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The Pay Model

1

Chapter

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1. Explain how perceptions of compensation differ among society, stockholders, managers and employees.

2. Discuss the difference between cash compensation (direct compensation) and benefits (indirect compensation) and define each of the direct and indirect forms of compensation.

3. Explain how the employment relationship combines both transactional and relational returns to form an implicit contract between employers and employees.

4. Explain the three main components of a pay model.5. Understand how the pay model integrates objectives,

policies, and techniques into a compensation system.6. Be able to distinguish empirical research from

surveys and opinions.

Learning ObjectivesAfter discussing Chapter 1, students

should be able to:

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Chapter Topics

Compensation: Definition, Please? Forms of Pay The Employment Relationship

Combines Transactional and Relational Returns

A Pay Model Book Plan Caveat Emptor - Be an Informed

Consumer

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Key Questions and Issues

How do differing perspectives affect our views of compensation?

What can a pay system do for an organization? For an employee?

How does the pay model help organize one’s thinking about compensation?

Under what circumstances would one of the four basic pay policies be emphasized relative to the others?

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Society’s Views

Stockholders’ Views

Employees’ Views

Managers’ Views

Contrasting Perspectives of Compensation

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1-6Exhibit 1.1: Hourly Compensation

Costs for Production Workers

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1-7Exhibit 1.2: Labor Costs as a Percentage of Revenues, Airline

Industry

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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?

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Exhibit 1.3: Total Returns for Work

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Direct Pay Forms

Cash Compensation: Base

Cash Compensation: Merit Pay / Cost-of-Living Adjustments

Cash Compensation: Incentives

Long-Term Incentives

Indirect Pay Forms

Benefits: Income Protection

Benefits: Work/Life Focus

Benefits: Allowances

Forms of Pay

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Relational Returns from Work

Recognition& Status

EmploymentSecurity

ChallengingWork

LearningOpportunities

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An unwritten understanding between employers and employees over their reciprocal obligations and returns; employees contribute toward achieving the goals of the employer in exchange for returns given by the employer and valued by the employee.

What Is an ImplicitEmployment Contract?

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1-13Exhibit 1.4: Framework for Analyzing Employment

Relationships

HIGH PAY – LOW COMMITMENT

Hired Guns (Stockbrokers)

HIGH PAY – HIGH COMMITMENT

Cult - like (Microsoft)

LOW PAY – LOW COMMITMENT

Workers as Commodity (Employers of Migrant

Farm Workers)

LOW PAY – HIGH COMMITMENT

Family (Starbucks)

Hig

hH

igh

Low

Low

TR

AN

SA

CTIO

NA

LTR

AN

SA

CTIO

NA

L

LowLow HighHigh

RELATIONALRELATIONAL

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POLICIES TECHNIQUES OBJECTIVES

EFFICIENCY• Performance• Quality• Customers• Stockholders• Costs

FAIRNESS

COMPLIANCE

COMPETITIVENESSMarket Surveys Policy PAY definitions lines STRUCTURE

CONTRIBUTORS Seniority Performance Merit INCENTIVE based based guidelines PROGRAMS

MANAGEMENT Costs Communication Change EVALUATION

Exhibit 1.5: THE PAY MODEL

ALIGNMENTWork Descriptions Evaluation/analysis certification

INTERNALSTRUCTURE

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Compensation Objectives

Efficiency

Fairness

Compliance

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Medtronic Support objectives and increased

complexity of business Minimize increases in fixed costs Emphasize performance through

variable pay and stock Competitiveness aligned with

financial performance: 50th percentile performance paid at 50th percentile of market. 75th percentile performance paid at 75th of market.

AESOur guiding principles are to act with integrity, treat people fairly, have fun,

and be involved in projects that provide social benefits. This means we will

Help AES attract self-motivated, dependable people who want to keep learning new things

Hire people who really like the place and believe in the AES system

Pay what others are paid both inside and outside AES, but hire people who are willing to take less to join AES

Use teams of employees and managers to manage the compensation system

Make all employees stockholders

Exhibit 1.6: Pay Objectivesat Medtronic and AES

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Internal alignmentFocus - Comparisons among jobs or skill levels

inside a single organizationExternal competitiveness

Focus - Compensation relationships external to the organization: comparison with competitors

Employee contributionsFocus - Relation emphasis placed on employee

performanceManagement

Focus - Policies related to managing the pay system

Pay System Policies

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Include methods used to operationalize policy decisions and link decisions to overall compensation objectives

Examples of techniquesInternal consistency

Job analysisJob evaluation

External competitivenessPay surveys

Employee contributionsIncentive plansPerformance-based pay increases

Pay System Techniques

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Does the research measure anything useful?

Does the study separate correlation from causation?

Are there alternative explanations?

Caveat Emptor -Be An Informed Consumer