Diploma in Business Management

This chapter reviews the basic model of compensation decisions, 
including pay level, pay structure and pay system decisions

Almost every worker receives a paycheck at some regular interval. The amounts of these paychecks vary enormously, from the minimum wage to the salary of the chief executive of a major corporation.

These answers are almost as diverse as the amounts on the paychecks. People are paid for the work they do. They are also paid for their performance, their skills, their seniority, and a host of other factors. Their pay is influenced by the market value of labor, by unions, by social attitudes, and by other factors. The way the organization they work for sets pay rates also influences the size of the paycheck.

In other words, compensating people is a complex task requiring many decisions. This textbook is about this daily multitude of decisions and the influences on them both inside and outside the organization. Of note are new outside influences that create new responses such as:

PAY AND WORK

In short, this text is about pay...how it is determined and managed. But pay, like a coin, has two sides: it represents income to employees and cost to the employer. What the employer provides the employee is called a wage or a salary. Often, the term compensation is used to indicate the various forms of pay � money, benefits, non-financial rewards.

What the employee provides the employer is labor service, usually called work. This labor service consists of many different kinds of employee behavior, for example: showing up regularly and on time, carrying out tasks dependably, cooperating with others, making useful suggestions.

So pay or compensation represents an exchange between the employee and organization. Each gives something in return for something else. In the past, the communication equation has been neutral. Employees knew as much about competitive compensation as their employers knew about their performances. Today the Internet appears to be shifting this equation.

To an employee, pay is a primary reason for working. For some people, it may be the only reason. For most of us, it is the means by which we provide for our own and our family's needs. Few people refuse to accept pay for their work. Perhaps fewer would continue to work if they were told they would not be paid. Pay can represent status or recognition of accomplishment to an employee.

Compensation is also important to organizations. It represents a large proportion of expenditures. In manufacturing firms it is seldom as low as 20 percent; in service enterprises it is often as high as 80 percent. Even more important, organizations try to accomplish many goals with compensation. These goals include attracting and retaining people and motivating them to perform more effectively.

Compensation is also significant in the operation of the economy. Salaries and wages account for about 60 percent of the gross U.S. national product. Compensation is the largest type of income generated albeit, not widely appreciated.

So far we have established that compensation (1) represents an employment contract, and (2) is important to employees, organizations, and the economy. But what class of variable does it represent? In what scholarly discipline does it belong? What kind of theory is applicable to it?

Compensation is a price for a factor of production. As such it serves to allocate scarce human resources to productive uses. To the employer, compensation is the price paid for labor services. As an economic concept, compensation is governed by the same logic as any other purchase by a firm. An organization strives to get the greatest quantity and the highest quality for its money. By the same logic, the worker is selling labor services to obtain income and holds out for the highest price obtainable. The actions of these buyers and sellers are supposed to set the price and to allocate labor (employee services) to its most productive use.

But the market for labor services differs in many ways from the market for commodities. Labor service is perishable. If today's labor is not purchased today, it has no value tomorrow. Also, labor service may vary from hour to hour and day to day because it varies with the ability of a person to work. Furthermore, the labor supplier cannot be separated from the labor services supplied: he or she can change the quality and quantity of those services.

This variability of supply has advantages and disadvantages to the employer. Through various personnel policies and practices, the quality and quantity of labor services may be enhanced. Also, the labor supplier can quickly fill the needs of the organization as they change. This flexibility of labor supply permits the employer to vary his or her demands.

Because the employer's demand for labor services is derived from the demand for the goods and services the organization supplies, any change in demand may change the labor services needed. These changes and the variety of labor supplies needed at any one time are evidence of how organizations depend on the variability of labor supplies.

But this variability is also a disadvantage. The variability of both demand and supply makes it difficult for the purchaser to quote a price. The real cost of labor services to the purchaser is the cost per unit of output. But the seller requires that a price be quoted in advance. Hence, the purchaser must offer a price before the bargain is made. This price must come from estimates of the value of average quality and quantity of labor services in this exchange. This value is in turn derived from cost per unit of product or service.

The supplier of labor service likewise experiences difficulty in deciding what price to accept. The labor supplier can, at best, know only the range of going rates for particular jobs. Other aspects of the employment exchange: design of the job, working conditions, supervision, work associates, personnel policies and practices are typically unknown before the person is hired. Translating these elements into money terms is not easy.

The labor market is assigned the task of making sense out of these forces. It brings together purchasers and sellers of labor services, sets prices, and seeks to allocate labor to its most productive uses. Many labor markets exist, corresponding to the many types of labor service and the many types of employees of labor services. Neither a balance between demands and supplies nor a single price is likely to emerge for a single type of labor service. A single price, when it does appear, is usually caused by restrictions on the market mechanism, such as that caused by a strong union.

