Chapter 11 Establishing Rewards and Pay Plans_

CHAPTER 11
ESTABLISHING REWARDS AND PAY PLANS
CHAPTER OVERVIEW
The opening vignette illustrates the success of FirstMerit Bank in increasing checkprocessing speed and accuracy via a pay-for-performance plan. Employee turnover
was reduced while pay was doubled. Effective incentives and compensation are
discussed to improve performance in the most monotonous jobs. Pay is presented as
one type of organizational reward which can be used to motivate performance if
administered correctly. Complying with laws, evaluating the relative worth of jobs, and
comparing pay to current labor market data are HRM activities that contribute to
effective compensation administration. Todays incorporation of incentives, competencybased pay and team-based pay are discussed, as well as issues relevant to executive
and international compensation.
Additional Features of this Chapter
Exhibit 11-1 provides an overview of the different types of rewards.
Exhibit 11-3 illustrates a point method job evaluation system.
Exhibit 11-4 illustrates a wage curve.
Exhibit 11-5 illustrates a six pay range wage structure.
An Ethical Decisions box presents information on both sides of the issue of
whether we are paying executives too much.
A Workplace Issues insert on "Job Enrichment discusses the process of giving
employees increased planning and control of their work, usually with less
supervision and more self-evaluation. It highlights the proper way to establish a
job enrichment program and touches on the potential benefits.
Did You Know: Compensation in the Global Village compares minimum wage
rates and average work hours for several countries.
ADDITIONAL LECTURE OR ACTIVITY SUGGESTIONS
Several controversial current issues make this a good topic area for scheduling a
formal in-class debate. Executive pay, comparable worth, team-based incentives, and
competency-based pay, for example, are excellent topics for students to research and
present the pros and cons.
Students often confuse job evaluation with performance evaluation. Clarify by
explaining that the purpose of job evaluation is to compare the relative worth to the
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company of different jobs, or having different types of work done. A jobs evaluation
should remain the same regardless of who is hired to do the job. Performance
evaluation, on the other hand, is based on the accomplishments of an individual
employee within the job. New, competency-based systems recognize the difficulties of
separating the value of a persons skills from the value of the work performed.
The concept of pay structures can seem complex, especially the procedures used to tie
together salary survey information and job evaluation points using benchmark jobs. Its
helpful to use the concepts of internal equity (determined through job evaluation);
external equity (determined using salary surveys); and individual equity (determined by
fairly evaluating an individual to place him/her within a pay range). Its also beneficial
to take students step-by-step through the process of designing a simple pay structure.
They can be given a simplified point rating system to evaluate some jobs they are
familiar with. Then, you can provide salary survey information on some benchmark
jobs, which they should also evaluate. The pay curve determined using the benchmark
jobs can be used to determine the fair pay for the other jobs they have rated.
CHAPTER OUTLINE AND LECTURE SUGGESTIONS
I. Introduction
A. People do what they do to satisfy some need and they look for a payoff or
reward.
B. The most obvious reward is pay, but there are many others, including
promotions, desirable work assignments, peer recognition, and work freedom.
II. Types of Employee Rewards
A. Intrinsic versus Extrinsic Rewards
1. Intrinsic rewards (personal satisfactions) come from the job itself, such as
pride in ones work, feelings of accomplishment, or being part of a work team.
2. Extrinsic rewards come from a source outside the job; they include rewards
offered mainly by management, such as money, promotions and benefits.
B. Financial versus Nonfinancial Rewards
1. Financial rewards include wages, bonuses, profit sharing, pension plans,
paid leaves, and purchase discounts.
2. Nonfinancial rewards emphasize making life on the job more attractive;
employees vary greatly on what types they find desirable.

