Strategic Compensation A Human Resource Management Approach, Global Edition, 8th edition Solution Ma

8

Strategic Compensation A Human Resource Management Approach, 8th Edition By Joseph Martocchio

Instructor’s Manual to Accompany Strategic Compensation: A Human Resource Management Approach, 8e, Global Edition

Preface This Instructor’s Manual provides instructors with course outlines as well as suggested responses for the end-of-chapter Discussion Questions. In addition, answers to case questions and instructor’s notes for the end-of-chapter case and additional case found in MyManagementLab are included. Finally, two MyLab Questions and recommended answers are provided.

Table of Contents Chapter 1: Strategic Compensation: A Component of Human Resource Systems I. Overview II. Exploring and Defining the Compensation Context A. What Is Compensation?

B. Core Compensation C. Employee Benefits III. A Historical Perspective on Compensation A. Causes of Changes in Human Resources Practices B. Initial Emphasis on Personnel Administration C. From Personnel Administration to Human Resources D. Compensation Practices That Contribute to Competitive Advantage IV. Strategic versus Tactical Decisions A. Strategic Management Defined B. Competitive Strategy Choices C. Tactical Decisions That Support the Firm’s Competitive Strategy V. Compensation Professionals’ Goals A. How HR Professionals Fit into the Corporate Hierarchy B. How the Compensation Function Fits into the HR Department C. Compensation Department’s Main Goals VI. Stakeholders of the Compensation System A. Definition B. Stakeholders Include C. Employees Rely on Compensation Professionals to D. Line Managers Rely on Compensation Professionals to E. Executives Rely on Compensation Professionals to

i

1 2 3

6

8

12

18

F. Unions Rely on Compensation Professionals to G. U.S. Government Requires Compensation Professionals to VII. Discussion Questions and Suggested Answers VIII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses MyLab Questions IX. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses

19

Chapter 2: Contextual Influences on Compensation Practice I. Employment Laws That Influence Compensation Practices A. Legislative Actions B. Four Amendments to the U.S. Constitution C. Government Makeup D. Four Key Legislative Themes E. Income Continuity, Safety, and Work Hours Laws F. FLSA of 1938 G. Pay Discrimination Legislation H. Equal Pay Act of 1963 I. Title VII of Civil Rights Act of 1964 J. Bennett Amendment K. Executive Order 11246 L. ADEA of 1967 M. OWBPA N. Executive Order 11141 O. Civil Rights Act of 1991 P. Accommodating Disabilities and Family Needs Q. PDA of 1978 R. ADA of 1990 S. FMLA of 1993 T. Prevailing Wage Laws U. Davis–Bacon Act of 1931 V. Walsh–Healey Contracts Act of 1936 II. Laws That Guide Discretionary Employee Benefits A. Internal Revenue Code (IRC) B. Employee Retirement Income Security Act of 1974 (ERISA)

24 25

ii

21 22 22

37

C. Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) D. Health Insurance Portability and Accountability Act of 1996 (HIPAA) E. Pension Protection Act of 2006 F. Patient Protection and Affordable Care Act of 2010 III. Contextual Influences on the Federal Government as an Employer IV. Labor Unions as Contextual Influences A. Labor Unions Overview B. National Labor Relations Act of 1935 C. Compensation Issues in Collective Bargaining V. Market Influences A. Inter-Industry Wage/Compensation Differentials B. Companies in Product Markets with Little Competition C. Capital Intensity D. Outsourcing VI. Discussion Questions and Suggested Answers VII. End of Chapter Case; Instructor Notes and Questions and Suggested Student Responses MyLab Questions VIII. Additional Cases from the Student Companion Website; Instructor Notes, and Questions and Suggested Student Responses

Chapter 3: Traditional Bases for Pay: Seniority and Merit I. Seniority and Longevity Pay A. Overview B. Historical Overview C. Who Participates?

D. Effectiveness of Seniority Pay Systems E. Design of Seniority Pay Plans F. Advantages of Seniority Pay G. Fitting Seniority Pay with Competitive Strategies II. Merit Pay A. Overview B. Who Participates?

