Business
Help with Board Question no word count and Essay. APA Format throughout.
Unit Essay
For this assignment, you will write an essay that explores the topics of gender gap and compensation.
In your introduction, explain whether you think the gender gap is a women’s issue, men’s issue, or both. Explain your response and reasoning within your introduction.
Then, divide the body of your paper using the headers below, and cover in that section what is indicated under the header.
Closing the Gap
Explain why the gender gap continues to be an issue in our society and what can be done to help close this gap in terms of opportunities and pay.
Legal Provisions
Identify legal provisions that are in place for addressing the gender gap. Hypothesize why legal provisions have not been successful in closing the gap. Discuss how ethics may play a role in future changes.
Recruitment Planning
Explain what human resource professionals should consider when planning compensation and pay during recruitment planning.
Support your essay with a minimum of two resources from the Waldorf Online Library. Your essay should be two pages in length, not counting the title or reference pages. Adhere to APA style when constructing this assignment, including in-text citations and references for all sources that are used. Please note that no abstract is needed.
Board Question.
Pay and incentive programs are being used both for knowledge workers and in non-knowledge worker occupations. In every industry, from restaurants to construction and low-tech manufacturing, companies are using more comprehensive pay and incentive programs to attract and keep workers in a tight labor market.
Think about an industry you currently work in, have worked in, or would like to work in. What incentive programs do you believe would motivate you to perform at a higher level? Explain why that is a motivation for you.
Unit VI Lecture Transcript
Slide 1
Unit VI, Compensation Management and Incentive Pay.
Slide 2
In order to gain a deeper understanding of the concepts presented in
this course, the unit lessons will be structured in question and answer
format. Each slide will provide at least one question based on concepts
presented in this unit and an accompanying audio response from a subject
matter expert. Review each slide to further enhance your practical
knowledge about the field of human resource management.
Slide 3
Meet Marilyn Pike. Marilyn has over 20 years of experience in HR
leadership positions in both the public and private sector, large and small
businesses, and union and non-union environments. She currently holds
both the SPHR and SHRM-SCP.
Question: What is involved in creating a compensation strategy?
Answer: Well first, of course, does the organization’s ability to pay
(compensate) their employees? An organization has to budget for wages, so
they are going to look at the KSAs (knowledge, skills, and abilities) needed
for particular positions and the market wage rate for those positions, as well
as the supply of potential workers. Do we want to be at, above, or below the
market in compensation? Then there are types of compensation. The mix of
the four basic components of compensation—base pay, wage addons,
incentives, and benefits. Currently I recruit a lot of RNs; we offer hiring
bonuses, reimburse for Internet/phone use, and we provide a good health
plan while picking up the majority of the premium. Just last week, I had an
RN decline our offer solely because she did not like the healthcare package
we offered. Of course, there is pay for performance or longevity. While often
employees expect to be paid an increasingly higher wage depending on how
long they have been with the organization, the reality is that usually is only
going to happen if their performance increases. And, of course, they also
expect to earn more vacation time after they have been with the
organization for a longer period of time.
Then there is skill- or competency-based pay. For example, registered
nurses are in high demand now and that demand is only going to become
greater as the Baby Boomer generation continues to retire as well as have
more medical needs. Unfortunately, as the Baby Boomers retire we lose
many RNs at just the time when the demand is increasing. Right now, there
is a shortage of RNs and that shortage is projected to continue. This means
RNs can attract top dollar and can be entertaining several offers at once.
Conversely, if you have a low skill set position, one which doesn’t require a
lot of education or training, one which many people can do, the wage is
going to be lower. I’m going to use the example of when I recruited
warehouse workers. Really, what we were looking for was a positive attitude
and strong work ethic. We could train the new hires and have them on the
floor picking and/or packing in just a day or two.
Slide 4
Question: What is pay compression?
Pay compression can happen between tenured employees and new
hires. It occurs when new hires are paid the same as current workers in the
same position. Causes of pay compression can be longer-term employees
started at lower wages and annual increases have not kept pace with current
market demands/inflation. Or the job requires a “hot skill” that led the
company to raise the starting salary to attract the right talent.
For example, let’s say someone comes in making the Federal minimum
wage of $7.25 and has worked with the company for five years, getting a
3% wage each year. After five years they will be making about—not exactly,
this is just a rough example—$7.50 an hour. The state raises the minimum
wage to $8, which is great and their pay suddenly increases to $8/hour. But,
every new employee who comes in is also making $8, so the employee has
lost the pay increase for longevity/experience.
This happened when I was Human Resources Director for a warehouse
distribution center in Chicago. We had employees (pickers/packers) who had
been with the company for many years and had received good bonuses over
the years. But the state increased the minimum wage to a point where we
had to give these employees a pay bump to be compliant with the new
minimum wage. While obviously the employees loved getting the increase in
pay – because employees talk they soon figured out they were that now
(with their years of experience) were making the same wage as a new hire
with no experience. This was demoralizing to the employees, luckily I
worked for a very employee-friendly company. We were a privately held
(which means not traded on the stock market) family-owned company, and
the owners made the decision to tack on the increases the employees had
previously earned to the new hourly wage. But it was at significant cost to
the owners. I suspect a lot of publicly traded companies might not be so
generous.
As I said, employees talk; we refer to this as pay transparency. Some
companies have policies that say that employees cannot share their wage
information, but the NLRB (National Labor Relations Board) has made clear,
an employee has a right to tell anyone they want what wage they make. Pay
transparency particularly exists in the public sector where employees’ wages
are public information. I remember when I became an HR Analyst for the
city of Las Cruces many years ago. I was shocked (read not pleased) to find
out literally anyone could find out what I made.
Pay compression can even happen between managers and their direct
reports. Employees who work a lot of overtime can begin to make as much
or more than their supervisor, who might be salaried so will not earn
overtime pay regardless of how many hours they work. This issue is going to
be alleviated somewhat because of the new minimum salary threshold that
is being proposed by the Department of Labor. It would increase from the
current $455 a week salary (the equivalent of $11.75 for a 40-hour week,
and most salaried workers work more than 40 hours a week) to $679 a week
(the equivalent of $16.98 an hour).
Slide 5
Question: What is pay equity and comparable worth? How is that
different from equal pay for equal work?
Answer: Comparable worth is similar pay for similar work that is
different from equal pay for equal work. The concept of comparable worth
holds that if we can compare your job with that of another person and they
are similar, we should pay you a similar wage, which makes this concept
much broader than equal pay. The biggest problem with comparable worth
from a legal standpoint is how to legislate the value of a job while taking
supply and demand into account.
The Equal Pay Act requires that men and women in the same
workplace be given equal pay for equal work. The jobs do not need to be
identical, but they must be substantially equal. The job titles do not have to
be the same. The focus is on job content in the sense of the basic KSAs
(knowledge, skills, and abilities) that are needed—that’s what determines
whether jobs are substantially equal. A classic example of this would be the
position of secretary/receptionist versus the position of janitor, where the
janitor might not even need a high school diploma or GED. All forms of pay
(bonuses, benefits, etc.) are covered by this law. If there is an inequality in
wages between men and women, employers may not reduce the wages of
either sex to equalize their pay.
Slide 6
Question: Why do companies use independent contractors, as opposed
to employees?
Answer: Companies are using more independent contractors to
maintain maximum organizational flexibility, and, in some cases, at least, to
lower costs associated with maintaining employees. Employees cost more
than just their wage, there are the cost of benefits, healthcare insurance
eligibility, or any other compensation factors like federal (social security and
other) taxes or state mandated (unemployment, workers’ compensation,
etc.) taxes on employees and other potential costs. For several years, Uber
drivers, who are independent contractors, have wanted to wanted to form a
union, but the NLRB recently concluded Uber drivers are independent
contractors and not employees—a classification that means they have no
right to form a union or bargain collectively (Romo, 2019).
Slide 7
Question: Can you tell us about incentive pay plans?
Answer: While there is concern that at least in some cases, incentives
don’t work, evidence does show that group incentives work better than
individual incentives. But in general, it is difficult to tie employee actions to
company success. There is also an issue of incentives becoming an
entitlement. If this occurs, the incentive no longer motivates changed
behaviors. Classic example of this was when I worked at a bank. Every year,
employees had gotten a holiday bonus and they had come to expect it. One
year, the banking industry was struggling and the bank did not offer a
holiday bonus. This caused huge dissatisfaction among employees. There is
also a school of thought that external incentives may act to lower a person’s
internal motivation to do something, which may mean that we actually lower
performance instead of raising it when we apply incentives. Finally, there is
the problem of people only focusing on what they are receiving incentive pay
to do.
Slide 8
This concludes the Unit VI question and answer session with subject
matter expert, Marilyn Pike. Reflect on this question and answer session as
you review your readings for this unit.
Slide 9
Reference
Romo, V. (2019). Uber drivers are not employees, National Relations Board
rules. Drivers saw it coming. Retrieved from
https://www.npr.org/2019/05/15/723768986/uber-drivers-are-not-
employees-national-relations-board-rules-drivers-saw-it-com
https://www.npr.org/2019/05/15/723768986/uber-drivers-are-not-employees-national-relations-board-rules-drivers-saw-it-com
https://www.npr.org/2019/05/15/723768986/uber-drivers-are-not-employees-national-relations-board-rules-drivers-saw-it-com
11
Compensation Management
Media Library
CHAPTER 11 Media Library
PREMIUM VIDEO
HRM in Action
LICENSED VIDEO
Boosting Wages
Employee Wages
LEARNING OBJECTIVES
After studying this chapter, you should be able to do the following:
11-1.
Identify the components of a compensation system and describe how expectancy and equity theories apply to compensation.
PAGE
388
11-2.
Identify the seven basic issues that make up the organization’s compensation strategy.
PAGE 393
11-3.
Discuss the three major provisions of the FLSA and the penalties for misclassification of employees.
PAGE 398
11-4.
Briefly describe the concept of comparable worth and highlight the other legal issues in compensation.
PAGE 404
11-5.
Identify the three types of job evaluation and discuss whether they are more objective or subjective in form.
PAGE
405
11-6.
Briefly describe the concepts of job structure, pay levels, product market competition, and labor market competition.
PAGE
407
11-7.
Briefly describe the concept of a pay structure, including broadbanding and delayering.
PAGE
411
11-8.
Briefly discuss the issues of independent contractors versus employees and the problem of the gender–wage gap.
PAGE 413
CHAPTER OUTLINE
Compensation Management
The Compensation System
Motivation and Compensation Planning
Compensation Strategy
Ability to Pay
What
Types of Compensation
?
Pay for Performance or Pay for Longevity?
Skill-Based or Competency-Based Pay?
At, Above, or Below the Market?
Wage Compression
Pay Secrecy
Legal and Fairness Issues in Compensation
Fair Labor Standards Act of 1938 (Amended)
Pay Equity,
Comparable Worth
, and
Other Legal Issues
Comparable Worth
Other Legal Issues
Job Evaluation
Job-Ranking Method
Point-Factor Method
Factor Comparison Method
Developing a Pay System
Job Structure and Pay Levels
Pay Structure
Stacking Pay Levels and Evaluating
Delayering and Broadbanding
Trends and Issues in HRM
Designation of Independent Contractors Continues to Be an Issue
The Stubborn Gender–Wage Gap: Can It Be Fixed?
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Practitioner’s Perspective
Cindy tells the story of when Drew walked dejectedly into her office and flopped down in the nearest chair.
“I hear they hired a new payroll clerk—the same job I’ve been doing for five years—and this new person is going to be paid more than I make! I’ve been a loyal employee for years and haven’t had a real raise since I started. Is that fair?”
Cindy couldn’t fault Drew for his feelings, and she knew it was past time the company examined its compensation guidelines.
Once you have an established pay scale, is it really important to reexamine your compensation levels? What is the solution when the going market rate for a position outdistances your set pay scale?
Chapter 11
answers these questions and more as it demonstrates the reasons why compensation management is so vital to attracting and retaining your best employees.
SHRM
HR CONTENT
See Appendix: SHRM 2016 Curriculum Guidebook for the completelist
B. Employment Law (required)
8.
Fair Labor Standards Act of 1938 (FLSA)
E. Job Analysis/Job Design (required)
2. Job evaluation and compensation (grades, pay surveys, and pay setting)
6. Compliance with legal requirements
Equal pay (skill, effort, responsibility, and working conditions) and comparable worth
Overtime eligibility (exempt vs. nonexempt work)
G. Outcomes: Metrics and Measurement of HR (required)
11.
Benchmarking
I. Staffing: Recruitment and Selection (required)
16. Employment brand
K. Total Rewards (required)
A. Compensation
1. Development of a base pay system
2. Developing pay levels
3. Determining pay increases
4. Role of job analysis/job design/job descriptions in determining compensation
6. Compensation of special groups (e.g., executives, sales, contingent workers, management)
7. Internal alignment strategies
8. External competitiveness strategies
9. Legal constraints on pay issues
10. Monitoring compensation costs
11. Union role in wage and salary administration
12. Minimum wage/overtime
13. Pay discrimination and dissimilar jobs
14. Prevailing wage
15. Motivation theories: Equity theory, reinforcement theory, agency theory
Get the edge on your studies.
edge.sagepub.com/lussierhrm3e
• Take a quiz to find out what you’ve learned.
• Review key terms with eFlashcards.
• Watch videos that enhance chapter content.
p.388
COMPENSATION MANAGEMENT
LO 11-1
Identify the components of a compensation system and describe how expectancy and equity theories apply to compensation.
Compensation is the total of an employee’s pay and benefits. Compensation affects both attracting and retaining employees.1 Pay is now the top reason for job satisfaction, overtaking job security as the top driver of satisfaction back in 2013.2 According to recent research by Payscale, “Compensation has officially expanded from ‘just a human resources issue’ to a C-suite issue,”3 with about 57% of individuals in their survey saying that compensation is becoming more important to executives and that it has strategic value to the firm. Pay is the most important priority to North Americans, Latin Americans, and Western Europeans—so HR must pay attention to fair and equitable compensation for company employees.4
|
HRM in Action |
Compensation costs are frequently the largest part of total production costs at today’s firms. Because this is the case, management must continually monitor and manage total organizational compensation. This monitoring function usually falls to the HR department. Compensation costs also continue to rise as companies started to face shortages of skilled talent after the latest recession.5According to the US Bureau of Labor Statistics, average total compensation costs rose from $31.93 to $35.28 per hour from March 2014 to March 2017.6
The Compensation System
A business designs and implements a compensation system to focus worker attention on the specific efforts the organization considers necessary to achieve its desired goals.7 However, if rewards are to be useful in stimulating desired behavior, they must also meet the demands of employees whose behavior they’re intended to influence.8 Thus, poor compensation management practices can have negative effects on performance.9 The compensation system of an organization includes anything that an employee may value and desire and that the employer is willing and able to offer in exchange. This includes the following:
1. Compensation components. All rewards that can be classified as monetary payments and in-kind payments constitute the compensation component.
2. Noncompensation components. All rewards other than monetary and in-kind payments (e.g., company cafeterias, gyms) constitute the noncompensation component.
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TYPES OF COMPENSATION. There are four basic parts of a compensation system:
1. Base pay. This is typically a flat rate, either as an hourly wage or salary. Many employees consider this to be the most important part of the compensation program, and it is therefore a major factor in their decision to accept or decline the job.
2. Wages versus salary. Wages are paid on an hourly basis. Salary is based on time—a week, a month, or a year. A salary is paid regardless of the number of hours worked. Wages are common for blue-collar workers, and salaries are common for white-collar professionals and managers. A salary, however, does not make an employee “exempt”; we will cover this in detail shortly.
2. Wage and salary add-ons. This includes overtime pay, shift differential, premium pay for working weekends and holidays, and other add-ons.
3. Incentive pay. Also called variable pay, incentive pay is pay for performance, and it commonly includes items such as piece work in production and commissioned sales. Pay for performance, especially in the form of short-term incentive pay, continues to increase as a percentage of employee compensation due to the ability of the employer to shift risk from the company to the individual employee.10 The use of pay for performance rather than hours worked11 and giving bonuses12 are the trend today. We will discuss incentives in detail in
Chapter 12
.
4. Benefits. This is indirect compensation that provides something of value to the employee. You need to include benefits in your system, because they cost thecompany a lot of money even though they aren’t direct compensation to the employee. Benefits are expensive costing employers 25 to 35% of total employee compensation.13 Benefits may include health insurance; payments to employees if they are unable to work because of sickness or accident; retirement pay contributions; and provision of a wide variety of desired goods and services such as cafeteria service, tuition reimbursement, and many other items. We will discuss benefits in detail in
Chapter 13
.
WORK
APPLICATION 11-1
Select a job. Identify the compensation you received there in detail.
Direct versus indirect compensation. The first three compensation components—base pay, any add-ons, and incentive pay—are known as direct compensation. These forms of compensation go directly to the employees as part of their paycheck. Benefits are indirect compensation. The employees don’t directly get any funds from a benefits program. Benefits are usually paid for by the company, and the employees never see those funds.
In for-profit businesses, we want to design the mix of compensation and noncompensation components that provide us with the best productivity return for the money spent. However, to do that, we need to understand something about the motivational value of our compensation system. Let’s take a look at a few theories that help us understand better how compensation systems can motivate our workers to learn and act in the way we need them to act.
11-1 APPLYING THE CONCEPT
Types of Compensation
Review the types of compensation and then write the letter corresponding to each one before the statement(s) describing it.
a. base pay
b. wage and salary add-ons
c. incentive pay
d. benefits
____ 1. I’d like to work for a firm that will help pay for me to get my master’s of business administration (MBA) degree.
____ 2. I get paid only $11 an hour, so I’m looking for a better job.
____ 3. I like getting paid the same each week. It helps me to budget my expenses.
____ 4. I like being paid for every sale I make, but my pay does vary from week to week.
____ 5. I like working nights because it pays more.
p.
390
Anya Semenoff/The Denver Post via Getty Images
A Honda and MINI dealership in Colorado. Organizations can motivate employees to work harder with incentive systems that pay for high performance.
Motivation and Compensation Planning
When we look at designing compensation programs, we need to remember that we are trying to motivate the employee to do the things that we need them to do, consistently, over a period of time. However, “while 73 percent of employers say they pay their workers fairly, only 36 percent of employees agree.”14 Why does this result exist? Probably the most significant theories that help you to understand compensation planning and employee motivation are expectancy theory and equity theory.15 However, we also need to look at how our employees learn and carry out their jobs in the organization, so we need to remember what we discussed in
Chapter 7
about learning theories. But let’s get started with motivation and how it affects the design of our compensation system.
SHRM
K:A1
5
Motivation Theories: Equity, Reinforcement, Agency
EXPECTANCY THEORY. Expectancy theory is a process theory of motivation. This basically means that we, as human beings, go through a cognitive process to evaluate something; and if we evaluate the process positively, we will likely continue to be motivated to do the same thing. Alternately, if we evaluate the process negatively, we will be disinclined to do the same thing in the future. Expectancy theory proposes that employees are motivated when they believe they can accomplish a task and that the rewards for doing so are worth the effort. Expectancy theory is based on Victor Vroom’s formula: Motivation = Expectancy × Instrumentality × Valence.16
For compensation purposes, we have intentionally simplified the theory to show how it affects a person’s motivation to perform. Expectancy is the person’s perception of their ability to accomplish or probability of accomplishing an objective. Generally, the higher one’s expectancy, the better the chance for motivation. Instrumentality is the perception that a particular level of performance is likely to provide the individual with a desired reward. Valence refers to the value a person places on the outcome or reward, because not all people value the same reward. Again, generally, the higher the valence (meaning the importance to the individual) of the outcome or reward, the better the chance of motivation. One thing that we need to remember here is that the three components of the theory—valence, instrumentality, and expectancy—are multiplicative. This means that ifany one of the three is near zero, the motivating potential is also near zero, and the individual has almost no motivation to perform!17
WORK
APPLICATION 11-2
Give an example of how expectancy theory has affected your motivation or that of someone you work with or have worked with. Be sure to specify the expectancy and valence.
How does this theory affect the compensation of our workforce? The simple way to answer is to show expectancy in action (see
Exhibit 11-1
). An employee will have an expectation to put forth some form of effort at work. This effort is expected to result in some level of performance, and higher effort should result in higher performance levels. (This is expectancy.) The performance level is expected to result in some type of desired reward (this is instrumentality); and if it does, the employee expects to put out more effort. (Obviously, compensation in some form is at least part of the reward expected by the employee.) The reward must be significant to the individual (this is valence); and if it is, the motivation to put forth effort should continue. As long as the process continues unbroken, the employee will continue to put out effort. In other words, as HR managers, if we help employees get what they want, they will give us the work we want to help meet the organizational goals.18
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Exhibit 11-1 EXPECTANCY THEORY AND COMPENSATION
We need to realize that expectancy is based on the individual employee’s perception of fairness. So the result of expectancy theory is that our employees will either be motivated by their outcomes, including compensation, or be demotivated by them. A brewing problem here is that new employees are coming into the workforce with unrealistic expectations concerning compensation. In a 2017 survey, college seniors expected to make about $53,500 once they graduated, with more than half expecting at least $50,000; but recruiters said that a new graduate would average a little over $45,000.19 This sets up a very real danger to companies that their new employees will be strongly demotivated if the company cannot get the employee to change their perception of fair pay. Knowing how people internally evaluate their outcomes using the cognitive process of expectancy theory therefore helps us when we are structuring the compensation plan.
Motivating employees with expectancy theory. Here are some keys to using expectancy theory successfully:
1. Clearly define objectives and the performance needed to achieve them. In other words, goal setting is part of expectancy theory.
2. Tie performance to rewards. High performance should be rewarded. Highlight how the reward is a fair return for the performance. When one employee works harder to produce more than other employees and is not rewarded, that employee may slow down.
3. Be sure rewards have value to employees. What motivates one employee may notmotivate other employees, so managers should get to know employees as individuals.20 Letting employees speak (called employee voice) about the rewards they want, and giving those rewards, results in higher levels of motivation and performance.21
4. Make sure employees believe that management will do what it says it will. For example, employees must believe that management will give them a merit raise if they meet their performance goals. And, as noted in
Chapter 10
, management must do so to earn employees’ trust.
EQUITY THEORY. Equity theory is another concept that affects people in our organizations. Let’s face it, we are not all equal; but we want to be treated fairly,22 with mutually beneficial relationships.23Employees’ perception of being treated fairly affects their attitude and performance.24 So we need to be honest and fair to develop trusting relationship to motivate others.25 When managers are unfair and abusive, they can demotivate employees and hurt performance.26
p.
392
We all apply equity theory constantly.27 Equity theory, particularly the version developed by J. Stacy Adams, proposes that people are motivated to seek equity in the rewards they receive (outcomes) in exchange for their performance (input).28 So in general, equity theory proposes that employees are motivated when the ratio of their perceived outcomes to inputs is at least roughly equal to that of other referent individuals. Employees are more motivated to achieve organizational objectives when they believe they are being treated fairly,29 especially regarding pay.30 Here again, there appears to be a problem—almost half of US employees feel they are being paid unfairly,31 and employees in many other countries feel the same.
SHRM
K:A7
Internal Alignment Strategies
According to equity theory, people compare their inputs (effort, loyalty, hard work, commitment, skills, ability, experience, seniority, trust, support of colleagues, and so forth), financial rewards (pay, benefits, and perks), and intangible outcomes (praise, recognition, status, job security, sense of advancement, achievement, etc.) to those of relevant others.32 A relevant other could be a coworker or a group of employees from the same or different organizations.33 Notice that the definition says that employees compare their perceived (not actual) inputs and outcomes.34 Equity may actually exist, but if employees believe that there is inequity, they will change their behavior to create what they consider to be equity. Employees must perceive that they are being treated fairly, relative to others. Managers can also help control employee perceptions of fairness through honest discussion of compensation.35 Perceptions of inequity hurt attitudes, commitment, and cooperation, thereby decreasing individual, team, and organizational performance.36 This perceived inequity is used as a justification for unethical behavior.37
SHRM
K:A8
External Competitiveness Strategies
Unfortunately, at least in some cases, employees tend to inflate their own efforts or performance when comparing themselves to others.38 They also tend to overestimate what others earn. A 2016 Willis Towers Watson report noted that only about 39% of employees understood how their pay compared with others in their own organization, and that number went to 34% compared with employees in other organizations.39 Employees may be very satisfied and motivated until they perceive that a relevant other is earning more for the same job or earning the same for doing less work. When employees perceive inequity, they are motivated to reduce it by decreasing input or increasing outcomes. A comparison with relevant others leads to one of three conclusions: the employee is either underrewarded (will try to get equity, such as ask for a raise or leave for a better job or reduce output), overrewarded (may work harder, or will accept it as equity), or equitably rewarded (not dissatisfied with compensation).40
WORK
APPLICATION 11-3
Give an example of how equity theory has affected your motivation or that of someone you work with or have worked with. Be sure to specify if you were underrewarded, overrewarded, or equitably rewarded.
Motivating employees with equity theory. Using equity theory in practice can be difficult, because you don’t know employees’ reference groups and their views of inputs and outcomes. However, the theory does offer some useful general recommendations:
1. Managers should be aware that equity is based on perception, which may not be correct. Possibly, managers can create equity or inequity, so the manager’s role is to be the arbiter of equity.41 If employees believe they are not being treated fairly, there should be procedures in place to resolve the issue or complaint.42 A good performance appraisal system (as discussed in
Chapter 8
) can help.
2. Rewards should actually be equitable. When employees perceive that they are not treated fairly, morale suffers and performance problems occur. Employees producing at the same level should be given roughly equivalent rewards. It helps to know who the comparison person or group is to know if equity does exit.43
3. High performance should be rewarded, but employees must understand the inputs needed to attain certain outcomes. When using incentive pay, managers should clearly specify the exact requirements to achieve the incentive. As discussed in Chapter 8, a manager should be able to state objectively why one person got a higher merit raise than another did.
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As HR managers, we need to understand that people will be demotivated if they feel (perceive) that they are not fairly compensated.44 As a result, we have to use this information when we begin to structure our compensation plan. We need to “build in” equity to minimize the problems associated with equity theory.
LEARNING THEORIES. We talked about learning at length in Chapter 7, so we want to do just a brief review of those theories here. Remember that learning theories are about changing behaviors of people in the organization. We especially need to remember how reinforcement and social learningwork, because compensation is designed at least partly to reinforce learned behaviors at work.45 If you make something more (or less) attractive, people will do more (or less) of it.46 People respond to consequences and will behave as you want them to if you find the right incentives.47 Managers need to say, “This is what we do and do not do, and here is the behavior that will be rewarded and punished.”48
B. F. Skinner said that if we give employees something that they want in return for doing what we need them to do, they are more likely to continue to do the same work successfully in the future, because their behavior got positive reinforcement. Positive reinforcement generally works better than punishment,49 especially when training employees.50 In the same way, if an employee sees another get positive reinforcement for doing something, Skinner said that the person observing this action is more likely to imitate the rewarded behavior, because of social learning, in order to get a similar reward.
