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Chapter 7 Total Rewards and Compensation Chapter Overview Total rewards including compensation systems in organizations must be linked to organizational strategies. Compensation remunerates employees for their knowledge, skills, and abilities through: Base pay Variable pay Benefits The chapter opens with a discussion of the nature of total rewards and compensation regarding the components of compensation, compensation philosophies, and compensation responsibilities. Then the legal constraints on pay systems are explored. Particular attention is given to the Fair Labor Standards Act (FLSA) with its coverage of minimum wage, child labor provisions, exempt and nonexempt statuses, overtime, and common overtime issues for employees in the private and public sectors. Other issues addressed include Equal Pay Act, Lilly Ledbetter Fair Pay Act, independent contractor regulations, and garnishment laws. Next, the chapter discusses the strategic compensation decisions including compensation philosophies, communicating pay philosophy, compensation responsibilities, HR resource metrics and compensation. Then, compensation system design issues are explored including motivation theories and compensation philosophies, compensation fairness and equity (external equity, internal equity, and pay secrecy), and market competitive compensation (lag-the-market, lead-the-market, and match-the-market strategy). Next, the chapter discusses the global compensation issues and the compensation plan for international assignees. The chapter continues with a discussion on development of a base pay system using the compensation philosophy and job analysis. The process incorporates information gathered while valuing jobs and analyzing pay surveys—activities designed to ensure that the pay system is both internally and externally equitable and in line with the organizational philosophy. The two general approaches for valuing jobs are job evaluation and market pricing. A description of the various types of job evaluation methods (ranking method, classification method, factor-comparison method, and point factor method), market pricing, pay surveys (internet-based pay information, using pay surveys, pay surveys and legal issues) are also explored. The importance of combining data from pay surveys and job evaluations to develop pay structures is then detailed. The establishment of pay grades, pay ranges, and individual pay issues (red-circled employees, green-circled employees, and pay compression) are discussed. The chapter ends with a discussion on determining pay increases and describes performance-based increases and standardized pay adjustments such as seniority, cost-of-living adjustments (COLA), across-the-board increases, and lump-sum increases (LSIs). Chapter Outline Companies address pay and benefits with a total rewards philosophy. The total rewards package includes all forms of compensation which are the monetary and nonmonetary rewards provided by a company to attract, motivate, and retain employees. I. Nature of Total Rewards and Compensation Several strategic decisions guide the design of compensation practices: Legal compliance with all applicable laws and regulations Cost-effectiveness for the organization Internal and external equity for employees Optimal mix of compensation components Performance enhancement for the organization Performance recognition and talent management for employees Enhanced recruitment, involvement, and retention of employees Figure 7-1 identifies elements of three primary components of the total rewards package. A. Components of Compensation Tangible rewards can be measured and it is possible to calculate the monetary value of each reward. However, intangible rewards cannot be as easily measured or quantified. The perceived value of intangible rewards can differ among employees, making the total rewards approach complex. One tangible component of a compensation program is direct compensation, the monetary rewards for work done and performance results achieved. Base pay and variable pay are the most common forms of direct compensation. The most common indirect compensation is employee benefits. Base Pay The basic compensation that an employee receives, usually provided as an hourly wage or a salary, is called base pay. Many organizations use two base pay categories, hourly and salaried. Employees paid by the hour receive wages, which are payments calculated on the basis of the time worked. In contrast, employees paid a salary receive the same payment each period regardless of the number of hours worked. Variable Pay Another type of direct pay is variable pay, which is compensation linked directly to individual, team, or organizational performance. The most common types of variable pay are bonuses, incentive program payments, equity rewards, and commissions. Benefits A benefit is an indirect reward—for instance, health insurance, vacation pay, and retirement pensions—given to an employee or a group of employees for organizational membership, regardless of performance. II. Laws Governing Compensation Pay practices are regulated by several key laws that address issues such as overtime pay, minimum wage standards, hours of work, and pay equity. A. Fair Labor Standards Act (FLSA) The primary federal law affecting compensation is the Fair Labor Standards Act (FLSA), which was passed in 1938. Compliance with FLSA provisions is enforced by the Wage and Hour Division of the U.S. Department of Labor (DoL). Penalties for wage and hour