C. Exploring the Elements of Merit Pay iii

42 43

46

47 48 50 50

52 53

56

III. Performance Appraisal A. Types B. Trait Systems C. Comparison Systems D. Behavioral Systems E. Goal-Oriented Systems F. Exploring the Performance Appraisal Process IV. Strengthening the Pay-for-Performance Link A. Activities B. Link Performance Appraisals to Business Goals C. Analyze Jobs D. Communicate E. Establish Effective Appraisals F. Empower Employees G. Differentiate Among Performers V. Possible Limitations of Merit Pay Programs A. Potential Problems B. Failure to Differentiate Among Performers C. Poor Performance Measures D. Supervisors’ Biased Ratings of Employee Job Performance E. Lack of Open Communication between Management and Employees F. Undesirable Social Structures G. Factors Other Than Merit H. Undesirable Competition I. Little Motivational Value VI. Discussion Questions and Suggested Answers VII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses MyLab Questions VIII. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses

58

Chapter 4: Incentive Pay I. Exploring Incentive Pay II. Contrasting Incentive Pay with Traditional Pay

73 74 76

iv

65

66

67 69 70 71

III. Individual Incentive Plans A. Defining Individual Incentives B. Types of Individual Incentive Plans C. Piecework Plans D. Management Incentive Plans E. Behavioral Encouragement Plans F. Referral Plans G. Advantages of Individual Incentive Plans H. Disadvantages of Individual Incentive Plans IV. Group Incentives A. Defining Group Incentives B. Types of Group Incentive Plans C. Team-based or Small Group Incentive Plans D. Gain Sharing Plans E. Scanlon Plan F. Rucker Plan G. Improshare H. Comparison of Plans I. Advantages of Group-Incentive Plans J. Disadvantages of Group-Incentive Plans V. Companywide Incentives A. Defining Companywide Incentives B. Types of Companywide Incentive Plans C. Profit Sharing Plans D. Calculating Profit Sharing Awards E. Advantages of Profit Sharing Plans F. Disadvantages of Profit Sharing Plans G. Employee Stock Option Plans VI. Designing Incentive Pay Programs A. Five Key Considerations B. Group versus Individual Incentives C. Level of Risk D. Complementing or Replacing Base Pay E. Performance Criteria F. Time Horizon VII. Discussion Questions and Suggested Answers VIII. End of Chapter Case; Instructor Notes and Questions and Suggested Student Responses v

77

80

87

90

93 94

MyLab Questions Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses

95

Chapter 5: Person-Focused Pay I. Defining Person-Focused Pay: Competency-Based Pay, Pay-for-Knowledge, and Skill-Based Pay A. Person-Focused Pay Plans B. Pay-for-Knowledge Plans C. Skill-Based Pay D. What Is a “Competency”?

II. Usage of Person-Focused Pay Programs III. Reasons to Adopt Person-Focused Pay Programs A. Overarching Reasons B. Technological Innovation C. Increased Global Competition IV. Varieties of Person-Focused Pay Programs A. Four Main Types B. Stair-Step Model C. Skill-Blocks Model D. Job-Point Accrual Model E. Cross-Departmental Models V. Contrasting Person-Focused Pay with Job-Based Pay A. Person-Focused Pay B. Job-Based Pay VI. Advantages of Person-Focused Pay Programs A. To Employees B. To Employers VII. Disadvantages of Person-Focused Pay Programs VIII. Discussion Questions and Suggested Answers IX. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses MyLab Questions X. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses

98

IX.

vi

96

99

101 102

104

106

108

109 110 112 113 115

Chapter 6: Building Internally Consistent Compensation Systems I. Internal Consistency II. Job Analysis A. Definition B. Steps in Job Analysis Process C. Legal Considerations D. Job Analysis Techniques E. O*NET III. Job Evaluation A. Definition B. Compensable Factors C. The Job Evaluation Process IV. Job Evaluation Techniques A. Two General Types B. The Point Method C. Alternative Job-Content Evaluation Approaches D. Alternatives to Job Evaluation V. Internally Consistent Compensation Systems and Competitive Strategy VI. Discussion Questions and Suggested Answers VII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses MyLab Questions VIII. Additional Cases from the MyManagementLab Website; Instructor Notes and Suggested Student Responses