We can also use negative reinforcement because, you will remember, it also causes a person to repeat a desired action. If employees are less motivated because they have to work too much overtime, we can take the overtime away. Because we take away something that the employees don’t want, they are inclined to be more motivated. The whole point of compensation is to motivate employees, so we don’t want to demotivate them because we are working them too hard.
WORK
APPLICATION 11-4
Give an example of the types of reinforcement used on a present or past job.
We also set work standards to ensure that employees do a reasonable amount of work for their compensation. (This is called avoidance reinforcement.) If not, we use punishment, such as pay cuts, demotions, and (when necessary) firings.
COMPENSATION STRATEGY
LO 11-2
Identify the seven basic issues that make up the organization’s compensation strategy.
In addition to understanding our compensation options and how they motivate employees, we need to identify what our overall compensation strategy will be. We need to ask ourselves (and get honest answers to) a series of questions concerning the compensation system that we need to design. How much can we afford to pay? What actions are we willing to pay for? How will we structure our compensation system, and why? Will our pay structure be higher or lower than that of our competitors, and why? Let’s discuss some of these major organizational issues that we will need to understand and make decisions about before we can set up our system.
WORK
APPLICATION 11-5
Assess the ability to pay of an organization you work or worked for. Explain how you came up with your answer.
Ability to Pay
Probably the first thing we need is an honest assessment of how much we can afford or are willing to afford to pay our employees. This of course means we need to complete an assessment of estimated revenues from our business operations and determine what percentage of revenues can or should realistically go toward compensation costs. There are a number of ways of figuring this out, such as building pro forma financial analyses, but these are beyond the scope of this text.
SHRM
K:A10
Monitoring Compensation Costs
In our analysis, we want to calculate the total amount of annual organizational revenue that we expect to be available for all compensation components—wages, incentive payments, and benefits. One of the worst possible situations a company can find itself in is to have promised a particular level of compensation and then not be able to provide what was agreed upon because the funds are not available. This is especially true in the case of incentive payments. Making incentive promises at the beginning of a year and then reneging on them at the end of the year will almost always cause intense demotivation and high rates of turnover among our workers.51
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What Types of Compensation?
Once we identify how much revenue is available for compensation, the next thing we need to do is determine how to break the compensation structure down. We noted earlier in the chapter that we have four basic components to compensation—base pay, wage add-ons, incentives, and benefits. We will need to determine how to divide the funds available between each of the components.
There are some legal requirements for certain benefits such as Social Security (we will discuss these in Chapter 13), so these legal requirements have to be dealt with “off the top”—they have to be subtracted from the available funds. Once we subtract the amount necessary to provide the benefits that are legally mandated by local, state and federal requirements, we need to determine how much direct compensation will be in the form of base pay and how much will be incentive pay. We will have to ensure that the direct compensation that we provide will allow us to be competitive in the labor markets from which we must draw our employees. Otherwise, we may not be able to get recruits to select jobs with our firm.52
The last type of compensation that we will consider is voluntary benefits. Here again, we need to analyze competition within the labor market and what benefits each of our close competitors provides. We will most likely have to approximately match the benefits that are provided by our main competitors.53 In addition, we may determine that other benefits provide us with leverage that allows us to get better employees to commit to work for our firm, and such benefits may also help us keep the workers who are already part of the organization more satisfied and less likely to quit.54
Pay for Performance or Pay for Longevity?
In breaking down base pay versus incentives, we will need to look at whether our organization is going to have a performance philosophy or a longevity philosophy. What do we mean by performance and longevity? Some companies pay people more for longevity or seniority, meaning accumulating years of service with the firm. If we work for this type of organization, we will likely get promotions and raises over time (assuming that we meet minimal organizational standards) regardless of performance because we have been a loyal member of the organization. Other companies, however, pay more for performance—for completing certain tasks or doing certain things faster or better than average, not just for being there and being loyal to the firm.55
WORK
APPLICATION 11-6
Select a job you have or have had. Did the firm pay for performance or longevity? Explain in detail.
Why would anyone pay people just for being in the company for a long time? We may be in an industry where customers have strong relationships with their contact within the firm and where training new employees is costly. In this case, we might need to reward service because it gives us stability and our customers rely on this stability. A common example of an industry where at least part of direct compensation is based on longevity is the insurance industry. Customers create a relationship with their insurance agent, and they may not feel comfortable changing to a new agent every few months. And the company does not want to have to pay to train new insurance agents every few months. In this type of company, base pay may be the largest component of direct compensation.
There certainly may be problems with longevity philosophies. Some of our employees may think, “As long as I am here, regardless of my performance, I will get more compensation over time.” So entitlement-style pay philosophies don’t motivate us much. They may cause us to continue to work, but they probably won’t make us want to perform better over time.
However, if we are in an industry that focuses on performance and where customers want the best possible product or service, then we probably have to lean toward a performance orientation rather than a longevity-based philosophy.56 Such industries include those where competition is intense or where products or services are constantly developing and changing. Here companies might need to base at least a significant portion of their pay on performance. An example might be a company such as Samsung or Apple, which are continuously developing new microcircuit-based electronic products. In these firms, speed to market is a critical component of overall strategy, so major parts of their compensation strategy may be based on worker performance. In companies such as these, incentive pay will likely be a very large component compared to base pay.
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One caution here, though: Pay for performance is on the rise, but there is a potential dark side to individual incentives, as linking pay and performance is difficult in many jobs and employees frequently don’t think the system is fair.57 For example, was one of your professors (or physicians) better or worse than others? Why? And would all professors and students (or doctors and patients) agree and think it is fair to pay such a person differently based on performance? Also, many people believe in the egalitarian approach that we are all in this together, we are all equal, it is not fair to treat people differently, and we deserve the same compensation.58 This is the common mentality of most unions (e.g., teachers’ unions) that fight merit pay. So the challenging part is to design compensation programs that are perceived as fair to everyone.59
Skill-Based or Competency-Based Pay?
The next item that we may consider is whether or not we want to utilize competency-based or skill-based pay. Both fall within the incentive component of compensation. While Chapter 12 is the primary chapter covering incentive pay, we need to consider whether or not we’re going to use this type of incentive pay before we create the company’s pay structure.
©iStockphoto.com/Sproetniek
Organizations commonly pay based on the skills and competencies needed to do the job.
If we decide to use skill-based or competency-based pay, we will pay members of the workforce for individual skills or competencies that they bring to work, whether or not those skills are necessary for the individuals to do their current job. Competencies involve the individual’s level of knowledge in a particular area, while skills involve the ability to apply that knowledge set in that field. Examples of competencies include such things as an understanding of negotiation and collaboration, an understanding of the basic principles of physics, or problem-solving and decision-making expertise. Examples of skills related to these competencies would include the ability to actually negotiate contract agreements, apply principles of physics to a new equipment design, or make a high-quality decision based on good analysis of a situation.
Should we use competency-based or skill-based pay? Again, it depends.60 Probably the most important thing that we need to consider is our generic strategy. As we noted in
Chapter 2
, if our generic strategy is low cost, we probably want to hire and train people for specific jobs and will not generally pay them for knowledge and skills outside of that narrow job description. If, however, our strategy says that we’re going to act as a differentiator, then we may gain significant value from paying individuals extra for bringing to the workplace skills or competencies that can allow them to think, analyze a situation, and come up with good solutions to organizational problems.
However, we are paying our employees for knowledge, skills, and abilities that they may not necessarily ever use in the organization. This obviously drives up our overall costs for compensation. So we have to ask whether it is valuable to have somebody who is well rounded or whether we just need someone who is specifically trained for a job. Thus, skills-based pay is commonly measured based on the number of actual jobs the person can perform. For example, on an assembly line, a person who can work only on one part of production will be paid less than a person who can work on two or three parts. People who can perform multiple jobs are more valuable because they can help out wherever they are needed at any particular time.
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396
At, Above, or Below the Market?
The next item we must determine is whether we will pay above market, at market, or below market. Are we willing to pay more than necessary to hire individuals? Can we pay less than average and still get people to apply for jobs in our company? What are the advantages and disadvantages of each option?
SHRM
I:16
Employment Brand
Why would we ever want to pay above the market? The simple answer is to attract better workers and enhance our employment brand. We want good employees to have a strong incentive to work for us, and one way to enhance our employment brand is to pay above the market rate.61 We also want better productivity out of our workforce if we pay more for employees.
Do better workers generally have higher levels of productivity? In fact, there is some evidence that says that this is the case. Efficiency wage theory says that if a company pays higher wages, it can generally hire better people who will in turn be more productive.62 Walmart began an experiment using efficiency wage theory in 2015, at least partially due to a continuing slip in customer satisfaction surveys. As of late 2016, they were paying 13.7% above the average employee wage at “general merchandise stores” in an attempt to improve the candidate pool and ultimately the total skill set of their 1.2 million employees in the United States.63 There is some evidence that their attempt is working, as customer satisfaction has been rising steadily, although profit has not risen in step with customer ratings yet. Efficiency wage theory says that because we have higher-quality employees, we get a productivity increase that more than offsets the higher cost of employing them; but it does not conclude that increased profitability will necessarily follow increased productivity.64
Based on efficiency wage theory, would we necessarily get lower productivity from our workforce if we paid below the market? In general, yes, but not always. Low-paying firms may save money on pay, but the savings can be lost to the high cost of turnover as employees leave for better jobs; but just good pay will not retain good employees.65 If our firm is in an industry where unemployment is high, it is easy to find replacement workers; and if most positions require a low-level skill set, we may be able to get away with paying less than average. But is this a good idea? What will likely happen if the labor market gets tighter and there are fewer unemployed workers with the skills that we require? It will become easier for an employee with such skills to quit our company and go to work for another, and we will likely start to lose at least some of our more skilled employees because of job dissatisfaction and a lack of organizational commitment.66 So if you pay too little and the skill set you need is in high demand, it will be hard to find people.
WORK
APPLICATION 11-7
Select a job you have or have had. Did the firm provide above-average, average, or below-average compensation? Explain how you came up with your answer, using comparisons to competitors.
So we have to think about our overall pay levels. Are they going to be at the market average, above it, or below it? We can’t pay higher than average if we can’t afford to, but HRM professionals consistently conduct research to find out what the average compensation is so they know where they stand. In the end, most of them select the average option.
Wage Compression
Wage compression is another concern in setting up a pay structure. Wage compression occurs when new employees require higher starting pay than the historical norm, causing narrowing of the pay gap between experienced and new employees.67 It generally occurs over a significant period of time. We bring workers into the organization in both good economic times and bad. When the economy is doing poorly and overall wages are depressed, people will generally accept jobs for less than they would if the economy were doing well and higher-wage jobs were available. Since raises are frequently based on an employee’s initial salary or pay rate, those who start at lower pay than others may stay that way over time, and pay inequality for the same work may increase over time as well.
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Because we have to pay more to attract new employees when the overall economy is doing well or when their skills are in high demand, we may create a situation where workers with less time on the job might be paid nearly as much as, or more than, employees who have worked for us for many years but who came into the organization under other circumstances. For example, the supply of accounting professors with PhDs and CPA certifications is far lower than the demand. So some universities end up hiring such professors who don’t have any full-time academic experience and pay them more than some tenured full professors in other areas, such as organizational behavior.
This wage compression can weaken the desired link between pay and performance (expectancy theory), creating significant dissatisfaction on the part of long-term employees because of the pay differential.68 Employers are usually unaware that pay compression exists until problems surface. Most companies and organizations don’t set out to do this—they just fall into it.69 If we understand wage compression when creating a pay structure for the organization, we can avoid at least some of the dissatisfaction associated with the pay differentials between short-term and long-term employees.
Pay Secrecy
If we are savvy managers, we know that based on equity theory, our employees will review both internal and external equity, meaning they will compare themselves to other people both inside the firm and in other companies. Because our employees do this, we also have to pay attention to both types of pay equity. Sometimes we actually do a worse job with internal equity than we do with external equity. We have some knowledge of what a job is worth in other companies or on the open market through the use of pay survey data. However, we can have people working next to each other who have significant differences in salary, possibly because of wage compression or possibly from other factors such as personal productivity. When workers talk to each other and find out that they are getting significantly different pay, they might get upset.
Many managers think that one of the solutions to deal with this issue is pay secrecy, which means requiring employees to not disclose their pay to anyone else. But the NLRB has consistently ruled over the past several years that companies may not discipline workers who reveal information about their pay and other work conditions as long as the workers are participating in “protected, concerted activity,” and the NLRB views this activity very broadly. As a result of these rulings, any company that continues to function with pay secrecy rules and that uses those rules to discipline employees in any way may be charged by the NLRB with violating the NLRA. In addition, President Obama signed an Executive Order in 2014 (EO 13665) prohibiting pay secrecy policies in federal government contractors, with potential loss of government contracts as punishment for failure to comply. So, enforcing pay secrecy clauses is becoming more dangerous to companies.
However, there may be legitimate concerns about pay secrecy within companies. We may want to keep employees from discussing their pay because if we have two people working next to each other and doing the same basic job, and if there are big pay differences between them, then there could be a problem—even if the two individuals have significantly different performance histories. We think we may be able to avoid the problem by not letting them talk about it, but can we really avoid the problem? As a general rule, we can’t.
If you’re an employee who is required to sign a contract with a pay secrecy clause, what is one of the first things that pops into your head? You immediately begin to believe that we must be paying somebody else more than you. So, one of the issues here is that we almost immediately create a motivation and job satisfaction problem because of your perception of inequity (remember, perception is the key to equity).70
So there is a perception problem associated with pay secrecy, even if pay secrecy is deemed to be legal in some cases. Employees may assume the employer is unfair and biased against them, whether it is the truth or not. Therefore, they may try to balance the equation in a different way. There are also potential legal questions that the employer may be trying to avoid—potential age, race, and gender discrimination or other issues. For example, companies might have pay secrecy rules because they have older employees making less than younger employees. This may be because of the wage compression that we discussed in the last section, or it may be because the older workers have fewer current skills than someone who is just out of school. When you get out of college, you should have fairly up-to-date skills, but older employees may not even want to learn those new skill sets. In that kind of situation, the younger person may be worth more to the company, but the older person doesn’t feel like that’s true. So there is some potential for discrimination lawsuits.
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But will all of this really keep everyone from talking about their pay? Of course not—at least some people will talk. So one thing that we create by putting a pay secrecy clause into employment contracts is a whole bunch of rule breakers. This is never a good idea. Well, will it cause people to be more satisfied with their pay, since they don’t know that anyone else is getting paid more than they are? We have already dispelled that assumption, because of perception. All right, won’t we have to answer a lot of questions about why someone is getting paid more than someone else in a similar job? Yes, we might, but isn’t this something that you should do proactively if you are doing your job and you know that the differential exists because of performance, knowledge, or skills? If we can explain the reason for inequity successfully, we change the equity theory equation. So, there usually are no defensible reasons for pay secrecy.
Open companies, where large amounts of corporate information are available to everyone in the organization, are becoming more common. Namaste Solar in Colorado has decided to practice complete salary transparency.71 And salaries at SumAll are continually adjusted, both up and down. SumAll’s CEO says that peers will be your measure. “When they feel you’re doing well, they argue for you to make more money, and when they feel you’re doing poorly, they pull you down.”72
Recent research supports opening the books as well, with evidence that pay secrecy has an adverse effect on performance and voluntary turnover.73 According to Ed Lawler of the University of Southern California, companies may not have a choice to remain secretive because of the nature of work in the new economy. However, this will put more pressure on management to be able to explain differences in pay when questioned.74
LEGAL AND FAIRNESS ISSUES IN COMPENSATION
LO 11-3
Discuss the three major provisions of the FLSA and the penalties for misclassification of employees.
In
Chapter 3
, we discussed the Equal Pay Act and how it specifically deals with paying women and men equally when all other factors are the same. We also just mentioned EO 13665, which requires pay openness and gender equity for federal contractors. We have to provide equal pay for equal work unless there is a difference in productivity, seniority, merit, or other factors “other than sex.” There are also a number of federal and state laws that directly or indirectly affect pay and compensation systems. Virtually every equal employment opportunity (EEO) law identifies compensation as one of the employment actions where discrimination is prohibited if it is based on a protected characteristic. So we have to keep these laws in mind as we set up our pay system. See
Exhibit 11-2
for a list of some of the major EEO laws and legal concepts that cover compensation.
WORK
APPLICATION 11-8
Select a job you have or have had. Did people know how much other employees made, or was there pay secrecy?
Fair Labor Standards Act of 1938 (Amended)
Besides the Equal Pay Act and the other EEO laws, there are some laws that deal with specific compensation issues. The grandfather of these laws is the Fair Labor Standards Act (FLSA). We must really understand the FLSA well in order to create a pay system. The law’s major provisions cover minimum wage, overtime issues, and child labor rules for most US-based businesses.75 Let’s complete a quick review of the major provisions of the FLSA.
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Exhibit 11-2 SAMPLE OF JOB SATISFACTION SURVEY (JSS) QUESTIONS
SHRM
B:8
Fair Labor Standards Act of 1938 (FLSA)
THE MINIMUM WAGE. The first major provision of the FLSA concerns the federal minimum wage. The minimum wage is the lowest hourly rate of pay generally permissible by federal law. The current federal minimum wage for most employees in the United States as of 2017 is $7.25 per hour.76 This is adjusted periodically by Congress, but the FLSA applies the minimum wage provision. It doesn’t matter how the employer pays employees—the net value paid per hour can’t generally fall below the minimum wage. In other words, we can compensate employees based on a “piece-rate” payment; on commission; or by use of a straight hourly wage, salary, or other common form—but the amount has to equal $7.25 per hour or more for the hours worked.77 Some states and even cities have set the minimum wage higher than the federal rate. You may have seen in the news that Seattle, Washington, is increasing the city’s minimum wage to $15 per hour! However, there is some recent research that posits that this increase in the minimum wages has actually harmed low-wage workers because their hours have been cut and others laid off. As wages increase, businesses will use more technology to replace workers. Have you seen an ordering and paying kiosk at McDonald’s or other places? Other research disputes this, so we are not sure at this point whether or not a higher minimum wage helps the lowest paid workers in a particular labor market.78 In addition, a rule to raise the minimum wage for federal contract workers to $10.10 per hour was in place as of July 2017.79
SHRM
K:A12
Minimum Wage/Overtime
Does everyone get paid at least the minimum wage for their area? Not exactly. There are some exemptions to the rules.80 If someone is exempt, by the definitions in the FLSA, they are exempt from the minimum wage requirement, overtime provisions, or child labor rules or possibly all three. People not meeting any of the requirements for an exemption are called nonexempt and must be paid minimum wage, overtime, and so forth.
WORK
APPLICATION 11-9
Select a job you have or have had. What is the minimum wage in your state? Does the firm pay its lowest-level employees below, at, or above the state minimum wage?
As an example, workers who most people know are commonly exempt include restaurant servers. The current minimum wage for servers is $2.13 per hour.81 Why should servers be paid less than $7.25? The obvious answer is that they are in a “tipped” position. Servers would normally expect to get a large portion of their wages in tips. The FLSA says that we can pay servers a minimum of $2.13 per hour as long as their tips make up the difference. If somebody in a restaurant works 20 hours in 1 week and does not make an average of $5.12 an hour in tips, it is illegal to pay that person $2.13. So just because there is an exemption, it does not mean that we can pay our servers $2.13 per hour, no matter the circumstances. This is why workers at the local McDonald’s or Taco Bell are not paid $2.13 an hour: Most workers at fast-food restaurants don’t get tipped. For food service workers, average tips must make up the difference between the wage paid and the minimum wage; and in these businesses, tips will not do so.82 There are also other exemptions for individuals who are live-in child care providers, newspaper carriers, seasonal workers, and so on. In fact, there are hundreds of exemptions (see
Exhibit 11-3
for examples).
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WORK
APPLICATION 11-10
Give examples of jobs that are exempt and nonexempt. Be sure to state why they are classified as such.
However, there is a set of quick guidelines concerning exempt and nonexempt persons at work. If you make under $23,660 per year, you are pretty much guaranteed to be nonexempt under the current provisions of the FLSA.83 “Highly compensated employees” paid $100,000 or more per year (and at least $455 per week) are pretty much automatically exempt from the minimum wage and overtime rules if they regularly perform at least one of the duties of an exempt executive, administrative employee, or professional employee identified in the standard tests for exemption.84 If an individual is paid more than $23,660 but less than $100,000, then the employee usually must meet a set of specific “duties tests” in order to fall within an exemption category (see
Exhibit 11-4
).
You may have heard that in the United States the minimum weekly salary test was going to increase significantly. The Department of Labor (DOL) did implement a rule that would have nearly doubled the weekly salary requirements for anyone in one of the general exemption categories to $913 per week,85 but the rule had not taken effect before the new president was inaugurated. Once this change occurred, the DOL withdrew the new rule, although it is still possible that we will see an increase in the salary test, but at a lower level than originally proposed. If you are about to graduate and are going to work in the HRM field, you will want to pay close attention to this issue so that you can take action once you are employed.
Exhibit 11-3 COMMON EXEMPTIONS
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11-2 APPLYING THE CONCEPT
Employee Exemptions
Identify each job as generally being considered exempt or not from minimum wage or overtime pay (write a or b before each job type).
a. exempt
b. nonexempt
____ 6. Auto mechanic
____ 7. Fruit picker
____ 8. Worker on a foreign-flag cruise ship
____ 9. Librarian
____ 10. Taxi driver
____ 11. Real estate agent
____ 12. Bellperson at a hotel
____ 13. Computer programmer (paid more than $27.63 per hour)
____ 14. Hairdresser
____ 15. Bank teller
Exhibit 11-4 DUTIES TESTS FOR GENERAL EMPLOYEE EXEMPTIONS
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Source: US Department of Labor, http://www.dol.gov/whd/regs/compliance/fairpay/fs17g_salary.htm, retrieved July 15, 2017.
OVERTIME. Overtime is a higher than minimum, federally mandated wage, required for nonexempt employees if they work more than a certain number of hours in a week. Overtime is currently set by the FLSA as “time-and-a-half,” or 150% of the individual’s normal wages. If somebody is not an exempt employee and works more than 40 hours a week, do we have to pay that employee overtime? Yes, in almost all cases. But what if the person works more than 8 hours a day? No, there is no limit to the number of hours per day for calculation of overtime. With very few exceptions, if a nonexempt employee works more than 40 hours in a week, that employee is eligible for overtime.
SHRM
K:A6
Compensation of Special Groups
In a few cases, the organization may be allowed to average an employee’s work hours over 2 weeks in order to determine whether the individual is eligible for overtime—but this is an exception, not the rule! One type of work for which this may be allowed is shift work for firefighters, police officers, or medical personnel who may work 12- or 24-hour shifts. This is because they may work 48 hours one week and 24the next, so we can calculate their overtime based on a 2-week average rather than a 1-week total. Remember, though, that these situations are fairly rare and are explicitly identified in the FLSA.
SHRM
E:6
Compliance With Legal Requirements
Overtime Eligibility
What about double time? If an employee works more than 60 hours in a week, do we have to pay that person double time? In fact, we don’t. The FLSA has no requirement for paying anything more than time-and-a-half for any overtime work.87 Employers are also not required to provide paid holidays, vacation, or extra pay for working on weekends or on holidays. Many do this, though, because of the issue of job satisfaction and organizational commitment.
CHILD LABOR. The FLSA also has rules on the use of child labor, meaning any workers under 18 years old. If individuals are 18 or older, we can use them in any normal employment situation. However, we can employ 16- and 17-year-olds only in nonhazardous jobs, although their work hours are unrestricted. Finally, there are significantly different rules for 14- and 15-year-olds.
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WORK
APPLICATION 11-11
Select a job you have or have had. Who gets paid overtime, why, and how much?
Minors age 14 and 15 may work outside school hours for no more than “three hours on a school day, 18 hours in a school week, eight hours on a non-school day, and 40 hours in a non-school week.”88 They can’t start work before 7:00 a.m. or work after 7:00 p.m., except from June 1 through Labor Day, when they can work until 9:00 p.m. Jobs they can work are limited to retail, food service, and gasoline service at establishments specifically listed in the FLSA regulations. Employees 14 and 15 years old may not work overtime. While there are some exceptions to these rules for businesses such as family businesses or family farms, these are the general guidelines for child labor.
WORK
APPLICATION 11-12
Select a job you have or have had. Does the organization hire child labor? If so, why, and what do the child laborers do?
EMPLOYEE MISCLASSIFICATION UNDER THE FLSA.Misclassification of employees as exempt from minimum wage or overtime is one area where companies can get into serious trouble. In a news release in June of 2017, the Department of Labor noted the recovery of $3.4 million in unpaid overtime from Zenefits, a human resources benefits company.89 The DOL charged that the 743 account executives and sales representatives identified in their investigation were non-exempt. You would think that an HR company would know—and follow—the rules on minimum wage and overtime, but this shows how complicated it can sometimes be to identify who is exempt under federal rules. Another interesting point here is that the investigation was most likely initiated by the complaint of one or a few workers. So how would more than 700 people end up getting back wage settlements when perhaps only one made a complaint?
Once a complaint is filed, the Department of Labor’s Wage and Hour Division (see the website at
http://dol.gov/whd/
), the enforcement arm for wage complaints, will investigate the situation. If it finds evidence of minimum wage or overtime violations with the complainant, it will typically investigate every employee record at the company (at least in that employee class). In the case of Zenefits, the Department of Labor investigated all of individuals in the sales and account executive jobs who had been labeled as exempt by the company. They determined that these individuals did not meet the duties tests that we discussed earlier, and as a result, Zenefits agreed to pay back wages for the misclassification.
Why does misclassification occur? Obviously, companies want to save money. Many employers think that if they put you on salary, they don’t have to pay overtime—so they put you on a salary and work you 70 hours per week. Another company might say, “All my people are professionals, so they are all exempt.” But this is rarely possible in reality, if you look at the FLSA rules for exemption.
So what happens if we exempt someone who is not legitimately in an exempt category? We could end up being investigated by the Wage and Hour Division of the DOL. And what are the penalties for misclassifying employees? The employer can personally be criminally prosecuted and fined up to $10,000 per infraction. That can add up real fast—think of the 743 Zenefits employees; that would have been more than $7.4 million if the DOL had decided that the misclassification was willful on top of the $3.4 million paid to the employees! Also, there is no limit to the fines in this law—a fact that most managers don’t realize. A second conviction could result in imprisonment, and in addition, employers who willfully or repeatedly violate the exemption rules may be assessed civil penalties of more than $1,100 per violation. It’s also worse for child labor violations. Here, the civil penalty can be more than $11,000 per worker for each violation. And this can go to as much as $50,000 or even $100,000 if the violation causes the death or serious injury of an employee younger than 18 years of age.90
So what do we need to do as HR managers? We must try to impress on company leadership that misclassifying employees as exempt to save a few dollars is not the smart thing to do. Would you rather pay a few extra dollars a week or have a multimillion-dollar liability because of multiple fines?