violations often include awards of up to two years of back pay for affected current and former employees along with a monetary penalty. Willful violations may be penalized by up to three years of back pay. The provisions of both the original act and subsequent revisions focus on minimum wage, limits on the use of child labor, and exempt and nonexempt status. Minimum Wage The FLSA sets a minimum wage to be paid to a broad spectrum of covered employees. A lower minimum wage is set for “tipped” employees, such as restaurant servers, but their compensation must equal or exceed the minimum wage when average tips are included. The current minimum wage of $7.25 an hour was set as part of the Fair Minimum Wage Act of 2007. Child Labor Provisions The child labor provisions of the FLSA set the minimum age for employment with unlimited hours at 16 years. For hazardous occupations, the minimum is 18 years of age. Individuals 14 to 15 years old may work outside school hours with certain limitations. Exempt and Non-exempt Statuses Under the FLSA, employees are classified as exempt or nonexempt. Exempt employees hold positions for which employers are not required to pay overtime. Nonexempt employees must be paid overtime. The current FLSA regulations used to establish whether or not a job qualifies for exempt status classify jobs into five categories (Figure 7-2). The regulations identify several factors to be considered when determining exempt status. The regulations are complex and a thorough review of each job is recommended to ensure proper classification and prevent misclassifying employees. When designing base pay, employers often categorize jobs into groupings that tie the FLSA status with the method of payment. Employers are required to pay overtime for hourly jobs to comply with the FLSA. Employees in positions classified as salaried nonexempt are also entitled to overtime pay. The FLSA does not require employers to pay overtime for salaried exempt jobs. Overtime The FLSA established overtime pay requirements at one and one-half times the regular pay rate for all hours worked over 40 in a week, except for exempt employees. The workweek is defined as a consecutive period of 168 hours (24 hours × 7 days), which does not have to be a calendar week. Hospitals and nursing homes are allowed a special definition of the workweek to accommodate their 24/7 scheduling demands. No daily number of hours requiring overtime is set, except for special provisions relating to hospitals and other specially designated organizations. Common Overtime Issues For individuals who are nonexempt, employers must consider the following issues: Compensatory time off—“comp” hours are earned by public-sector nonexempt employees in lieu of payment for extra time worked at the rate of one and one-half times the number of hours over 40 that are worked in a week. Comp time is prohibited in the private sector and cannot be legally offered to employees working for private organizations. Incentives for non-exempt employees—employers must add the amount of direct work-related incentives to an employee’s base pay and then calculate overtime pay as one and one-half times the higher (adjusted) rate of pay. Training time—time spent in training must be counted as time worked by non-exempt employees unless it is voluntary or not directly job-related. Travel time—travel time must be counted as work time if it occurs during normal work hours for the benefit of the employer. Travel to and from work is not considered compensable travel time. Donning and doffing time—some jobs require employees to change clothes or to spend a significant amount of time donning protective equipment before they report for duty. Regulations regarding putting on and taking off such clothing and gear are complex. The FLSA does not require employers to provide breaks, lunch periods, or to pay double-time for any hours worked. State laws vary on these topics and employers should research compliance requirements in all states in which they operate. B. Pay Equity Laws Title VII of the Civil Rights Act of 1964 prohibits discrimination based on race, color, sex, religion, or national origin. However, prior to its passage, pay discrimination on the basis of sex was outlawed under the Equal Pay Act of 1963. Equal Pay Act of 1963 The act prohibits companies from using different wage scales for men and women performing substantially the same jobs. Pay differences can be justified on the basis of merit, seniority, quantity or quality of work, experience, or other factors not related to gender. Similar pay must be given for jobs requiring equal skills, equal responsibilities, equal efforts, or jobs done under similar working conditions. Lilly Ledbetter Fair Pay Act This law was enacted in 2008 in response to a Supreme Court decision restricting the statute of limitations allowed under the Equal Pay Act for claiming pay discrimination based on sex. Under the Equal Pay Act, an employee alleging discrimination had up to 300 days to file a claim. The Fair Pay Act essentially treats each paycheck as a new act of discrimination. Pay discrimination need not be intentional to be unlawful. Pay practices resulting in disparate impact are also actionable. C. Independent Contractor Regulations The growing use of contingent workers by many organizations has drawn the attention of several enforcement agencies such as the Internal Revenue Service (IRS), DoL, U.S. Treasury Department, and state taxing authorities. When workers are improperly classified as independent contractors, payroll tax