116 117 117

Chapter 7: Building Market-Competitive Compensation Systems I. Market-Competitive Pay Systems: The Basic Building Blocks A. Definition B. Market-Competitive Pay Systems II. Compensation Surveys A. Purposes B. Preliminary Considerations C. Using Published Compensation Survey Data D. Compensation Surveys: Strategic Considerations

142 143

vii

127

129

136 137 138 139 140

144

E. Compensation Survey Data III. Integrating Internal Job Structures with External Market Pay Rates IV. Compensation Policies and Strategy Mandates V. Discussion Questions and Suggested Answers VI. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses MyLab Questions VII. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses

Chapter 8: Building Pay Structures That Recognize Employee Contributions I. Constructing a Pay Structure A. Overview B. Step 1: Deciding on the Number of Pay Structures C. Step 2: Determining a Market Pay Line D. Step 3: Defining Pay Grades E. Step 4: Calculating Pay Ranges for Each Pay Grade F. Step 5: Evaluate the Results II. Designing Merit Pay Systems A. Considerations B. Merit Increase Amounts C. Timing D. Recurring versus Nonrecurring Merit Pay Increases E. Present Level of Base Pay F. Rewarding Performance: The Merit Pay Grid G. Merit Pay Increase Budgets III. Designing Sales Incentive Compensation Plans A. Purposes of Sales Incentive Compensation Plans B. Alternative Sales Compensation Plans C. Sales Compensation Plans and Competitive Strategy D. Determining Fixed Pay and the Compensation Mix IV. Designing Person-focused Programs A. Overview B. Establishing Skill Blocks C. Transition Matters viii

154 156 158 159 160 161

163 164

170

173

178

D. Training and Certification V. Pay Structure Variations A. Broadbanding B. Two-Tiered Pay Structures VI. Discussion Questions and Suggested Answers VII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses MyLab Questions VIII. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses

Chapter 9: Discretionary Benefits I. An Overview of Discretionary Benefits II. Components of Discretionary Benefit Components A. Protection Programs B. Paid Time Off C. Services III. The Benefits and Costs Discretionary Benefits IV. Discussion Questions and Suggested Answers V. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses MyLab Questions VI. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses

Chapter 10: Employer-Sponsored Retirement Plans and Health Insurance Programs I. Exploring Retirement Plans A. Overview B. Origins of Employer-Sponsored Retirement Plans C. Trends in Retirement Plan Coverage and Costs II. Qualified Plans A. Overview B. Minimum Standards for Qualified Plans III. Defined Benefit Plans A. Overview ix

183

185 187 188 188

190 190 192

202 203 204 205 206

207 209

211

214

B. Minimum Funding Standards C. Benefit Limits and Tax Deductions IV. Defined Contribution Plans A. Overview B. Individual Accounts C. Investments of Contributions D. Employee Participation in Investments E. Accrual Rules F. Minimum Funding Standards G. Contribution Limits and Tax Deductions V. Types of Defined Contribution Plans A. Types B. Section 401(k) Plans C. Profit-Sharing Plans D. Stock Bonus Plans E. Employee Stock Ownership Plans (ESOPs) VI. Hybrid Plans: Cash Balance Plans A. Overview VII. Defining and Exploring Health Insurance Programs A. Overview B. Origins of Health Insurance Benefits C. Health Insurance Coverage and Costs VIII. Fee-for-Service Plans A. Overview B. Features of Fee-for-Service Plans IX. Managed Care Plans A. Overview B. Health Maintenance Organizations C. Features of Health Maintenance Organizations X. Preferred Provider Organizations A. Overview B. Features of Preferred Provider Organizations C. Deductibles D. Coinsurance XI. Point-of-Service Plans XII. Specialized Insurance Benefits A. Overview B. Prescription Drug Plans x

214

216

218 219

220

222

223

224 224

C. Mental Health and Substance Abuse D. Features of Mental Health and Substance Abuse Plans XIII. Consumer-Driven Health Care Plans A. Overview B. Flexible Spending Accounts XIV. Discussion Questions and Suggested Answers XV. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses MyLab Questions XVI. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses

Chapter 11: Legally Required Benefits I. An Overview of Legally Required Benefits II. Components of Legally Required Benefits A. SSA B. Unemployment Insurance C. OASDI D. Medicare E. State Compulsory Disability Laws (Workers’ Compensation) F. FMLA III. The Benefits and Costs of Legally Required Benefits IV. Designing and Planning the Benefits Program A. Overview B. Determining Who Received Coverage C. Financing D. Employee Choice E. Cost Containment F. Communication V. Discussion Questions and Suggested Answers VI. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses MyLab Questions VII. Additional Cases from the MyManagementLab Website; Instructor Notes and Suggested Student Responses

xi

226

228 229 230 231

233 233 234

247 247

250 251 252 253

Chapter 12: Compensating Executives I. Contrasting Executive Pay with Pay for Nonexecutive Employees II. Principles of Executive Compensation: Implications for Competitive Strategy III. Defining Executive Status A. Who Are Executives?

IV. Executive Compensation Packages A. Overview B. Components of Current Core Compensation C. Short-Term Incentives D. Components of Deferred Core Compensation E. Employee Benefits: Enhanced Protection V. Principles and Processes for Setting Executive Compensation A. The Key Players in Setting Executive Compensation B. Theoretical Explanations for Setting Executive Compensation VI. Executive Compensation Disclosure Rules VII. Say on Pay VIII. Executive Compensation: Are U.S. Executives Paid Too Much?

A. Comparison between Executive Compensation and Compensation for Other Worker Groups B. Strategic Questions: Is Pay for Performance?

C. Ethical Considerations: Is Executive Compensation Fair?

D. International Competitiveness IX. Discussion Questions and Suggested Answers X. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses MyLab Questions XI. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses

254 255 255 256 257

266

269 271 272

275 276 277 278

Chapter 13: Compensating the Flexible Work Force: Contingent Employees and Flexible Work Schedules I. The Contingent Workforce A. Overview B. Groups of Contingent Workers C. Reasons for U.S. Employers’ Increased Reliance on Contingent Workers xii

280 281

II.

Pay and Employee Benefits for Contingent Workers A. Legalities B. Part-time Employees C. Temporary Employees D. Leased Workers E. Independent Contractors, Freelancers, and Consultants III. Flexible Work Schedules: Flextime, Compressed Work Weeks, and Telecommuting A. Main Types B. Flextime C. Compressed Work Weeks D. Telecommuting E. Balancing the Demands of Work Life and Home Life IV. Pay and Employee Benefits for Flexible Employees A. Pay B. Benefits V. Unions’ Reactions to Contingent Workers and Flexible Work Schedules VI. Strategic Issues and Choices in Using Contingent and Flexible Workers A. Cost Control Objectives B. Product and Service Innovation Objectives VII. Discussion Questions and Suggested Answers VIII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses MyLab Questions IX. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses

287

Chapter 14: Compensating Expatriates I. Competitive Advantage and How International Activities Fit In A. Overview B. Lowest Cost Producers’ Relocations to Cheaper Production Areas C. Differentiation and the Search for New Global Markets D. How Globalization Is Affecting HR Departments E. Complexity of International Compensation Programs

301 302

xiii

292

294

295 295

296 298 299 300

II.

Preliminary Considerations A. Overview B. Host Country Nationals, Third Country Nationals, and Expatriates: Definitions and Relevance for Compensation Issues III. Components of International Compensation Programs IV. Setting Base Pay for U.S. Expatriates A. Methods for Setting Base Pay B. Purchasing Power V. Incentive Compensation for U.S. Expatriates A. Overview B. Foreign Source Premiums C. Hardship Allowances D. Mobility Premiums VI. Establishing Employee Benefits for U.S. Expatriates A. Overview B. Standard Benefits C. Enhanced Benefits VII. Balance Sheet Approach for U.S. Expatriates’ Compensation Packages A. Overview B. Housing and Utilities C. Goods and Services D. Discretionary Income E. Tax Considerations VIII. Repatriation Pay Issues IX. Discussion Questions and Suggested Answers X. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses MyLab Questions XI. Additional Cases from the MyManagemetLab Website; Instructor Notes, and Questions and Suggested Student Responses