Finally, states can’t allow a lower minimum wage than the federal guidelines of $7.25, but they can require a higher wage. Therefore, we need to remember that many states have a state minimum wage that is higher than the federal minimum wage.91 Currently, over half of US states have their own minimums that are higher than the federal minimum wage. So we need to make sure that we know our state’s laws concerning minimum wage and overtime. Note that this can be complicated for firms with employees in several states, and even more so with international business operations.
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PAY EQUITY, COMPARABLE WORTH, AND OTHER LEGAL ISSUES
LO 11-4
Briefly describe the concept of comparable worth and highlight the other legal issues in compensation.
Although the FLSA is the major compensation law, there are a number of other federal laws, as well as state and local statutes that affect organizational compensation decisions. Companies have to be aware of all of the laws—and even local sentiment concerning fair pay—in order to be able to set up a compensation system. Let’s look at some of the other issues here.
Comparable Worth
One of the more controversial issues in compensation is comparable worth. Comparable worth is the principle that when jobs are distinctly different but entail similar levels of ability, responsibility, skills, and working conditions, they are of equal value and should have the same pay scale. Comparable worth legislation has been proposed as a solution to the problem of persistent gender inequity in pay. According to the US Senate, women earn an average of 79 cents for every dollar that men earn.92This is one of the major reasons that comparable worth continues to be an issue in both business and government. While equal pay for equal work is the law (EPA of 1963), comparable worth is not currently federal law except in some very limited cases. However, a number of states—with California in the lead—have passed fair pay laws that are designed to require comparable pay in at least most work environments, and shift to the employer the burden of showing that any pay differences are due to valid, legal reasons.93
SHRM
K:A13
Pay Discrimination and Dissimilar Jobs
What does “comparable worth” mean? It is simply “similar pay for similar work.” While this sounds almost like the equal pay for equal work stipulated by the Equal Pay Act, the doctrine of comparable worth says that if we can compare your job with that of another person, and if the two jobs are similar but not the same, then we should pay you a similar wage but not necessarily exactly the same wage. So this concept is much broader than equal pay.
SHRM
E:6
Compliance With Legal Requirements
Equal Pay and Comparable Worth
If comparable worth were federal law, companies would be required to pay people who are in similar jobs similarly, which leads to a whole bunch of questions: What is similar work? Who determines what work is comparable? How do we take market supply and demand for labor into account? And what is comparable pay?
Let’s look at an example to see what comparable worth is all about. Say that Amanda and Kenny—an engineer and a nurse, respectively—both work for Baptist Medical Center. Amanda has a graduate degree in mechanical engineering. She started working at Baptist about 5 years ago as the head of heating/ventilation/air-conditioning services. Amanda is paid $85,000 a year. Her primary job is maintaining the HVAC system and reengineering it as necessary when the hospital changes its facilities in any way. Kenny, on the other hand, is a registered nurse (RN), and he also has a master’s degree (in nursing). He has been at Baptist for about 5 years, too. Kenny’s primary job is to work as an RN in one of the intensive care units (ICUs). He is responsible for maintaining the health of the patients in the ICU, and his job frequently involves life-and-death situations. However, Kenny gets paid only $65,000 a year. He may feel like Amanda’s job doesn’t involve life and death as his job does, although it might in some ways if she were to do a poor job of engineering something at the hospital and thus caused an accident. How might Kenny feel about the pay differential if he knew about it? He might feel like he is not getting paid enough, right? Kenny would therefore be using the equity equation that we talked about earlier in the chapter to determine that he is underpaid, and that is exactly what comparable worth legislation would do.
OK, so how much should Kenny be paid relative to Amanda?
There is no simple answer to this question, and it would be very difficult to apply comparable worth to determine a dollar value for Kenny’s job. Why? It is too hard to classify these jobs and determine what is comparable, because there are too many variables. These jobs are certainly comparable in such things as education (both have graduate degrees), tenure on the job (both about 5 years), and classification (both are considered professional occupations). But are there other factors? Of course there are, including thousands of details within each job plus the supply and demand for nurses and mechanical engineers. So who should get paid more if there are too many nurses and not enough engineers? It would be very difficult to deal with the market value factor of a job within a federal law. This is probably the main reason why Congress has not been able to pass a comparable worth law, at least not one that covers most businesses. Almost every year since the mid-1990s, at least some members of Congress have tried to bring up and pass a comparable worth law. Attempts to pass such laws have so far failed, mainly because of the issue of market forces and the difficulty of enforcing the laws.
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WORK
APPLICATION 11-13
Select an organization you work at or have worked at. Could comparable worth work at that organization? Why or why not?
As we noted, though, there are a few cases where comparable worth is now law, even though business argues that the laws are vague. Some states have passed comparable worth legislation that applies to state, county, and city agencies; and some have now even passed “fair pay” acts that apply to all employers in the state. California’s law requires all employers to provide comparable pay for “substantially similar work,”94 but who makes the decision concerning what work is substantially similar? It will be interesting to see what effect these laws have on pay equity and comparable worth, and how such laws will be enforced.
SHRM
K:A9
Legal Constraints on Pay Issues
Other Legal Issues
A number of other federal laws place controls on pay and benefits. Recall from Chapter 10 that the National Labor Relations Act (NLRA) allows collective bargaining on the part of workers who join a union. Since the NLRA allows employees to bargain collectively with their employers for wages, benefits, and working conditions, in limited cases, the workers can agree to a workweek that is longer than 40 hours. The wages paid must be significantly higher than the minimum wage, and other conditions apply; but it is possible for the collective bargaining unit to agree to more than a 40-hour workweek.95
SHRM
K:A11
Union Role in Wage and Salary Administration
Mandatory employee pension and benefits legislationalso includes the following:
• Social Security
• Workers’ compensation
• Unemployment insurance
• Family and Medical Leave Act (FMLA)
• Patient Protection and Affordable Care Act (PPACA)
• Employee Retirement Income Security Act (ERISA—mandatory for employers who offer pension plans)
• Health Insurance Portability and Accountability Act (HIPAA—mandatory for employers who offer health insurance)
We will discuss each of these laws further in Chapter 13.
JOB EVALUATION
LO 11-5
Identify the three types of job evaluation and discuss whether they are more objective or subjective in form.
Deciding how much to pay each employee in a company is difficult. There are two approaches to this—internal and external—though they may be used together. An external approach involves finding out what other organizations pay for the same or similar jobs through available pay surveys, and it sets pay levels based on market pricing. The vast majority of firms use this external approach to identifying pay levels. In a recent survey, about 95% of companies said that they use at least one source of pay survey data or other external information to determine market pricing for their jobs.96 On the other hand, an internal approach uses job evaluation. Job evaluation is the process of determining the worth of each position relative to the other positions within the organization. The most common form of internal job evaluation, the point-factor method, was used in only about one sixth of the companies surveyed.97 Organizations commonly group jobs into pay levels or grades, and the higher the grade of the job, the higher the pay. A common example of this type of grouping is the federal government’s GS ratings.
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SHRM
E:2
Job Evaluation and Compensation (Grades, Pay Surveys, and Pay Setting)
How do we accomplish a job evaluation? There are several ways, but the methods usually involve assigning points to activities that occur within a job and totaling the points for the job. Once this is done, we can place the job in a hierarchy and create our pay grades. Let’s discuss some of the more popular job evaluation methods.
SHRM
K:A4
Role of Job Analysis/Job Design/Job Descriptions in Determining Compensation
Job-Ranking Method
Job ranking is simply the process of putting jobs in order from lowest to highest or vice versa, in terms of value to the company. This is the easiest and fastest method of job evaluation, but it has limited usefulness because it is subjective.
Luke Sharrett/Bloomberg via Getty Images
Generally, the higher a person is in the organization, the more compensation that employee is given.
When doing job ranking, we utilize the job descriptions that we discussed in
Chapter 4
to identify the factors in each job and then rank those jobs based on their content and complexity. We usually do job ranking without assigning points to different jobs. So we might start at the top of the organization with the CEO as the highest-ranking person and then work all the way down to the lowest-skilled housekeeping job.
But if you look at this method for a second, you will see that somebody has to decide the value of each job and do so without any quantitative factors. Therefore, this determination requires judgment and is highly subjective. This means it is difficult to defend if we have to do so.
Point-Factor Method
A second type of job evaluation is the point-factor method. The Hay Guide is probably the most well-known point-factor method, but there are many others.98 Point-factor methods attempt to be completely objective in form. They break a job down into components like particular skills or abilities, and then they assign a number of points to each component based on its difficulty. These components are usually referred to as compensable factors.
Essential functions, as defined in the ADA, would certainly be compensable factors to which points would be assigned when evaluating a job. Many of the compensable factors will be common among a number of different jobs, so once we have identified the number of points the factor is worth, we can then transfer that same value to all other jobs where the factor is present. The value of the point-factor job evaluation method is that we can differentiate jobs based on the difficulty or intensity of each factor, so it becomes easier to determine the total value of the job in a quantitative form.
WORK
APPLICATION 11-14
Select an organization. Identify and describe which of the four job evaluation methods are used in that organization to determine pay.
Factor Comparison Method
The factor comparison method combines the job-ranking and point-factor methods to provide a more thorough form of job evaluation.99 This model is somewhat similar to the point-factor method in that it assigns points to compensable factors. However, the factor comparison method first identifies a group of benchmark jobs—positions that are identified and evaluated in a large number of organizations and that can generally be found in most pay surveys. Examples of benchmark jobs include “Training Specialist I,” “Accountant II,” “Lending Officer I,” or “Hotel Registration Clerk.” These benchmark jobs are then analyzed in some detail based on their compensable factors. We then rank the benchmark jobs in order, and we finally compare all other jobs in the organization to the benchmark jobs to determine where each one fits in the rankings. Here again, the primary method of determining the monetary value of a job is through the analysis of the compensable factors.
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11-3 APPLYING THE CONCEPT
Job Evaluation
Review the list of job evaluation methods and then write the letter corresponding to each method before each statement below.
a. external
b. job-ranking
c. point-factor
d. factor comparison
____ 16. I use two methods together to determine how much to pay each position because I’m an HR professional.
____ 17. I look at the job and determine the specific skills needed to do the job, and then I add up the total point value of the skills to set the pay.
____ 18. To figure out how much to pay the data entry person, I’m checking the SHRM data.
____ 19. I placed all the jobs in rank order, from the one that was worth the most to the one that was worth the least, in order to determine how much to pay for each position.
____ 20. All of the companies in our industry pay essentially the same hourly wage.
A custom factor comparison method is more complex and time-consuming than the ranking or point-factor methods, mainly because it is customized to the individual organization and to the jobs within the organization.100 Because the factor comparison method uses both point factors and ranking, it has both objective and subjective components.
DEVELOPING A PAY SYSTEM
LO 11-6
Briefly describe the concepts of job structure, pay levels, product market competition, and labor market competition.
Well, we have finally gotten to the point where we can start to develop our new pay structure. Remember, though, all of the things that we had to review and decide on first. We had to review motivational theories that show us how compensation motivates our workers, and why. We also looked at how much revenue we expect to be available for compensation purposes. Then we reviewed each of our pay policies to make sure they were fresh in our minds so that we could maintain consistency in our compensation system.
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SHRM
K:A1
Development of a Base Pay System
We also reviewed each of the major federal lawsconcerning compensation and equity, and we went through the process of ensuring that our job analysisfiles were up-to-date. From these, we were able to complete job evaluations of each of the jobs in the organization. We also most likely researched external equity using one or more industry-specific pay surveys.
Take a look now at
Exhibit 11-5
to see how each of these items comes together to allow us to create a pay structure and individual pay rates for each job.
Job Structure and Pay Levels
A pay structure is a hierarchy of jobs and their rates of pay within the organization.101 It allows us to identify what the pay range is for each job. Once we have completed the process of creating a pay structure, we will have the pay range for every job in the hierarchy. From that, managers can determine individual compensation levels based on the employee’s performance, seniority, skills, and any other significant contingency factors.
A pay structure is composed of both a job structure and pay levels. The job structure is what gives us our job hierarchy. As we noted in the job evaluation section of this chapter, the job structure is the stacking up of the jobs in the organization, from the lowest to the highest level. Each of the jobs within the job structure will end up at a particular pay level. On the other hand, a pay level (frequently called a pay grade) is made up of many different jobs, and each pay level has a maximum pay rate and a minimum pay rate.
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Exhibit 11-5 CREATION OF A
PAY STRUCTURE
AND INDIVIDUAL PAY RATES
CREATION OF PAY LEVELS. To establish pay levels and determine the maximum and minimum pay rates for particular jobs, we have to look at some market factors. We must look at market pricing because if we don’t pay attention to external equity or fairness, we are going to have trouble filling many of our jobs.
PRODUCT MARKET COMPETITION AND LABOR MARKET COMPETITION. To set the minimum value for a particular pay level, we have to look at the applicable labor market competition, meaning labor supply versus demand for labor. If we graph compensation for a given type of work versus the number of workers in the labor market who can do that type of work, the place where the two lines cross is the average pay for that work. Per
Exhibit 11-6
, when the supply of labor equals the demand for that labor in the workforce, we have equilibrium. The market will pay about what the workers demand to be paid, or workers who have the necessary skills won’t be willing to fill the job.
What happens in bad economic times when there are more workers available than jobs? The market can get some of them to work for less than the normal rate (where the lines cross) because those workers need to work and earn a living. So the average compensation will most likely go down because we will have an oversupply situation. Conversely, what if we have more jobs available than we have workers with the requisite skills? In this case, we will usually have to pay more to attract the limited number of workers with the skills set that we require. We noted earlier in the chapter that as of 2016, Walmart was paying about 13.7% more than the average wage to entice workers to apply to work in their stores. The company realized that the labor market was tightening, and that they would have to pay more in order to get applicants with good skill sets. In either case, though, labor market competition will set the minimum pay that a worker will require in order to come to work for us. Also recall that we have to pay at least minimum wage to nonexempt employees. For example, if we need to hire an arc welder for one of our shops and the average pay for a welder is $16 per hour, what happens if we advertise that we will pay minimum wage ($7.25 per hour)? Will we be able to hire a qualified welder for that wage? It is really unlikely, unless there are way too many welders who are out of work. If that’s the case, though, we might be able to hire a welder for minimum wage, but we had better understand that as soon as the market for welders recovers, the new employee will likely quit.
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Exhibit 11-6 SUPPLY AND DEMAND CURVE
What happens if, instead of there being too many welders available, there are too few? If the average pay for a welder is $16 per hour and we advertise that we will pay $16 per hour for a welder, will we be able to hire one? We will probably have to raise the minimum amount that we are willing to pay in order to get someone to take the job. If our pay rate is too low in either situation, we won’t get anybody. That’s why we have a base wage—the bottom of our pay level. We have to compete for people who are willing to do the job, and labor market competition sets the minimum amount for any pay level—but it can be a moving target that we have to track.
On the other hand, how do we determine the top of the pay level? We have to look at something called product market competition. This is basically a function of the value of the product or service that we sell to the customer.102 Again, an example will help make it clear.
Let’s say we manufacture utility trailers (see
Exhibit 11-7
). The public will pay about $500 for our 5- by 8-foot utility trailers. To make the problem simple, we will pretend that we have only a couple of components that go into making that trailer: labor (our welder can also assemble other parts of the trailer) and materials (all of the pieces that go into the making of the trailer). Let’s assume that all of the materials are going to cost $250 (we might need bolts, axles, angle iron for the basic frame, welding rods, etc.).
What do we have left for labor? Do we have $250? No! We also have some other indirect costs, don’t we? And we would like to make a profit, right? So if we estimate all of our other costs at $50, we now have $200 left. We can pay labor $200 if we only want to break even. However, if we want to make any money, we have to pay less than $200 for labor. Assume again that our welder makes $20 per hour (because this employee is a good welder and has worked for us for a long time) and it takes the welder 8 hours to build a trailer—$160 for the 8 hours of labor costs. So we have a $40 profit left, or about 8% profit.
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Exhibit 11-7 PRODUCT MARKET COMPETITION LIMITS
Now, our welder comes to you and says, “Boss, I need more money—I need a raise.” What do you just about have to tell the employee? “We can’t pay you more.” The trailer can sell only for a certain amount of money. If our trailer is $800 and a competitor’s trailer is $500, almost everyone will buy the competitor’s trailer. We can’t charge much more than the normal rate for a product or service. The labor is worth only so much money, because the sale price of the good or service has to cover the cost of the labor.
Something you always need to keep in mind in HR and as a manager is how much you can pay for labor, meaning what the job is worth. We do not price the value of a person when we create a pay scale—we price the value of a job. You need to understand that you can’t pay more than the value added to the product or service by the labor. The biggest reason that you need to understand this is so that you can explain it to your employees. The decision of whether or not to pay someone more for a particular job is not a function of liking or disliking the employee; it is a function of being able to pay only a certain amount because of the product’s market value. So, product market competition sets the top of the pay level for most types of jobs in the company.
SHRM
K:A2
Developing Pay Levels
Exhibit 11-8
shows that we have a maximum and a minimum level of pay for a particular class of jobs. So labor market competition sets the bottom of the range, and product market competition sets the top of the range. Remember, though, that this is a simplified example—there may be other factors involved as well.
BENCHMARKING PAY SURVEY DATA. Next, we look at benchmarks from the pay survey data that we reviewed earlier and put those benchmark jobs into the pay level where they belong (the blue dots in Exhibit 11-8). Once we place some benchmark jobs in a plot of our pay levels, we can get a market pay line (sometimes called a pay curve)—a line that shows the average pay at different levels in a particular industry (see
Exhibit 11-9
). We use the benchmarks to see whether or not what we are doing is OK. If the range is correct, we have successfully created a pay level; if not, we have to figure out what is wrong with our range.
Exhibit 11-8 PAY LEVELS
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Exhibit 11-9 PAY STRUCTURE
SHRM
G:11
Benchmarking
After going through this process for a particular pay level, we end up with a rate range, which provides the maximum, minimum, and midpoint of pay for a certain group of jobs. Once the range is created, we can go in and add to the range any other jobs that are at approximately the same level based on our earlier job evaluations.
SHRM
K:A14
Prevailing Wage
PAY STRUCTURE
LO 11-7
Briefly describe the concept of a pay structure, including broadbanding and delayering.
So we have figured out our first pay level. So what do we do now? Job structure and paylevel design are the last pieces that we need in order to put together a complete pay structure for our organization. How are we going to accomplish this? Let’s review theprocess.
Stacking Pay Levels and Evaluating
We start to lay pay levels out next to each other, creating a pay dispersion.103 Again, look at Exhibit 11-9. We take our first pay level and put it down: bottom, midpoint, and top. The bottom of the range for the first level will probably be near minimum wage in most cases. Then our second tier will start, and beyond that will be the third and the fourth, and so on.
p.
412
Notice that the ranges overlap each other in Exhibit 11-9. Why do they overlap? What would happen if each pay level started with its minimum pay rate at the maximum rate of the previous level? Would we have any room to pay people differentially in a particular level? Take a look at the market pay line. It would have to go exactly through the corners of each pay level if the levels didn’t overlap. That doesn’t give us much wiggle room on which to base people’s pay rates, does it? So the major reason for the overlap is to give the company some flexibility in each person’s pay within a particular pay level.
SHRM
K:A3
Determining Pay Increases
Once we set up our pay levels, we can actually plot the real pay levels for people in the organization. These are indicated in Exhibit 11-9 as black dots. We identify where people fall within the pay structure, and we will sometimes see that we have someone plotted outside our pay-level ranges—either too high or too low. Individual pay rates that fall outside our pay range on the high side are called red-circle rates (red dots in Exhibit 11-9), and those that are lower than the bottom of the pay range are green-circle rates (green dots in Exhibit 11-9). If we find a green-circle rate for an individual, the correct thing to do is to raise the individual’s pay to at least the minimum for that pay level, because we are not paying them fairly for their skill set.104
WORK
APPLICATION 11-15
Select an organization. Identify the rate range for a category of jobs.
But what should we do about a red-circle rate? We probably won’t cut someone’s pay, but we will not be able to pay them any more unless they move up to a higher skill level, and therefore a higher pay level. For instance, if our welder is making $24 per hour, the maximum for his pay level is $20, but he wants a pay raise and hasn’t had a one in several years, we may have to tell him no. However, we can also tell him that if he is willing to become a supervisor over other welders, he can get the chance to raise his pay rate because the skill level for a supervisor is higher than that of a welder.
Understanding pay levels and our pay structure allows us to provide good answers to our employees about why their pay is set at a certain level. If a worker decides to become a supervisor, that employee is worth more and we can pay more. So we are able to tell the employee, “The job isn’t worth any more than what you are being paid,” instead of saying, “You are not worth any more than that.” It also gives us leverage to get good workers to consider becoming supervisors or managers if we tell them, “If you want a pay raise, become a supervisor.”
Delayering and Broadbanding
A trend over many years now has been to lower the number of pay levels using one of two options—either delayering or broadbanding. Delayering is the process of changing the company structure to get rid of some of the vertical hierarchy (reporting levels) in an organization. On the other hand, broadbanding is accomplished by combining multiple pay levels into one.105 What is the benefit of combining levels either vertically or horizontally in this way? Is it that we can make bigger groups, and bigger is always better? Well, bigger isn’t always better, but in this case it may be. When we lower the number of pay levels that we have to deal with, we make the process simpler. It takes a long time to create, maintain, and evaluate 20 pay levels, when instead we can have just 5 broadbands. It also allows us more capacity to reward outstanding performers. Because we have taller and wider levels, we can move them up way more while staying within the boundaries of the pay level.
Take a look at what happens to our pay structure in
Exhibit 11-10
when we convert it into a broadband pay structure. The new broadband pay structure combines the first two pay levels, the third and fourth level, and finally the fifth and sixth, making three levels instead of six. This causes our red- and green-circle rates to disappear. It also gives us greater ability to adjust the pay of people based on their performance and ability. Finally, it lowers the administrative burden of maintaining the compensation system. For these reasons, companies may have broadened the pay levels that they use. It is fairly easy to see why it would be easier to work with just 5 pay levels rather than 20. It just takes much more management time to administer the larger number of levels. However, recent research showed that only about 3% of companies worldwide are actually using some form of broadbanding.106
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Exhibit 11-10 BROADBANDING OF MULTIPLE PAY LEVELS
So when we are done with our pay structure, we will have created that hierarchy of jobs that we mentioned earlier—from lowest to highest. And as you have probably already guessed, much of this work is now done using computers. Once the HRIS have the necessary data, we can create most of our pay structure using existing company information. The computer models will identify the outliers for us. In many cases, the HRIS can identify the market pay line and provide other compensation information, too. We can see very quickly if we have a whole bunch of employees in level 3 and also see that they are all getting almost the highest possible pay for that level. From this information, we can analyze why this may be happening and figure out whether the pay scale needs to be changed in some manner. HRIS are very valuable tools for job structure analysis.
TRENDS AND ISSUES IN HRM
LO 11-8
Briefly discuss the issues of independent contractors versus employees and the problem of the gender–wage gap.
What compensation trends and issues do we see in organizations? One continuing trend is toward classifying individuals as independent contractors instead of as employees. And gender equity in pay continues to elude most organizations, even though awareness is at an all-time high. Let’s look at these issues in a little more depth here.
Designation of Independent Contractors Continues to Be an Issue
Earlier, we discussed the trend toward more on-demand workers, and companies continue to create more independent contractor relationships and fewer employer-employee relationships as part of this trend. While some of these contract relationships are absolutely legitimate, many have been set up to intentionally avoid an employee relationship and all of the associated record-keeping and legal issues.
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11-1 SELF ASSESSMENT
Compensation Management Satisfaction
This exercise is also a good review of the chapter, as it uses most of the important concepts. Select an organization that you work or have worked for and select your level of satisfaction with each of the following parts of the compensation management system, on a scale of 1 to 5.
_____ 1. Base pay
_____ 2. Wage and salary add-ons
_____ 3. Incentive pay
_____ 4. Benefits
_____ 5. Meeting expectancy theory
_____ 6. Meeting equity theory
_____ 7. What the firm actually pays based on its ability to pay
_____ 8. Pay for performance versus longevity
_____ 9. What the firm pays based on being below, at, or above market-level pay
____ 10. Wage compression
____ 11. Pay secrecy
____ 12. Meeting the Fair Labor Standards Act
____ 13. Pay equity and comparable worth
____ 14. The system used for job evaluation
____ 15. Job structure
____ 16. Pay levels
____ 17. Benchmarking
____ 18. Pay structure
____ 19. Pay raises
____ 20. Benefit increases
_____ Total the points and place the score on the continuum below.
The higher the score, the greater your level of satisfaction with the compensation management system of the organization. However, to most employees, what really matters most is answers to questions regarding their own pay and benefits (compensation), and we all are more satisfied when these increase.
Think about the people you worked with as a group. You can select the group’s level of satisfaction with each question. Would their answers vary from yours? Would the satisfaction level vary by the level in the organization—among executives versus nonmanagers, by department, or among other groupings?
Why are companies so intent on moving toward independent contractor relationships? One reason for the shift is to maximize organizational flexibility. In many cases, the relationship with independent contractors can be severed much more easily than those with employees. If there is no long-term contract, the company can release the contractor immediately on completion of whatever job is currently being done. Another reason for maintaining this type of arms-length relationship is that it can save the company from significant costs. Compensation of an independent contractor is much simpler than compensation of employees. In the contract relationship, the company pays the agreed-upon amount on the contract, and there is no need to calculate hours, minimum wage, overtime, benefits costs, health care insurance eligibility, or any other compensation factors. They also do not have to pay federal (social security and other) taxes or state mandated (unemployment, workers’ compensation, etc.) taxes on employees and other potential costs. All of those requirements fall to the contractor to manage.
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Employers may think that it is easy to make an employee into a contractor, but independent contractors must be truly independent of the company’s control. According to the IRS website, “The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done” (emphasis added).107 The US Supreme Court identified an “economic realities” test to help determine whether or not a case is dealing with an employer-employee relationship:108
1. The extent to which the work performed is an integral part of the employer’s business.
2. Whether the worker’s managerial skills affect his or her opportunity for profit and loss.
3. The relative investments in facilities and equipment by the worker and the employer.
4. The worker’s skill and initiative.
5. The permanency of the worker’s relationship with the employer.
6. The nature and degree of control by the employer.
Mike Coppola/Getty Images for Lyft
Lyft uses contractors as drivers. Drivers’ compensation depends on how often they choose to work; however, the company does not provide benefits to drivers.
Most everyone has by now heard of the ongoing dispute between the ride-sharing service Uberand the federal government concerning whether or not Uber drivers are independent contractors. At last count, there were more than a dozen lawsuits on this single issue. In one case, a federal judge rejected a proposed settlement for $100 million because the deal “undervalued” potential claims.109 The government wants to show an employee relationship because, if they can, they receive more in the form of taxes on those employees’ wages. And drivers suing Uber want to be employees because of the worker protections involved under the FLSA and other federal and state laws. Of course, Uber wants to maintain the independent relationship so that the company doesn’t have the internal costs associated with collecting and delivering those tax costs to the federal (and state) government. HR managers will need to follow these cases as they progress through the courts as the decisions will significantly affect the ability to identify independent contractors in the future.