revenues are lost and workers are not insured for unemployment or work-related injuries. For an employer, classifying someone as an independent contractor rather than an employee offers major advantages. The employer does not have to pay Social Security taxes, unemployment, or workers’ compensation costs. Most federal and state entities rely on the criteria for independent contractor status established by the IRS. D. Additional Laws Affecting Compensation Several compensation-related laws apply to firms that have contracts with the U.S. government. These laws require that federal contractors pay the prevailing wage, which is determined by a formula that considers the rate paid for a job by a majority of the employers in the appropriate geographic area. Garnishment occurs when a creditor obtains a court order that directs an employer to set aside a portion of an employee’s wages to pay a debt owed to the creditor. Regulations passed as a part of the Consumer Credit Protection Act limit the amount of wages that can be garnished. The act also restricts the right of employers to terminate employees whose pay is subject to a single garnishment order. III. Strategic Compensation Decisions A. Compensation Philosophies There are two basic compensation philosophies that are situated at opposite ends of a continuum (Figure 7-3). At one end of the continuum is the entitlement philosophy; at the other end is the performance philosophy. Most compensation systems fall somewhere in between these two extremes. Entitlement Philosophy The entitlement philosophy assumes that individuals who have worked another year are entitled to pay increases with little regard for performance differences. When organizations give automatic increases to their employees every year, they are using the entitlement philosophy. Most employees receive the same or nearly the same percentage increase. These automatic increases are often referred to as cost-of-living raises, even if they are not tied specifically to economic indicators. Performance Philosophy A pay-for-performance philosophy assumes that compensation decisions reflect performance differences. Organizations using this philosophy do not guarantee additional compensation simply for completing another year of service. Instead, pay and incentives are structured to reward performance differences among employees. B. Communicating Pay Philosophy Sharing the organizational pay philosophy helps employees to recognize the value of the total reward package provided and shows how their job performance might affect their compensation. Honest, transparent communication about compensation can lead to higher employee engagement and productivity because employees better understand what is expected of them and how they will be rewarded. C. Compensation Responsibilities HR specialists and line managers work together to administer compensation expenditures. HR specialists develop and administer the organizational compensation system and ensure that pay practices comply with all legal requirements. Because of the complexity involved, HR specialists typically conduct job evaluations and wage surveys and develop base pay programs and salary structures and policies. Line managers evaluate employee performance and participate in pay decisions. Payroll Administration Calculating pay and ensuring timely, accurate payroll processing is particularly important to assure compliance with compensation laws and maintain positive employee relations. Payroll staff may report to the company’s HR function or the accounting function. D. Human Resource Metrics and Compensation Employers spend a substantial amount of money on employee compensation. Just like any other area of cost, compensation expenditures should be evaluated to determine their effectiveness. A number of widely used measures are shown in Figure 7-4. The raw data needed to calculate various measures may be found in many organizational functions. Wage rates, total payroll costs, and overtime information can be obtained from the payroll staff or vendor. Productivity numbers may be logged by the Operations Department. Tenure and pay range information may be recorded in the HRIS. Compiling all the necessary information to make proper assessments is complex and may require HR professionals to coordinate with other organizational functions. Ideally, compensation metrics should be computed each year and compared with historic results to show how the rate of compensation changes compares with the rate of other financial changes in the organization. IV. Compensation System Design Issues Depending on the compensation philosophies, strategies, and approaches used by an organization, many decisions are made that affect the design of the compensation system. Employee satisfaction with the compensation system can be influenced by how the organization manages these issues. A. Motivation Theories and/or Compensation Philosophies Two theories of motivation in particular influence the design of compensation systems. Expectancy theory and equity theory are especially relevant to the perceptions employees have of the total rewards provided by the organization. Expectancy Theory According to expectancy theory, an employee’s motivation is based on several linked concepts. This theory emphasizes the importance of finding rewards that are valued by the employee. Rewards that are not appreciated by the employee have little power to motivate performance. Additionally, a break between the promise and delivery of the reward will decrease motivation. Equity Theory