304

Chapter 15: Pay and Benefits Outside the United States I. Introduction II. North America A. Overview B. Canada

321 322 322

xiv

305 306

307

309

312

315 316 318 319 319

C. Mexico III. South America A. Overview B. Brazil IV. Europe A. Overview B. Germany V. Asia A. Overview B. India C. People’s Republic of China VI. Discussion Questions and Suggested Answers VII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses MyLab Questions VIII. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses

Chapter 16: Challenges Facing Compensation Professionals I. Overview II. Fallout from the “Great Recession” A. The U.S. Economy Experienced an Economic Recession B. What Is an Economic Recession?

III. Underemployment: Implications for Compensation A. Underemployment: Implications for Compensation B. The Compensation-Productivity Gap IV. Executive Compensation V. Rising Wages in China VI. Challenges in Healthcare Reform A. Overview B. Key Considerations for Employers VII. Workforce Demographics Shifts A. Labor Force Diversity B. Relevance for Employee Benefits C. Considerations for Employee Motivation VIII. Marriage Between Same-Sex Individuals and the U.S. Supreme Court Ruling on the Defense of Marriage Act xv

325

327

328

332 333 334 335

337 337 338

339

342 342 343

343

345

IX.

Discussion Questions and Suggested Answers

MyLab Questions

347 347

xvi

Sample Syllabus Martocchio, Strategic Compensation: A Human Resource Management Approach 8e, Global Edition, with MyManagementLab Suggested Grade Distribution First team written report (based on Strategic Analysis in Building Strategic Compensation Systems (BSCS):

15% of course grade

Second team written report (based on Internal Consistency part of casebook):

15% of course grade

Third team written report (based on Market Competitiveness part of the BSCS casebook):

15% of course grade

Team oral report (based on Employee Contributions part of casebook):

15% of course grade

Compensation mid-term exam:

15% of course grade

Compensation final exam:

20% of course grade

Individual class participation:

5% of course grade

Compensation Team Project: Building Strategic Compensation Systems This experiential project is designed to provide you an opportunity to integrate and apply knowledge that you will learn in this course. Teams of 5 class members will be established to complete this project that consists of four separate reports (one report for team for each part of the project. The four reports and due dates are listed below: Written Report 1: Written Report 2: Written Report 3: Team Oral Report:

Strategic Analysis (Week 3) Internal Consistency (Week 7) Market Competitiveness (Week 12) Employee Contributions (Week 15)

Each team will serve as compensation experts who have been hired by the firm to develop an integrated compensation plan. An instructor’s grade will be assigned to each report for each team. All team members will receive the same grade based on the instructor’s evaluation.

Each part of the case builds uniquely on your answers to prior parts of the case.

Each report should be written as recommendations to top management. A good approach to developing the report is to identify and discuss decisions that must be made to meet the objectives. Each decision should be supported with rationale that is logical and based on the content presented within your texts. Identify plausible alternatives to your decisions, and discuss possible problems that may be encountered.

1

Each written report should be summarized in a one- to three-page executive summary at the front. This executive summary should contain the major objectives of the report and the corresponding major findings. Also, the body of the report should follow the outline included at the beginning of each part of the BSCS casebook.

Suggested Course Schedule1

Week

Reading Assignment Chapter 1: Strategic Compensation (corresponds to the topic of the Strategic Analysis in the BSCS casebook)

1

Chapter 2: Contextual Influences on Compensation Practice

2 3

Team Written Report (Strategic Analysis) is due.

Chapter 3: Traditional Bases for Pay & Chapter 4: Incentive Pay Chapter 4: Incentive Pay (continued) & Chapter 5: Person-Focused Pay

4

5 6 7 8

Team Written Report (Internal Consistency) is due.