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C. Performance-based versus Membership-Based Rewards

1. Performance-based rewards, such as commissions, piecework pay plans,
incentive systems, group bonuses, and merit pay, are tied to specific job
performance criteria.
2. Membership-based rewards such as cost-of-living increases, benefits, and
salary increases are offered to all employees.
III. Compensation Administration
A. The process of managing a compensation program so that the organization can
attract, motivate and retain competent employees who perceive that the program
is fair.
B. Job evaluation is the process which is used to determine each jobs appropriate
worth within the organization. It is based on job analysis information.
C. Government Influence on Compensation Administration
1. Fair Labor Standards Act: 1938 act which requires minimum wage,
overtime pay, record-keeping, and child labor restrictions.
2. Exempt employees, which include professional and managerial employees
are not covered under FLSA overtime provisions.
3. Nonexempt employees are eligible for premium pay (time and one-half)
when they work more than 40 hours in a week.
4. The Civil Rights and Equal Pay Acts
a. Equal Pay Act of 1963 act requires that men and women hired for the
same job be paid the same.
b. Civil Rights Act: Is broader than Equal Pay Act; prohibits discrimination
on the basis of gender; is used to support comparable worth concept.
c. Salaries should be established on the basis of skill, responsibility, effort,
and working conditions.
IV. Job Evaluation and the Pay Structure
A. Job Evaluation
1. Use of job analysis information to determine the relative value of each job in
relation to all jobs within the organization.
2. The ranking of jobs within an organization is only one type of information
considered in designing a pay structure. Labor market conditions, collective
bargaining, and individual skill differences are others.
B. Isolating Job Evaluation Criteria
1. Judgment is involved in defining what factors should be used to compare
jobs.
2. Typical criteria are mental requirements; supervisory control; complexity;
physical demands; and personal contacts.
3. Typically jobs are grouped according to type and compared within their
group; for example, clerical jobs; sales jobs; professional jobs.
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C. Job Evaluation Methods

1. Ordering method: A committee places jobs in a simple rank order from
highest (worth highest pay) to lowest.
2. Classification method: Jobs are placed in classification grades
by
comparing their descriptions to the classification description and
benchmarked jobs and looking for a common denominator such as skills,
knowledge, or responsibility.
3. Point method: Jobs are rated and allocated points on several identifiable
criteria, using clearly defined rating scales. Jobs with similar point totals are
placed in similar pay grades. The point method offers the greatest stability.
D. Establishing the Pay Structure
1. Compensation surveys are used to gather factual data on pay rates for
other organizations or areas where you are competing for employees.
Information is often collected on associated employee benefits as well.
2. Wage curves are drawn by plotting job evaluation data (such as job points or
grades) against pay rates (actual or from survey data). These graphs
indicate whether the pay structure is logical, and can be used to determine
the pay rates for jobs where good external comparisons are not available.
3. The wage structure designates pay ranges for groups of jobs which are
similar in value to the organization and which are grouped by their
classifications, grades or points. This should result in a logical hierarchy of
wages, consisting of ranges that overlap.
V. Special Cases of Compensation
A. Incentive Compensation Plans: Incentives can be added to the basic pay
structure to provide rewards for performance.
1. Individual Incentives: These include merit pay plans (annual increase,
based on performance); piecework plans (pay based on number of units
produced typically in a specified time period.); time-savings bonuses and
commissions.
a. Work best where clear objectives can be set and tasks are independent.
b. Many organizations today require employees to place a percentage of
their salary at risk so that merit pay does not become a substitute for
automatic cost-of-living raises.
2. Group Incentives:
Incentives can be offered to groups, rather than
individuals, when employees' tasks are interdependent and require
cooperation.
3. Plant-wide Incentives: These direct employee efforts toward organizational
goals (such as cost reduction) and include the Scanlon Plan (supervisor and
employee
committees
suggest
labor-saving
improvements)
and
IMPROSHARE (formula is used to determine bonuses based on labor cost
savings).

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B. Paying for Performance

1. Pay is based on some measure of performance. Common performance
measures are: piece-rate plans, gainsharing, wage incentive plans, profit
sharing and lump sum bonuses.
2. Pay for performance is gaining in popularity and is useful both for motivation
and cost control.
3. Competency-based compensation
a. Individuals are rewarded for the skills, knowledge and behaviors they
possess such as leadership, problem solving, decision making, or
strategic planning.
b. Broad-banding refers to pre-set pay levels that determine what people
are paid based upon the type and level of competencies they possess.
C. Team-Based Compensation
1. Organizations today use team-based rewards as incentives for empowered
work teams to exceed established goals and share equally in rewards.
2. Effectiveness of team-based compensation depends on clarity of team
purpose and goals, ability of the team to obtain needed resources, and
effective team communication skills and trust.
VI. Executive Compensation Programs
A. Salaries of Top Managers
1. Executive salaries, bonuses and stock options may seem high; the top twenty
CEOs average more than $100 million in total compensation.
2. Competition for executive talent raises the price of hiring an executive.
3. High salaries can be a motivator for executives and lower-level managers
aspiring for top positions.
B. Supplemental Financial Compensation
1. Deferred bonuses are paid to executives over extended time periods, to
encourage them to stay with the company.
2. Stock options allow executives to purchase stock in the future at a fixed
price, which can serve as a performance-based incentive to improve
profitability.
3. Some executives are offered hiring bonuses to compensate for the deferred
compensation they lose when leaving their former company.

