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Chapter

The Pay Model

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After discussing Chapter 1, students should be able to:

Learning Objectives

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1.
2.

3. 4. 5.

6.

Explain how perceptions of compensation differ among society, stockholders, managers and employees. Discuss the difference between cash compensation (direct compensation) and benefits (indirect compensation) and define each of the direct and indirect forms of compensation. Explain how the employment relationship combines both transactional and relational returns to form an implicit contract between employers and employees. Explain the three main components of a pay model. Understand how the pay model integrates objectives, policies, and techniques into a compensation system. Be able to distinguish empirical research from surveys and opinions.
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Chapter Topics
Compensation: Forms

Definition, Please?

of Pay

The

Employment Relationship Combines Transactional and Relational Returns

Pay Model Plan

Book

Caveat

Emptor - Be an Informed Consumer

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Key Questions and Issues

How do differing perspectives affect our views of compensation? What can a pay system do for an organization? For an employee? How does the pay model help organize ones thinking about compensation? Under what circumstances would one of the four basic pay policies be emphasized relative to the others?
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Contrasting Perspectives of Compensation

Societys Views

Stockholders Views

Employees Views
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Managers Views
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Exhibit 1.1: Hourly Compensation Costs for Production Workers

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Exhibit 1.2: Labor Costs as a Percentage of Revenues, Airline Industry

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What Is Compensation?

Compensation refers to all forms of financial returns and tangible services and benefits employees receive as part of an employment relationship.
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Exhibit 1.3: Total Returns for Work

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Forms of Pay
Direct Pay Forms
Cash

Indirect Pay Forms

Benefits:

Compensation:

Base
Cash

Income Protection Work/Life

Compensation: Merit Pay / Cost-ofLiving Adjustments Compensation: Incentives Incentives

Benefits:

Focus
Benefits:

Allowances

Cash

Long-Term
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1-11

Relational Returns from Work

Recognition & Status Employment Security

Challenging Work
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Learning Opportunities
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What Is an Implicit Employment Contract?

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

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Exhibit 1.4: Framework for Analyzing Employment Relationships

HIGH PAY LOW COMMITMENT HIGH PAY HIGH COMMITMENT Cult - like (Microsoft)

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TRANSACTIONAL

Hired Guns (Stockbrokers)

LOW PAY LOW COMMITMENT Workers as Commodity (Employers of Migrant Farm Workers)
Low

LOW PAY HIGH COMMITMENT Family (Starbucks)

Low

High

RELATIONAL
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Exhibit 1.5: THE PAY MODEL

POLICIES TECHNIQUES OBJECTIVES

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ALIGNMENT

Work Descriptions Evaluation/ INTERNAL analysis certification STRUCTURE

COMPETITIVENESS

Market Surveys definitions

Policy lines

PAY STRUCTURE

EFFICIENCY Performance Quality Customers Stockholders Costs FAIRNESS

CONTRIBUTORS

Seniority based

Performance based

Merit guidelines

INCENTIVE PROGRAMS

COMPLIANCE
MANAGEMENT
Costs Communication Change EVALUATION

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Compensation Objectives
Efficiency

Fairness

Compliance
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Exhibit 1.6: Pay Objectives at Medtronic and AES

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Medtronic Support objectives and increased complexity of business Minimize increases in fixed costs Emphasize performance through variable pay and stock Competitiveness aligned with financial performance: 50th percentile performance paid at 50th percentile of market. 75th percentile performance paid at 75th of market.

AES Our guiding principles are to act with integrity, treat people fairly, have fun, and be involved in projects that provide social benefits. This means we will Help AES attract self-motivated, dependable people who want to keep learning new things Hire people who really like the place and believe in the AES system Pay what others are paid both inside and outside AES, but hire people who are willing to take less to join AES Use teams of employees and managers to manage the compensation system Make all employees stockholders
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1-17

Pay System Policies

Internal

alignment

Focus

- Comparisons among jobs or skill levels inside a single organization

External

competitiveness

Focus

- Compensation relationships external to the organization: comparison with competitors

Employee

contributions

Focus

- Relation emphasis placed on employee performance - Policies related to managing the pay system
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Management

Focus
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Pay System Techniques

Include

methods used to operationalize policy decisions and link decisions to overall compensation objectives Examples of techniques
Internal
Job

consistency

analysis Job evaluation

External
Pay

competitiveness contributions

surveys

Employee

Incentive
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plans Performance-based pay increases

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Caveat Emptor Be An Informed Consumer

Does the research measure anything useful? Does the study separate correlation from causation? Are there alternative explanations?

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