Even though the DOL has recently pulled back on previously issued guidance concerning the employee versus independent contractor designations, employers need to be aware of, and concerned with their use of such identifications. Intentionally misclassifying of employees as contractors is similar to calling an individual exempt under the FLSA when that worker is nonexempt by current laws. It is unethical and illegal to intentionally misclassify individuals to avoid paying them what would reasonably and ordinarily be due them in their relationship with the company, and it carries the same penalties as other FLSA violations should the employer get caught.
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The Stubborn Gender–Wage Gap: Can It Be Fixed?
According to Fortune magazine, “Gender parity in wages still has a long way to go.”110 Research backs this up. Sex differences in total rewards in the workplace were 14 times larger than sex differences in performance evaluations,111 according to one study. Even though the pay gap is likely the smallest it has been since about 1960, evidence still shows that women make about 79% of what men do on average across all industries in the United States.112 Why is this wage gap so stubborn?
Some of the gender–wage gap can be explained away based on a number of factors other than discrimination. For instance, it is true that women leave the workforce more often than men and that women tend to be absent more when employed than their male counterparts. There are logical reasons for these facts, including the fact that women still tend to be the primary care giver to children in a family; but they are still facts. However, at least some of the difference appears to still be an inherent bias in companies toward paying men more than their female counterparts. Some states have begun to pass laws that limit the ability for companies to exhibit such biases. For instance, Oregon recently passed a pay equity law that provides for “two years of back pay at the employee’s regular rate of pay, compensatory and punitive damages, and attorney fees”113 to an employee who wins a fair pay claim against their employer; and California passed a law that required comparable pay for “substantially similar” work—which significantly expands the ability of an employee to claim unfair wage discrimination.114
Companies are taking notice. According to HR Magazine, “Pay equity has become a top-of-mind concern for employers nationally as a result of California’s new gender pay equity law and similar legislation in New York and elsewhere.”115 Pay equity is not just a US issue either. Countries as varied as Iceland, New Zealand, Canada, and Singapore are discussing the issue and passing gender equity laws.116 But not enough seems to be getting done.
So what can be done to mitigate the problem? Government rulemaking can go only so far. In some cases, it appears that there has been some overreach on the part of federal—and maybe state—agencies, which will probably not help the situation very much. Google recently pushed back when the DOL demanded information that the company claimed would cost more than $1 million to gather on a contract that paid them only $600,000.117 That argument is still being litigated as this is written. But good companies, including Google, say that they want to do something to minimize the gap. The monitoring of the problem and enforcement of solutions will almost always fall to the HR department for implementation in such situations. HR leaders can maintain records of initial salary negotiations and ultimately of offers, manage and evaluate any compensation increases over time, and complete pay audits on a periodic basis. If unexplainable disparities are found during the various analysis efforts, HR needs to make recommendations to senior management to correct any problems by adjusting compensation components as needed. Pay disparity is a fact. Consistent vigilance is the only way to combat this historically stubborn issue.
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Get the tools you need to sharpen your study skills. Access practice quizzes, eFlashcards, video and multimedia, and more at
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.
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DIGITAL RESOURCES
Compensation Management*
Employee Performance and Compensation Management
Is There a Research-Practice Gap in Compensation Management?
Boosting Wages*
Total Compensation Statement
Integrated Pay for Performance
Employee Wages*
Compensation and “Total Rewards”
* premium video only available in the interactive eBook
CHAPTER SUMMARY
11-1. Identify the components of a compensation system and describe how expectancy and equity theories apply to compensation.
Components of compensation include the following four items:
1. Base pay, either an hourly wage or salary. Base pay is frequently a major decision factor for most employees in deciding to accept the job.
2. Wage and salary add-ons. These include overtime pay, shift differential, premium pay for working weekends and holidays, and other add-ons.
3. Incentive pay for performance. Incentives give workers strong reasons to perform above the standard.
4. Benefits. This is indirect compensation that provides something of value to the employee. Benefits cost the company money even though they aren’t direct compensation.
Expectancy theory (Motivation = Expectancy x Instrumentality x Valence) says that employees expect to put forth some form of effort at work and believe they can accomplish the task or objective (expectancy). This effort is expected to result in some level of performance resulting in some type of reward (instrumentality). The reward has to be significant (valence) to the individual; and as long as it is, the employee will continue to put out effort to get the reward.
According to equity theory, people compare their inputs (the things they do in the organization) and outcomes (the things that they receive from the organization) to those of relevant others. But it’s their and others’ perceived inputs and outcomes that employees compare, not necessarily actual inputs and outcomes. If employees believe that there is inequity, they will change their work behavior to create equity. Employees must perceive that they are being treated fairly, relative to others. Compensation is obviously a large part of the perceived outcomes.
11-2. Identify the seven basic issues that make up the organization’s compensation strategy.
1. Ability to pay. This is an honest assessment of how much we can afford, or are willing to afford, in order to compensate our employees.
2. Types of compensation. This refers to the mix of the four basic components of compensation—base pay, wage add-ons, incentives, and benefits—that we employ. We must divide available funds among the components.
3. Pay for performance or longevity. Will we pay people based on organizational loyalty/tenure, or will we pay based on performance in their jobs?
4. Skill- or competency-based pay.
5. At, above, or below the market. What will our general pay structure look like, and why?
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6. Wage compression. This lowers the pay differential between long-term and newly hired employees.
7. Pay secrecy. Will we utilize pay secrecy clauses in employment contracts? Pay secrecy may allow us to hide actual wage inequities from employees, but it has the potential to create dissatisfaction and demotivation.
11-3. Discuss the three major provisions of the FLSA and the penalties for misclassification of employees.
1. Minimum wage rates identify the lowest hourly rate of pay generally allowed under the FLSA. There are many exemptions; but if a person is nonexempt, minimum wage willapply.
2. Overtime rates are also required for persons who are nonexempt. However, there are different exemptions for overtime than there are for minimum wage, so HR managers must check the law to determine who will have to be paid overtime.
3. Child labor requirements within the FLSA identify the jobs and allowable working hours for individuals between 14 and 18 years old. Sixteen- and 17-year-olds can be employed only in nonhazardous jobs, but their work hours are unrestricted. However, 14- and 15-year-olds can work only outside school hours, and the jobs that they are allowed to do are limited to retail and other service positions. They may not work overtime.
The employer can personally be criminally prosecuted and fined up to $10,000 per misclassification infraction. There is no maximum limit to the allowable fines, so fines in the millions of dollars have been assessed in the past. A second conviction can result in imprisonment. Employers who willfully or repeatedly violate the exemption rules may be assessed civil penalties of up to $1,100 per violation. For child labor violations, the civil penalty can be up to $11,000 per worker for each violation and can go to as much as $50,000 or even $100,000 if the violation causes the serious injury or death of an employee younger than 18 years old.
11-4. Briefly describe the concept of comparable worth and highlight the other legal issues in compensation.
Comparable worth is similar pay for similar work, which is different from equal pay for equal work. The concept of comparable worth holds that if we can compare your job with that of another person and they are similar, we should pay you a similar wage, which makes this concept much broader than equal pay. The biggest problem with comparable worth from a legal standpoint is how to legislate the value of a job while taking supply and demand into account.
Other legal issues besides the FLSA and comparable worth include:
• The NLRA
• Social Security
• Workers’ compensation
• Unemployment insurance
• Family and Medical Leave Act (FMLA)
• Patient Protection and Affordable Care Act (PPACA)
• Employee Retirement Income Security Act (ERISA—mandatory for employers who offer pension plans)
• Health Insurance Portability and Accountability Act (HIPAA—mandatory for employers who offer health insurance)
11-5. Identify the three types of job evaluation and discuss whether they are more objective or subjective in form.
1. The job-ranking method is simply the process of putting jobs in order from lowest to highest or vice versa, in terms of value to the company. However, it has limited usefulness because it is subjective.
2. Point-factor methods, on the other hand, attempt to be completely objective in form. They break a job down into component skills or abilities, known as factors, and then apply points to each factor based on its difficulty.
3. The factor comparison method combines the job-ranking and point-factor methods to provide a more thorough form of job evaluation. It identifies benchmark jobs, and then analyzes and rank-orders them. We then compare all other jobs in the organization to the benchmark jobs to determine where each one fits in the rankings.
11-6. Briefly describe the concepts of job structure, pay levels, product market competition, and labor market competition.
• The job structure is what gives us a job hierarchy. The job hierarchy is the stacking of the jobs in the organization from the lowest (simplest) to the highest (most complex) levels.
• A pay level (frequently called a pay grade) will be made up of several different jobs. Pay levels provide a framework for the minimum and maximum pay for a particular group of jobs in the organization. Pay levels are then laid out one next to another in order to create the entire pay structure for the company.
• Product market competition sets the top of a pay level. We can pay someone only as much as we can recover from a customer when we sell our goods or services. We can’t pay more than the value added to the product or service by the labor. Together, product market and labor market competition identify the maximum and minimum rates of pay for a particular group of jobs in a pay level.
• Labor market competition sets the bottom of a pay level. We have to compete with other companies to attract labor; and if we don’t pay enough, we will be unable to attract the workers we need. So we compete in the labor market for available workers.
11-7. Briefly describe the concept of a pay structure, including broadbanding and delayering.
A pay structure is created by laying out our pay levels, one next to the other. The entire group of pay levels creates the pay structure. Benchmark jobs can be plotted on the pay structure to get a market pay line—a line that shows the average pay at different levels in a particular industry. Once pay levels are set, we can actually plot employee rates of pay on the pay structure to see if any are plotted outside our pay-level ranges, either high or low. Individuals who fall outside our pay range to the high side are paid red-circle rates, and those who fall outside low are paid green-circle rates. Each of these rates should be reviewed and corrected if necessary.
Broadbanding lowers the number of pay levels that a company administers by combining multiple pay levels into one. Lowering the number of pay levels makes the process simpler. It takes a long time to create, maintain, and evaluate many pay levels; but instead, we can have just a few broadbands. Because pay bands are wider and taller under broadbanding, the company also has more flexibility in pay rates for individuals who are overperforming or underperforming. Broadbanding may also cause most red- and green-circle rates to disappear. Delayering also lowers the number of pay levels, but it does so by getting rid of layers of vertical hierarchy in the organizational structure.
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11-8. Briefly discuss the issues of independent contractors versus employees and the problem of thegender–wage gap.
Companies are using more independent contractors to maintain maximum organizational flexibility, and in some cases at least, to lower costs associated with maintaining employees. Costs include the need to calculate hours, minimum wage, overtime, benefits costs, health care insurance eligibility, or any other compensation factors. They also do not have to pay federal (social security and other) taxes or state mandated (unemployment, workers’ compensation, etc.) taxes on employees and other potential costs. The gender–wage gap continues to stymie governments and companies. Evidence still shows that women make about 79% of what men do on average across all industries in the United States. Some of the gap can be explained based on legitimate factors, but some can’t. Individual states and local governments are starting to pass wage equity laws, which makes it more difficult for companies to manage widespread operations, so pay equity has become an executive concern. HR leaders need to maintain records of initial salary negotiations and ultimately of offers, manage and evaluate any compensation increases over time, and complete pay audits on a periodic basis. If unexplainable disparities are found during the various analysis efforts, HR needs to make recommendations to senior management to correct the problem.
KEY TERMS
broadbanding 412
compensation 388
compensation system 388
delayering 412
equity theory 392
expectancy theory 390
job evaluation 405
minimum wage 399
overtime 402
pay structure 407
rate range 411
wage compression 396
KEY TERMS REVIEW
Complete each of the following statements using one of this chapter’s key terms.
1. ________ is the total of an employee’s pay and benefits.
2. ________ includes anything that an employee may value and desire and that the employer is willing and able to offer in exchange.
3. ________ proposes that employees are motivated when they believe they can accomplish a task and that the rewards for doing so are worth the effort.
4. ________ proposes that employees are motivated when the ratio of their perceived outcomes to inputs is at least roughly equal to that of other referent individuals.
5. ________ occurs when new employees require higher starting pay than the historical norm, causing narrowing of the pay gap between experienced and new employees.
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6. ________ is the lowest hourly rate of pay generally permissible by federal law.
7. ________ is a higher than minimum, federally mandated wage, required for nonexempt employees if they work more than a certain number of hours in a week.
8. ________ is the process of determining the worth of each position relative to the other positions within the organization.
9. ________ is a hierarchy of jobs and their rates of pay within the organization.
10. ________ provides the maximum, minimum, and midpoint of pay for a certain group of jobs.
11. ________ is the process of changing the company structure to get rid of some of the vertical hierarchy (reporting levels) in an organization.
12. ________ is accomplished by combining multiple pay levels into one.
COMMUNICATION SKILLS
The following critical-thinking questions can be used for class discussion and/or for written assignments to develop communication skills. Be sure to give complete explanations for all answers.
1. Do you believe it is always necessary to provide incentives as part of a pay structure? Why or why not?
2. As the HR manager, would you pay more attention to expectancy theory or equity theory in designing your compensation system? Why?
3. If your company had promised an incentive program right before the recession of 2007–2008, and if the recession made it impossible for the company to pay employees what they had been promised, then how would you explain this to your workforce to keep them motivated?
4. Would you rather have higher pay or better benefits? Why?
5. Would you ever consider paying below the market rate for employees if you had control of wages? Why or why not?
6. Do you believe that pay secrecy can ever really work in a business? Why or why not?
7. How would you approach a CEO or company president who insisted on classifying nonexempt workers as exempt? What would you say to get the CEO to stop this practice?
8. Do you think that comparable worth should be made federal law? Why or why not?
9. If you were the lead HR manager in your company, would you ever consider setting pay levels by just using external pay surveys and no internal analysis? What are the advantages and disadvantages of this?
10. As the head of HR, would you rather change narrow pay levels into broadbands? Can you think of any disadvantages to doing so?
CASE 11-1 DISCOUNTING EVERYTHING BUT COMPENSATION AT COSTCO
Costco has gone head to head with the likes BJ’s, Target, and SAM’s Club and has come out the winner. Offering over 3,700 discounted household products to over 71 million people across Asia, Spain, Puerto Rico, Mexico, Canada, and 44 states in the United States, and like their competitors, they also offer additional services including mortgage, car, and home insurance, as well as travel packages.(1)
Costco has proven though that there is more to warehouse stores than just low prices. So how can Costco beat other retailers like Walmart, BJ’s, and Target, who sell similar products and services? By having “great jobs, great pay, great benefits and a great place to work,”(2) Costco has attracted employees who are ardent and arduous workers, who thrive on working in a dynamic and hypercompetitive industry, who are high achievers and excel in a team environment. So how does one then attract such superstars to one’s business?
Costco has learned that the secret to hiring the best and the brightest is not through salary alone but by offering a superior work environment including a comprehensive benefits package. They pay a higher insurance premium percent than their competitors toward employees’ and include in the plan the employees’ entire family (spouse, domestic partner, and dependents). Employees pay their portion of the premiums with pre-tax dollars, therefore reducing their taxable income. Employees also qualify very quickly for benefits relative to industry standards. Salaried employees receive benefits after the first month of service while full-time/part-time hourly employees are eligible after 90/180 days of service or 450/600 hours.
Costco’s generous benefits package includes the following:
• Health care
• Dental care
• Pharmacy program
• Vision program
• 401(k) plan
• Dependent care assistance plan
• Care network
• Voluntary short-term disability
• Long-term disability
• Life insurance
• Employee stock purchase plan
• Health care reimbursement account
• Long-term care insurance
Does Costco’s strategy about superior benefits work? If one asks their employees, the resounding answer is yes.
Glassdoor.com
ranks the best companies to work for based upon benefits and compensation and obtains this information directly from the firms’ employees. Ninety-two percent of Costco’s personnel thought CEO Craig Jelinek was doing a good job, while 82% would want a friend to work there as well. Interestingly their benefits package received an 88% rating, while employee satisfaction slipped to 76%. Nonetheless the scores where high enough to rank Costco 2nd overall, just behind the megastar Google.(3)One Costco employee on glassdoor.com’s website summed it up quite well:
The best incentive at Costco is the benefits, whether you are working full time or part time. I paid 20 bucks a month for a $500 deductible with no co-pay. The hourly compensation is more than fair, and I got the sense very quickly that management was eyeing the most competent workers for advancement. . . . Great wages, benefits . . . and working for a great company that really truly cares about their members and employees.(4)
Questions
1. What organizational processes does compensation affect and what is Costco’s rationale for having an exceptional compensation plan?
2. What are the parts of a compensation system, and what component(s) does Costco’s compensation system focus on?
3. What are the four basic types of compensation, and which are evident at Costco?
4. What is expectancy theory, and how does or does not Costco employ this theory within their compensations system?
5. What are the differing types of basic wage classifications, and how does Costco categorize their workforce by basic wage?
6. What is Costco’s philosophy about employee compensation?
7. Costco lists numerous benefits that the firm provides employees above their basic salary. What pay rate and benefits must Costco provide their employees as required by Federal Labor Laws?
References
(1) Gledhill. M. (n.d.). Costco Wholesale Corporation. Hoovers. Retrieved May 3, 2017, from
http://0-subscriber.hoovers.com.liucat.lib.liu.edu/H/company360/fulldescription.html?companyId=17060000000000
(2) Costco Wholesale. (n.d.). Costco careers. Retrieved May 3, 2017, from
https://www.costco.com
/jobs.html
(3) Costco Wholesale. (n.d.). Costco has great benefits. Retrieved May 3, 2017, from
https://www.costco.com/benefits.html
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(4) Denman, T. (n.d.). Costco employees rave about compensation and benefits. Retail Information Systems. Retrieved May 3, 2017, from
https://risnews.com/costco-employees-rave-about-compensation-and-benefits
Case created by Herbert Sherman and Theodore Vallas, Department of Management Sciences, School of Business Brooklyn Campus, Long Island University
CASE 11-2 EMPLOYEE RED-LINING AT CVS: THE HAVE AND THE HAVE NOT
CVS Caremark is the second-largest drugstore chain in the United States (just behind Walmart). It employs 286,000 people in 45 states under the CVS logo, and it operates more than 7,600 drugstores. In 2013, CVS’s sales exceeded $126 billion, but its net income was only around $4.6 billion, for about a 3.6% profit—about the median profit for the industry.(1)
As would any other public corporation, CVS wanted to increase its profitability for stockholders and regain its position as the industry leader. One method of increasing profits is cutting operational costs, and CVS decided to do just that. It adjusted employee annual pay raises by placing an earnings ceiling on salaries, and any employees earning the highest hourly wage in their job classification became ineligible for a raise.
Besides the obvious cost savings, why put a “red line” on wages? The main goal was to adjust the highest-paid employees’ compensation to the job market average and, with these savings, provide raises to the employees who were paid below that average. The philosophy was that as a CVS employee, one should expect lower raises (or none at all) if one is earning much more than one’s colleagues. So once an employee reached the red line, that person received no additional compensation.
CVS executives knew that the new compensation policy would negatively impact some of their most loyal employees, yet the executives felt that they needed to draw a line on salaries in order to make the most of limited compensation dollars. What they did not figure was that the policy mostly hurt the employees who had been working there the longest. Worse, these same employees feared retaliation if they publicly criticized the new policy. How would it look to the other lower-paid employees (and worse, the public at large) if the highest-paid employees complained about their lack of raises?
Nationwide, the minimum wage is set at $7.25 per hour, but the wage management guidelines of CVS are different in most regions depending on the minimum wage in each state. Lowest-ranked employees with exceptional skills would receive a 4.75% raise on an annual basis if they were making minimum wage. However, if an employee with exceptional skills in the same position was already earning $12.50 an hour, that person would not receive a raise, having already crossed the red line.(2) With employment-at-will, the possibility of being laid off, and a tough job market, where would these employees get such high-paying jobs in the retail and service industries? It was better for them to keep quiet about their pay and stay in a company that they were comfortable with.(3)
Wage rates depend on employees’ rank, and it is no secret that the CEO is going to be paid much more than the company’s average worker. This is because the CEO job requires a more demanding set of skills compared to the average store job, and the workload of a CEO is much more demanding. But if the range of compensation is so great, it may discourage employees who are paid less.(4)
Some ethical and legal concerns arose when these same red-lined employees found out that this new compensation policy did not seem to apply to the top-level executives. The CEO of CVS was paid a total of $23 million in 2013, including bonuses and additional perks. He earned a 26% raise from the previous year, and that was almost 800 times more than the median income of a CVS employee. The red-lined employees saw an inequitable pay situation, with the rich getting richer because they were allowed a raise while the in-store employees had a cap on their income. The CEO’s salary package was tied to the company’s performance, and according to CVS spokesperson Carolyn Castel, “Last year, CVS Caremark had an outstanding year and continued to deliver strong financial results and enhanced returns to shareholders in a challenging economic environment, performing favorably against our peer group in several key areas.”(5)
Questions
1. Describe the pay structure and compensation system for a CVS store employee. How might this pay structure be different from that of the CEO of the firm?
2. Define the rate range of CVS employees. How would you change the pay structure to encourage performance, especially for red-lined employees?
3. In terms of expectancy and equity theories, describe how the red-line policy will affect the motivation of employees.
4. In light of the red-line policy, what was CVS’s philosophy toward employee performance, compensation, and longevity?
5. If you were CVS’s CEO, knowing that you have to reduce costs and balance employee wages, what other measures would you take besides freezing raises for the highest-paid employees?
6. Why would the firm implement an HR policy that it knew would negatively affect its highest-paid employees? Did it perhaps have a hidden agenda?
References
(1) Hoover’s Inc. (2014). CVS Caremark Corporation [Hoover’s Company Records: In-Depth Records]. Retrieved July 12, 2014, from Long Island University Academic Database.
(2) Lazarus, D. (2014, June 26). At CVS, only the very rich get much richer. Los Angeles Times.
http://www.latimes.com/business/la-fi-lazarus-20140627-column.html
(3) Ibid.
(4) Ibid.
(5) Kell, J. (2013, March 29). CVS Caremark CEO’s pay jumps 44%. Wall Street Journal.
http://online.wsj.com/news/articles/SB10001424127887323501004578390383929384430
Case created by Herbert Sherman and Theodore Vallas, Department of Management Sciences, School of Business Brooklyn Campus, Long Island University
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SKILL BUILDER 11-1 JOB EVALUATION
Objective
To develop a better understanding of the job evaluation process
Skills
The primary skills developed through this exercise are as follows:
1. HR management skills—Technical, conceptual and design, and business skills
2. SHRM 2016 Curriculum Guidebook—K: Total Rewards
Assignment
Step 1. You decided to open a restaurant and pub, and you have five job categories:
• Owner/manager: You are the owner, performing all the management functions and also greeting and seating people as you oversee all activities.
• Wait staff: They take food orders and bring food to customers.
• Cooks: They prepare the food.
• Helpers: They bus tables, wash dishes, help in food preparation, and bring food to some customers.
• Bartenders: They make the drinks for both the dining and bar areas.
Step 2. Using the table below, rank each job for each of the five factors commonly used in job evaluations. Rank the jobs from 1to5, with 5 being the highest-ranking job and 1 being the lowest.
Step 3. The five factors are commonly weighted since some are more important than others.
(A) In the above table in the bottom row—Factor Rank—now rank the five factors from 1 to 5, with 5 being the most important and 1 being the least important.
(B) The five factors can also be weighted as percentages. For example, based on a total of 100%, the highest-rated factor could be weighted at 40%, then the next-highest could be rated at 30%, followed by 20%, and the other two at 5% each. So also include your percentage-based weights for each factor, like in the example.
People generally will not agree on all the rankings, and that is a major reason why there is virtually always a committee that conducts job evaluations.
Step 4 (optional due to difficulty). Assign pay values to each of the five factors and weight them to determine pay levels for each job.
Apply It
What did I learn from this experience? How will I use this knowledge in the future?
____________________________________________________________
____________________________________________________________
____________________________________________________________
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SKILL BUILDER 11-2 PRODUCT MARKET COMPETITION LIMITS
Objective
To develop a better understanding of product market competition limits
Skills
The primary skills developed through this exercise are as follows:
1. HR management skills—Technical and business skills
2. SHRM 2016 Curriculum Guidebook—K: Total Rewards
Assignment
Complete the math problems below:
_____ 1. Your product sells for $1,000. Materials cost $300, labor costs $300, and overhead costs $200. What is your profit in dollars and as a percentage?
_____ 2. Your product sells for $750. Materials cost $250, labor costs $300, and overhead costs $150. What is the profit in dollars and as a percentage?
_____ 3. Your product sells for $1,000. Materials cost $300 and overhead costs $200. What is the maximum amount you can pay labor to make a $100 profit with a 10% return?
_____ 4. Your product sells for $750. Materials cost $250 andoverhead costs $150. What is the maximum amount youcan pay labor to make a 10% profit return on the sales price?
_____ 5. Your product sells for $800. Materials cost $300 andoverhead costs $200. What is the maximum amount youcan pay labor to make a 15% profit return on the sales price?
12
Incentive Pay
Media Library
CHAPTER 12 Media Library
PREMIUM VIDEO
HRM in Action
LICENSED VIDEO
Pay for Performance
Bonus
es
LEARNING OBJECTIVES
After studying this chapter, you should be able to do the following:
12-1.
Discuss the major reasons why companies use incentive pay.
PAGE 425
12-2.
Identify the advantages and disadvantages of both individual and group incentives.
PAGE
427
12-3.
Briefly discuss options for individual incentives.
PAGE 431
12-4.
Briefly discuss options for group-based incentives.
PAGE
439
12-5.
Discuss the major reasons why incentive plans fail and the challenges involved.
PAGE 443
12-6.
Identify the guidelines for creating motivational incentive systems.
PAGE
445
12-7.
Discuss the issue of executive compensation and how the major provisions of the Dodd-Frank Act affect the issue.
PAGE 449
12-8.
Briefly discuss the question of whether incentives improve performance and some options available for incentivizing employees other than knowledge workers.
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CHAPTER OUTLINE
Incentive Compensation
Why Do We Use Incentive Pay?
Individual or Group-Based Incentives?
Individual Incentives
Group Incentives
Options for Individual Incentives
Commission
s
Merit Pay
Piecework Plans
Standard Hour Plans
Giving Praise and Other Nonmonetary Incentives
Options for Group Incentives
Profit-Sharing Plans
Gainsharing Plans
Employee Stock Ownership Plan (ESOP)
Stock Options and Stock Purchasing Plans
Failures and Challenges in Creating Incentive Pay Systems
Why Do Incentive Pay Systems Fail?
Challenges to Incentive Pay Systems
Guidelines for Creating Motivational Incentive Systems
Executive Compensation
Too Much or Just Enough?