The equity theory of motivation states that individuals judge fairness (equity) in compensation by comparing their inputs and outcomes against the inputs and outcomes of referent others. These referent others are workers that the individual uses as a reference point to make these comparisons. Inputs include time, effort, loyalty, commitment, skill, and enthusiasm. Outcomes include pay, job security, benefits, praise, recognition, and thanks. B. Compensation Fairness and Equity Most people work for monetary rewards. Whether they receive base pay or variable pay, the extent to which employees perceive their compensation to be fair often affects their performance and how they view their jobs and their employers. External Equity If an employer’s rewards are not viewed as equitable compared to other organizations, the employer is likely to experience higher turnover. This also creates greater difficulty in recruiting qualified and in-demand individuals. Internal Equity Internal equity means that employees are compensated fairly with regard to the knowledge, skills, and abilities (KSAs) they use in their jobs, as well as their responsibilities, accomplishments, and job performance. Two key issues are important to internal equity are: Procedural justice—it is the perceived fairness of the process and procedures used to make decisions about employees, including their pay. Distributive justice—it is the perceived fairness in how rewards are distributed. To address concerns about both types of justice, some organizations establish compensation appeals procedures. Pay Secrecy Another equity issue concerns the degree of secrecy organizations have regarding their pay systems. Individual pay information may be kept secret in “closed” systems and might include pay amounts, pay raises, and incentive payouts. Some firms have policies that prohibit employees from discussing their pay with other employees, and violations of these policies can lead to disciplinary action. C. Market Competitive Compensation Whether an organization’s total reward practices are competitive has a significant impact on employees’ views of compensation fairness. Providing competitive compensation to employees is a concern for all employers. Organizations face the challenge of whether to adopt practices common in an industry or to differentiate the firm by using novel or distinct compensation practices. Many organizations establish policies about where they wish to be positioned in the labor market using a quartile strategy (Figure 7-5). The quartile strategy reflects the overall market position in which the organization sets its compensation levels. Lag-the-Market Strategy An employer using a first-quartile strategy chooses to “lag the market” by paying below market levels for several reasons. If the employer is experiencing financial difficulties it may be unable to pay more. Also, when an abundance of workers is available, particularly those with lower skills, a below-market approach can be used to attract sufficient workers at a lower cost. The downside of this strategy is that it increases the likelihood of higher worker turnover and lower employee morale. Lead-the-Market Strategy A third-quartile strategy uses an aggressive approach to “lead the market” in pay. This strategy generally enables a company to attract and retain sufficient workers with the required capabilities and be more selective when hiring. Match-the-Market Strategy Most employers position themselves in the second quartile (median), the middle of the market, as determined by pay data from surveys of other employers’ compensation plans. Choosing this level attempts to balance employer cost pressures and the need to attract and retain employees by providing compensation levels that “meet the market” for the company’s jobs. V. Global Compensation Issues Organizations with employees working throughout the world face some special compensation issues. One significant issue is how to compensate employees from different countries. Local wage scales vary significantly among countries. Costs of living standards vary a great deal between nations, and compensation differences may reflect differences in purchasing power among nations. These variations in compensation levels have led to significant offshoring of jobs to lower-wage countries. A. International Assignees Multinational companies may staff their operations with a mixture of employees from around the world. The two primary approaches to international compensation for expatriates are: Home-country based approach—it is the most commonly used method. The overall objective is to maintain the expatriate’s standard of living in his or her home country. Housing, taxes, and discretionary spending expenses are calculated based on those items in the home country. The company pays the expatriate the difference so that he or she is compensated at the same level while working in the host country. The home country approach can result in higher employer costs and more administrative complexity than other plans. Host-country based approach—it compensates the expatriate at the same level as workers from the host country. The company might continue to cover the employee in its retirement plan and also to provide a housing allowance. VI. Developing a Base Pay System The process incorporates information gathered while valuing jobs and analyzing pay surveys—activities designed to ensure that the pay system is both internally and externally equitable and in line with the organizational philosophy. The data compiled in these two