If compensation for labor services were influenced only by economic forces, pay for similar work would be equal. Differences in pay between occupations would reflect only scarcities for which the market had not had time to adjust or actual differences in ability.

This brief description of compensation as an economic variable shows that economic analysis is essential in any study of compensation. But the differences between labor markets and other markets suggest that economic analysis alone is not sufficient.

Compensation (pay) represents the psychological contract between the individual and the organization. An organization's reward practices have consequences only through this contract. Thus pay, as a psychological concept, is pay viewed from the standpoint of the individual.

The situation and the needs, perceptions, and attitudes of the individual determine behavior. But the situation and the individual are not independent, because the situation is that perceived by the individual. Needs are felt states both influencing and influenced by perceptions. Means for satisfying needs are those perceived by individuals and interpreted as such through attitudes (categories of past experiences). One need may be satisfied by a number of means, and one means may satisfy a number of needs.

The psychological contract between the individual and the organization is created by perceptions. Rewards offered by the organization enter the contract only if the individual perceives them. In fact, both organizations and employees often speak and act as if they believe that employees work only for money. But even carefully controlled laboratory experiments of simple employment contracts show that many other rewards are operating. Pay is perceived by most people as a means of satisfying many kinds of needs. But many other factors (interesting work, congenial associates, competent supervision, and security, for example) may also be perceived as rewards.

Rewards are offered by organizations to motivate many types of behavior. Which rewards motivate what kinds of behavior, and how rewards operate, are functions of perceptions and attitudes. Motivation is a complex phenomenon only partially understood. All rewards appear to follow the law of diminishing returns. It is therefore necessary to determine whether a particular reward motivates, and if so, within what range.

Thus pay is a psychological concept much involved with motivating the behavior of individuals in organizations. As such, it complements the economic perspective by emphasizing the perceptions of individuals.

Pay is a status symbol within organizations and society. In less complex societies, the status of individuals is a product of many standards of judgment; for example, their families, friends, occupations, education levels, and religious and political affiliations. In large, mobile societies, many of these standards are harder to measure and become less significant. Income as a symbol of status does not present this problem.

Organizations create status structures of jobs. Status differences are measured by both organizations and individuals in terms of pay and pay differences. In fact, employees learn to place associates in the status structure of the organization according to how much they are paid.

Because pay is such a universal measure of status in organizations, it is easy to understand why even small differences in pay assume great significance. Also explained is the symbolic significance of methods of payment and frequency of payment. Salary may imply a status different from that of wage, while a yearly salary may imply a higher status than a monthly or weekly salary. This symbolic significance adds another dimension to the importance of compensation to individuals. As pay acquires more meanings, its importance increases.

Compensation viewed as a status symbol helps to explain the force of custom and tradition in pay determination. The protection of present status and the desire to improve it appear to be universal human values. Protection of present status gives force to the custom defined as what is right. Custom and tradition require that change be justified. The force of custom is conservative. When changes are made they call forth numerous other changes based on traditional relationships.

These values operate within an organization as well as in society in general. In designing the status structure of jobs and pay, an organization is influenced by what pay the job commanded in the past and what other organizations are paying at present. The force of outside influences varies with the kind of people hired, their attachment to the organization, and the similarity of the organization's jobs to those found elsewhere. If the organization can create unique jobs, hire only for beginning jobs, and do its own training for higher level jobs, outside influence is minimized. But customary relationships that are just as conservative soon arise inside the organization. Groups within the organization struggling for status and pay bring forces at least as powerful as traditional forces from outside the organization.

Unions are just as subject to these forces as employing organizations. In fact, unions tend to serve as channels through which customary relationships are made or restored. Both unions and employing organizations are subject to group pressures. Both hesitate to violate customary relationships.

Viewing compensation as a sociological concept focuses neither on the organization nor on individuals but on the relationship between them. The mutual influence of individuals, organizations, and of groups within and without constitutes another dimension of compensation decision making.

Compensation as a political concept involves the use of power and influence. Organizations, unions, groups, and individual employees all use their power to influence pay. Unions exert influence at the time the contract is bargained and during the life of the contract through the grievance procedure. Similarly, compensation in unionized organizations influences that in nonunion organizations.

Organizations exert power in the same situations. In addition, some choose to be pay leaders and thus become major forces in labor markets. Within organizations, groups try to use their power to enhance their influence and pay. As organizations acquire more differentiated but interdependent units, more and more individuals achieve power to influence compensation. Highly skilled individuals in demand by other employers also have the power to influence their pay.

