinfivecategories:

1. Prosperity&SpendingPowerOfthecompany(arelatedfactoris
thedifferentTaxandsocialsecuritySysteminthecountry.
2. CulturalDifference
3. Policy&Strategies(inproductivityandPerformanceevaluation)
4. SituationsontherelevantLabourmarket&Labourcapitalratios
5. Institutional Frameworks within which wage Bargaining takes
place

CompensationPhilosophy:

Sincecompensationisacrucialfactor,havingitsbearingonperformance
andsatisfaction,itisadvisablethatinternationalbusinessshouldhavea
clearcutcompensationphilosophy

NowthequestioncomeswhatisCompensationPhilosophy?

Compensation philosophy is the set of values and beliefs that an


organization has with regard to monetary and non monetary benefits
payabletoemployees.

Anycompensationphilosophyshouldcoverthefollowingaspects:
Goalsoftheorganizationalcompensationsystem
Percentage of compensation linked to individual
performanceandbasesalary.
Roleofperformanceappraisalindisbursingcompensation
The positioning of compensation of employees relative to
market

Therefore, Compensation philosophy or the set of values and beliefs


combined with a set of guidelines that further assist in compensation
administrationofMNCs.

Theoriesofcompensation:

There are (generally) 4 theories in the context of international


compensation:
1. Contingencytheory.
2. Resourcebasedtheory.
3. TheAgencytheoryand
4. Equitytheory

1. Contingencytheory(mostpopular):Expatscompensationshould
be based on particular contingencies or situation prevailing in a
host country. The compensation Phil. In every organization is
normally de centralized and allows units to localize the
compensationstructure

2. Resourcesbasedtheory:Humanresourceisthegreatestassetof
the MNCs in its competitive advantage needs good pay and st.
salary band for cont. motivation. The organizations follow this
theory, remain market sensitive and are constantly reviewing
compensationtoretaintheirpositioninthehiringandretaining
thetalents

3. The Agency Theory: This theory focused on the divergent


interests and goals of org.s stakeholders and the way that
employees compensation can be used to align these interests &
goals. According to this theory, there exists a principle agency
relationshipbetweentheMNCsHQanditsSubsidiariesforExpats
Compensation.

4. EquityTheory:Equitytheorysuggeststhatthereshouldbeafair
balance between an expatriates contribution to an MNC and
what he / she receives as compensation. Of late, the equity
principle is sought to be compromised with a new approach to
compensationPersonbasedratherjobcentric.

Compensationpracticesindifferentcountries:Theoverallcompensation
package often varies from country to country due to legally mandated
benefits,taxes,costofliving,culturesandemployeeexpectations.

However, As we observed, there are, some common elements in


compensation package including base salary, benefits, allowances,
incentivesandtaxes;letseethecompensationsystemsinthedifferent
countries:
Criterion

America

Orientation

Performance
oriented

Components

BS,VB,LTI,CBC,VBC MW(BA+OT),VB

Link
withExcellentlinkage
performance

Japan
Senioritybased

Moderatelinkage

Russia

MiddleEast

Joblevel
based

Nationality group and


joblevel

BS,FB,NMB BS,HA,AA,FA,AF/VT,SF,
VBIncentives.
Poorlinkage ModerateLinkage

BasisofIncreaseAnnual
increase

meritSeniority and age,Seniority inJobLevel


performance ratings,Joblevel
spring
wage
negotiation
Achievement
Hierarchy;Patience Material
MaterialPossessions
orientation
Possessions Statusseniority
Materialpossession

Influencing
Cultural
variables

BSBasicSalary,VBVariablebonus,LTILongternincentives,CBCCompulsory
benefitcontributions,VBCVoluntarybenefitcontribution,MWMonthlywage,BA
BasicAllowance,OTOvertime,FBFixedBonus,NMBNonmonetarybenefits)

Approachestoexpatriatearecompensation:

Working within the components described above, MNCs seek to tailor


remuneration packages to fit with the specific siuation. For example,
senior level managers, in Japan are paid four times more than their
juniorsstaffmembers.ThisissharpcontrasttotheUS,wherethegapis
much higher. Many senior level managers in Europe are paid much
lessthantheirUScounterparts.