activities are used to design pay structures, including pay grades and pay ranges. After pay structures are established, individual jobs are placed in the appropriate pay grades and employee pay is determined. Finally, the pay system is monitored and updated. The two general approaches for valuing jobs are job evaluation and market pricing. Job evaluation looks at pay levels within the company and market pricing looks outside the company. Both methods use relative comparisons to determine the worth of jobs in an organization. To comply with equal pay and nondiscrimination laws, companies should review the relative standing of each job to ensure that jobs held by women and minorities are not consistently ranked the lowest in the organization. A. Job Evaluation Methods Ranking method—it is a simple system that places jobs in order, from highest to lowest, by their value to the organization. This is a qualitative method in which the entire job is considered rather than individual components. Classification method—it is often used in public sector organizations. Descriptions of job classes are written and then each job is put into a grade according to the class it best matches. Factor-comparison method—it is a complex quantitative method that combines the ranking and point factor methods. Organizations that use this method must develop their own key jobs and factors. Point Factor Method The most widely used job evaluation method, the point factor method, looks at compensable factors in a group of similar jobs and assigns weights, or points, to them. A compensable factor identifies a dimension that is part of every job and can be rated for each job. This method is relatively simple to use and considers the components of a job rather than the total job. However, point factor systems have been criticized for reinforcing traditional organizational structures and job rigidity. Although not perfect, the point factor method is generally better than the ranking and classification methods because it quantifies job elements. Compensable factors are derived from job analysis and reflect the nature of different types of work performed in the organization. B. Market Pricing While the point factor method has served employers well for many years, the trend is moving to a more externally focused approach. More companies are moving to market pricing, which uses market pay data to identify the relative value of jobs based on what other employers pay for similar jobs. Key to market pricing is identifying relevant market pay data for jobs that are good “matches” with the employer’s jobs, geographic considerations, and company strategies and philosophies about desired market competitiveness levels. The switch to market pricing as part of strategic compensation decisions can ensure market competitiveness of compensation levels and practices. C. Pay Surveys A pay survey is a report based on research of compensation rates for workers performing similar jobs in other organizations. Pay surveys are an important element in establishing external pay equity. It is particularly important to identify common benchmark jobs—jobs that are found in many other organizations. Often these jobs have stable content, are common across different employers, and are performed by a large number of employees. An employer may obtain surveys conducted by other organizations, access Internet data, or it may conduct its own survey. Internet-Based Pay Information HR professionals can access a wide range of pay data online. Employment-related website such as salary.com and glassdoor.com provide data gathered from companies and employees. Use of these sources requires caution because their accuracy and completeness may not be verifiable or may not be applicable to individual firms and employees. Using Pay Surveys The proper use of pay surveys involves evaluating many factors to determine if the data are relevant and valid. The following questions should be answered for each survey: Participants—does the survey cover a realistic sample of the employers with whom the organization competes for employees? Broad-based—does the survey include data from employers of different sizes, industries, and locales? Timeliness—how current are the data (when was the survey conducted)? Methodology—how established is the survey and how qualified are those who conducted it? Job matches—does the survey contain job summaries so that appropriate matches to job descriptions can be made? Details provided—does the survey report on base pay, incentive pay, and other elements of compensation separately for comparison of the reward mix? Pay Surveys and Legal Issues One reason for employers to use outside sources for pay surveys is to avoid charges that they are attempting to “price fix” wages. The concern is that employers might collude to set wages and restrict employees from earning a true market wage. Organizations are permitted to participate in surveys but only if they meet the following conditions: The survey must be administered by a third party such as a consultant or trade/professional association. The data must be more than three months old. A minimum of five employers must participate in the survey. No single employer’s data may be worth more than 25% of the total. All data must be aggregated and stripped of any identifying information. In addition to antitrust considerations, companies participating in pay surveys must safeguard employee privacy and provide only de-identified data so that specific employee pay rates and names are not shared. Care must