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C. Supplemental Nonfinancial Compensation: Perquisites

1. Perks may include paid life insurance, club memberships, company cars,
expense accounts, interest-free loans, free financial, legal and tax
counseling, mortgage assistance, etc.
2. Golden parachutes protect executives when a merger or hostile takeover
occurs by providing severance pay or a guaranteed position.
VII.

International Compensation:

A. It is important to understand the statutory requirements of each country.

International compensation packages generally utilize the balance-sheet
approach, using the four factors below:
B. Base Pay: The pay of employees in comparable jobs at home. (Complexities
include narrow pay ranges in foreign countries, foreign laws & currencies,
taxation).
C. Differentials: Compensation given to offset higher costs of living abroad.
D. Incentives: Inducements given to encourage employees to accept overseas
assignments.
E. Assistance Programs: Payment for expenses involved in moving a family abroad
and in providing some services overseas.
DEMONSTRATING COMPREHENSION: Questions for Review
1.

Contrast intrinsic and extrinsic rewards.

Intrinsic rewards are those things that are internally satisfying to the individual
worker, such as satisfaction with the work or meaning of the job itself. Extrinsic
rewards are external to the work itself money, promotions, benefits.

2.

How do financial and nonfinancial rewards differ?

Financial rewards are wages, bonuses, profit sharing, pension plans, vacations,
sick leaves that increase and ensure stability in the financial position of the
employee. They make life better off the job. Nonfinancial rewards are such
things as perks and status which make life on the job more attractive.

3.

What is a membership-based reward? How does it differ from a performance-based reward?

A membership-based reward is received for simply belonging to the organization
or a particular group. Employee benefits are an example of membership-based

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rewards, in that every employee gets them irrespective of performance levels.

Performancebased rewards are tied to some measure of job performance.
4.

What is compensation administration? What does it entail?

Compensation administration is the process of managing a company's
compensation program. Compensation administration seeks to design a costeffective pay structure that will not only attract, motivate, and retain competent
employees, but also be perceived as fair by these employees.

5.

How do governmental influences affect compensation administration?

Governmental influences affect compensation administration in several ways by
mandating certain practices. For instance, the Fair Labor Standards Act sets
minimum wage and overtime pay requirements. Both federal and state
governments have passed laws that require government contractors to pay
prevailing rates. The Equal Pay Act protects employees from unequal pay based
solely on gender.

6.

What is job evaluation? Discuss the three basic methods of job evaluation.
Job evaluation systematically determines the value of each job in relation to all
jobs within the organization. There are three basic approaches to job evaluation:
ranking, classification, and point method.
In the ranking method, jobs in the organization are compared to each other and
ranked from most important to least important.
In the classification method, jobs are slotted into predefined job grades, based
on skills, knowledge, and ability.
The point method is the most commonly used method of job evaluation. Points
are assigned to the degrees of each job element, jobs are rated on each element
and the total points are summed. Dollar amounts are established for point values
by determining the market value of key, or benchmark jobs and where they fit
into the structure.

7.

What are the advantages and disadvantages of (a) individual incentives, (b)
group incentives, (c) organization-wide incentives?
Individual incentives are performance based and are used to reward good
individual performance that benefits the organization. The disadvantage is that
the correct criteria to measure for rewards may be difficult to determine.
Individual incentives are inappropriate when group effort is needed to perform
the task or when the individual's work is not truly reflected in the end product.
Group incentives have the advantage of rewarding good team performance. The
disadvantage is that some team members may be slackers, and competition
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between teams may produce unfavorable organizational consequences. Group

incentives are inappropriate when individual effort is what is desired.
Organizationwide incentives have the advantage of making the goals and
accomplishments of the organization very visible to all employees. The
disadvantage is that workers may feel cheated if they feel their efforts are not
reflected in the incentive rewards given to everyone in the organization.
8.

