3.2 - Compensation Concepts

Unit 4, Lecture 1: Compensation Concepts
COMPENSATION CONCEPTS
Prof. John Kammeyer-Mueller MGT 4301
Plan
Where we are
Understand the legal framework for compensation Have a few principles related to compensation known
Where we want to be
Understand
some of the basic ideas underlying compensation plans
How we know how were doing

How
can we figure out how much a job should be paid? How does justice factor into the compensation system? Unit 4, Lecture 1: Compensation Concepts
Major Principles in Setting Wages
Market pay
Employees should be paid what other people in similar jobs in the external labor market are being paid should be paid based on difficulty of a job, the demands on workers, and the level of qualifications required judge how much they should be paid based on their subjective assessment of what other people like them are being paid
Job analysis
Employees
Distributive justice and social comparison

Employees
Market Pay and Wages
Why compare to market wages?
If firms are wage takers, they cannot afford to pay less than competitors If firms are in a highly competitive industry, they cannot afford to pay more than competitors
Salary surveys
Sent
out (usually by consulting firms) asking employers to tell how much they pay workers. Results are sold on the open market. If you want a raise, check out this link
Trends in Wages
9 8.8 8.6 8.4 8.2 8 7.8 7.6 7.4 7.2 7
Average Hourly Earnings, 1982 Dollars
19 68 19 71 19 74 19 77 19 80 19 83 19 86 19 89 19 92 19 95 19 98 20 01 20 04 20 07
Factors that Change Market Wages
Supply side changes

Education
level Demographic shifts (baby booms and busts) Immigration
Demand side changes

Technology Market
for domestic goods and services International markets for goods and services
Technology and Employer Demand
Complements in production
Complementary
technology makes workers more productive, and therefore increases employer demand (MRP of labor increases along with MRP of capital) technology replaces workers because the MRP of capital becomes greater than the MRP of labor
Substitutes in production
Substitute
Technology and Employer Demand
Complements and substitutes in action

Computers
complement the skills of professionals and creative workers by making their productive activities faster and less expensive to accomplish Computers substitute the skills of clerical workers by making it possible to completely eliminate jobs like typists, filing clerks, and phone operators Result: increasing wage gap based on skills
International Perspectives on Technology
Why do some countries specialize in low-wage labor and others specialize in high-skill labor?

Increasing levels of industrialization increase the need for education, which reduces birth rates Reductions in birth rates reduce the supply of labor Drops in the supply of labor increase the MRP of labor relative to capital Higher capital investments favor skilled workers
The movement of low-wage manufacturing across Asia during industrialization shows this process at work
Supporting Evidence
Efficiency Wage Theory and Above Market Wages
Above market wages are rational for some firms

Reduces
shirking with imperfect monitoring
managers cant watch you all the time to pressure you to work harder, but the threat of firing motivates workers to never be caught goofing off
Minimizes
turnover and replacement costs Ability to attract more qualified candidates
Shown in A. Barber, 1998, Recruiting Employees; Barker and Bretz, 2000, Compensation in Organizations
Issues for the Market Wage Approach
How do you define the market for a job?

New
England, California, Hawaii and Alaska have the highest cost of living; the South and Midwestern states are lowest. In some fields, relocation is expected A survey of 35 compensation specialists said that the most important factor for evaluating the relevance of a salary survey was the region of the country where the firm was located; working conditions, industry, or size were less important
Viswesvaran & Barrick, Journal of Applied Psychology, 1992
How do you define the market for a job?

The
market of other jobs in the same industry or from different industries?

Nonprofit
industry jobs pay less Some industries require more qualifications or work of the same job title than others As noted earlier, profitable firms do tend to pay quite a bit more Large firms usually pay more, and will compare themselves to other large firms
What if your jobs are unlike the market?
Job titles are seldom sufficient to establish similarity Worth of a job to a company varies considerably
Authority
based on company structure Importance of tasks based on niche and strategy Possibility for advancement effects Unit 4, Lecture 1: Compensation Concepts wages
Job Evaluation Approach
Focus is on the value of the job to this company

Evaluate
jobs using job analysis Estimate the worth of various KSAOs, decision making requirements, and working conditions for jobs
Considering the job of an employee in your final project company, what does this internal approach add?
Determining compensible factors
Compensible factor: a feature of a job that you believe should be compensated What sorts of things lead to increased pay for most workers?
KSAOs Decision
making authority Working conditions
Compensible Factors From an Economic Angle

wages employee indifference curve employer indifference curve
q*
s*
stress
Employees and employers derive equal utility from any point along the indifference curve The equilibrium stress/wage level is s* and q* Workers with different indifference curves will not work at this company Unit 4, Lecture 1: Compensation Concepts
A Small Danger in Doing Job Evaluations
Determining compensible factors
Concerns with compensible factors

Evidence
suggests that compensation committees can stereotype jobs Political processes

Managers
argue to increase wages for their
division Desire to increase average qualifications Powerful divisions of a company may be overpaid
What compensible factors look like in the market overall