also be taken to avoid violating the National Labor Relations Act provisions that apply to disclosing wage and benefit information. VII. Pay Structures After job evaluations and pay survey data are gathered, pay structures can be developed. Pay structures may be created for various categories of jobs such as hourly, salaried, technical, sales, and management. Organizations may have separate pay structures for exempt and nonexempt jobs. A. Pay Grades When establishing a pay structure, organizations use pay grades to group individual jobs having approximately the same job worth. Two methods are commonly used to establish pay grades are job evaluation data and use of job-market banding. Setting Pay Grades Using Job Evaluation Points One approach for determining pay grades uses job evaluation points or other data generated from the traditional job evaluation methods. This process ties pay survey information to job evaluation data by plotting a market line that shows the relationship between job value as determined by job evaluation points and job value as determined by pay survey rates. Market lines are developed by calculating the regression equation using statistical analysis techniques. Figure 7-6 shows an example of a market line and regression equation used in setting a particular set of pay grades. A market line uses data to place jobs having similar point values into pay grades. Pay ranges can then be computed for each pay grade. Setting Pay Grades Using Market Banding Closely linked to the use of market pricing to value jobs, market banding groups jobs into pay grades based on similar market survey amounts. The midpoint of the survey average is used to develop pay range minimums and maximums. B. Pay Ranges Once pay grades are determined, the pay range for each pay grade must be established. Using the market line as a starting point, the employer can determine minimum and maximum pay levels for each pay grade by making the market line the midpoint line of the new pay structure (Figure 7-7). Once pay grades and ranges have been computed, then the current pay of employees is compared with the proposed ranges. Broadbanding The practice of using fewer pay grades with much broader ranges than in traditional compensation systems is called broadbanding. Combining many grades into these broad bands is designed to encourage horizontal movement and therefore more skill acquisition. The main advantage of broadbanding is that it is more consistent with the flattening of organizational levels and the growing use of jobs that are multidimensional. C. Individual Pay Once pay grades and pay ranges have been established, pay can be set for each individual employee. Setting a range for each pay grade gives flexibility by allowing individuals to progress within a grade instead of having to move to a new grade each time they receive a raise. A pay range also allows managers to reward employees based on performance while maintaining the integrity of the pay system. Red-Circled Employees A red-circled employee is an employee who is paid above the range for the job. Several approaches can be used to bring a red-circled employee’s pay into line. Although the fastest way would be to cut the employee’s pay, that approach is not recommended and is seldom used. Instead, the employee’s pay may be frozen until the pay range is adjusted upward. Another approach is to give the employee a small lump-sum payment but not adjust the pay rate when others are given raises. Green-Circled Employees An individual whose pay is below the range for a job is a green-circled employee. Promotion is a major contributor to this situation. Green-circled problems might also result from opportunistic hiring when employees are earning below-market pay at their former employer. Generally, it is recommended that the satisfactory green-circled individual receive fairly rapid pay increases to reach the pay grade minimum. More frequent increases can be used if the minimum is a great deal above the incumbent’s current pay. Pay Compression One major problem many employers face is pay compression, which occurs when pay differences among individuals with different levels of experience and performance become small. Pay compression is frequently a result of labor market pay levels increasing faster than current employees’ pay adjustments. In response to shortages of particular job skills in a highly competitive labor market, companies may have to pay higher amounts to hire people with those scarce skills. VIII. Determining Pay Increases Decisions about pay increases are important in the relationships between employees, their managers, and the organization. Individuals express expectations about their pay and about how much of an increase is “fair,” especially compared with the increases received by other employees. Pay increases can be determined in several ways, including performance, seniority, cost-of-living adjustments, across-the-board increases, and lump-sum increases. These methods can be used separately or in combination. A. Performance-Based Increases Some employers have shifted to more pay-for-performance philosophies and strategies. Consequently, they have adopted the following means to provide employees with performance-based increases. Targeting High Performers This approach focuses on providing the top-performing employees with significantly higher pay raises. Some organizations target the top 10% of employees for significantly greater increases while providing standard increases to the remaining satisfactory performers. The primary