Compensation as a political concept involves no notion that the parties have equal power. Nor does all the power reside on the side of the organization. A political perspective stresses accommodating the influence of all parties.

Few discussions of compensation are conducted without repeated appeals to fairness. Phrases such as a fair day's pay or the just wage are common. In both cases, the equity sought is distributive justice. The foundation concept is that returns should be proportionate to contributions.

But problems occur in the definition of contributions. Not everyone agrees on what contributions are being sought or obtained. As a consequence, there are no universal standards of equity.

Because people have different ideas of what to measure and how to measure, opinions differ widely on what justice, fairness, and equity mean in pay. Everybody agrees that justice in distribution should be based on merit of some sort. But people do not understand, nor necessarily agree, as to the definition of merit.

This probably means that equity is best viewed from the eyes of the beholder. This in turn may mean that although equity in compensation can exist for both the organization and the individual, this situation is unlikely unless it results from bargaining and a relatively complete specification of the terms.

Viewing compensation as an equity concept means analyzing pay from the separate viewpoints of the parties. Ideally, compensation will be adjudged fair by all of them.

Compensation is being drastically affected by the Internet. Employees now have easy access to the competitive rates commonly paid for their positions within any given geographic area. A future where employees know more than their employers about the value of their positions in the competitive marketplace is what now faces worldwide employers. Unfortunately, when competitive values are known, the effect appears to be inflationary. For example, before U.S. executives had ready access to what their peers were receiving competitively, organizations could concentrate on internal goals. Consultants and SEC requirements for reporting have made executive compensation a focus within all publicly held companies' Boards of Directors and Compensation Committees. Since most companies do not wish to pay below average rates and since all averages are known, the trend is for everyone to attempt to pay above average. This is not a new concept. It is now, however, a concept being extended to the rank and file.

Compensation has thus been studied selectively by those in separate disciplines.

Economists have focused on the price (wage) of a factor of production and abstracted employee behavior into labor units employed (typically in terms of working hours). Psychologists have focused on the needs of individuals and the means by which they may be met by organizations, emphasizing less the needs of the organization. Sociologists, political scientists, and philosophers have not often studied compensation per se, but concepts they have developed for other purposes may be usefully applied to the study of pay. Management researchers and teachers have focused on the more esoteric aspects of compensation; few have focused on the ability to control costs.

This discussion to pin down the appropriate domain for the study of compensation assumes the existence of certain organizations, groups, and individuals involved in compensation decisions. It will be useful now to enumerate these parties. The employing organization may be a private profit-seeking organization, a nonprofit entity, or a government agency. Through pay policies and practices, all of these organizations seek to obtain the participation of the types, number, and quality of employees needed. They may also use pay policies and practices to elicit certain types of employee behavior. Profit-seeking private organizations range from marginal operations very sensitive to changes in labor markets to large, closed bureaucracies relatively isolated from labor-market influences. Nonprofit entities and government agencies can vary in exactly the same way.

Employees of organizations fall into several categories: (1) production employees (those who work on the products or provide the services of the organization), (2) clerical employees, (3) sales employees, (4) technical employees, (5) professional employees, (6) supervisors, and (7) managers. Although the pay of these employee groups is determined on similar grounds and administered in similar ways, these determinants are not identical. Pay determinants may be weighted differently for different employee groups. One reason for this is that the numbers and types of employees change with changes in technology.

Unions, as representatives of employees, are parties to both pay determination and pay administration. One or several unions may represent production employees. Where clerical employees are organized, they are often represented by the same union that represents production employees. Some technical and professional employees are organized, usually in a separate union. It is conceivable that changing production technology could foster unionization of employee groups now primarily not organized.

The public is a party to compensation determination. But public participation seldom occurs except through the pressure of public opinion and through government policy. Consumers are very much concerned with pay questions, but no mechanism exists for their voice to be heard. Individuals on fixed incomes (pensions, for example) are much concerned with possible inflationary effects of pay increases.

Federal, state, and municipal governments are also parties to compensation determination. Public policy directly influences pay decisions, as does the less direct policy influencing collective bargaining.

Other parties, of course, may be involved in pay determination. For example, suppliers and industrial customers of large corporations may indirectly influence or be influenced by a pay dispute.

Under our system, all of these parties either have a voice in or are influenced by compensation decisions. Making pay decisions serve this variety of interests is not easy.