Usa dr i e nt nadzd Cefce t ofi i ns Cn o vra l s ot l ai be r Pr e tf me ecn e a l Pr e tue p yd ecn nm oe l Pr e tui nzd ecn n i e o J b hr cei tc o c aat rsi s Pyi a D a d hscl e ns m Cgii eD a d on v e ns t m E o oa LbrD a d m i nl a o e ns t m M eR o l d
2
Pr e t g ecn e a I pra c m t ne o Wgt eh i * * * * * * * * * * * * * * 94 . % 8 2. 5 3 % 6 21 . % 8 41 . % 1 5. 9 6 % 5 31 . % 0
-. 0 04 -. 2 05 .0 06 -0 6 . 5 0 02 . 6 3 -0 7 . 8 0 07 . 7 7
Source: Glomb, T.M., Kammeyer-Mueller, J.D., & Rotundo, M. (2005). Emotional labor and compensating wage differentials. Journal of Applied Psychology
Distributive justice concepts
Equity: a persons perceptions that they are paid comparable to individuals in other similar jobs
OS/IS:OO/IO
Example: dollars per hour worked Monkeys and distributive justice Ancient Israel examples !Kung people divide their hunt Concepts of justice in Ancient Greece Indian concept of karma is related
This is robust across species:
This appears to be robust across cultures:

Distributive Justice Concepts: Conceptual Difficulties

Relatively Simple Case Simplest Case Hours Chris Gene 8 8 Pay $80 $80 Ratio 1:1 1:1 Result Fair Fair Chris Gene 8 4 $80 $80 1:2 2:1 Underpaid; reduce hours Overpaid; change comparitor Result Unfair Fair Result Fair? Fair Unit 4, Lecture 1: Compensation Concepts Hours Pay Ratio Result
Complicated Case # 1 Hours Chris Gene Educ. Chris Gene 12 yrs. 16 yrs. 8 6 Pay $80 $80 Pay $12/hr $16/hr Production 50 units Ratio 6 : 8 (hours)
50 units 50 : 50 (output) Complicated Case # 2 Ratio 12 : 16 (money) 1 : 1 (money & educ.)
A Humorous Perspective on Distributive Justice
A Picture of Internal and External Equity Comparisons

Regents Hospital Mount Sinai Hospital
Dr. Hayes
external internal
Director Clinton
Dr. Worrell
internal
Dr. Collins
external
St. James Hospital

Dr. Brown
internal
Nurse DeVoid
Distributive justice and compensation systems
External equity: employee perceptions that they are paid comparable to individuals in other similar jobs
Results of underpayment inequity? Results of overpayment inequity?

Distributive justice and compensation systems
Internal equity: employee perceptions that they are paid comparable to individuals in other jobs in the same organization
Results
of underpayment inequity? Results of overpayment

Rent Sharing, Justice, and Wages: Implications for Pay and Firm Profit
Consider a highly profitable pharmaceutical company like Merck
They need to pay their research scientists a high wage because they lead directly to firm profitability and having an above-average base of scientists is directly related to how profitable they can be An accountant at Merck may receive more than the market wage simply because the desire to create an internally consistent wage policy leads the firm to pay everyone commensurate with other above-marketCompensation Concepts wages Unit 4, Lecture 1:
Trends in Wage Dispersion (from Social Security data)
Potential Explanations for Wage Dispersion

Declines in unionization Increased need for skilled workers because of computerization (as noted earlier) The service sector tends to generate low skilled jobs with short duration of employment The increased dispersion is seen both across and within organizations
Cappelli,
Bassi, Katz, Knoke, Osterman, and Useem, Change at Work, 1997

The Case of Executive Compensation and Internal Equity
I think it is unconscionable when the guy who is the head of Countrywide and his co-conspirators make huge amounts of money when Americans face the threat of losing their homes. If there's ways we can motivate shareholders and boards of directors to punish these people we should do it.
John McCain
I cannot imagine a position more selfish and greedy at a time of national crisis. So, I would like to speak directly to those CEOs right now: Do not make that mistake. The enormous rewards that you've reaped come with serious responsibilities to your workers, to your shareholders, to the American people. And we expect and demand that you live up to those responsibilities.
Barack Obama
HR in the News: College Sports Coach Salaries

QUESTION- Do coaches deserve such large salaries? EXAMPLE- At least 23 college football coaches now earn $1 million. REASON- The rapid increase of bowl money and television contracts has powered the escalation in salaries. Is it wrong to pay a coach more than the president of the university? YES!
Hurts the integrity of the American university. A person coaching football makes more than professors teaching future doctors and lawyers Programs generate lots of money. Must pay coaches top dollar to keep them from going to the NFL. Students and Alumni love athletics. Coaches work many hours and there are intense expectations.
NO!
The Case of Executive Compensation and Internal Equity
Why are CEOs popular targets?
They have a lot of money and power Beliefs that markets should be consistent with principles of justice and fairness They are a psychological outgroup
Few
people personally know CEOs Their background and life stories are atypical Few people really know quite what they do
Variations in Job Structure: Executive Compensation