reason for having such differentials is to reward and retain critical high-performing individuals. Key to rewarding exceptional performers is identifying how much their performance exceeds normal work expectations. Pay Adjustment Matrix Integrating performance appraisal ratings with pay changes is done through the development of a pay adjustment matrix, or merit-based performance matrix. A pay adjustment matrix reflects an employee’s upward movement in an organization. The matrix considers two factors—the employee’s level of performance as rated in an appraisal and the employee’s position in the pay range, which is often related to experience and tenure. An employee’s placement on the chart determines his or her recommended pay increase. The general objective is for all employees to be paid at approximately the pay-range midpoint. To determine each individual employee’s standing in relationship to the midpoint, many organizations use a value called the compa-ratio. The compa-ratio is calculated by dividing the individual’s pay rate by the midpoint of the pay range. All employees whose compa-ratio is below 1.0 are paid below the pay range midpoint; all employees whose compa-ratio is over 1.0 are paid above the pay range midpoint. Pay administrators calculate the overall compa-ratio for the entire organization to determine the general pattern of pay rates relative to midpoint levels to ensure that the pay philosophy is enforced. B. Standardized Pay Adjustments Companies that have an entitlement philosophy rely more on standardized pay increases. Several methods can be used to provide standardized pay increases to employees. Seniority Time spent in an organization or on a particular job, called seniority or tenure, can be used as the basis for pay increases. Many employers have policies that require an employee to work for a certain length of time before being eligible for pay increases. Pay adjustments based on seniority are often set as automatic steps depending on satisfactory performance during the required length of time. This is often used early in a person’s employment. Cost-of-Living Adjustments Another pay-raise practice is the use of a cost-of-living adjustment (COLA) whereby every employee’s pay is increased to compensate for inflation and rising prices. Often, these adjustments are tied to changes in the Consumer Price Index (CPI) or some other general economic measure. However, the CPI may overstate the actual cost of living, and COLA increases do nothing to recognize employees for their relative contributions to the organization. Across-the-Board Increases Some employers give across-the-board raises and call them merit raises, which they are not. They are usually given as a percentage raise based on a standard market or determination. If all employees get the same percentage pay increase, it is clearly not tied to merit or good performance. For this reason, employers should reserve the term merit for any amount above the standard raise, and they should state clearly which amount is for performance and which amount is the “automatic” portion. Lump-Sum Increases Most employees who receive pay increases, either for merit or for seniority, receive an increase in the amount of their regular monthly or weekly paycheck. In contrast, a lump-sum increase (LSI) is a one-time payment of all or part of a yearly pay increase. The pure LSI approach does not increase the base pay. The major advantage of an LSI plan is that it heightens employees’ awareness of what their performance levels “merited.” Another advantage is that the firm can use LSIs to slow down the increase of base pay and thus reduce or avoid the compounding effect on succeeding raises. One disadvantage of LSI plans is that workers who receive a lump-sum payment may become discouraged because their base pay does not change. Unions generally resist LSI programs because of their impact on pensions and benefits. And when calculating the employee’s overtime pay, the LSI should be considered as part of the base wage calculation. C. Compensation Challenges A number of concerns for managers affect compensation planning and administration. Circumstances within and outside the organization can create employee dissatisfaction or turnover. Economic Recessions During trying economic times, many organizations address shortfalls in revenue by reducing employment-related expenses. Layoffs and reductions in workforce may be strategies to lower costs, but some organizations take less drastic steps in the hopes of retaining employees through the downturn. Wage and salary freezes or cuts and reductions in employee benefits may be used to save money while not losing talented workers. Two-tier Wage Systems As global competition has increased and low-skilled jobs have been sent offshore, some companies have been saddled with high wage costs from decades of generous pay increases. One way some companies have addressed this is to institute a two-tier wage system in which new employees are paid a lower starting wage than existing workers. Gender Pay Gap Despite laws prohibiting pay discrimination on the basis of sex, there is a persistent pay gap between men and women in the workplace. Women have been gaining ground in recent years. Continued monitoring of an organization’s pay levels and career progress for female employees are ways to address these concerns. Instructor Manual for Human Resource Management: Essential Perspectives Robert L. Mathis, John Jackson, Sean Valentine 9781305115248

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