In designing an expatriates remuneration, firms generally follow a


numberofapproaches.Themostcommonaretwo:

1. TheBalancesheetorHomenetsystem
2. ThelocalGoingratesystemorlocalizationsystem

BalanceSheetApproach:

Whichinvolvesensuringthattheexpatriatesismadewholeanddoes
notlosemoneybytakingtheforeignassignment.Thebasicobjectiveis
tomaintainthehomecountrylivingstandard,plusoffersomefinancial
inducement

Thus,itlinksthesalaryofexpatriatesandTCNstohomecountrysalary
structure.

Thekeyassumptionisthatforeignassigneesshouldnotsufferfinancially
duetotransfers.Thesalarypackageisdividedintofourparts:

GOODS AND SERVICES FOOD, PERSONAL CARE, CLOTHING,


HOUSEHOLDFURNISHING,RECREATION
HOUSING:Majorcostassociatedwithhostcountry
INCOMETAXESParentcountryandHostcountryincometaxes
RESERVE CONTRIBUTIONS TO SAVINGS, PAYMENTS FOR
BENEFITS, PENSION CONTRIBUTIONS, INVESTMENTS, EDUCATION
EXPENSES,SOCIALSECURITYTAXES

When costs associated with the host country assignment exceed


equivalent costs in the parent country, the firm and expatriates,

together meet these costs to ensure that parent country equivalent


purchasingpowerisachieved.

Forexample,ifUSnationalispostedinIndiaandsupposethedollar
exchangerateis$1=Rs.50/andCOLAIndexis5,thenthebreakup
oftheannualpaywillbe:

Item
Amount in $ per Paid in $ in Paid in Rs. In
yearinUS
India
India
Basepay
1,00,000
60,000
20,000,00
Cost of living 10,000
Nil
5,00,000
allowance

Overseas

allowance
20,000
20,000
Nil
Hardship

allowance
5,000
5,000
Nil
Housing

deduction
10,000
- 10,000
Nil
Income
tax

deduction
30,000
30,000
Nil
Totalpay
$95,000
$45,000
Rs.25,00,000

Advantages:
Expatriateisguaranteedhishomecountryspendingpower.
Easytocommunicatetoemployees

Disadvantages:
Threeproblemsfacedinapplyingthissystemare:
1. Recalculatingthesalaryfromgrosstonetandviceversa.
2. Ingrossingupthenetincomeinthehostcountry,thereshouldbe
strictly identical items (same car and housing). This is the
difficulty.
3. Canresultindisparitiesbetweenexpatriatesofdifferentcountries

2.GoingRateApproach:

In this, expatriates are paid according to the host country salary


structures.

Based on local market rates the base salary is linked to the


salarystructureinthehostcountry.
Base pay and benefits may be supplemented by additional
paymentsforlowpaycountries.

Advantages
Equalitywithlocalnationals
Simplicity
Identificationwiththehostcountry
Equityamongdifferentnationalities

Disadvantages
Variationbetweenassignmentsforsameemployees
Variation between expats of same nationality in different
locations (Indian expatriated to the US may be
compensated better than those assigned to a developing
country) Potential reentry problems ( on return to home
country, the expats. finds that his or her compensation is
lowerthanthatofthehostcountry.

TheStandardPolicyofCompensationmanagementrequired:

A) The knowledge of employment and taxation laws: customs, cost


of living index, environment, employment practices of various
countries.

B) The knowledge of labour markets and industry norms regarding


benefitsandcompensations.

C)
The knowledge of foreign exchange rate fluctuations and
monitoring rate of inflation or cost of living Index in different
countries.

D) Theknowledgeandclearconceptionaboutthevisionandmission
of the company, its corporate philosophy regarding managing
humanresources,itscorporatestrategyofgrowthorstabilityand
strategy of its business units regarding cost, leadership,
differentiationandinnovation


Conclusion:

Higherbasicsalarywithlowerbenefitsandincentivesor
Lowersalarywithhigherlevelofbenefitsandincentives,maynot
motivatedtheexpatriatesandtherefore,requiredhighdegreeof
expertise / standard policies for MNCs specially in the field of
compensationmanagement.
Thepolicydecisionsshouldbeconsistentwiththeoverallstrategy
structureandbusinessneedsofthemultinationals.
The policy should be attract and retain the best staff in those
areas where the firm has greatest needs and opportunities and
whereitscorecompetencies.
Thepolicymustfacilitatethetransferofinternationalemployees
inacosteffectivemanner.
The policy should give due consideration to equity case of
administration.

PreparedbyDr.ShyamalGomes

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