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
Executive Incentives
Short-Term Versus Long-Term
The Goal of Executive Compensation
Trends and Issues in HRM
Does Incentive Pay Actually Improve Performance?
Comprehensive Pay and Incentive Programs Aren’t Just for Highly Skilled Employees
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Practitioner’s Perspective
Cindy reflects: Whether the economy is up or down, your star employees can always find another job. This keeps HR departments looking for ways to keep their best employees motivated and engaged in their positions.
One of Cindy’s colleagues, Terry, is a big advocate of incentive pay. “We need to look at ways to reward our exceptional employees now without expanding our base labor costs into future years,” Terry said at one of their strategy meetings. “I’ve seen evidence to support the case that employees work harder if they know they have a fair chance of being rewarded for that extra effort.”
“Well, I’ve heard lots of complaints against incentive pay,” says Bill, another member of their department. “I’m not sure we want to open our compensation program to those issues.”
Is incentive pay a good idea? The pros and cons plus the methods of implementation are detailed for your consideration in
Chapter 1
2
.
INCENTIVE COMPENSATION
LO 12-1
Discuss the major reasons why companies use incentive pay.
Chapter 11
provided an overview of compensation planning, so we now know that the HR department typically develops pay systems1 and that compensation is an important part of the HRM process.2 Recall for a moment the motivation theories that we discussed in that chapter. Incentive compensation takes advantage of both expectancy theory (where the employee expects a reward that matches their effort and performance) and equity theory (where that individual employee evaluates their rewards against others based on the amount of “input” effort that they provide). Incentives allow us to vary the reward based on the individual (or group) effort put into the work process. While we briefly discussed incentive pay in the last chapter, let’s get into some more detail on why we use incentives, what they are, their advantages and disadvantages, and why they might be successful in motivating our workforce.
|
HRM in Action |
SHRM
HR CONTENT
See Appendix: SHRM 2016 Curriculum Guidebook for the complete list
A. Employee and Labor Relations
24.
Promotion
25.
Recognition
26. Service awards
K. Total Rewards
A. Compensation
5. Pay programs: Merit pay, pay-for-performance, incentives/bonuses, profit sharing, group incentives/gainsharing, balanced scorecard
15. Motivation theories: Equity theory, reinforcement theory, agency theory
B. Employee Benefits
18. Financial benefits (gainsharing, group incentives, team awards, merit pay/bonuses)
Get the edge on your studies.
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• Take a quiz to find out what you’ve learned.
• Review key terms with eFlashcards.
• Watch videos that enhance chapter content.
p.
426
Why Do We Use Incentive Pay?
Incentives, or variable pay, is compensation that depends on some measure of individual or group performance or results in order to be awarded. But why do we need variable pay? Isn’t it enough that our employees get a set amount of money each week or month in a paycheck from the organization? The simple answer is “Not always.” So to answer employees’ often unasked question What’s in it for me? companies develop incentive systems.3 People respond to incentives,4 and rewards and recognition are combined to create motivational incentive systems.5 The use of pay for performance rather than hours worked is the trend today.6
In Chapter 11, we identified which employees fit into which pay levels. We noted, though, that individual effort and performance levels can vary. That is why we have pay ranges in each level. We want to be able to reward our best employees so that they feel that they are being recognized.7Recognition is a highly motivational tool that we will discuss in some detail shortly.8 But pay levels only have so much flexibility built into them, so wewould sometimes like to have a tool that will allow us to provide greater rewards to thebest people in our organization. Managers like to use discretion in compensating employees.9 This is why we create incentives.10
SHRM
A:24
Promotion
What are we attempting to do when we provide employees with incentives? We are rewarding them for their past performance, but we are doing it in the hope that they will want similar rewards in the future and therefore will repeat the desired behaviors.11 It issimply a reinforcement process like the one we discussed when we covered learning theories in
Chapter 7
.
There is a second reason why we use variable pay in organizations. Variable pay moves some of the risk associated with having employees (and the associated payroll costs) from the firm to the individual. If the employee has variable pay that is tied to organizational productivity as part of their annual compensation, and the company (and therefore the employee) doesn’t do well in that year, the individual loses part of their pay. The company does not have to pay out as much in compensation when the organization’s performance in a given year is lower than expected. This effectively moves the risk associated with the incentive payment from the organization to the employee. If all annual compensation was provided in the form of base pay, we would still have to provide it to each employee, no matter how well the company did in a particular year. But if we have part of the annual compensation budget applied to variable pay, we don’t have to pay out as much in lean years.
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Our final reason for incentive pay ties into company strategy. We noted in
Chapter 2
that “HRM is a critical component of meeting organizational goals, because without the right people with the right types of education, skills, and mind-set, we cannot expect to accomplish the objectives that we set for ourselves.” However, we can’t get the right people to accomplish organizational objectives without providing some incentives to do so.12 Incentive pay has to aim at the strategic goals of the organization in order to make any sense. Remember that people will not focus on attaining goals that we don’t emphasize as important, and we emphasize what is important by attaching incentives to the achievement of the goal. People respond to incentives and can nearly always be guided toward goals if we find the right incentives.13 Incentives are so important that they are one of the most written-about topics in management.14
INDIVIDUAL OR GROUP-BASED INCENTIVES?
LO 12-2
Identify the advantages and disadvantages of both individual and group incentives.
There are two basic choices in incentive pay—individual or group-based incentives. Groups can be small (a work cell of three people who assemble a computer) or large (an entire manufacturing plant or a call center), but all of these divisions are a bit artificial when it comes to incentive pay and, in fact, even the individual and group categories may cross. So in this text we will just divide incentives into individual or group options. You will see as we go through our incentive pay options that a lot of incentives can work in either an individual or a group setting. For example, bonuses have historically been provided as an individual incentive,15 but they can and are being used as group incentives as well.16 Let’s take a look at the advantages and disadvantages of each and when each option tends to work best.
Individual Incentives
Individual incentives reinforce performance of a single person with a reward that is significant to that person. What are some of the more common advantages and disadvantages of individual incentive plans for the organization? Let’s take a look at
Exhibit 12-1
for a brief list.
ADVANTAGES OF INDIVIDUAL INCENTIVES
• Makes it easy to evaluate individual employees. Individual incentive programs, if designed correctly, make it easier to identify individual efforts. This is because performance goals will be set at the personal level, not the group or organizational level. If goals are reached, it will be due to individual efforts, not those of a larger organizational group.
• Offers the ability to match rewards to employee desires. Recall that expectancy theory (Chapter 11) shows the need to reinforce individual performance levels with rewards that are significant to the individual. Individualized incentives allow us to do this to a much greater degree than group incentives.
• Promotes the link between performance and results. Individual incentives provide a direct link between performance levels and the rewards received—pay for performance.17 A side benefit to this link is that we get equitable (fair) distribution of incentives; higher incentive payments go to those who perform at a higher level.
• May motivate less productive employees to work harder. Recall social learning theory: People learn by watching the consequences of others’ behavior (Chapter 7). Less productive employees who see others getting valued rewards for performance may be convinced to increase their own performance levels in order to get similar rewards.
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Exhibit 12-1 INDIVIDUAL INCENTIVE PLAN ADVANTAGES AND DISADVANTAGES
DISADVANTAGES OF INDIVIDUAL INCENTIVES
• Many jobs have no direct output. We don’t have any way to directly measure results of some jobs in organizations. We discussed this in
Chapter 8
when we discussed results-based performance appraisals. What is a measurable result on which we can base an incentive for most managers? How about equipment maintenance personnel or health care providers? It may be very difficult or even impossible in some jobs to identify individual output on which we can base an incentive.
• May motivate undesirable employee behaviors. If rewards are distributed based on personal performance levels, a perception of favoritism can be created if we don’t make clear why some are provided with greater incentives than others. Jealousy can occur because of this perception. Jealousy can then cause other problems, such as dysfunctional conflict or competition—and even sabotage if it is significant enough. Another problem is that even top performers may focus only on the items that are being measured for incentive payments. So we end up with a situation in which only the things that are rewarded get done. Everything else may be allowed to lag.
• Record-keeping burden is high. Individual incentive plans require that we keep track of individual efforts. Supervisors must develop and maintain comprehensive records to manage the program. This makes individual incentive programs much more time intensive than group incentives.
• May not fit organizational culture. Individual incentives may not be acceptable in team-oriented organizations or in societies in which the culture is highly collectivist. For example, in some Central and South American countries and in many countries in Southeast Asia, the national cultures do not condone the rewarding of individual efforts. In these societies, the team or group is what is valued, and therefore the team or group should be rewarded as a whole. In these situations, individual reward systems go against the norms of the employees and will likely cause significant backlash if implemented.
WORK
APPLICATION 12-1
Select a job. Assess the advantages and disadvantages of offering incentives for your job and whether the criteria are met for individual incentives to be effective at motivating employees.
CRITERIA FOR INDIVIDUAL INCENTIVES. Individual incentive plans work best in the following circumstances:18
• When there are distinct, measurable outcomes for individual efforts. If we can isolate individual results, individual incentives can work. If not, they won’t be very effective at motivating employees.
• When individual jobs require autonomy. In some jobs, autonomy is a necessary condition, because a group effort may just cause confusion or unnecessary conflict. Individual effort is almost always necessary in one-to-one sales situations, for instance. Or think about your professor. Is at least some part of teaching an individual effort on the part of the professor?
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429
Exhibit 12-2
GROUP INCENTIVE PLAN ADVANTAGES AND DISADVANTAGES
Group Incentives
Individual incentive programs obviously work well in some cases. However, group incentives tend to work better in a number of other situations. CEO Alan Mulally said, “We’re aligning compensation with the success of Ford.”19 Group incentives provide reinforcement for actions of more than one individual within the organization. What are the advantages and disadvantages of group incentive plans? See Exhibit 12-2 for a list.
ADVANTAGES OF GROUP INCENTIVES
• Promotes better teamwork. Group incentives, to no one’s surprise, tend to encourage higher levels of teamwork and group cohesiveness. They can foster loyalty and trust between group members. Rewarding members for successfully working within the group creates an enticement to perform in ways that improve group outcomes, not just individual outcomes.
• Broadens individual outlook. Recall the discussion of the job characteristics model in
Chapter 4
. When we broaden the individual’s job by giving them more and different things to do, we can ultimately increase motivation and productivity. By allowing employees to see how their actions affect others, we create positive psychological states that improve performance. Group incentives encourage this type of understanding because the employee has to know what others are doing and how one’s individual efforts affect each of the members of the group.
• Requires less supervision. Group incentives, at least in some cases, tend to require less supervision. This is due to the tendency for the group to police its own members when they are not performing as well as they can. The “social loafers” in the group will feel pressure to improve their efforts from others in the group who are performing up to standards.
• Is easier to develop than individual incentive programs. Developing incentive programs for groups is less difficult than creating separate incentives for each individual in the organization. We can cover entire segments of the workforce with one set of incentives in many cases, and we may be able to design just a few different incentive program options that will motivate most of our employees.
DISADVANTAGES OF GROUP INCENTIVES
• Social loafing can occur. Social loafers (or free riders) may be able to stay hidden within the group while allowing others to do the majority of the group work. Social loafers avoid providing their maximum effort in group settings because it is difficult to pick out individual performance. This social loafing, if left uncorrected, can cause group morale and ultimately motivation and performance to drop significantly. If you want to learn more about social loafing, search the Internet for the “Ringelmann effect.”
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12-1 APPLYING THE CONCEPT
Individual Incentives
Identify each statement by placing the letter of its advantage or disadvantage on the line next to it.
Advantages
a. Easy to evaluate individual employees
b. Ability to match rewards to employee desires
c. Promotes the link between performance and results
d. May motivate less productive employees to work harder
Disadvantages
e. Many jobs have no direct output
f. May motivate undesirable employee behaviors
g. Record-keeping burden is high
h. May not fit organizational culture
____ 1. The HR staff offered me a few different gifts for my top performance, but I took the cash.
____ 2. The old compensation system without incentives was easier. Now I have to keep track of everyone’s performance.
____ 3. The new incentive system will be easy for me because all my employees are sales reps and we already keep track of each sale.
____ 4. I just do the minimum required for my job. If I want more compensation, I will just have to produce more to earn more.
____ 5. I’m a new high school teacher, and I’m very concerned about how the administration will assess my teaching in order to award tenure.
• Individual output may be discounted. Individual effort and results may get “lost” in the group. Some individuals may feel as if they are providing most of the group’s effort, while others take a “free ride.” Therefore, they may hold back their efforts and commitment,20 especially when the relationship with other group members is not good.21
• Outstanding performers may slacken efforts. If the group is highly cohesive and has low performance norms, individual high-level performers may be pressured to lower their output to conform to group norms. Peer pressure can operate on the individual member to force them to stay within the performance boundaries of the rest of the group.
• Group infighting may arise. There might be a breakdown of communication and/or cooperation among individuals within the group, and they might begin to compete with each other instead of cooperating. High-performance group members may even sanction or coerce low-performance group members to provide greater effort.
WORK
APPLICATION 12-2
Select a job. Assess the advantages and disadvantages of offering incentives for your work group and whether the criteria are met for group incentives to be effective at motivating employees.
CRITERIA FOR GROUP INCENTIVES. Group incentive plans work best in the following circumstances:22
• When we need people to cooperate.When a group effort is necessary in order to optimize an outcome or to produce organizational goods or services, group incentives are far more powerful than individual incentives.
• When individual contributions are difficult to identify. When an activity requires the work of many individuals, all doing their part of the job, it may be difficult orimpossible to identify how important one individual’s contribution is compared to that of others in the group. Think about a team designing software: Did the interface engineer do more than the programmer, or vice versa? It may be impossible to tell.
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12-2 APPLYING THE CONCEPT
Group Incentives
Identify each statement by its group advantage or disadvantage.
Advantages
a. Promotes better teamwork
b. Broadens individual outlook
c. Requires less supervision
d. Is easier to develop than individual incentive programs
Disadvantages
e. Social loafing can occur
f. Individual output may be discounted
g. Outstanding performers may slacken efforts
h. Group infighting may arise
____ 6. What happened? Latoya and Katie used to get along so well. Now they are constantly bickering.
____ 7. Katrina, you are not being fair to the rest of us by not doing your fair share of the work.
____ 8. Now that we use a team-based process, the manager doesn’t check up on us like she used to.
____ 9. By assembling the product as a team, we actually increased production by 20%.
____ 10. I know I’m the best, but none of the department members work very hard, so why should I?
LO 12-3
Briefly discuss options for individual incentives.
• When group members possess either similar or complementary skills. If group members all have similar skill levels (think about comparable worth from Chapter11), it may be difficult to determine whose efforts are more significant in creating the desired results. Similarly, if group members complement each other’s skill sets, it may be impossible to say that one set of skills was more important than others.
SHRM
K:A5
Pay Programs
OPTIONS FOR INDIVIDUAL INCENTIVES
Many different potential incentive programs can be used to meet the award needs of every individual.23Remember, each person has to consider the incentive to be significant or it won’t act as a mechanism to motivate that individual to increase their performance. Because of this, sometimes the best thing to do is ask the members of the organization what they want.24 However, some rewards have become commonplace partially because we as managers believe that they work, at least in some cases.
Exhibit 12-3
summarizes some of the more common incentive options. In this section we discuss the individual option, while group incentives are presented in the next section.
Exhibit 12-3 INDIVIDUAL AND GROUP INCENTIVE OPTIONS
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432
Luke Sharrett/Bloomberg via Getty Images
Restaurant servers have an incentive through tipping. Darden Restaurants, which operates Olive Garden and Red Lobster, enforces a tip-sharing policy so that servers share tips with bussers and bartenders.
We noted earlier that individual incentives work best when we can isolate individual efforts and when jobs require autonomy. There are six common options for individual incentive programs that are used in a wide variety of organizational settings. Let’s take a brief look at each of these six incentives used to reward individual employee performance.
Bonus
A bonus is a lump sum payment, typically given to an individual at the end of a time period.25 A bonus does not carry over from one period to the next. Over what type of period do we usually provide bonuses? Generally they will be provided annually. Many companies will call them a “seasonal bonus,” “holiday bonus,” or “year-end bonus” or something similar. How would a bonus program have to be designed in order to motivate increased performance? We would need to identify specific and measurable goals that the individual could affect and a bonus that would cause the individual (assuming we are making this an individual incentive program) to change something that they are doing to perform at a higher level.26 If they then reached the measurable goal, they would receive the bonus.27
Bonuses
can also be used at the group level but are generally considered an individual incentive.
INEFFECTIVE BONUS IMPLEMENTATION. Let’s look at how motivational the “year-end bonus” is in most companies—remember that we are talking about things that are supposed to be incentives to perform at a higher level! Three years ago, because the company was doing well, senior management decided to provide a bonus at the end of the year to all employees. Joanna received a $3,000 bonus based on her pay level at the time. Two years ago, she again received $3,000 at the end of the year (because the company was doing well). The same thing happened last year, but then this year she received no bonus. Management explained that new competitors and technologies had hurt company performance and, as a result, there would be no bonuses provided at the end of the year. But Joanna had worked hard all year expecting to receive her bonus at year end. How do you think Joanna feels? Is she frustrated and demotivated? Wasn’t a bonus supposed to do the opposite—make her feel like she wanted to perform better?
EFFECTIVE BONUS IMPLEMENTATION. However, to use a bonus as it was originally designed and should be used, what should we do? We create a specific, measurable, and attainable goal that the individual has control over and communicate that goal to the employee. Thegoal is continuously measured during the performance period, and that measurement is communicated to the employee so they know where they stand. When the individual meets the goal, the bonus payment is provided—immediately, not at the end of the year.29 The reward is applied for doing more than was required—it was a bonus! Now, the bonus can act as an incentive to perform. So the biggest problem with a bonus as an incentive is in allowing it to become a time-based entitlement instead of a performance incentive.
WORK
APPLICATION 12-3
Select a job. Does the organization offer bonuses? If not, how could it offer bonuses to effectively motivate employees? Assess the advantages and disadvantages of offering bonuses at your organization. Should it offer bonuses?
What did management do wrong? First, they provided the bonus based on a period of time, not based on meeting a performance goal. Reinforcement theory says that variable reinforcement works much better than fixed reinforcement.28 The end of each year is a fixed reinforcement period. That is one error on the part of the managers. What else did they do wrong? What individual goal did they base the bonus on? They didn’t base it on individual results but on company performance, so the employees most likely did nothing different than they had done in the past. In addition, the individual employees most likely have no idea how to affect the overall performance of the company because nobody explained the relationship between their actions and organizational success. Third, because the bonus had been provided on the fixed schedule, as soon as management provided it to the employees twice, the employees started to expect it. It became an entitlement, or something that they felt the company owed them because it had been provided in the past. As soon as the bonus became an entitlement (you owe me), it ceased to motivate any additional performance on the part of employees. This is historically how most companies use a bonus payment. And if we use it this way, it just becomes an expected part of your annual pay.
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433
In the global competitive environment, many businesses are giving bonuses effectively to keep valuable employees from leaving for other companies. Most bonuses of this type will typically be paid out over several years based on performance goals. Technology companies are closely looking at their top 10% of performers and asking themselves, Are they locked in? What can we do to keep them?
Google awarded a $5 million bonus package to a top engineer to keep him from leaving for a job with a start-up firm.30
Commissions
Commissions are well-known incentive tools for sales professionals. A commission is a payment typically provided to a salesperson for selling an item to a customer and is usually paid as a percentage of the price of an item that is sold. If you sell a $100 product and you are on a 10% commission, you would receive $10 for that sale. Salespeople sometimes work on straight commission, where they only get paid when they sell an item, orthey can be paid a salary plus commission, where they receive a lower salary and it is supplemented by commissions on sales. Commissions can also be used at the group level in some cases. In general, commissions are good individual incentives to sell.31
Daniel Acker/Bloomberg via Getty Image
Real estate agents are paid on commission. It takes the right type of employee to be successful on commission pay.
INEFFECTIVE COMMISSION IMPLEMENTATION. Are commissions sometimes ineffective as individual incentives? If not implemented correctly, they can certainly be unproductive and maybe even harmful. The salesperson may ignore the customer’s needs or desires in order to sell something that makes the salesperson more money. If the salesperson gets the customer to buy something they didn’t really want, it may harm the long-term relationship between the company and the customer. The company can also create too much competition within the sales force if the commission structure isn’t set up right. We may create dysfunctional conflict among members of the sales force or even motivate one salesperson to sabotage another in order to make the sale themselves.32 Overall, however, commissions are a strong incentive to perform well in a sales role.
EFFECTIVE COMMISSION IMPLEMENTATION. In order for a commission incentive program to work, it must provide a significant return to the salesperson who is successful in selling to the customer, but it also has to provide a disincentive to harm the customer, or the company, to make a “quick sale.” You may have noticed that more automobile dealerships are now using customer satisfaction surveys after a customer buys a vehicle.33 What they are trying to do is determine whether the salesperson may have done anything to damage the long-term relationship between the customer and the company. In some cases, dealers are even making customer complaints part of their commission structure so that if a salesperson gets too many complaints, part of their commissions will have to be reimbursed to the dealership.
Merit Pay
The next incentive option is called merit pay. Merit pay is a program to reward top performers with increases in their annual wage that carry over from year to year. Merit pay is different from most other individual incentives in that if an individual gets merit pay increases consistently over time, their annual pay can become significantly greater than that of others who do not consistently get merit increases.34
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Merit pay works as follows: The company announces a “merit pool” available for pay increases in a given period, usually annually. The merit raises will be given to the top performers in the company based on performance evaluations. Frequently, individuals who receive either outstanding or excellent marks will get merit increases above the average, while average performers will get a lower raise, and those who receive below-average marks will get no raise at all.
WORK
APPLICATION 12-4
Select a job. Does the organization offer commissions? If not, how could it offer commissions to effectively motivate employees? Assess the advantages and disadvantages of offering commissions at your organization. Should it offer commissions?
INEFFECTIVE MERIT PAY IMPLEMENTATION. There are some significant potential problems in using merit pay as an incentive. The first issue is that merit pay is typically a very small percentage of the individual’s total pay, which makes it very difficult to use it as a motivator to perform. Remember that people need to feel that the reward is “significant” to them in order for it to motivate. In many cases, merit raises may amount to only an extra 1% of pay in any given year. Many employees won’t consider this significant.
Another major issue is inflation of the performance appraisal process. If the company does not set limits on how many employees can be judged as outstanding or excellent, and supervisors know that a pay increase is attached to the individual’s performance rating, nearly everyone tends to become outstanding or excellent.35 While we know this is not true, the supervisor doesn’t want to be the person to keep someone in their department from getting a pay raise. Also, when you limit the number of people who can get a merit raise in any given year, sometimes the manager rotates who will get merit pay, rather than rewarding the best performers, to keep the majority happy.
In order for merit pay to be valuable as an incentive, it must be significant, which means it must be more than 1% of the employee’s pay. However, there is another problem here. Remember that merit pay increases the individual’s pay from one year to the next and it carries forward, so if merit pay is 5% to 10% instead of 1% to 2%, we can end up with employees who break right through our maximum wage for a specific pay level very quickly. If we had a pay level (from Chapter 11) that began at $12 per hour and went to $16 and an employee was hired with a base pay of $12, they could “max out,” or reach $16 per hour, in only 3 years if they received a merit raise of 10% each year. So merit pay is difficult to use as an incentive to perform at a higher level.
WORK
APPLICATION 12-5
Select a job. Does the organization offer merit pay? If not, how could it offer merit pay to effectively motivate employees? Assess the advantages and disadvantages of offering merit pay at your organization. Should it offer meritpay?
EFFECTIVE MERIT PAY IMPLEMENTATION. Merit pay is one of the most frequently used individual incentive programs in companies, and it can be used in some team-based situations as well.36 It requires that we pay attention to some details though. The first and probably most important item that HR needs to develop for a merit pay program is material that communicates the value of merit pay over time. We need to communicate that even what would normally be considered a small incentive can become a significant boost to an individual’s pay when they are judged to have merit over several years. For instance, if we have a merit raise each year of only 2%, because of compounding, this becomes an additional permanent increase in the pay of an individual employee of nearly 10.5% above cost-of-living increases if received for 5 years. Over the employee’s entire work life, this will make a huge difference in total wages earned. So HR needs to communicate the value of merit pay better than has historically been the case.
Secondly, we only want to reward true top performers with merit pay. If we do so, this means that those who are rewarded are truly recognized as having exceptional ability, and it also means that limited amounts of merit pay cash can provide a larger merit increase to those who deserve it. Alternately, if we provide all employees with merit raises, the pool of funds must be spread out among everyone, and the small amount of the supposed “merit” increase doesn’t amount to much. Let’s look at a quick example.
If your company has 1,000 employees and the annual payroll is $60 million, and the leadership decides to provide a 2% merit pool for the coming year, that is $1.2 million inavailable dollars for merit increases. If we spread that money evenly over all 1,000employees, each employee receives an increase in pay of about $100 per month. However, if we truly identify the individuals who are meritorious and limit our payout to the top 30% of the employee group, each individual receives an average merit raise of about $350per month. Most of us would consider an extra $350 per month to be significant, while $100 is probably not significant to many of us. So if we give “all As” to our employees and say that everyone is meritorious, our actual top performers are demotivated because their efforts aren’t being recognized, and nobody in the employee group considers the reward to be significant because it is too small to make much difference in their lives.
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Piecework Plans
Piecework or piece-rate plans are among the simplest forms of compensation, and they can act as an incentive to produce at a higher level because the more workers produce, the more they get paid. In a “straight piece-rate” compensation system, the employee gets paid for every “piece” that they complete. If they are faster than the average, they can make more money than other employees.37 A “differential piece-rate” system (sometimes called a Taylor plan after Frederick Taylor of scientific management theory fame) provides the employee with a base wage to complete a certain amount of work, and if they produce more than the standard, a differential wage is paid for the extra pieces produced. In either case, the employee is being paid for increased speed. Take a look at
Exhibit 12-4
for an example of a piece-rate system.
INEFFECTIVE PIECEWORK IMPLEMENTATION. Are there any problems associated with a piecework incentive program? There is an obvious one—quality.38 If we pay employees “by the piece,” they may make lots of pieces with lots of quality problems because they are trying to work too fast and not paying attention to how well they are doing the work. So quality is an issue in a piece-rate system. There may also be a problem in determining where the standard is going to be set for a differential piece-rate system, and there are other potential problems.
WORK
APPLICATION 12-6
Select a job. Does the organization offer piecework? If not, how could it offer piecework to effectively motivate employees? Assess the advantages and disadvantages of offering piecework at your organization. Should it offer piecework?
EFFECTIVE PIECEWORK IMPLEMENTATION.However, in some situations, a piecework plan can be an incentive to produce at a faster rate. The obvious answer to potential quality problems is to set clear standards that each piece must meet to be accepted and paid for. Thus, if the employees don’t do a quality job, they don’t get paid. Clear standards tell the employee what they need to do in order to benefit from the piecework pay schedule. If they will not be given credit for items that don’t meet quality standards, they need to know this up front. If they will have to rework any items that aren’t correct, they need to know this, too. They also know that they don’t have to “hit a moving target” if the standards are clear from the beginning—that the company isn’t going to just lower the amount paid per piece in order to pay the employees what they have always been paid.
