Compensation and Its Impact on Behavior in Organizations
Chapter 1: The Pay Model
Introduction
Learning changes everything.
Compensation: Does it Matter? (Or, “So What?”)
Recent patterns observed in failed companies:
Labor costs higher than competitors without corresponding advantages in efficiency, quality, and customer service.
Successful companies demonstrate relatively high pay alongside increased productivity compared to competitors.
Example: Financial services firms and banks have incentive plans rewarding development of innovative financial investment vehicles.
Case: Novartis attempted to persuade doctors to prescribe its drugs using improper inducements.
Conclusion: Pay structures significantly influence employee behavior, which in turn affects organizational success.
Compensation: Definition, Please (Stakeholders)
Society
Different perspectives exist regarding pay:
Viewed by some as a measure of justice, illustrated by male/female earning differentials.
Question: Does pay matter only to a certain point? Evidence showing diminishing returns on happiness beyond $95,000, yet a steady rise in life evaluation.
Benefits as part of total compensation:
Seen as a reflection of societal equity or justice.
Private sector employers: Approx. 42 cents spent on benefits for every dollar paid in wages and salaries.
Job losses or gains influenced by relative labor costs and productivity across countries.
Consumer perception: Awareness that pay increases may lead to price hikes.
Stockholders
Diverse opinions on employee stock options among stockholders.
Interest in executive pay decisions influenced through shareholder proposals and proxy votes for directors.
Exhibit 1.3: Annual Compensation of Chief Executive Officers (U.S. S&P 500 Public Companies)
Median Compensation Components:
Salary: $1,200,000
Bonus: $2,000,000
Stock Grants: $6,500,000
Stock Option Awards: $0
Total Annual Compensation: $12,300,000
Mean for stock option awards: $2,000,000.
Customers
Compensation recognized as the largest single operating cost.
For firms relying on low product/service costs, focus on minimizing compensation costs.
Ethical considerations: Customers may prefer companies perceived to treat employees responsibly.
Buying decisions influenced by beliefs about company treatment of employees and supply chain practices.
Managers
Managers view compensation as:
Major expense requiring management; competitive pressures necessitate affordable compensation decisions.
Labor costs as a percentage of total costs vary.
Compensation used to influence employee behaviors and organizational performance:
High pay can lead to high returns as one strategy.
Pay impacts:
Quality of work
Attitude towards customers
Flexibility, skill learning, and innovation suggestions.
Pay can drive unionization or legal actions.
Employees
Employees may perceive compensation in several ways:
Return on exchange with employer.
Entitlement received for employment.
Incentive for job acceptance and performance investment.
Reward for past performance.
Pay is a focus for labor unions.
Legal framework regulating pay includes minimum wage, living wage, overtime pay, and nondiscrimination regulations, illustrating its central importance in employment relationships.
How Pay Influences Behaviors: Incentive and Sorting Effects
Pay impacts employee motivation and behavior:
Two forms of influence:
Incentive Effect: Motivational intensity, direction, and persistence linked to pay. Together with ability and organizational design, influences performance behavior.
Sorting Effect: Pay's indirect influence through attracting and retaining the right workforce. The question for organizations
Are the pay policies effectively attracting desirable employees?
Pay Model:
Encompasses compensation policies and the objectives aimed at influencing efficiency, fairness, and compliance.
Global Views—Vive la Différence
Compensation:
In English, it means to counterbalance or offset something.
In Chinese, the term is represented by symbols for logs and water, implying it provides basic necessities.
In Japanese, termed "kyuyo," which translates as “giving something.”
Definition of Compensation:
Refers to all forms of financial returns and tangible services and benefits received as part of an employment relationship.
Forms of Pay
Total returns categorized into:
Total compensation
Relational returns
Cash Compensation: Base
Definition: Base wage is the cash compensation for work performed. Reflects the work value and ignores employee differences.
Salary:
Given to exempt employees under Fair Labor Standards Act (FLSA), not subjected to overtime regulations.
Nonexempt employees have hourly calculated pay.
Some companies use an all-salaried workforce to reinforce a team-oriented culture, yet must comply with FLSA regulations.
Cash Compensation: Merit Increases/Short-Term Incentives/COLAs
Base wage adjustments may derive from:
Changes in market pay rates.
Cost of living changes.
Employee experience/skill improvements.