We have said that compensating employees necessitates a series of decisions. The end result of these decisions is a pay rate for each employee in the organization. There are three core decisions, those involving: pay level, pay structure, and pay system. Supporting these are three other decisions, concerning pay form, pay treatment for special groups, and pay administration. All these decisions are influenced by a number of environmental and organizational variables. Examples of these variables are the economic, social/cultural, and legal environments; and the organization's structure and work force. All these variables are represented in Figure 1-1 and described in the pages that follow.

The broadest of the core decisions is the pay level decision. This decision determines how much the organization will pay for labor services, or what its average pay will be. Pay level refers to the average pay for jobs, for departments, or for the entire enterprise. An average pay must be set that will secure and keep a productive work force. Major considerations in the pay level decision are (1) public policy, (2) pay for comparable work in the community or industry (usually called the going rate), and (3) company response to economic, political, and social issues. These considerations may be weighed unilaterally or together with the union(s) representing employees. Some of these decisions end with personal interactions (salaries), some are provided on a group basis (medical insurance, etc.)

The second core decision is the pay structure decision, which focuses on the relationships between jobs within the organization and thus pay. Pay structure decisions usually involve arraying jobs in a hierarchy and setting pay for these jobs relative to their status within the hierarchy. It also involves decisions by the organization regarding the amount and type of benefits to provide.

Together the pay level and pay structure decisions determine the pay for jobs. In addition, they involve external and internal standards. Presumably, pay level decisions ensure that the organization is in line with the requirements of the external environment, and pay structure decisions ensure that the pay for jobs is internally consistent.

Although pay level and pay structure decisions have been cited as providing external and internal equity, it might be more accurate to relate pay level to external competitiveness and pay structure to internal equity (fairness). If equity is synonymous with fairness, it seems meaningless in economic decisions.

The third core decision involves determining the pay of individual employees on the same job. Of course, it is possible for all employees on the same job to get the same pay, in which case no decision is needed. But once a decision is made to differentiate the pay of employees on the same job, two further decisions are required: (1) how to differentiate among employees, and (2) whether to pay for time or for output. We can label the first of these decisions as individual pay determination and the second as the pay method decision. Adopting the designation of pay system for both decisions makes sense.

The first supporting decision is pay form, the composition of the pay the individual receives. The major part is money, or take-home pay. But a large proportion is in benefits of several kinds.

The second supporting decision involves the pay treatment of some special employee groups. Although the organization wants similar behavior from all employee groups, compensation policies and practices may differ somewhat for salespeople, professionals, and managers.

The final supporting decision involves ensuring that pay achieves organization and individual objectives and meets public policy goals. Those responsible for compensation planning and control seek answers to questions of efficiency, effectiveness, and legality. (Discrimination in pay is a particularly important issue today.)

Compensation administration as defined by this book is the organizational process of arriving at the decisions just described. Actually, the separation of pay determination and management into these six decisions is an analytical convenience to aid understanding. It is quite possible though, for an organization to use one set of procedures in two or more decisions. Also, each of these decisions affect the other decisions. A bit more discussion on each of these issues is worthwhile.

The level of pay of an organization is a response to the changing pressures of the labor market. If it is too low, the organization may have difficulty attracting and holding qualified people. There may also be legal penalties from those charged with administering minimum wage and public-contract laws. Unions within or seeking entry into the organization may exert pressure. If the pay level is too high, on the other hand, the competitive position of the firm in the product market may suffer. In times of wage controls, too high a level may bring government sanctions.

An organization's pay level is decided after consideration of many factors, among them are (1) public policy on pay, (2) going wages for comparable work in the community and/or industry, (3) union wage policy and collective bargaining, and (4) management's philosophy on proper pay levels as reflected in its reaction to the economic, social, and legal environment.

Relationships between the pay of different jobs within the organization may be more important to employees than pay level. Although the pay level may attract qualified employees, inequitable pay relationships may do the opposite. If, for example, Herb is earning less money than Jim, on a job he believes is worth more than Jim's, he is likely to consider the situation unfair and do something about it.

Preventing such inequities and correcting them if they do occur are two of the objectives of pay structure decisions. Pay structures may be set up by management judgment or constructed through collective bargaining. The technique traditionally used in the mid 1900s in the U.S. was formal or informal job evaluation. Today, the technique most utilized in the U.S. is that of market pricing. (Interestingly, Brazil, Argentina, Canada and other countries continue to heavily utilize job evaluation plans.)

Although there are several methods of traditional job evaluation, they all involve the following steps. First, jobs are analyzed and job descriptions written. Then the factors on which pay will be based are identified; such factors as skill, effort, and responsibility are typical. Next, jobs are evaluated on the basis of these factors. The result is a logical job structure. The final step is assigning pay rates that relate to the job structure. These rates constitute a wage structure. (Market pricing circumvents the first few steps and assigns the pay rate by comparing the job and job description to competitive labor market data.)