The other key to effective piecework plans is feedback. Employees need to know how they are doing as they go through the workweek. In some cases, they may see that they are not meeting their own goals of performance and pick up the pace, and in others, they may see that their performance is producing a desired result. Many people expect that once the employee reaches a level of production that provides them with an acceptable wage, they will slow down, but there is very little evidence that this occurs in more than isolated cases. Feedback gives the employees information about the “significant reward” that they seek and can motivate continued performance—just as expectancy theory shows.
Standard Hour Plans
Standard hour plans are used quite a bit in some types of service work. In a standard hour plan, each task is assigned a “standard” amount of work time for completion.39 Generally, this time will be shown in a standard-hour manual. The individual doing the job will get paid based on the standard time to complete the job, but good workers can frequently complete the work in less than the standard amount of time. If they do, they can get paid for an hour of work while working less than an hour of time. Take a quick look at
Exhibit 12-5
for two examples of a standard hour plan. In many cases, good service employees can do better than the standard most of the time, so they get an incentive to work faster.
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Exhibit 12-4 PIECE-RATE PLANS
INEFFECTIVE AND EFFECTIVE STANDARD HOUR IMPLEMENTATION. Like the piecework plan, standard hour incentives can cause quality problems. So most standard hour plans also require that if there are any quality problems, the job has to be redone; the worker must do the rework for no additional pay. This is one way to make sure that speed doesn’t create poor quality. Standard hour plans, like most individual incentive programs, can be used for groups if the group is responsible for completion of the work.
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Exhibit 12-5 STANDARD HOUR PLAN
Standard hour plans are used heavily in automotive and heavy equipment repair and in other areas, like heating and air-conditioning services. The biggest challenge with standard hour plans is creating the manuals showing the allowable time for a job. We have to have a large baseline measuring the amount of time necessary to perform specific tasks in order to figure out the average time needed to do a particular job. We can only do this in jobs where the same task is done many times in a year. We also need to keep an ongoing record of the actual times to do the jobs so we can adjust the standards accordingly and not over- or underpay for each job.
Giving Praise and Other Nonmonetary Incentives
WORK
APPLICATION 12-7
Select a job. Does the organization offer a standard hour plan? If not, how could it offer a standard hour plan to effectively motivate employees? Assess the advantages and disadvantages of offering a standard hour plan at your organization. Should it offer a standard hour plan?
People work for money, so financial rewards are critical, but just as important is recognition for the work we do.40 Employee recognition leads to profits,41 so both financial and nonfinancial rewards and recognition are important to motivate employees to meet objectives and put their ideas into practice.42 Nonmonetary recognition can come in many forms (e.g., service awards), but evidence says that honest praise is one of the most effective motivational tools that management has at its disposal.43
INEFFECTIVE RECOGNITION IMPLEMENTATION. Wait just a minute! Service awards—things like Employee of the Month—are motivators? How often is an award such as employee of the month just rotated among the employees? In such a case, is it a motivator, or is it a joke? It is a joke if not used correctly, because everyone knows that there are no criteria that the employee must meet in order to become “employee of the month.” So how do we make an employee-of-the-month award a valuable incentive?
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SHRM
A:26
Service Awards
EFFECTIVE RECOGNITION IMPLEMENTATION. Remember that recognition is a powerful incentive, so we need to use it effectively to motivate our employees. In order for this type of recognition to mean something, there has to be a specific set of criteria that must be met in order to receive the recognition. The employee has to do something extra, above what others do, in order to be recognized.44
How many of you have seen a military awards ceremony at which service members receive meritorious awards? Why do military services all over the world perform these ceremonies? It takes a lot of time and man-hours to do so. The ceremonies are carried out to recognize special efforts by service members, because the officers in charge know that other service members will see such ceremonies and (through social learning!) determine that they can perform at a higher level in order to also receive an award.
If service awards have strong requirements for eligibility, they can become a powerful motivational factor in any workforce. So if our company has an employee-of-the-month or -year program, it needs specific and measurable criteria, clearly communicated to theworkforce, that require performance above the company’s standards in order to be eligible for the award. If this is done, these awards can become excellent motivators.
SHRM
A:25
Recognition
PRAISE AS RECOGNITION. Empirical research studies have found that feedback and social reinforcers (praise) may have as strong an impact on performance as pay. Tom Gimbel, CEO of LaSalle Network and one of the INC. “Best Workplaces 2016,” believes this wholeheartedly. He constantly talks with his employees, and says “I may say the wrong thing sometimes, but I’m never going to have somebody leave here for something I did not say. People want to be appreciated.”45
Praise actually works by boosting levels of dopamine in the brain, a chemical linked to joy. In the 1940s, a survey revealed that what employees want most from a job is full appreciation for work done. Similar studies have been performed over the years with little change in results. Employees want to know that their organization values their contributions and cares about their well-being.46Giving praise is simply complimenting theachievements of others,47 and this recognition increases performance.48 It costs you nothing to give praise,49 involves very little effort, and produces a lot in return.50 It is probably the most powerful, simplest, least costly, and yet most underused motivational incentive there is.
WORK
APPLICATION 12-8
Select a job. Does the organization offer a recognition plan? If not, how could it offer a recognition plan to effectively motivate employees? Assess the advantages and disadvantages of offering a recognition plan at your organization. Should it offer a recognition plan?
Ken Blanchard and Spencer Johnson popularized giving praise back in the 1980s through their best-selling book The One-Minute Manager. They developed a technique that involves giving 1 minute of positive feedback.
Model 12-1
: The Giving Praise Model, is an adaptation. Blanchard called it “one-minute praise” because it should not take more than 1 minute to carry out. It is not necessary for the employee to say anything. The four steps are described and illustrated in Model
12-1.
Step 1: Tell the employee exactly what was done correctly. When giving praise, look the person in the eye. Eye contact shows sincerity and concern. It is important to be very specific and descriptive.51 General statements like “You’re a good worker” are not as effective. On the other hand, don’t talk for too long or the praise loses its effectiveness.
Step 2: Tell the employee why the behavior is important. Briefly state how the organization and/or person benefits from the action. It is also helpful to tell the employee how you feel about the behavior. Be specific and descriptive.
MODEL 12-1 THE GIVING PRAISE MODEL
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Step 3: Stop for a moment of silence. Being silent is tough for many managers. The rationale for the silence is to give the employee the chance to “feel” the impact of the praise. It’s like “the pause that refreshes.” When you are thirsty and take the first sip or gulp of a refreshing drink, it’s not until you stop and maybe say “Ah” that you feel your thirst quenched.
Step 4: Encourage repeat performance. This is the reinforcement that motivates the employee to continue the desired behavior.52 Blanchard recommended touching the employee because it has a powerful impact. However, he recommends doing this only if both parties feel comfortable. Others recommend that you don’t touch employees, as physical contact could lead to a sexual harassment charge.
WORK
APPLICATION 12-9
Select a job. How often does your boss criticize your work? How often does your boss praise your work? What is the last thing you did that deserved praise? How often do you criticize and praise others at work? Will you now give more praise, knowing how it affects others?
As you can see, giving praise is easy, and it doesn’t cost a penny. Managers trained to give praise say it works wonders. It’s almost always a much better motivator than giving a raise or other monetary rewards.53
Other nonmonetary recognition, besides praise, also increases motivation if the individual considers it to be significant.54Some of the more common forms are extra time off, ability to choose tasks or jobs, flexible hours, or extra training in a particular area of interest to the employee. Younger workers, especially, often want more flexible hours and working conditions.55
OPTIONS FOR GROUP INCENTIVES
LO 12-4
Briefly discuss options for group-based incentives.
Individual incentives can work well, but what can we use to motivate higher levels of performance from groups? After all, in most of our 21st-century companies, groups and teams are the norm. Let’s take a look at some of the more common group incentive options.
Profit-Sharing Plans
Profit-sharing programs provide a portion of company proceeds over a specific period of time(usually either quarterly or annually) to the employees of the firm through a bonus payment. The programs are designed to cause everyone in the company to focus on total organizational profitability.56 This sounds like a good opportunity for the employee to get a share of the returns that the company receives from their work, right? But how well does it work? What if the company does not have any profit during a particular period? If this is the case, then there is no profit to be shared.
SHRM
K:B18
Financial Benefits
INEFFECTIVE PROFIT SHARING IMPLEMENTATION. If the company doesn’t have any profits, employees may not be motivated to work harder. But how can a company have no profit? It is actually pretty easy for the company to have no profit, or a minimal amount of profit, in any given year.
The company can, and frequently does, manipulate net profit in many ways in order to pay less in tax on corporate profits at the end of the year, and in some cases to minimize profit sharing. Management might put profits back into the company by buying new equipment or other assets. It can decide to pay management an unscheduled bonus, acquire another business, or increase finished goods inventory. However, if the company is manipulating expenses or other cost factors to decrease profit sharing and employees find out, the plan will certainly not be a performance motivator and most likely will cause other problems.
Another issue with profit sharing as a motivator is that it is focused on total organizational profitability. How can the average employee affect company-wide profitability? If the employee doesn’t know what to do in order to increase profits, what will they do differently in their job? The answer is “absolutely nothing.” Remember that we need to be able to personally affect the desired result in order to be motivated to do anything different. So profit sharing in many cases does not provide the company with the expected boost in productivity.57
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12-3 APPLYING THE CONCEPT
Individual Incentive Options
Place the letter of the individual incentive on the line next to the scenario illustrating it.
a. bonus
b. commissions
c. merit pay
d. piecework
e. standard hour
f. nonmonetary awards
g. praise
____ 11. I’m an auto mechanic at a dealership, and we have a set amount of time to complete each type of repair work. I complete a job before a stated time so that I can go on to the next car and get paid extra for being faster than the average guy.
____ 12. I just sold that top-of-the-line BMW M3. I can’t wait to get my pay this week.
____ 13. I’m the top producer in the entire department, so I will get an extra raise for high performance this year.
____ 14. The boss had me come to the front of the room at the annual meeting to get a plaque for 5 years of service to the company. She listed some of my major accomplishments.
____ 15. The boss just thanked me for getting a shipment that was behind schedule out on time today.
WORK
APPLICATION 12-10
Select a job at a for-profit company. Does the organization offer profit sharing? If not, how could it offer a profit-sharing plan to effectively motivate employees? Assess the advantages and disadvantages of offering profit sharing at your company. Should it offer a profit-sharing plan?
EFFECTIVE PROFIT SHARING IMPLEMENTATION. To motivate employees, we need to be sure that management is not manipulating factors to minimize profits so it doesn’t have to pay much in profit sharing. The second thing is to be sure to train all employees on how to increase revenues and decrease cost in their job areas so that they can affect the bottom line and increase their profit share. In addition, a running record of organizational revenues and profitability should be maintained and updated on at least a weekly basis. This record should be posted where everyone can see it and keep track of company performance—some companies post it in the lunch/break room. This allows the employees to see how their efforts are affecting profitability of the firm overall. It can also allow interim payments of incentives, which can assist the company in maintaining high worker efficiency over longer periods of time.
Gainsharing Plans
An alternative to profit sharing is a gainsharing program. Gainsharing is similar to profit sharing because in each case, the gain (in either profit or some other factor) is shared with the employees who helped to create the gain. Gainsharing is a bit broader than profit sharing though. Gainsharing can be accomplished using any organizational factor that costs the company money and that can be analyzed and modified for performance improvement.58 Originally, gainsharing usually used corporate revenue, but today, many gainsharing options exist. Some of the more common gainsharing options are increased revenues, increased labor productivity or lower labor costs, improved safety (fewer lost-time accidents), return on assets or investment, and increased customer satisfaction.
WORK
APPLICATION 12-11
Select a job. Does the organization offer gainsharing? If not, how could it offer gainsharing to effectively motivate employees? Assess the advantages and disadvantages of offering gainsharing at your firm. Should it offer a gainsharing plan?
INEFFECTIVE AND EFFECTIVE GAINSHARING IMPLEMENTATION. Being somewhat similar to profit sharing, gainsharing has the same potential problems. Here, as with profit sharing, we have to show employees how they can affect the desired outcome in order for them to be motivated to change the way they work.59 However, different from profit sharing, many of the options for gainsharing are more difficult for management to manipulate, so workers feel that they have more control over their results. It is tougher for management to modify total revenue or days lost to accidents, for instance, than it is to modify net profit. So gainsharing sometimes initiates a stronger reaction and more motivation from the workforce than profit sharing.
How do we incorporate gainsharing effectively in the organization? It’s pretty straightforward but easier said than done. Here is the process. We establish the objective(s), identify the performance measure (usually as a per-unit value), determine how to split the gain between the organization and the employees, and then provide the payout when earned.
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WORK
APPLICATION 12-12
Select a job at a for-profit company. Does the organization offer ESOPs? If not, how could it offer an ESOP to effectively motivate employees? Assess the advantages and disadvantages of offering ESOPs at your company. Should it offer an ESOP?
Employee Stock Ownership Plan (ESOP)
An employee stock ownership plan (ESOP) ultimately allows at least part of the stock in the company to be provided to the employees over a period of time based on some formula.60 For example, if you work for the company for a year, you might get 10 shares of stock, and for every additional year of employment, you would receive 10% more than the year before. An ESOP is actually a retirement benefits plan because the company putsthe tax-deferred stock in a trust for eventual use by employees who retire. But it also has the potential to be an incentive to the company’s employees, because they become part owners of the firm.
Why would the current owners of the firm give away stock in the company? Well, there are a couple of major reasons. Because an ESOP is basically a “qualified” retirement benefits plan, it has some significant tax advantages to both the firm and the employee in most cases.61 This means that owners can give their employees part of the company and receive a tax break for doing so. A second major reason for giving employees stock in the company is to cause them to act more like owners. It is thought that this will motivate employees to do such things as reduce scrap, increase quality, improve customer service, and pay attention to many other things that cost the company money over the course of ayear.
INEFFECTIVE AND EFFECTIVE ESOP IMPLEMENTATION. But does an ESOP always work as intended? Of course not. Because an ESOP is like the other two group incentives, it is subject to the same potential problems and requires the same lack of manipulation and employee training.
Stock does, however, have a unique potential problem. The entire company typically has to improve in order for the value of its stock to increase. But even if the employees are highly motivated and work really hard, the value of the stock can actually go down for many reasons that are outside the control of the individual and groups. For example, a recession may hit and sales and profits may go down, as well as the price of your stock. Competition can take some or all of your business away, as Netflix did to Blockbuster, or the company can go bankrupt as Hostess did, and you can lose it all.
12-4 APPLYING THE CONCEPT
Group Incentive Options
Place the letter of the group incentive option on the line next to the matching description.
a. profit sharing
b. gainsharing
c. ESOP
d. stock options
e. stock purchasing
____ 16. Our group incentive option gives us a bonus at the end of the year based on how profitable we were for the year.
____ 17. Our group incentive option plan allows me to get stock and put it in my retirement account without paying anything for it.
____ 18. Our group incentive option plan worked like this. The manager told us that if we could cut cost in our department by 5%, as a group we would get 5% of the savings to the company distributed evenly among us.
____ 19. Our group incentive option allows me to buy company stock for 10% less than the market value.
____ 20. Our group incentive option plan allows me to buy $50 shares of the company stock for only $13 apiece next year.
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Stock Options and Stock Purchasing Plans
There are two other common stock plans used by companies as incentives. The first is a stock option plan, and the second is direct stock ownership.
STOCK OPTIONS. Stock options are usually offered to an individual employee to allow them to buy a certain number of shares of stock in the company at a specified point in the future, but at a price that is set when the option is offered.62 Options can be provided either to executives or to nonexecutive employees.63 So, we might offer our employees the option to buy stock in the company in a year at today’s stock price.
WORK
APPLICATION 12-13
Select a job at a for-profit company. Does the organization offer stock options and/or stock ownership? If not, how could it offer one or the other to effectively motivate employees? Assess the advantages and disadvantages of offering stock options and stock ownership at your company. Should it offer stock options and/or a stock ownership plan?
The intent here is to motivate the employees to work to improve the value of the company so that when the option to buy the stock comes up in a year, the price of the stock has increased, giving the employee more value than what they paid for. For example, we may offer our employees the option to buy 100 shares of our stock in 1 year at today’s price of $10. If the company’s value increases so that at the end of the year, a share of stock is worth $20, the employee can buy $2,000 worth of company stock for $1,000. However, if the value of the stock doesn’t go up in a year, the option isn’t worth anything.
STOCK PURCHASING. These plans are similar to stock options, but instead of giving you the option to buy stock in the future, they let qualifying employees buy the stock essentially anytime, usually at a discount. ESOPs, stock options, and stock purchasing give employees ownership in the company, but the big difference is that with an ESOP, the employees are given the stock over time, whereas with stock options or purchases, employees have to buy the stock.
12-1 SELF ASSESSMENT
Compensation Options
Answer each question based on how well it describes you:
____ 1. I enjoy competing and winning.
____ 2. I usually work faster than others.
____ 3. I like working alone more than being part of a group.
____ 4. I don’t need to have approximately the same pay every week; varying income is fine.
____ 5. I enjoy meeting new people and can strike up a conversation with most people.
____ 6. I take risks.
____ 7. I would prefer to get a large sum of money all at once rather many smaller payments.
____ 8. I’m thinking long term for my retirement.
____ 9. I like working toward a set of goals and being rewarded for achieving them.
____ 10. I like knowing that I am one of the best at what I do (merit pay and praise).
There is no simple sum to add up here. Although we would all love to have a high wage or salary with lots of incentive pay on top of it, this is not the reality in most jobs today. In general, the higher your number of “describes me” statements, the more open you are to incentives versus wages/salaries. Following is an explanation of each statement.
Item 1: If you don’t like competing and winning, you may be more comfortable in a job with a wage or salary; you usually have to compete for incentives like merit raises. Item 2: If you are not faster than others, piecework and standard hour incentives may not be your best option. Item 3: Commissions, piecework, and standard hours are often based on individual performance. Item 4: Wages and salaries give you a fixed income, whereas incentives provide a variable income. Item 5 is characteristic of commission salespeople. Item 6: If you don’t like risk, incentives can be risky. Item 7: Getting a large sum at once tends to involve a bonus, profit sharing, or gainsharing incentives. Item 8: ESOPs are retirement plans, and stock purchases can be, too. Item 9 reflects gainsharing and bonuses. Item 10 reflects merit pay and praise.
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INEFFECTIVE AND EFFECTIVE STOCK OPTIONS AND PURCHASING IMPLEMENTATION. Stock options and stock purchasing don’t always work as intended for essentially the same reasons as ESOPs. The hope is that if you are an owner, you will think more about the long-term value of the company and work to improve its performance. But with stock options, there is a unique potential problem. The employee can simply buy the stock and then quickly sell it for a profit so that they are no longer an owner of the company. The same problem can occur with stock purchases, depending on the arrangement; there can be restrictions on the sale of the stock, and if it is part of a qualified retirement plan, there are penalties for selling before retiring.
FAILURES AND CHALLENGES IN CREATING INCENTIVE PAY SYSTEMS
LO 12-5
Discuss the major reasons why incentive plans fail and the challenges involved.
Now that we know a little about the various types of incentives available to the company, let’s discuss some of the issues that we will have to deal with in creating an incentive program that works.
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Why Do Incentive Pay Systems Fail?
Too often, incentive systems are poorly designed and badly implemented.64 If we are not going to carefully manage a system, then we shouldn’t even create it. It is worse than no system at all. There are many reasons why incentive plans might fail to motivate the workforce, but let’s take a look at some of the more common ones.
POOR MANAGEMENT. Even the best incentive plan won’t work with bad management. Managers are the core of any incentive program, because they have to keep track of individual and group performance in order to reward those who perform the best. Management also has to monitor the program and adjust things as necessary when the environment or the organizational tasks change.
COMPLICATED PROGRAMS. If the employees can’t figure out what they need to do in order to receive the incentives, they won’t do anything different. Complex programs will almost always lead to failure of an incentive program because the workers don’t know how to reach the goals or, in many cases, even what the true goals are.65 In addition, failure to successfully communicate the plan to employees creates the same problem—the employee won’t know how to reach the goals.
THE PLAN DOESN’T REALLY INCREASE REWARDS, OR IT PROVIDES INSIGNIFICANT REWARDS. If a plan takes away from base pay in order to add incentive pay, the employee isn’t really gaining anything. The net result is the same, and employees will see right through such a “rewards” program. Even if there is a minimal increase in pay, often employees will figure that the extra effort required is not worth the return—again, we see expectancy theory in action.66 We have to tailor the incentive program to the things that matter to each specific employee.67
EMPLOYEES CAN’T AFFECT THE DESIRED OUTCOMES. Frequently, we create rewards programs that promise a return to the employee, but we base the promised reward on something the employee can’t do anything about. Think about company profit—what can the housekeeping staff (and many others in the organization) do about company profit? So if the desired outcome is increased profit, the employee doesn’t know what to do to affect profitability.
EMPLOYEES DON’T KNOW HOW THEY ARE DOING. In order for an incentive plan to motivate, the employee has to know how they are doing compared to the desired outcomes.68 If you know that you have to reach a certain production goal by the end of next week in order to get a desired reward and you are currently behind schedule, you will likely work harder to reach the goal. However, if you don’t know where you stand, you may feel that everything is going well and won’t increase your efforts. People have to know how they are doing compared to the program goals.
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Justin Sullivan/Getty Images
Wells Fargo was fined $185 million regarding its incentive program after a number of employees were found to have opened up additional accounts without customers knowing, in order to meet goals and earnincentives.
Challenges to Incentive Pay Systems
There are obviously going to be challenges associated with incentive systems. Employees do respond to incentives, but unfortunately, they don’t always respond to incentives in the way we expect them to.69 Questions covered in this section will discuss four of the major challenges: Do incentives work? Do incentives become entitlements? Will employees only do what they get paid for? And do extrinsic rewards decrease intrinsic motivation?
DO INCENTIVES REALLY WORK? The answer here is “It depends on who you ask.” If you ask the CEO of a company that does incentive planning for other firms, they work great. If you ask some company leaders who have tried them, they don’t work at all. For others, they work some of the time, but not always.70 One of the things that we have found out over the past 20 years or so is that incentives don’t work as well as we might have thought they would in at least some cases.71
There is some recent evidence that group incentives work significantly better than individual incentives when people in the organization have to cooperate or coordinate with one another in completing a set of tasks.72 However, there is little clear evidence that supports company-wideapplications of group incentives. One HR Magazine article noted that “company incentives do little to drive performance. They’re the least effective motivational tool.”73 This is primarily because of the difficulty in establishing a link between the individual employee’s actions and the success of the entire firm.
WORK
APPLICATION 12-14
Select an organization that you know or work for. Assess how likely the factors that lead to failed incentives are to occur in the organization.
Does this mean companies shouldn’t use incentives? No, but managers need to make sure that employees understand how their actions connect to the needed results. We have to help our people figure out how they can help the group or organization gain. If we can create the connection between how the employee acts and how they gain from it, we can create strong performance incentives. If not, the incentives will not work.
WORK
APPLICATION 12-15
Select an organization that you know or work for. Do incentives really work at your organization, or would they if the firm offered them?
INCENTIVE TO ENTITLEMENT—AN EASY STEP.Remember from our discussion of bonuses that in order for an incentive to continue to motivate, it can’t be considered an entitlement. An entitlement is something that the employee feels they have a right to receive from the company. A common example of an entitlement would be a weekly paycheck. Most employees feel that if they show up to work, the company owes them a paycheck. In academia, some students feel they deserve a B for showing up. It doesn’t matter whether they did anything or not! So we have the same challenge with regular pay and incentive compensation. However, an effective incentive makes the employees actually earn the reward based on their performance—it is not automatic like a salary. The current group of younger employees entering the workforce has been called the entitlement generationbecause of the expectation that they are entitled to certain perquisites just for becoming an employee.74
Consultants are seeing that in many cases, “what was intended to be ‘pay for performance’ in many organizations deteriorated into a bland set of rewards based on an entitlement mindset.”75 As soon as this happens, our incentive program ceases to motivate higher levels of performance. Incentive pay of any kind is going to be a significant portion of overall compensation costs in companies where it is used. In fact, it will almost always be at least a few percent of base pay and in some situations can go up to 100% of base pay or even more, so we have to ensure that we get something in return for the cost.
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WORK
APPLICATION 12-16
Select an organization that you know or work for. Do employees in general have a sense of entitlement about pay and/or incentives? Is there a difference in feelings of entitlement between the younger and older workers?
“DO ONLY WHAT GETS PAID FOR” SYNDROME.Another of the challenges associated with incentive programs is the tendency of people to only do what is measured and is paid for. In other words, our people will pay attention to the work that will get them the rewards that they desire. There is a lot of anecdotal evidence that this occurs. However, there is not much empirical evidence that incentive pay fails because of this syndrome. Besides, we have the same challenge with regular compensation. Remember, reinforcement theory notes that if we reward an individual for doing something, they are likely to continue to do that thing in the expectation that they will continue to receive a desired reward.
However, assuming that this might be a problem in some cases, one way to combat it is to make the incentive specific but make overall job performance a part of any variable pay program. The incentive causes the employees to focus on the specific goals that we need accomplished, but the performance component lets everyone know that they still have to do all of the other things that make the organization successful over the long term.
WORK
APPLICATION 12-17
Select an organization that you know or work for. Do employees only do what they get paid for?
EXTRINSIC REWARDS MAY DECREASE INTRINSIC MOTIVATION. Extrinsic rewards are valued returns (such as incentive pay for performance) to the individual in exchange for doing something that the organization desires of the employee. Intrinsic motivation means that a person does something because they like it, it is interesting and personally satisfying, and they want to do it. More than 100 studies over many years have shown that there is a relationship between the application of extrinsic rewards and a decrease in intrinsic motivation.76 In other words, when we get an external reward for doing something that we enjoy, the enjoyment level will go down. Some evidence says that this is due to the fact that we may feel like we are being controlled externally and then rebel against that control.
However, there is also evidence that in at least some cases, we can increase internalization of extrinsic motivators (cause the individual to believe that the rewards are for the “right” things), which lowers resistance to the external rewards.77 We always need to be on the lookout for ways to show that the external motivators that we provide are good things for both the employee being rewarded and others who depend on the actions of the employee being rewarded to increase this internalization process.
GUIDELINES FOR CREATING MOTIVATIONAL INCENTIVE SYSTEMS
LO 12-6
Identify the guidelines for creating motivational incentive systems.
So we now know that we have a number of factors that make incentive programs more or less successful. Anytime we are developing a variable pay plan, we have to consider what we need to do to make it work. What will make the system motivational to the workforce while also improving organization success overall?