Merit Increases:
Increments to base pay based on performance assessments; merit bonuses more commonly used as lump sum payments, not permanent base salary increases.
Cash Compensation: Incentives
Incentives tie pay increases to performance:
Differ from merit adjustments as they depend on objective performance measures.
Do not raise base wage and must be re-earned periodically.
Known potential incentive payments ahead of time; examples include commission structures in sales.
Incentives influence future behaviors and can apply to individuals, teams, or business units as one-time payments, aiding in controlling labor costs.
Termed as variable pay; can have significant impacts, positive or negative.
Cash Compensation: Long-Term Incentives
Aim to align employee efforts with multiyear results, often taking form as:
Stock ownership or options to purchase stock at a fixed price.
Significant part of executive compensation packages; some companies extend these benefits beyond just executives.
Benefits: Income Protection
Income protection programs as part of total compensation:
Include legally required benefits like disability and unemployment insurance.
Employers contribute to Social Security half.
Common offerings: medical insurance, retirement, life insurance, savings plans to shield employees from financial risks.
Companies can provide benefits more affordably than employees obtaining them independently.
Trend of reducing benefit costs by transferring portions to employees.
Benefits: Work/Life Balance and Allowances
Programs addressing work/life responsibilities include:
Time-off provisions.
Access to specific services.
Flexible work arrangements.
Enhanced emphasis on these benefits due to demographic changes, especially post-pandemic.
Allowances can arise from local shortages, e.g., housing and transportation allowances common in Vietnam and China; car provisions expected in many European nations.
Total Earnings Opportunities: Present Value of a Stream of Earnings
Compensation analysis traditionally viewed as a snapshot:
Job acceptance example: $50,000 per year, with a 4% annual increase, leading to:
Earnings after 5 years: $60,833.
Employer cost over 5 years: $331,649 without adding for benefits, leading over $430,000 total with an additional 30% for benefits.
Present-value perspective compares initial offers against future bonuses, merit increases, and promotions, emphasizing long-term earnings considerations.
Forms of Pay: Relational Returns from Work
Non-financial returns from work significantly affect behavior.
Relational returns include:
Recognition and status
Employment security
Challenging work
Opportunities for learning
Recognizing the broader context of total returns beyond compensation illustrates diverse managerial strategies influencing employee satisfaction.
Example of “motivational purity bias,” where candidates viewed as only money-driven are rated lower in evaluations.
The Organization as a Network of Returns
Organizations can be perceived as networks formed by various return types, comprised of:
Total compensation
Relational returns
Goal: Design a network of returns that enhances organizational success, ensuring cohesion among bonuses, development opportunities, and promotions.
Job seekers encouraged to evaluate total returns beyond just monetary compensation.
A Pay Model
The pay model framework is significant for assessing current pay systems and guiding the textbook's discussions.
Compensation Objectives
Primary objectives include:
Efficiency: enhancing performance, ensuring quality, satisfying customers and shareholders, and managing labor costs.
Fairness (Equity): fundamental aim of pay systems concerning both procedural and distributive fairness.
Compliance: adherence to federal and state compensation laws and regulations.
Ethics: organizational commitment to ethical practices regarding pay results.
These objectives guide both design and effectiveness measures of pay systems.
Four Policy Choices
Internal Alignment: Evaluations of job pay relationships within an organization. Pay differences may be managed through caps on total cash compensation.
External Competitiveness: Pay comparison with competitors to support recruitment and retention while controlling labor costs.
Employee contribution perception impacts attitudes and behaviors, considering pay mix nature.
Management: Ensuring equitable, objective-oriented pay distribution for appropriate roles satisfying company needs.
Pay Techniques and Book Plan
The section delineates techniques forming pay systems to connect basic policies to pay objectives.
Variations in pay techniques exist.
Book Plan Overview:
Part One: Introduction to the Pay Model
Part Two: Focus on Internal Alignment
Part Three: Examination of External Competitiveness
Part Four: Concentration on Employee Contributions
Part Five: Services and Employee Benefits
Part Six: Compensation Systems for Special Groups and Global Practices
Part Seven: Management of the Compensation System.
Caveat Emptor – Be an Informed Consumer
Evaluative guide for research studies encompasses three critical questions:
Is the research useful?
Does the study differentiate between correlation and causation?
Example: The correlation coefficient is a typical measure of how one variable's changes are associated with another's.
Are alternative explanations present?