What is broad-banding and how does it work?

Broad-banding refers to pre-set pay levels in competency-based compensation
plans. These pay levels reflect the degree to which employee behaviors such as
leadership, problem solving, decision-making or planning, exist as well as
knowledge of the business and its core competencies.
LINKING CONCEPTS TO PRACTICE: Discussion Questions

1.

Would you rather work for an organization where everyone knows what
others were earning or an organization where this information is kept
secret? Why?
Open salary system: Everyone knows how salaries are determined and who is
being rewarded the most. This may help to clarify the reward system so that
individuals know what to do to move up financially. Openness also opens up the
possibility of perceived unfairness and resentment if employees do not agree
with the system.
Closed salary system: A perception of equity is not as difficult to maintain when
no one really knows what anyone else is making. On the other hand, what they
imagine may be much less fair than reality.

2.

Subjectivity can be successfully removed from the compensation administration process. Build an argument for and against this statement.
Pro: As in the earlier chapter on performance evaluation, subjectivity can be
minimized with several techniques. Treat similar cases in the same way.
Establish a pay system which is tied to the worth of the job or the value of
individual competencies to the organization. Make sure that evaluation criteria
are valid and that individuals are rated by more than one evaluator. Utilize
external salary data as one tool in determining internal salaries. Openly
communicate the components of the pay system to employees. Train managers
in the effective use of the system.
Con: You can never entirely remove subjectivity from a compensation plan. One
reason is that a compensation plan is typically established based upon the value
that positions are perceived to have to the organization. Another reason is that
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when performance evaluations are considered in determining salaries, it in itself

brings an element of subjectivity to the process.
3.

Team compensation allows some individuals to work harder than others,

yet receive the same pay. Do you agree or disagree? Defend your
position.
Disagree. Team members who do not contribute equally to the attainment of
team goals will not last long as a member of the team. Successful teams have
members who respect one another, effectively communicate with one another,
and treat each member fairly and equitably. Members who do not measure up to
these standards are subject to peer pressure to change or leave.

4.

U.S. executives earn every dollar of their pay. People who complain about
these people earning millions are just envious that they are not being paid
at that level. Build an argument for and against this statement.
For: Top company executives have tremendous organizational responsibilities.
They often work long hours six or seven days a week. Their jobs typically
require a high level of skills, knowledge, and abilities. Incentive pay encourages
them to excel.
Against: U.S. executives make two to five times the salaries of their foreign
counterparts. They typically receive large base salaries regardless of the
companys performance. Should they be fired, they often receive large
severance packages. There are numerous examples, such as Enron, where
executives obviously put their personal well-being before that of the company, its
employees, and stockholders.
CASE APPLICATION 11-A: IS IT MERIT OR NOT?

CASE SUMMARY
Cisco and AFLAC have opposite compensation strategies. Cisco is increasing
base salaries and looking at annual pay increases. AFLAC, on the other hand,
keep base-pay low and focuses heavily on pay-for-performance.
1.

From the material presented in the case, how would you describe the basic
compensation philosophy of Cisco and AFLAC respectively?
Cisco is increasing base salaries and looking at annual pay increases, which is
more membership-based. AFLAC, on the other hand, keeps base-pay low and
focuses heavily on pay-for-performance.

2.

What factors are

organizations?

effecting

the

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3.

Need to increase productivity.

Retaining the most highly skilled employees.
Growing the organization.
Reducing labor costs.

If all things were equal, would you prefer to work in a Cisco-type

organization where higher base salary and annual increases (assuming
successful performance, of course) dominate, or an AFLAC-type
organization where base salaries are lower, but incentive pay based on
performance can significantly add to your total compensation? Explain
your position.
Student answers will/may vary. Suggestions are below:
Cisco-type organization rewards longevity in a fast-paced, highly-mobile
technology industry where all or most employees have marketable skills.
Rewards with higher base pay and raises.
AFLAC-type organization rewards performance in the traditional insurance
industry where productivity is more tied to quantifiable benchmarks. Rewards
harder working employees in terms of incentive pay.
CASE APPLICATION 11-B: TEAM FUN!