At this final step, pay level and pay structure decisions come together. Often, a wage survey is used as an aid in both decisions. Ideally, the pay rates not only meet the test of internal consistency but are in tune with the external environment. But as we will see, some of the most difficult pay decisions involve correlating these two separate standards. Figure 1-3 offers a useful way of distinguishing pay levels and pay structures. Pay level is the height of the line above the x-axis. Pay structure is the slope of the line. (Line b represents a higher pay level than line a, but its structure is the same.)

Pay level and pay structure provide a decision on the pay for jobs. It is individuals who are paid, however, and a decision is now required as to whether all individuals on the same job shall receive the same pay. Most organizations decide that employees on the same job will get different pay. Some organizations pay by job difficulty or level of job importance.

Pay level and pay structure comparison organizations pay high-seniority employees more than low-seniority employees, presumably because they are concerned with keeping senior employees. Most organizations state that higher performers are paid more than lower performers. These pay systems are called merit systems. Often pay differences among people on the same job are based on a combination of performance and seniority, on the assumption that the organization wants to reward both membership and effectiveness.

Actually, an organization can reward the performance of employees not only by a merit system but also by an incentive system. The difference is that although merit systems attempt to relate pay to performance, incentive systems tie pay to performance. Under an incentive system, the usual practice is to set a base rate for the job and to vary individual pay with some measure of output. Logically, the applicability of an incentive system depends on technology. Practically, however, it depends more on tradition and custom. Incentive systems involve substantial administrative costs but often are associated with raising productivity above costs. Incentive plans can be based on group or organization-wide output as well as individual output.

Pay form refers to the makeup of the pay an individual receives. As noted, most of an employee's pay is cash in the form of take-home pay. But a growing portion is indirect, in the form of benefits. At least one-third of an average employee's pay consists of benefits. Some are required by legislation; others are voluntarily provided by the employer or are required by union agreement. The growth of benefits, employee differences in benefit needs, and greater individualization of organization benefit programs are important issues in pay form decisions.

Another way of viewing pay form is to recognize that in most organizations employees receive three forms of pay: membership pay, job pay, and performance pay. Membership pay is given employees as a consequence of their joining and remaining in the organization. Job pay is based upon accepting a particular job and performing at a satisfactory level. Performance pay is contingent upon differential employee behavior. In this sense, all forms of pay are contingent on some form of employee work behavior.

Although the objectives of an organization's pay are likely to be quite similar for all employee groups, pay programs and practices may differ for some of them. Ideally, where pay decisions and programs are differentiated, they are based on differences in employee behavior requirements and pay systems designed to meet them. Salespeople, professionals, and managers are examples of groups deserving separate pay analysis.

The final pay decision is whether the previous decisions are achieving the goals of the organization and of employees. The primary question is economic: is the firm really getting the employee contributions that it is paying for? In most organizations, pay is expected to obtain many different kinds of employee behavior. Is the organization getting the value it is paying for? Are employees getting the rewards they want for their contributions?

Other questions are legal: Are the pay programs meeting legal requirements? Do regular audits show that pay programs do not discriminate against members of protected groups?

Compensation decisions are not made in a vacuum: one must consider a number of environmental and organizational variables. As indicated earlier, compensation is at least partly an economic concept: economic conditions are a major influence upon what an employee is paid. Tied to this economic environment is the impact of unions on the wages, both industry-wide and in each organization.

Likewise, the social environment has an impact on compensation decisions. Members of a society have ideas about the worth of different jobs, and these ideas need to be taken into account. The social environment has been changing dramatically along with the changing views of women in the work force. These views have spurred the recent impact on compensation decisions and changes in law. (See Chapter 2.)

Compensation decisions are also affected by the dynamics of the particular organization. Employee pay must be consistent within the organization's structure. The organization's culture helps determine the priority to be placed upon various compensation goals. The organization's work-force characteristics influence the success of different compensation programs.

Finally, compensation decisions are going to be affected by the worldwide information highway. After all, compensation and benefits is data perfectly suited to the Internet. The impact will be great: one can expect severe communication conflicts relating to competitive practices. email, Chat Boards and dot.com companies who attract visitors to their site by giving employees compensation data are all now having an effect. Larger organizations are now administering their stock, salary, and incentive plans on a worldwide basis via the Internet. In time, smaller organizations will gain this capability. The Internet is just about to give Benefit and Compensation Administration a new identity.

		Diploma in Human Resource Management