Exhibit 12-6
lists some guidelines that researchers have come up with over many years of analyzing incentive programs that can significantly increase the chances of success. Let’s discuss our guidelines for creation of an effective incentive plan in a little more detail in this section.
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WORK
APPLICATION 12-18
Select an organization that you know or work for. Do incentives decrease intrinsic motivation, or would they if the firm offered them?
BASED ON ORGANIZATIONAL STRATEGY AND CULTURE. The incentive program must be based on the goals in the strategic plan—the direction of the organization.78 Think back to when we discussed strategic HR in Chapter 2. We talked about how HR can drive people to do things for the organization that it needs to have done in order to reach its goals. One thing we can use to avoid creating the entitlement mentality that we just discussed is to avoid basing our reinforcement on a fixed period of time or a fixed number of actions by the employee. We need to base the reward on achieving specific and measurable goals and provide at least some reinforcement as soon after the goal is achieved as is feasible. If the incentives are not driving our employees to work toward organizational goals, we won’t reach those goals. One of the most common problems in incentive systems is picking an expedient goal that is easy to measure but doesn’t aim at the strategic goals of the company.
Another thing that we need to keep in mind is to create both short-term and long-term goals for allorganization members. Both short- and long-term incentives should be provided based on those goals at each level in the firm. This will both mix up the timing ofthe rewards provided to the employee and provide them with incentives to improve company performance over the long term.
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Exhibit 12-6 GUIDELINES FOR CREATING MOTIVATIONAL INCENTIVE SYSTEMS
We also need to make sure that the incentive program is consistent with the organizational culture.79A lot of organizational cultures are egalitarian—everyone expects thatthey will be compensated equally with others in similar positions. Many others are collectivist, meaning the group has a strong desire to work together. In an egalitarian culture, it will be difficult or impossible to provide different rewards to individuals, even if rewards are based on performance differences. In collectivist cultures, the group won’t accept incentives that focus on the individual. So culture must be taken into account in designing incentive systems.80
INCENTIVES FOR ALL. Any incentive program needs to provide performance incentives to all individuals involved in the process that is being targeted.81 We can’t just provide incentives to management, because management will attempt to force lower-level employees to perform so that the manager can get rewarded. This is a recipe for frustration and resistance by the line employees. But what if we only provide incentives for the line workers and not management? Management’s job (at least a significant part of it) is to get obstacles out of the way so that line employees can do their jobs. If the manager has no incentive to move quickly to get obstacles out of the way, we just end up with frustrated employees who can’t meet their incentive goals.
12-5 APPLYING THE CONCEPT
Effective Incentives
Identify each statement by the guideline it is violating using the letters (a) to (l) in Exhibit 12-6. You should read the explanations of each guideline before completing this application.
____ 21. I went to the meeting to find out about the new incentive system, but I didn’t understand what they were talking about.
____ 22. I understand that if the price of the stock goes up next year, I can buy stock at today’s lower price. But I don’t see how my delivering mail can make any difference in the price of the stock.
____ 23. What’s the incentive for me? Management gets great bonuses every year and we do all the work and they don’t give us anything.
____ 24. How can we know if we are the best company in the sporting goods industry?
____ 25. This system isn’t fair to me. I was the top performer, but Sam, who didn’t even meet his quota, got the same bonus.
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Can the incentive apply differentially? Yes, if one group’s job is more important to reaching the goal, then it is OK to give them a differential incentive. However, everyone needs to be rewarded so that they have an incentive to work together.
UNDERSTANDABLE AND CLEARLY COMMUNICATED. Complexity is a part of many organizational environments in today’s businesses. However, our incentive programs have to be set up in such a way that employees at every level of the firm can understand them. If people can’t understand what is expected of them, there is no way that they will reach the goals that we set. In addition, even if the program is understandable, it has to be accurately communicated to everyone in the organization.82All of our employees need to know about the program: how to participate, what their goals are, any assistance that is available to help them meet those goals, how their performance ties in with that of others in the company, and any other pertinent information. Good incentive programs must be clearly and completely communicated to all the personnel affected by the program.83
BASED ON FACTORS THE TARGET CAN AFFECT. The incentive offered should be based on factors that the individual or group, whichever is the target of the incentive, can affect.84 If it is an individual incentive, the individual employee should be able to modify their behavior to affect the outcome of the process, and the same goes for a group of employees. If the individual or group can see no connection between what they do and reaching the goal, they will most likely do nothing different than before the incentive was instituted.
SMART GOALS. Remember in Chapter 8 where we talked about goals having to be SMART—specific, measurable, attainable, relevant, and time based? SMART goals provide a clear link between performance and payout.85 Here again, as with any valuable organizational goal, we have to ensure that our incentive program identifies the goals of the plan in SMART fashion. This is the only way that we can then accurately measure and reward our employees for goal attainment. So remember to use our setting objectives model: To + action verb + specific and measurable outcome + target date.
CLEARLY SEPARATE FROM BASE PAY. Base pay is almost always considered an entitlement by the employees in an organization. We utilize base pay to allow our workforce to meet their basic needs (Maslow’s physiological, safety, and social needs). This base pay very rarely motivates additional actions on the part of our employees. Incentives need to be clearly separated from base pay to avoid creating the impression that they, too, are an entitlement. Employees need to understand that they only receive incentive rewards if they do something extraordinary.
A SIGNIFICANT PIECE OF OVERALL COMPENSATION. What is a “significant piece” of compensation? Compensation studies will tell you different things about what is considered significant.86 A good recommendation would be at least 10% of overall pay and, in some cases, 20% or more. Why? Let’s take a look at an example.
You work for XYZ Co. and are getting paid $40,000 a year. Your manager decides to give you a 2% bonus if you reach your goals this year, or $800. You reach your incentive goals at the end of the year, and it is now time to pay you. If we pay you a lump sum at the end of the year, we generally have to take out 25% for federal withholding taxes and may have to take out state tax as well, so your $800 just dropped to between $500 and $600. At a salary of $40,000 per year, if you are paid twice monthly, you would normally receive about $1,350 or so per paycheck, depending on the state in which you reside. Howmany of you would work really hard next year if you got a whopping $500, a little more than one third of 1 month’s pay, as a bonus for meeting your goals the year before? To most of us, that would be an insignificant reward for meeting our goals for an entire year. Remember what we said when discussing merit pay earlier in the chapter: Merit pay is typically a very small percentage of the individual’s total pay, which makes using it as a motivator for performance very difficult.
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Alternatively, if we make your base pay $36,000 and provide a 10% incentive for reaching certain goals, you will receive around $2,600 after taxes—a sum that most people making $36,000 per year would consider significant. People need to feel that the reward is “significant” to them in order for it to motivate them.
TAKE GREAT CARE IN ADMINISTERING THE PROGRAM. Meticulously measure performance using multiple metrics and vigilantly calculate the rewards to be provided to persons who reach their incentive goals.87 If the company owes an individual or group an incentive award based on reaching their goals, then we must make sure that it is paid. Set attainable standards and then measure them fairly, when and how they are supposed to be measured. Once performance is measured, reward those who attain the goals as soon as possible. If individuals or groups did not meet their goals, communicate that to them so that they know why they didn’t get a reward.
Again, an example helps in understanding what might happen if we fail to be meticulous in our measuring and administration duties. Let’s say we have 600 employees in our company and set some ambitious goals at the beginning of the year for the company and for each individual employee. As a company, we met our goals for the year, and we calculated whether or not each individual employee met their personal goals. But we miscalculated with one person. How fast will the word likely get around the company that we “cheated” that one employee? Via the employee grapevine, it will probably be known throughout the company in 2 days—possibly 1. This employee starts telling their friends that “the company cheated me and lied to me.” And what will happen as soon as one person starts to complain? As soon as one person makes that claim, others will start to wonder whether or not they were treated fairly—even though we were correct in calculating their individual payments! Pretty soon, what was supposed to be a motivational program becomes a massive demotivator due to the fact that people begin to perceive that they may not have been treated fairly. We have to be meticulous in our management of any incentive program.
PROMPTLY APPLY ANY INCENTIVE AWARD. “Keep the time between the performance and reward as short as possible.”88 If the incentive is based on an annual goal, and we use a calendar year as our organizational fiscal year, our year ends in December, and we should provide any incentive awards on the first payday in January, or even on December 31 if we already have results calculated. If incentives are calculated monthly, pay them at the end of the month. Why? We provide the reward to reinforce the employee’s efforts that led to desired results. If you receive a reward 6 months after you do something, you don’t really see the connection. If you don’t see the connection, it does not reinforce your earlier actions.
DON’T FORGET NONMONETARY REWARDS. Remember from our discussion about praise and other nonmonetary recognition that not everyone is motivated by cash.89 Nonmonetary rewards often work better than monetary rewards. Having a bit of time off to play with the company’s resources, like 3M Company provides, can be a huge incentive. 3M gives 15% of work time to employees to use the company’s resources and labs and to just tinker around and see what they can come up with.90Post-it notes were created in just this way in 1974. A 3M employee was tired of bookmarks falling out of his books, so he used an adhesive that had been invented at 3M earlier (but considered a failure) and applied it to small pieces of paper. The incentive was in being allowed to be creative and avoid being bored. Incentives can include providing the ability to choose between work assignments, providing training and learning opportunities, allowing flexible schedules, providing extra paid time off, recognition at an awards ceremony, offers to present results to top management, having greater input into future incentive goals, and many others. We can use an on-site child care center or a gym or lounge as an incentive—for example, “If we reach a certain set of organizational goals by the end of the year, we will be able to build the child care center.” To many people in today’s workforce, this would be a significant incentive. However, to others, it may not be a reward at all. Remember that according to expectancy theory, we have to pay attention to significance.
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DON’T REWARD NONPERFORMERS. When goals are not met, do not apply rewards.91 It seems silly to have to say this, but in many cases, you will want to reward your employees, even when they don’t quite meet the goals that were set. Why would this happen? Let’s look at an example that will explain it.
Andy works for you and didn’t quite meet the goals set for the incentive program at the end of the year. You are a good manager, and you saw Andy consistently come to work and work hard, but he just wasn’t able to reach his goal. At the end of the year, you see that he didn’t make it, but you know that Andy is a hard worker. So you sit down and look at everyone in your department, and everyone except Andy met their goals. Then you think about how hard Andy tries and you say, “I know I saw him working all the time. Iam just going to give the incentive payment to him anyway because I know that he works hard.” Here again, how quickly will the word get around about Andy getting the reward even though he didn’t meet his goals? Again, the communication grapevine will start working, and within 1 or 2 days everyone will know, because Andy is going to tell them.
Well, what will happen next time incentives are being calculated? Next time, maybe several workers miss their goals, and they tell you, “Boss, I worked my tail off, but I just couldn’t reach my goals. But you gave Andy his incentive last time even though he missed his goal. You can go ahead and give it to me too, right?” You have succeeded in destroying your incentive program because you rewarded a nonperformer. Rewarding nonperformers just cannot be allowed if we want the incentive program to continue to work in the future.
WORK
APPLICATION 12-19
Select an organization that you know or work for. In which two or three incentive pay guidelines is your organization strongest and weakest at following to ensure it effectively motivates employees?
There is, however, a way that we may be able to reward Andy, at least partially, but we have to identify it at the beginning of the program. We can create a series of progressively more difficult goals in our incentive program. This allows us to provide a minimal incentive for meeting goals that are just above a baseline and provide progressively more significant awards for meeting more difficult goals. This will let us reward Andy for going above the standard but not quite meeting an aggressive incentive goal. So progressive or stair-step goals can help us avoid rewarding people who don’t meet the top-level, or most difficult, goals.
MAKE THE INCENTIVE PROGRAM PART OF A COMPREHENSIVE APPROACH TO MANAGING. Remember that incentives can create a “just do what you get paid for” mentality. So, as we noted earlier in this chapter, we “make the incentive specific but make overall job performance a part of any variable pay program.” We can’t create an incentive for every aspect of every job in most organizations, so we have to continue to evaluate and reward overall performance so that our employees know that they have to do all tasks successfully, even though only some have incentives directly attached to their performance. One easy way to do this is to provide a caveat in the incentive program that receipt of an overall performance appraisal of “Meets Expectations” or higher is required in order to be eligible for incentive rewards.
EXECUTIVE COMPENSATION
LO 12-7
Discuss the issue of executive compensation and how the major provisions of the Dodd-Frank Act affect the issue.
No modern discussion of compensation is complete without at least touching on the topic of executive compensation practices. Executives drive organizational performance more than any other employees. The great debate over how much chief executive officers (CEOs) matter rages on.92 CEOs like the late Steve Jobs of Apple have the power to make or break a company.93 When he retired in August of 2011 and died shortly thereafter, Apple stock lost nearly a third of its market value (about $120 billion!) in a year.94 Research clearly links managerial leadership to positive consequences for both the individual and organizations, including financial performance. Also, substantial evidence demonstrates that sound managerial leadership practice is critical to creating effective organizations.95 So it makes sense that executives are well paid for their managerial and decision-making skills. But has executive pay gotten out of line? The average CEO compensation for the largest 500 US public companies rose to about $11 million in 2016.96
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Too Much or Just Enough?
Tim Cook of Apple—$150 million97
Elon Musk of Tesla—$100 million
Virginia Rometty of IBM—$97 million
Leslie Moonves of CBS Corp.—$84 million
There are many cries in the business world today that executives are getting paid too much. In at least some cases, that certainly appears to be true based on the performance of their companies. But are executives generally paid too much, too little, or about right? In order to even attempt to answer such a question, we need to look at what executives are paid to do. If we were to ask you if anyone in a company physically produces enough products or services to make $1,000,000 or more in any given year, most of you would answer absolutely not. However, executives are not paid to be production employees; they are paid to make decisions for the organization and to guide it toward its goals. In addition, the decisions that executives are paid to make are not easy decisions. Successful executive leadership requires a high level of inherent intelligence, knowledge, and skills toanalyze so much information, as well as significant experience in making decisions of similar types and consequences.
While many of us think that we could run a billion-dollar company, the reality is that very few individuals have the required skills and abilities to do so. Since labor is always at least partly priced based on supply and demand, and there are very few executives with the high-level skills necessary to run large firms, these individuals are always going to be worth quite a bit of money to the firm. And how about professional athletes’ pay? Some of them make more for sitting on the bench than some CEOs, especially of smaller firms.
Troy Harvey/Bloomberg via Getty Images
There is an ongoing debate as to whether executives are overpaid. Elon Musk, CEO of Tesla, makes $100 million per year.
Think of it this way. If you were the owner of a company and had hired somebody to lead the company throughout the year, and at the end of the year this person had made you $10billion (that’s 10,000 times a million!) in profit, would you be willing to pay them $10 million (0.1% of the profit)? Most of us would have no problem paying someone this much money if they made us $10 billion. They deserve a piece of the pie they helped create.98
However, this is not to say that there have not been some serious excesses in executive pay in the past several years, especially when CEO pay increases while employees take pay cuts and get laid off.99 The company is not acting ethically or in a socially responsible manner in this situation because it is harming a large number of stakeholders (including employees and shareholders and maybe others) in order to reward a single stakeholder, or a few, in the executive suites. Actions such as this are certain to affect the market value of the firm as soon as they become publicly known. One result of excessive executive compensation was the writing of federal legislation that covers requirements for executive compensation—the Dodd-Frank Wall Street Reform and Consumer Protection Act.
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WORK
APPLICATION 12-20
Would you say the CEO of an organization you work(ed) for is overpaid, underpaid, orpaidfairlyfor the contribution made to thefirm?
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
One of the outcomes of both perceived and actual excesses in executive pay was the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The Dodd-Frank Act placed some significant limits on executive pay in public corporations and also added some new requirements for both reporting of compensation and shareholder involvement with executive compensation.100
SHAREHOLDER “SAY ON PAY” AND “GOLDEN PARACHUTE” VOTES. Among the most significant provisions of the act is that shareholders must be allowed to vote on compensation packages for their executive officers at least once every 3 years. This provision is called “say on pay.” While the vote is nonbinding, it can still put pressure on executives to maintain compensation in line with organizational performance.
Shareholders also have a vote on a “golden parachute” for executives. Golden parachutes provide executives who are dismissed from a merged or acquired firm with typically large lump sum payments on dismissal. This tool is typically used to discourage a takeover of the firm, because the cost of the takeover becomes much higher due to the high payout to these executives.
WORK
APPLICATION 12-21
Would you say the Dodd-Frank Act will help, hurt, or have no effect on an organization you workor have worked for?
EXECUTIVE COMPENSATION RATIOS. Other provisions in Dodd-Frank include a requirement that every public company disclose the total compensation of the CEO and the total median compensation of all employees and provide a ratio of these two figures.101 A 2015 survey on CEO pay by Glassdoor found that in Fortune 500 firms, the CEO–to–median employee pay ratio was 204 to 1, staying fairly stable since 2013.102 It would be very easy to argue that this pay ratio is significantly out of line with performance, though even the smallest of these firms have a market capitalization of about $2.5 to $3billion.103 However, we should also note that US Bureau of Labor Statistics (
BLS.gov
) research shows that the average annual CEO pay in all public and private companies was$194,350, a little under four times that of the average employee in the United States in2016.104
Another provision of Dodd-Frank is that all public firms will be required to provide information on the relationship between executive compensation and the total shareholder return of the company each year. This will allow shareholders to more easily evaluate the performance of firms in which they hold stock. The act also requires that public companies establish policies to “claw back” incentives in certain cases if the company has to restate financial information that is detrimental to the firm’s value.105 In other words, if the company paid out an executive incentive based on its financial statements and then had to disclose later that those statements were not accurate, company policy would require that any incentives paid out to the executives be given back to the company. An example of the use of a claw-back provision is the 2016 Wells Fargo Bank scandal in which employees were pressured to open fake accounts using customer information. The former CEO and former head of community banking got the blame for an incentive program that led to the illegal accounts and had to repay the company $75 million in pay and stock grants.106
While Congress has recently been attempting to undo or rework Dodd-Frank, as of the writing of this text, the law is still in full effect, and the first reports of CEO–to–median employee pay will be required in 2018.107 Executive pay is obviously not a simple issue. However, there is significant evidence that at least in some industries, executive pay has gotten out of line with organizational performance.108 As a result of this realization, and also due to new legislation placing limits on organizational compensation for executives, companies have to be more diligent both in creating and in managing their executive compensation packages.
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Executive Incentives
As with any other type of incentive, executive incentives are supposed to create motivation to perform for the organization in certain ways. Executive incentives should be designed to cause the executive receiving them to make decisions that will benefit the organization over both the short and the long term. We need the executive to act as an impartial “agent” for the organization.109 An agent is someone who acts on the owners’ (shareholders’) behalf. Agency theory says that agents will act in the way that provides the most benefit to them and not the owners unless we provide the agent with incentives to act in ways that help the owners of the firm. The way to do this is to align the benefits that go to the agent with benefits that accrue to the firm. This is what executive incentives should be designed to do.
SHRM
K:A15
Motivation Theories: Equity Theory, Reinforcement Theory, Agency Theory
What are some of the common incentives that are used to create this alignment? The first and probably most common is the stock incentive.110 We noted earlier that various types of stock incentives are available as group incentives. These same incentives—primarily stock grants and stock options—are used in executive compensation for basically the same reason. They are supposed to cause the executive to act to increase the value of the company over time, because if this is done, the executive’s stock becomes more valuable.
Long-term bonuses attached to company performance goals are another popular incentive for executives.111 These also help to focus the “agent” executive on goals that will improve the value of the company over several years. In addition to stock awards, executives may be paid retention bonuses for each year they continue in their positions, and they are often paid bonuses tied to either short- or long-term company performance.
In addition to incentive packages, executives generally receive compensation in the form of perquisites or “perks.” Perquisites are extra financial benefits usually provided to top employees in many businesses. While perks are not technically incentive pay (they are generally classed as benefits), they do serve to entice top-level executives to consider accepting jobs within an organization in some cases. Common perks include such things as vehicle allowances, memberships in various clubs, the use of company aircraft, tax assistance in various forms, home-buying or -selling assistance, security systems, and many others.112 While the prevalence of perks continues to decline according to Hay Group research, you need to be aware of executive perks and understand that they are still a common component of executive compensation systems.
WORK
APPLICATION 12-22
Identify the incentives the CEO of an organization you work or have worked for receives.
Short-Term Versus Long-Term
For many years now, executive incentives have been moving toward more long-term options and fewer short-term payments in order to force the executives to look at the health of the firm over many years.113 While CEO compensation rose every year from 2011 to 2016, corporate boards put more and more emphasis on aligning that pay with shareholder returns over the long term.114 Even though this is the case, there are still many short-term incentives being used by firms.
Most short-term incentives are in the form of bonuses for one or a combination of several company performance measures. These bonuses are (or should be) designed to focus executive behavior on managing performance measures that need immediate managerial attention. For example, if company labor costs are out of line with industry competitors, we could provide 10% of CEO base pay as a bonus for lowering per-unit labor costs by 7% over 1 year. If workers’ compensation premiums have tripled in the past 3 years due to increases in lost-time accidents, we might offer a 12% bonus for improving workplace safety (as measured by OSHA reports of lost-time accidents) by 3%. These bonuses would be designed to focus the CEO’s attention on specific problems.
In contrast to short-term incentives, most long-term incentives are made in the form of stock awards or options, with companies currently moving away from options toward more direct performance-based stock awards.115 Of course, there are other long-term incentives, such as the excess contributions to retirement plans and longevity bonuses mentioned earlier, but in general, at least for publicly traded companies, long-term incentives tend to be stock based. And there is another possibility with long-term incentives in many companies—the “claw-back” provision. The Dodd-Frank Act required this in some cases as noted earlier in the chapter, but companies are extending the claw back to instances that are not subject to the law’s provisions. Long-term incentives are designed tocause the executive to pay attention to how their decisions will affect the company and its profitability over the course of multiple years, not over the course of a single year orquarter.
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WORK
APPLICATION 12-23
Would you say the CEO of an organization you work or have worked for focuses more on short-term or long-term incentives orabalance of both to run the firmeffectively?
The Goal of Executive Compensation
So what is the overall goal of executive compensation? Remember that we want to create a system that aligns the behavior of the executive (agent) with the interests of the owners of the firm (shareholders). The best way to do this is to use a combination approach ofshort- and long-term incentives to focus on both the immediate future and long-term success of the organization.
One way companies are making the attempt to better align executive compensation with organizational performance is through the use of performance “scorecards.”116 The use of performance scorecards came about partly as the result of the 2008–2009 bank crisis in the United States. At least part of the crisis was blamed on CEOs who were being rewarded only for short-term organizational performance. The Hay Group has created one of these in the form of “A CEO Performance Dashboard,” which includes not only financial performance, but also strategic alignment, sustainability, people, governance, and crisis management.117 While it is still too early to tell whether this approach will work, it is at least an attempt to put a longer-term focus on executive compensation.
TRENDS AND ISSUES IN HRM
LO 12-8
Briefly discuss the question of whether incentives improve performance and some options available for incentivizing employees other than knowledgeworkers.
In this chapter’s Trends and Issues section, we are going to explore the ethical questions surrounding executive compensation, the heavy reliance on incentives to perform in entrepreneurial organizations, and how incentive pay can cause unethical actions on the part of managers and employees.
Does Incentive Pay Actually Improve Performance?
We would be remiss in discussing incentive pay if we did not mention the fact that there is an ongoing argument that incentive pay actually causes demotivation. While we can’t gointo all of the details in this section, we need to briefly lay out the issues. An article in Psychology Today makes the argument that incentives don’t work. It says one study “found it makes better business sense to reward team performance rather than provide bonuses to the top-performing individuals” and that “McKinsey consultants found that shareholder returns were no higher when management had incentive plans” (emphasis added).118 However, if you follow the guidelines that we provided earlier, you know that we never want to incentivize only managers (we should provide incentives to all) and that we take team performance into account through a number of the guidelines, from creating SMART goals that make sure that there is a link between performance and payout to making the program part of a comprehensive approach to managing people that ensures that all organizational goals are met, not just the individual goals that are incentivized.
The same study also notes that “financial incentives can create pay inequality, which in turn can cause turnover and harm performance.”119 But in fact, isn’t turnover of nonperformers or low performers part of what we want in the organization? If they self-select out of the company, we have the opportunity to bring in people better suited to do the job. Remember back in Chapter 1, where we said that some turnover is necessary in order for the organization to improve over time.
There are also many studies of incentives that back up variable pay despite the detractors. One recent meta-analysis on the effectiveness of incentives identified 146 studies of financial incentives and concluded that the “overall effect size of individual incentives was positive” and that the studies “indicated a positive effect regarding team-based rewards on performance” as well.120 The study also noted that equitably distributed rewards created higher performance levels than equally distributed rewards, which is what equity theory predicts.
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So there are arguments concerning the value of incentives. However, if you look at business research, the evidence seems to strongly favor providing equitable (fair but not equal) incentives to all in order to get maximum productivity in return. While team incentives seem to be more valuable based on the research, they are much more difficult to implement successfully in reality. So organizations have to choose what type of programs to implement, knowing that there are potential flaws with every option. Using the guidelines to creating motivational incentives will help you work through the issue and come up with an incentive program that can work for your company.
Comprehensive Pay and Incentive Programs Aren’t Just for Highly SkilledEmployees
We have discussed the shortage of skilled knowledge workers worldwide more than once already. However, another phenomenon is quietly occurring at the same time. Companies are working very hard to win the talent wars in occupations that may not be high tech. Restaurant workers, trade laborers, manufacturers, and others are finding that some employers are willing to provide good pay and incentives to employees who are loyal, willing, and able to work for them. Some employers draw people with high pay, some with incentives and benefits, and some with company policies that make the recruiting and selection process and ultimately working for the employer easier.
Some of you may have heard of Dan Price. He’s the founder and CEO of Gravity Payments, and in 2015 he announced that he would change his company’s compensation plan to make $70,000 the minimum salary for all employees. This is the approximate salary rate at which research says money ceases to be a factor in happiness. The evidence sofar is that productivity has improved, voluntary turnover has dropped drastically, andprofit almost doubled the first year after the announcement (recall efficiency wage theory from Chapter 11).121 Oh, and his employees bought him a Tesla Model S in appreciation.122
And then there’s Buffalo Wild Wings CEO Sally Smith, who says labor availability and wages are her biggest challenges today. She has considered providing paid time off, and she is paying higher wages and creating new positions to make the restaurants more friendly to employees and customers alike.123 Deli Express, a Minnesota company that makes about 1.5 million sandwiches a week, has raised starting pay by about 40%, pays $500 bonuses to new workers, and runs buses from Minneapolis to Eden Prairie to transport workers.124 In another example, consulting company FMIwrote that in order to retain talent, construction employers needed to be “an employer of choice … offering market-competitive compensation … providing comprehensive benefits and rewards [incentives].”