Mid-Term Exam (Chapters 1-6; 9-10)

Chapter 11: Legally Required Benefits

10

Chapter 12: Compensating Executives

11 Team Written Report (Market Competitiveness) is due.

13 14 15 16

Chapter 9: Discretionary Benefits Chapter 10:Employer-Sponsored Retirement Plans and Health Insurance Programs

Chapter7: Building Market Competitive Compensation Systems (corresponds to the topic of Market Competitiveness in the BSCS casebook)

9

12

Chapter 6: Building Internally Consistent Compensation Systems (corresponds to the topic of Section 1 in the BSCS casebook)

Team Written Report (Employee Contributions) is due.

Final Exam (Chapters 7-8 and 11-16)

Chapter 8: : Building Structures that Recognize Employee Contributions (corresponds to the topic of Employee Contributions in the BSCS casebook) Chapter 13: Compensating the Flexible Workforce & Chapter 14: Compensating Expatriates Chapter 15: Pay and Benefits Outside the United States Chapter 16: Challenges Facing Compensation Professionals

This course schedule is based on the use of the BSCS case. For course schedules that do not include the BSCS case, the material can be presented in the order in which it appears in the book.

1

2

CHAPTER 1 Strategic Compensation: A Component of Human Resource Systems Learning Objectives 1. Describe what compensation is and give at least three examples of core compensation practices and at least three examples of employee benefits practices.

2. Summarize at least two historical events in the evolution of compensation practice leading to the current strategic compensation era.

3. Discuss at least two differences between strategic and tactical compensation.

4. Name and summarize the goals of compensation professionals.

5. Identify the stakeholders of the compensation and summarize their stake in the work compensation professionals perform.

Outline I. II.

III.

IV.

V.

VI.

Overview Exploring and Defining the Compensation Context A. What Is Compensation?

B. Core Compensation C. Employee Benefits A Historical Perspective on Compensation A. Causes of Changes in Human Resources Practices B. Initial Emphasis on Personnel Administration C. From Personnel Administration to Human Resources D. Compensation Practices That Contribute to Competitive Advantage Strategic versus Tactical Decisions A. Strategic Management Defined B. Competitive Strategy Choices C. Tactical Decisions That Support the Firm’s Competitive Strategy Compensation Professionals’ Goals A. How HR Professionals Fit into the Corporate Hierarchy B. How the Compensation Function Fits into the HR Department C. Compensation Department’s Main Goals Stakeholders of the Compensation System A. Employees B. Line Managers C. Executives

1 © Pearson Education Limited 2015

D. Unions E. U.S. Government VII. Discussion Questions and Suggested Answers VIII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses IX. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses.

Lecture Outline I.

Overview A. Manpower Planning 1. Focus was on effective deployment of employees 2. Goal was to achieve maximum productivity per employee B. Personnel Management 1. Evolved due to government regulations concerning: a. Payroll taxes b. Minimum wage laws c. Antidiscrimination laws 2. New responsibilities include: a. Administration b. Support c. Consultation d. Quality human resources system design C. HR Professionals 1. Their role has evolved from compliance to consultation and system design 2. They help companies use compensation to attract and retain quality employees 3. They switch the role of compensation practices from controlling managers to facilitating their success 4. They use skills and creativity to apply fundamentals to build management tools that fit within the context of their business 5. They teach managers how to use those tools to maximize their employees’ potential 6. They become facilitators 7. Their transformation from compensation consultant to master compensation carpenter requires that: a. A solid foundation in a company’s business environment, strategy, and organizational structure, processes, and culture should exist 2 © Pearson Education Limited 2015

b. A manager’s toolbox should contain the tools required to run the business c. Managers should be taught how to use each tool II.

Exploring and Defining the Compensation Context A. What Is Compensation?

1. Intrinsic and extrinsic rewards employees receive for performing their jobs a. Intrinsic compensation: reflects employees’ psychological mindsets that result from performing their jobs b. Extrinsic compensation: includes both monetary and nonmonetary rewards for: i. Obtaining certain job performance levels ii. Acquiring new skills and knowledge 2. Monetary compensation represents core compensation 3. Nonmonetary rewards (also known as employee benefits) include: a. Protection programs (e.g., medical insurance) b. Paid time off (e.g., vacations) c. