McGraw-Hill/IrwinMcGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Milkovich/Newman: Compensation, Ninth EditionMilkovich/Newman: Compensation, Ninth Edition

Chapter 1Chapter 1The Pay ModelThe Pay Model

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Chapter TopicsChapter Topics Compensation: DefinitionCompensation: Definition Forms of PayForms of Pay A Pay ModelA Pay Model Book PlanBook Plan Caveat Emptor - Be an Informed ConsumerCaveat Emptor - Be an Informed Consumer Your Turn: Glamorous Internships, or House Your Turn: Glamorous Internships, or House

Elves?Elves?

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Key Questions and IssuesKey Questions and Issues How differing perspectives affect our How differing perspectives affect our

views of compensationviews of compensation

Definition of compensationDefinition of compensation– The meaning of compensation most The meaning of compensation most

appropriate from an employee's view: appropriate from an employee's view: return, reward, or entitlementreturn, reward, or entitlement

Examining “network of returns” a college Examining “network of returns” a college offers an instructoroffers an instructor

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Key Questions and Issues (cont.)Key Questions and Issues (cont.) Four policy issues in the pay modelFour policy issues in the pay model

– Objectives of the pay modelObjectives of the pay model Forms of pay received from workForms of pay received from work

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Contrasting Perspectives of Contrasting Perspectives of CompensationCompensation

Society’s Views

Stockholders’ Views

Employees’ Views

Managers’ Views

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Compensation: DefinitionCompensation: Definition SocietySociety

– Pay as a measure of justicePay as a measure of justice

– Benefits as a reflection of justice in societyBenefits as a reflection of justice in society

– Job losses (or gains) attributed to differences in Job losses (or gains) attributed to differences in compensationcompensation

– Belief that pay increases lead to price increasesBelief that pay increases lead to price increases

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Exhibit 1.1: Hourly Compensation Costs for Exhibit 1.1: Hourly Compensation Costs for Manufacturing Workers (in U.S. Dollars)Manufacturing Workers (in U.S. Dollars)

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Compensation: Definition (cont.)Compensation: Definition (cont.) StockholdersStockholders

– Using stock to pay employees creates a sense of Using stock to pay employees creates a sense of ownershipownership

– Linking executive pay to company performance Linking executive pay to company performance supposedly increases stockholders' returnssupposedly increases stockholders' returns

ManagersManagers– A major expenseA major expense

– Used to influence employee behaviors and to Used to influence employee behaviors and to improve the organization's performanceimprove the organization's performance

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Exhibit 1.2: The Relationship between Exhibit 1.2: The Relationship between Shareholder Return and Change in CEO PayShareholder Return and Change in CEO Pay

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Compensation: Definition (cont.)Compensation: Definition (cont.) EmployeesEmployees

– Major source of financial securityMajor source of financial security– Return in an exchangeReturn in an exchange between employer and themselvesbetween employer and themselves– EntitlementEntitlement for being an employee of the companyfor being an employee of the company– RewardReward for a job well donefor a job well done

Global Views – Global Views – Vive la diffVive la difféérencerence– China: Traditional meaning of compensation providing China: Traditional meaning of compensation providing

necessities of life replaced with necessities of life replaced with dai yudai yu– Japan: Traditional word Japan: Traditional word kyuyo kyuyo replaced with replaced with hou-syu; hou-syu; very very

recently the phrase used is recently the phrase used is teateteate

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Compensation refers to all forms of financial returns and tangible services and benefits employees receive as

part of an employment relationship

What Is Compensation?What Is Compensation?

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Exhibit 1.4: Total Returns for WorkExhibit 1.4: Total Returns for Work

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Forms Of PayForms Of Pay Relational returns

– Psychological in nature Total compensationTotal compensation

– Cash Compensation/ transactionalCash Compensation/ transactional Base wagesBase wages

– Difference between wage and salaryDifference between wage and salary

Merit pay/cost-of-living adjustmentsMerit pay/cost-of-living adjustments– Merit increases – given in recognition of past work behavior Merit increases – given in recognition of past work behavior – Cost-of-living adjustments –same increases to everyone, Cost-of-living adjustments –same increases to everyone,

regardless of performanceregardless of performance

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Forms Of Pay (cont.)Forms Of Pay (cont.)– Cash Compensation/ transactional (cont.)Cash Compensation/ transactional (cont.)

Incentives/ Variable pay – tie pay increases directly to performance

– Does not increase base wage; must be reearned each pay periodDoes not increase base wage; must be reearned each pay period

– Potential size generally known beforehandPotential size generally known beforehand

– Long-term (stock options), and short-termLong-term (stock options), and short-term

– BenefitsBenefits Income protectionIncome protection

Work/life balanceWork/life balance

AllowancesAllowances

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Forms Of Pay (cont.)Forms Of Pay (cont.) Total earnings opportunities: Present value of a Total earnings opportunities: Present value of a

stream of earningsstream of earnings– Shifts comparison of today's initial offers to Shifts comparison of today's initial offers to

consideration of future bonuses, merit increases, and consideration of future bonuses, merit increases, and promotionspromotions

Relational returns from workRelational returns from work– Nonfinancial returnsNonfinancial returns

Organization as a network of returnsOrganization as a network of returns– Created by different forms of pay, including total Created by different forms of pay, including total

compensation and relational returnscompensation and relational returns

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A Pay ModelA Pay Model Three basic building blocks:Three basic building blocks:

– Compensation objectivesCompensation objectives

– Policies that form the foundation of the Policies that form the foundation of the compensation systemcompensation system

– Techniques that make up the compensation systemTechniques that make up the compensation system

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Exhibit 1.5: The Pay ModelExhibit 1.5: The Pay Model

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Compensation Objectives (cont.)Compensation Objectives (cont.) EfficiencyEfficiency

– Improving performance, increasing quality, Improving performance, increasing quality, delighting customers and stockholdersdelighting customers and stockholders

– Controlling labor costsControlling labor costs FairnessFairness

– Fundamental objective of pay systemsFundamental objective of pay systems– Fair treatment by recognizing both employee Fair treatment by recognizing both employee

contributions, and employee needscontributions, and employee needs Procedural fairnessProcedural fairness

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Compensation Objectives (cont.)Compensation Objectives (cont.) Compliance

– Conformance to Federal and State compensation laws and regulations

Ethics– Organizations care about how its results are achieved

Objectives– Guide the design of the pay system

– Serve as the standards for judging success of the pay system

– Policies and techniques are means to reach objectives

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Exhibit 1.6: Pay Objectives at Medtronic Exhibit 1.6: Pay Objectives at Medtronic and Whole Foodsand Whole Foods

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Internal alignmentInternal alignment– FocusFocus - Comparisons among jobs or skill levels inside - Comparisons among jobs or skill levels inside

a single organizationa single organization– Pay relationships within an organization affect Pay relationships within an organization affect

employee decisions to:employee decisions to: Stay with the organizationStay with the organization Become more flexible by investing in additional trainingBecome more flexible by investing in additional training Seek greater responsibility Seek greater responsibility

External competitivenessExternal competitiveness– FocusFocus - Compensation relationships external to the - Compensation relationships external to the

organization: comparison with competitorsorganization: comparison with competitors– Pay is ‘market driven’Pay is ‘market driven’

Four Policy ChoicesFour Policy Choices

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Four Policy Choices (cont.)Four Policy Choices (cont.) External competitiveness (cont.)External competitiveness (cont.)

– Effects of decisions regarding how much and what forms:Effects of decisions regarding how much and what forms: To ensure that pay is sufficient to attract and retain employeesTo ensure that pay is sufficient to attract and retain employees To control labor costs to ensure competitive pricing of products/ To control labor costs to ensure competitive pricing of products/

servicesservices Employee contributionsEmployee contributions

– FocusFocus - Relation emphasis placed on employee performance - Relation emphasis placed on employee performance Performance based pay affects fairnessPerformance based pay affects fairness

ManagementManagement– FocusFocus - Policies ensuring the right people get the right pay - Policies ensuring the right people get the right pay

for achieving the right objectives in the right wayfor achieving the right objectives in the right way

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Techniques tie the four basic policies to the pay Techniques tie the four basic policies to the pay objectivesobjectives

Many variations existMany variations existSome techniques will be discussed through the Some techniques will be discussed through the

bookbook

Pay System TechniquesPay System Techniques

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Caveat Emptor -Caveat Emptor -Be An Informed ConsumerBe An Informed Consumer

Is the Research Useful?Is the Research Useful? Does the Study Separate Correlation from Does the Study Separate Correlation from

Causation?Causation? Are there Alternative Explanations?Are there Alternative Explanations?