In an example of nonmonetary rewards, some companies are easing employee fears by changing organizational policies that may be problematic. Reddit decided that they would ban salary negotiations and just pay “market-competitive” rates to their employees. For many job seekers, salary negotiations are one of the most nerve-wracking things that they have to do in the job-search process. Taking that away has proven to be an incentive to at least some job seekers. “Reddit has seen an uptick in candidates seeking to work at the company citing the policy” according to an article on the change.125
So we come to the conclusion, again, that pretty much anything that can become anincentive to the employee can also be used to improve relations and ultimately maybe even productivity and profit. Whether we provide new positions, raise baseline wages andincentives, provide a bus to take you to work, or get rid of a policy that some people fear, we just have to think through the opportunities and their consequences and then try them out.
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DIGITAL RESOURCES
Incentive Pay*
Incentives
Federal Incentive Pay in the Public Sector
Pay for Performance*
Individual Incentive Plans
One Firm’s Approach to Team Incentive Pay
Bonuses*
Merit Pay
* premium video only available in the interactive eBook
CHAPTER SUMMARY
12-1. Discuss the major reasons why companies use incentive pay.
Incentives are necessary because they give us the opportunity to recognize our best people and provide us with flexibility to give them greater rewards than average or low performers. Variable pay systems also shift some of the company risk to the employee when economic downturns affect our businesses. Companies don’t have to pay out some incentives if they are tied to organizational performance and the organization underperforms because of problems in the economy. Finally, incentive pay helps us achieve strategic goals, assuming that our incentives are aimed at accomplishing these objectives.
12-2. Identify the advantages and disadvantages of individual and group incentives.
Individual incentives make it easy to evaluate each individual employee; they provide the ability to choose rewards that match employee desires; they promote a link between performance and results; and they may motivate less productive workers to work harder. Disadvantages include the fact that many jobs have no direct outputs, making it hard to identify individual objectives; we may motivate undesirable behaviors; there is a higher record-keeping burden than in group incentives; and individual rewards may not fit in the organizational culture.
Group incentives help foster more teamwork; they broaden the individual’s outlook by letting them see how they affect others. They also require less supervision and are easier to develop than individual incentives. Disadvantages include the potential for social loafing; the possibility that we will discount individual efforts and output; the fact that outstanding performers may lessen their efforts; and the potential for group infighting.
12-3. Briefly discuss options for individual incentives.
Individual incentives can come in many forms. The first form that we discussed was bonus payments, lump sum payments for reaching a goal that don’t change base pay. Commissions can also be used as incentives for sales. Commissions also only occur based on certain actions on the part of the employee—they don’t add to base pay. Merit pay is different. Merit pay is based on past performance (appraisals) and does change base pay in future pay periods. However, merit pay is frequently too small to be considered a significant reward. Piecework and standard hour plans also work as incentives for speed of production. Under piecework, theemployee gets paid for each item produced, and under a standard hour plan, they are paid based on a standard time allowed toperform an action. Both plans may give rise to quality issuesifnot monitored. Finally, there are recognition and other nonmonetary rewards, which are very powerful incentives if used in the right ways.
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12-4. Briefly discuss options for group-based incentives.
Group incentives are mostly based on organizational gains of some kind or on gaining an ownership stake in the company. First, there is profit sharing, where if the company’s profits increase over thecourse of a year, the employees share in those increased profits. However, in some cases, gainsharing may be better, because profit can be easily manipulated. Gainsharing is based on other organizational gains that are more difficult to manipulate, such as revenue changes, lost-time accidents, or lower per-unit labor costs. If the company gains in these areas, it saves money, and some of the savings is shared with employees. ESOPs are thefirst stock (ownership) option, where at least part of the company’s stock is provided to the employees over time. Other stock incentives are stock ownership awards or stock options, where employees earn stock by meeting goals.
12-5. Discuss the major reasons why incentive plans fail and the challenges involved.
Incentive plans usually fail for one or more of five reasons. The first is bad management—managers have to manage the incentive program, and if they fail to do so, employees won’t trust the program. Second, programs may be so complex that people can’t figure them out, so they don’t change their behavior. Third, plans may not really increase the potential rewards available, or the rewards may not appear significant to the employees. The fourth problem is that in a lot of cases, employees can’t affect the desired outcomes by their actions. Finally, in many “reward” programs, employees never know how they are doing, so they don’t know whether to modify their behavior to change their output.
Challenges: There is still some concern that, at least in some cases, incentives don’t work. The evidence shows that group incentives do work better than individual incentives when cooperation is required in a work group, but in general it is difficult to tie employee actions to company success. If we fail to do that, incentives will not work. There is also an issue of incentives becoming an entitlement. If this occurs, the incentive no longer motivates changed behaviors. Third, external incentives may act to lower a person’s internal motivation to do something, which may mean that we actually lower performance instead of raising it when we apply incentives. Finally, there is the problem of people only focusing on what they are receiving incentive pay to do.
12-6. Identify the guidelines for creating motivational incentive systems.
1. Base all incentive programs on the company strategy and culture.
2. Make sure that the incentive program has some rewards for everyone—nobody should be left out.
3. Make the incentive program easy to understand and clearly communicate it to all involved.
4. Base the incentive on factors that the individual or group can affect.
5. Use SMART goals—specific, measurable, attainable, relevant, and time-based.
6. Clearly separate incentives from base pay to avoid the question of entitlement.
7. Make the reward a significant piece of overall compensation.
8. Take great care in program administration to provide rewards in the amount owed, when they are owed.
9. Promptly apply any incentive award—immediate reinforcement works much better than delayed reinforcement.
10. Don’t forget to use nonmonetary rewards too—not everyone is motivated by cash.
11. Don’t reward nonperformers, or you risk ruining the incentive system.
12. Make the incentive program part of a comprehensive approach to managing—pay attention to the entire performance of employees, not just specific behaviors tied to incentive payments.
12-7. Discuss the issue of executive compensation and how the major provisions of the Dodd-Frank Act affect the issue.
There is no doubt that in some cases, executive compensation has gotten out of control. However, research shows that overall executive pay only runs about four times the pay of an average employee in most firms, which means that as a general rule, executive pay is probably not out of line, considering the pressure on executives to perform at the highest level all the time.
Dodd-Frank requires that shareholders be allowed a “say on pay,” where they vote on executive compensation packages at least once every 3 years. Shareholders also have a vote on “golden parachute” payments to executives who are forced out of the company because of a merger or acquisition, and every public company is required to disclose the total compensation of the CEO and provide a ratio of CEO pay to the average pay in the company. Finally, all public companies are required to provide information on executive compensation compared to the company’s total shareholder returns every year to allow shareholders to evaluate the performance of companies in which they own stock.
12-8. Briefly discuss the question of whether incentives improve performance and some options available for incentivizing employees other than knowledge workers.
There is an argument that incentive pay doesn’t increase performance, but if you read the research, at least in most cases, evenarticles that argue against incentives note that group orteam incentives tend to work. There is concern that financialincentives create pay inequality, but again, that is not necessarily a problem. Equitable rewards work better than equal rewards.
Pay and incentive programs are also being used more in non–knowledge worker occupations. In every industry—from restaurants to construction and low-tech manufacturing—companies are using more comprehensive pay and incentive programs to attract and keep workers in a tight labor market. These programs include everything from across-the-board pay increases to paid time off (PTO), to bonuses and changing pay policies.
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KEY TERMS
bonus 432
commission 433
entitlement 444
extrinsic rewards 445
golden parachutes 451
group incentives 429
individual incentives 427
merit pay 433
perquisites 452
profit-sharing programs 439
social loafers 429
variable pay 426
KEY TERMS REVIEW
Complete each of the following statements using one of this chapter’s key terms.
1. _________ is compensation that depends on some measureof individual performance or results in order to be awarded.
2. _________ reinforce performance of a single person with a reward that is significant to that person.
3. _________ provide reinforcement for actions of more than one individual within the organization.
4. _________ avoid providing their maximum effort in group settings because it is difficult to pick out individual performance.
5. _________ is a lump sum payment, typically given to an individual at the end of a period.
6. _________ is a payment typically provided to a salesperson for selling an item to a customer.
7. _________ is a program to reward top performers with increases in their annual wage that carry over from year to year.
8. _________ provide a portion of company proceeds over a specific period of time (usually either quarterly or annually) to the employees of the firm through a bonus payment.
9. _________ is something that the employee feels they have a right to receive from the company.
10. _________ are valued returns (such as incentive pay for performance) to the individual in exchange for doing something that the organization desires of the employee.
11. _________ provide executives who are dismissed from a merged or acquired firm with typically large lump sum payments on dismissal.
12. _________ are extra financial benefits usually provided to top employees in many businesses.
COMMUNICATION SKILLS
The following critical-thinking questions can be used for class discussion and/or for written assignments to develop communication skills. Be sure to give complete explanations for all answers.
1. Do you think that incentive programs can really work to align the company’s goals with the employees’ goals? Why or why not?
2. Would you rather be given the opportunity to receive incentives based on individual performance or group performance? Does it depend on the situation? Why?
3. Have you ever been a “social loafer” in a group? If so, why did you not put out your best effort? What could the group or the company have done to limit your social loafing?
4. Do you feel that merit pay programs would cause you to work hard, knowing that the average merit award is only between 1% and 2%? If not, how big would they need to be to cause you to pay attention?
5. Would you rather work on a commission basis if you were in sales, or would you rather have a salary—or a combination of both? Why?
6. Do nonmonetary rewards ever motivate you? Why do you think you answered the way that you did?
7. Would you personally rather participate in a profit-sharing plan or a gainsharing plan? Why?
8. Which of the 12 guidelines for creating incentive systems is the most important in your mind? Why did you choose this one?
9. If you were a compensation consultant to a company, how would you recommend it provide incentives to the CEO and other executives? Why?
10. Is the Dodd-Frank Act a good or bad idea? Why?
CASE 12-1 BEST BUY OR BEST SCAM? TRYING TO GET COMMISSION RESULTS ONSO-CALLED NONCOMMISSION PAY
One cannot go shopping for a home theater system, big-screen TV, or computer in person without crossing paths with Best Buy. With more than 1,600 retail stores operating under the names Magnolia Audio Video, Five Star, Pacific Kitchen, Future Shop, and Home Sales as well as the more well-known Best Buy, Best Buy Mobile, and Best Buy Express, this conglomerate offers a plethora of consumer electronics including appliances, mobile phones, entertainment (music/movies), and computers. Although the firm has gone multinational, 92% of its total sales in 2016 were domestic and included kitchen appliance installations, mobile phone service, sales, and technology support. These ancillary services areoffered predominately through Best Buy stores using what is characterized as a “store-within-a-store” format.
As a category killer, Best Buy has itself come under attack from such warehouse retailers as Walmart and online behemoths as Amazon. In order to address reduced revenues and get the firm back on track, Best Buy has had to reshuffle the location of its stores, rethink in-store space allocation by product category, and renegotiate leases.(1)
One way that Best Buy has tried to increase store revenues is by focusing on providing customers product knowledge and services over direct sales. The Best Buy Code of Ethics is very clear on how customers should be treated.
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Customers are at the core of our success and must be treated with respect. Every customer. Every situation. Every day. On the Responsibility to Our Business Partners page, we noted how important Best Buy’s reputation is to the long-term success of our Company. For this reason, every employee is obligated to:
• Treat all customers fairly and honestly
• Communicate with customers in a respectful and helpful manner
• Provide prompt and accurate customer service. . . .
Our customers rely on us to price and present our products and services fairly and accurately. . . . We do not condone any behavior that would violate their trust in us. Ever.(2)
Best Buy, unlike other retail electronics stores, has marketed the fact that their employees are salaried, not commissioned. Out of the gate, their employees are told to tell clients that there are nocommissions involved and they are there to assist the customer. The focus was on growing revenue through quality service buttressed by customer confidence.(3)
We were told to emphasize this fact as to gain the customer’s trust. ‘Tell them that you won’t make a dime from the product you’re recommending. Tell them that you’re only recommending this product based on their needs and preferences.’(4)
According to one self-proclaimed employee veteran, this is not the complete truth. Although many of the personnel at Best Buy are not paid on a commission basis (i.e., sales personnel and Geek Squad members), Best Buy for Business employees do receive commission payments. For most others, though, sales are used in the calculation of additional employee income that would appear commission driven.
Large bonuses are awarded to managers who meet and exceed sales/margin objectives, while sales associates can earn what are called “Blue Crew Bucks,” which are added to their weekly salaries.
These compensation practices are certainly legal, but the question becomes whether just because Best Buy doesn’t call these systems “commissions” they are not. More important, having employees tell customers that sales is not a factor in their salaries seems both erroneous and unethical. The data following from Payscale indicates that sales associates earn bonuses plus commission.(5)
Sales Associate at Best Buy Salary Range(6)
|
$199.11–$2,970 |
|
| Commission |
$122.82–$16,650 |
|
Total Pay |
$19,262–$28,070 |
In an attempt to increase in-store sales due to increased online competition, the firm developed a new sales tracking system similar to a commission-driven pay system. Now employees are evaluated on several performance measures such as gross/marginal revenue per sale, accessory and extended warranty attach percentage, hourly sales, and ratio of sales on Best Buy credit cards.
Best Buy got far more (or less) than what they bargained for. They knew that this system had the possibility of backfiring and reducing sales, so they told the floor supervisors to use the data for on-the-job feedback. That is not at all how it worked out. Employees were being rated using the information from the system, resulting in demotions and promotions.(7) One employee blog reported that
One of the store managers was demoted recently because his department wasn’t meeting the sales numbers all the time even though he was the best manager in the store. He would be constantly running around from department to department helping any customer he could while the rest of the “leaders” stand around or sit in the back of geeksquad [sic] and talk, usually personal conversations.(8)
The tracking system rapidly and irreparably damaged the culture on the selling floor, including their relationship with the customer, who was led to believe that they were dealing with salaried-only employees. Fighting over customers and cut-throat competition emerged, mimicking all of the negative effects one would expect in a commission environment.
Is Best Buy getting the best they can from their sales associates given their current compensation system? Do the math—working 50 weeks a year, 40 hours a week, sales associates earn between $9.50 and about $14 per hour. Is this a “Best Buy” for the employees, their customers, and ultimately their stockholders?
Questions
1. What is the definition of an incentive pay system, and given this definition, does Best Buy have a pay-for-performance system?
2. Why would any firm (including Best Buy) use an “incentive-like” pay system?
3. There are two basic choices in incentive pay. Which one(s) do(es) Best Buy appear to utilize in their compensation plans and “tracking systems”?
4. The veteran employee claims that Best Buy has created using their “tracking system” all of the problems of a commission system. What are the advantages and disadvantages of this system in general and more specifically for Best Buy?
5. The veteran employee’s perception was that Best Buy’s metric system, which focused on individual employees’ behaviors, decreased their job performance. What would be the pros and cons of Best Buy using a group incentive system?
6. Best Buy seems to use bonuses and commissions as part of their pay system. What are the effective and ineffective uses of each system?
7. What group incentive do you think might work “best” for BestBuy?
8. In light of Best Buy’s code of ethics and the opinions reported in this case, do you believe that it is ethical for sales associates to tell customers that they are simply paid a flat rate?
References
(1) Huspeth, C. (n.d.). Best Buy Co. Inc. Hoovers. Retrieved May 10, 2017, from
http://0-subscriber.hoovers.com.liucat.lib.liu.edu/H/company360/fulldescription.html?companyId=10209000000000
(2) Anonymous. (2014, March). Code of business ethics: Best Buy (p. 8). Retrieved May 10, 2017, from
http://s2.q4cdn.com/785564492/files/doc_downloads/Gov_docs/code_of_business_ethics
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(3) Heyne, C. (2016, March 4,). The inside story: A prognosis of Best Buy from a veteran employee. Audioholics. Retrieved May 10, 2017, from
http://www.audioholics.com/editorials/best-buy-prognosis-employee
(4) Anonymous. (n.d.). Confessions of a former Best Buy employee. Geek in Heels. Retrieved May 10, 2017, from
http://www.geekinheels.com/confessions-of-a-former-best-buy-employee.html
(5) Heyne, C. (2016 March 4). The inside story: A prognosis of Best Buy from a veteran employee. Audioholics. Retrieved May 10, 2017, from http://www.audioholics.com/editorials/best-buy-prognosis-employee
(6) Anonymous. (n.d.). Employer: Best Buy average salary range by job. Payscale. Retrieved May 10, 2017, from
http://www.payscale.com/research/US/Employer=Best_Buy/Salary
(7) Heyne, C. (2016, March 4). The inside story: A prognosis of Best Buy from a veteran employee. Audioholics. Retrieved May 10, 2017, from http://www.audioholics.com/editorials/best-buy-prognosis-employee
(8) Anonymous. (n.d.). Confessions of a former Best Buy employee. Geek in Heels. Retrieved May 10, 2017, from http://www.geekinheels.com/confessions-of-a-former-best-buy-employee.html
Case created by Herbert Sherman and Theodore Vallas, Department of Management Sciences, Long Island University School of Business, Brooklyn Campus
CASE 12-2 BARCLAYS BONUS BANK: ROBBING PETER TO PAY PAUL
Barclays is a London-based multinational banking company that employs 140,000 employees. The company’s revenue drastically decreased in 2012 ($53 billion), with a year-end deficit of $1.7 million. Later in 2012, Anthony Jenkins was appointed the new CEO in order to turn things around so as to regain the trust of investors and thereby increase the profitability of the firm. In 2013, Barclays did achieve a positive net income of $890 million with sales growth of more than 9%, yet stockholders demanded far greater results.(1) Why did the bank experience so huge a downturn, and what did Jenkins do to try to turn the bank around quickly?
One way a bank can boost profits is by selling more financial products and services, including new bank accounts, credit cards, life insurance, financial advising services, or mortgages, to existing customers—in other words, cross-selling. In order to cross-sell these products and services, banks require employees with skills inpromotion and direct marketing. Banks, not unlike other firms, use individual performance-based bonuses and commissions to reinforce customer cross-selling. This type of incentive pay increases employee motivation and positively impacts sales performance.(2)
Historically, Barclays was productive in cross-selling its products to its customers until the firm initiated employee pay cuts in 2012 in order to generate more short-term profit. In return, Barclays started losing its most valuable employees, even at senior-level positions. Newly appointed CEO Jenkins decided to increase sales force salaries in 2013, but the plan failed to increase profits to desired levels. These actions came on the heels of government investigations of the bank’s possible manipulation of interest and foreign exchange rates.(3)
Watching the most skilled employees leave was no longer acceptable to Jenkins. In response to low profits and returns, Jenkins felt the need to take more radical actions in the first quarter of 2014 while bearing in mind the long-term interests of the shareholders. In order to increase performance and keep the best employees, compensation had increased to more competitive levels. In early 2014, the median amount of granted incentives was around $30,000 for its 130,000 employees,(4) funded by a 10% increase in the bonus bank. The pool of funds reached $4 billion by the end of 2014.(5)
These increased incentives did not come without a price tag. In order to generate sustainable returns to shareholders and satisfy the board of directors, Jenkins decided he had to lay off employees—perhaps the hardest decision he ever had to make. More than 10,000 employees were going to be laid off to fund the bonus pool. The British government was quite concerned about such massive layoffs and suggested that the situation could be better managed by deferring the bonuses. Jenkins rejected the proposed deferral plan, since employees would not receive their bonus for another 10years, a ludicrous amount of time to ask employees to wait. Timely bonuses and incentives were essential to motivate cross-selling products for Barclays, and as long as Barclays properly motivated its sales force, the firm would generate higher profits—profits it could later use to rehire some of its former employees.(6)
Time will tell whether Jenkins’s decision to fund the bonus pool rather than keep 10,000 employees was the right one.(7) Jenkins, in light of all of the firings, declined his own bonus from the board of directors in 2013, just as he did in 2012. Some might argue it was a noble gesture to refuse a bonus of $4.4 million, although it would not have had a noticeable impact on Barclays’s bottom line.
Questions
1. The British government took the position that saving 10,000 jobs and deferring employee incentive pay was more important than immediate extrinsic reinforcement of sales force performance. How do the notions of entitlement and social loafing possibly explain the government’s position?
2. Individual performance-based bonuses and commissions are one form of incentive pay. Might group and/or organizational incentive pay systems have achieved similar results for Barclays?
3. What other forms of individual incentive pay might Barclays have utilized? Which one of these plans might have saved the jobs lost to fund the bonus bank?
4. Develop a preliminary individual performance-based incentive plan that you think best suits cross-selling. Why?
5. Given your answer to question 4, develop a preliminary appraisal system for product cross-selling. How might this system be different if the incentive plan included group and organizational incentives?
6. Although Jenkins refused his bonuses in 2012 and 2013, as the CEO, he would have a comprehensive compensation package. What other incentives might Jenkins be entitled to beyond his annual bonus?
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References
(1) Hoover’s Inc. (2014). Barclays PLC [Hoover’s Company Records: In-Depth Records]. Retrieved July 15, 2014, from Long Island University Academic Database.
(2)
Accenture.com
. (2011, August). Smarter on-boarding: The key to higher client retention and cross-sell. Retrieved from
http://www.accenture.com/us-en/Pages/insight-smarter-on-boarding-key-higher-client-retention-cross-sell.aspx
(3) Anderson, J. (2014, March 5). Barclays chief defends contentious increase in bonus pay. DealBook [blog of the New York Times]. Retrieved from
http://dealbook.nytimes.com/2014/03/05/barclays-chief-
defends-contentious-increase-in-bonus-pay/
(4) Slater, S., & Scuffham, M. (2014, February 11). Barclays to cut 12,000 jobs, pays bigger bonuses. Reuters. Retrieved from
http://www.reuters.com/article/2014/02/11/us-barclays-earnings-idUSBREA190ES20140211/
(5) Jozwiak, G. (2014, February 12). Barclays raises bonuses by 10%. HR Magazine. Retrieved from
http://www.hrmagazine.co.uk/hro/news/1142131/barclays-raises-bonuses/
(6) Ibid.
(7) Slater, S. (2014, February 3). Barclays CEO turns down bonus for 2013. Reuters. Retrieved from
http://uk.reuters.com/article/2014/02/03/uk-barclays-ceo-bonus-idUKBREA1216E20140203/
Case created by Herbert Sherman and Theodore Vallas, Department of Management Sciences, Long Island University School of Business, Brooklyn Campus
SKILL BUILDER 12-1 CALCULATING INDIVIDUAL INCENTIVES
Objective
To develop your skill at calculating incentive pay
Skills
The primary skills developed through this exercise are as follows:
1. HR management skills—Technical and business skills
2. SHRM 2016 Curriculum Guidebook—K: Total rewards
Assignment
Complete the math for the following six incentive programs.
1. Bonus. You have a salary of $46,000 per year, and you get a 7% bonus at year end. (1) How much is your bonus, and (2)what is the premium percentage on your annual salary?
2. Commission. You are an independent real estate agent in a rural area in the South, and you get a 5% commission on every house you sell. Your monthly expenses are around $10,000. This month you sold two houses: one for $168,000 and the other for $116,000. (1) How much revenue did you earn this month? (2) What was your profit for the month? (3) If this was an average month, what would be your profit for the year?
3. Merit Pay. You are the top performer in your department, so you are getting a 2% merit raise over the 2% that everyone else will get. (1) How much is your merit pay if your current salary is $35,000? (2) What is the merit pay premium percentage on your annual salary of $35,000? (3) What willyour total pay be for next year? (4) What is the total pay premium percentage for next year?
4. Straight Piece-Rate. You make car parts. You get paid $1.10 for every part you make. This week you made 423parts. (1) What is your pay for the week? (2) The estimated average pay is $450, so how much more or less than average did you make? (3) What is the premium percentage?
5. Differential Piece-Rate. You sell cell phones and phone service contracts in a small rural town. You are paid a salary of $7.50 per hour for a 40-hour week—$300 or $1,350 for the (180-hour) month. You also get paid $8 for every phone you sell in excess of five for the month. This month you sold 15. (1) What is your total pay for the month? (2) What is your premium if the average pay is $1,400 per month? (3) What is your premium percentage over the average?
6. Standard Hour. You rebuild transmissions. The standard rate is 6 hours each. You are paid $25 per standard hour. During this 40-hour week, you rebuilt 8 transmissions. (1)What isyour pay for the week? (2) What is your premium for the week, and (3) what is your premium over the standard as a percentage?
SKILL BUILDER 12-2 DEVELOPING A COMPENSATION PLAN WITH AN INCENTIVE
Objective
To develop a better understanding of creating motivational incentives
Skills
The primary skills developed through this exercise are as follows:
1. HR management skills—Technical, conceptual and design, and business skills
2. SHRM 2016 Curriculum Guidebook—K: Total rewards
After a few years of selling new cars, you managed to get the funding to start your own small new car dealership as a sole proprietorship. Your starting staff of 10 employees will be as follows:
• You are the owner manager and will oversee everything. You will also be the sales managerand do some selling.
• Sales staff. Three salespeople report directly to you.
• Service and parts manager. You will have one person supervise the mechanics and detailer.
• Mechanics. Three mechanics will work on the cars.
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• Detailer. One person will clean the cars, help out the mechanics, and work in parts.
• Office staff. Two people will answer phones, greet customers, make up the bills and collect money from sales and service, and do other paperwork including bookkeeping. They will report to you.
Preparing for Exercise 12-2—Develop an incentive system
1. What type of compensation will each classification of employee receive for their work? Will you give them a wage, salary, or incentive pay (commissions, piecework, or standard hour)?
2. Will you give incentives (recognition and other nonmonetary incentives, merit pay, bonuses, profit sharing, gainsharing, ESOPs, stock option, and/or stock purchase plans)?
3. As the only executive, what will your compensation package include?
SKILL BUILDER 12-3 GIVING PRAISE
Objective
To develop your skill at giving praise
Skills
The primary skills developed through this exercise are as follows:
1. HR management skills—Human relations skills
2. SHRM 2016 Curriculum Guidebook—K: Total rewards, and L: Training and development
Assignment
Think of a job situation in which you did something well deserving of praise and recognition. For example, you may have saved the company some money, you may have turned a dissatisfied customer into a happy one, and so forth. If you have never worked or can’t think of a situation like this, interview someone who has. Put yourself in a management position and write out the praise you would give to an employee for doing what you did.
1. Briefly describe the situation in writing.
2. Write out the four steps of the giving praise model and what you would say to the person for steps 1, 2, and 4.
In-Class Role-Play
You will give and receive praise.
Procedure (10–15 minutes)
Break into groups of four to six. One at a time, give the praise you prepared.
1. Explain the situation.
2. Select a group member to receive the praise.
3. Give the praise. (Talk—don’t read it off the paper.) Try to select the position you would use if you were actually giving the praise on the job (both standing, both sitting, etc.).
4. Integration. The group gives the praise giver feedback on how they did:
• Step 1. Was the praise very specific and descriptive? Did the giver look the employee in the eye?
• Step 2. Was the importance of the behavior clearly stated?
• Step 3. Did the giver stop for a moment of silence?
• Step 4. Did the giver encourage repeat performance? Did the giver of praise touch the receiver (optional)?
• Overall. Did the praise take less than 1 minute? Was the praise sincere?