CEO compensation as a proportion of log annual salary of factory workers
From BusinessWeek
1000
100
10
19 80 19 85 19 90 19 95 20 00
The average CEO of a major corporation made 42 times the pay of an average American factory worker in 1980. By 2000 the ratio was 458 times the typical factory workers pay. This is clearly exponential growth (because the chart has a log transformation on the outcome axis)
Why is this happening?
Those Poor Corporate Vice Presidents
CEO Compensation as a Multiple of Lowest Paid Employee Salary 10 20 30 40 50 0

Br az il M ex ic o Br i ta in C an ad a Ita ly Sp ai n Fr an ce Ta iw an G er m an So y ut h Ko re a Ja pa n
60
Comparison of Executive Compensation (not just large corporations)
Executive Compensation in Bad Times: An Employee Perspective
HR in the News: A Shareholders Perspective on Internal Inequity
Proposal- Limit the Chiefs pay at seven companies to a figure that is 100 times that of the average worker.
Proposed by- Daniel J. Steininger, chairman of the Catholic Funds, a $30 million fund company Shareholders be allowed to vote on the compensation If the C.E.O. is making more than 100 times the salary of the average worker, then the C.E.O. must be able to justify this salary.
Idea
"We're trying to get at the notion of economic injustice in what the C.E.O. is making compared to the average worker," he said. Similar proposals are before congress currently
Who Sticks up for CEO Pay?
Compensation analysts and some economists argue
Fairness and efficiency are sometimes opposed Some economists (e.g., Kevin Murphy) even argue that CEO pay is insufficient to serve as a motivator Murphy also has argued that regulating CEO pay seldom works because they find other ways around the system CEOs manage an enormous amount of financial risk and most compensation is based directly on firm valueUnit 4, Lecture 1: Compensation Concepts Determining how much is enough becomes
Tournament Theory and CEO Pay
Top executives earn extraordinary wage premiums at the expense of other executives
Reaching
the CEO post is like winning the Superbowl or the Masters Golf Tournament The huge incentive to come in first (and the fact that second place is the first loser in a very real sense) means that everyone works extremely hard to get the job Ongoing competition keeps a constant threat on the CEO, who constantly risks being knocked off the top post Lazear, Personnel Economics, 1998 Unit 4, Lecture 1: Compensation Concepts
Wrap Up
Where we are

Understand the basics of organizational socialization Understand performance appraisal processes Understand some of the basic ideas underlying compensation plans What is the Fair Labor Standards Act and how does it apply to compensation? How does justice factor into the compensation system? How can we figure out how much a job should be paid?
Where we want to be
How we know how were doing

3.2 - Compensation Concepts

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Unit 4, Lecture 1: Compensation Concepts

some of the basic ideas underlying compensation plans

How we know how were doing

Major Principles in Setting Wages

Distributive justice and social comparison

Market Pay and Wages

Why compare to market wages?

Average Hourly Earnings, 1982 Dollars

Factors that Change Market Wages

Supply side changes

level Demographic shifts (baby booms and busts) Immigration

Demand side changes

Unit 4, Lecture 1: Compensation Concepts

Technology and Employer Demand

Unit 4, Lecture 1: Compensation Concepts

Technology and Employer Demand

Complements and substitutes in action

International Perspectives on Technology

Unit 4, Lecture 1: Compensation Concepts

Efficiency Wage Theory and Above Market Wages

Above market wages are rational for some firms

shirking with imperfect monitoring

turnover and replacement costs Ability to attract more qualified candidates

Issues for the Market Wage Approach

How do you define the market for a job?

Viswesvaran & Barrick, Journal of Applied Psychology, 1992

Unit 4, Lecture 1: Compensation Concepts

Issues for the Market Wage Approach

How do you define the market for a job?

market of other jobs in the same industry or from different industries?

Unit 4, Lecture 1: Compensation Concepts

Issues for the Market Wage Approach

What if your jobs are unlike the market?

Job Evaluation Approach

Focus is on the value of the job to this company

Determining compensible factors

making authority Working conditions

Unit 4, Lecture 1: Compensation Concepts

Compensible Factors From an Economic Angle

A Small Danger in Doing Job Evaluations

Unit 4, Lecture 1: Compensation Concepts

Determining compensible factors

Concerns with compensible factors

suggests that compensation committees can stereotype jobs Political processes

argue to increase wages for their

Unit 4, Lecture 1: Compensation Concepts

What compensible factors look like in the market overall

Pr e t g ecn e a I pra c m t ne o Wgt eh i * * * * * * * * * * * * * * 94 . % 8 2. 5 3 % 6 21 . % 8 41 . % 1 5. 9 6 % 5 31 . % 0

Distributive justice concepts

This is robust across species:

This appears to be robust across cultures:

Unit 4, Lecture 1: Compensation Concepts

Distributive Justice Concepts: Conceptual Difficulties

50 units 50 : 50 (output) Complicated Case # 2 Ratio 12 : 16 (money) 1 : 1 (money & educ.)

A Humorous Perspective on Distributive Justice

Unit 4, Lecture 1: Compensation Concepts

A Picture of Internal and External Equity Comparisons

St. James Hospital

Unit 4, Lecture 1: Compensation Concepts

Distributive justice and compensation systems

Results of underpayment inequity? Results of overpayment inequity?

Distributive justice and compensation systems