CASE SUMMARY
Tony is concerned about how Kenny and Norton decide who will be paid what.
He has explained that he cant find any pattern or rationale. Salary information
is kept confidential. The whole area of salary administration makes Tony
uncomfortable.

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1. Make lists of TEAM FUN! rewards: extrinsic vs. intrinsic; financial vs.
nonfinancial; performance-based vs. membership-based.
EXTRINSIC VS.
INTRINSIC
Profit-sharing
Team rewards
Eye insurance
Interesting work
BC/BS
insurance
Vacation
Group bonus
Retirement

FINANCIAL
VS. NONFINANCIAL
Profit-sharing
Play breaks
Eye insurance
wellness program
BC/BS insurance
Picnic
Vacation
Week to try new
equipment
Group bonus

PERFORMANCE-BASED
VS. MEMBERSHIPBASED
Group bonus
profit-sharing
Eye insurance
BC/BS insurance
Vacation
Group bonus
Retirement

It should be noted that the groups are not mutually exclusive and that there is
much overlap.
2.

Evaluate the appropriateness of these rewards for maintaining commitment

for employees of TEAM FUN! Does the compensation system of TEAM
FUN! meet the general goals of a compensation system?
TEAM FUN!s rewards are a blend of extrinsic and intrinsic and seem to have
worked well so far. However, any company that wants to maintain a strategic
advantage must try to make its reward system as attractive as its competitors.
Tony should survey his employees and see what they like best, what theyd like
that the company doesnt offer and what they would like to see changed.
The goals of compensation administration are to design a cost-effective pay
structure that will attract, motivate, and retain competent employees. Tony has
commented on a couple of benefits that are expensive (the BC/BS health
insurance and the four weeks vacation) and could perhaps be redesigned to still
be effective, but would not cost the company as much.

3.

Make three suggestions to improve the TEAM FUN! compensation system.

The benefits package could be redesigned to offer a core-plus option. As the
company continues to grow and diversify its workforce, employees will not all
have the same needs. Allowing them choices will increase their level of
satisfaction.
Setting up a Section 125 cafeteria plan will let employees save money by paying
for health-related expenses and childcare with pre-tax dollars.

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Employee Assistance Programs (EAP) have proven themselves to be very costeffective. They help reduce absenteeism due to personal problems and allow
employees to say focused on work.
4.

Identify three features of the compensation system that are excellent for
this organization. Would they be suitable for most organizations? What
types?
The week to try out new equipment is a benefit for the employee in terms of a
pleasant, non-stressful event, and its beneficial for the company because they
can get employee feedback on the products they sell. Because the company
places a lot of attention on promoting team effort, the group bonuses also work
well. The play breaks are well-received by TEAM FUN!, too. They serve as
great stress reducers and are most appropriate for a company called TEAM
FUN!
The week to try out new equipment and the play breaks would probably not be
suitable for most organizations. The loose structure currently endorsed by
Kenny and Norton would need to be replicated. Group bonuses would work if a
companys product lent itself to a team approach in production and marketing.
WORKING WITH A TEAM: UNDERSTANDING INCENTIVE PLANS

OVERVIEW
Students interview a compensation specialist using questions suggested in the text.
They summarize their results in a written report or brief presentation. Information can
also be shared and compared in class teams.
SUGGESTIONS/VARIATIONS
Students can also interview managers or owners of small businesses that do not have
a compensation specialist. Questions might include:

How do you determine wages and salary levels for your employees?
How do you ensure that the pay you offer is adequate to attract the types of
employees you need? How do you ensure that pay is perceived as fair?
Do job applicants or employees ever negotiate for pay? How do you handle the
negotiation process? Do you ever pay hiring bonuses?
Have you ever thought of changing pay systems? Why?
Do you offer any incentives to your employees? What are they and how do they
work?

Ask students to find salary information for a particular job category they are interested
in. They may contract professional associations, check out web sites, review
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employment ads, check out their University Career Center, or call compensation
specialists at companies that hire for their target job.

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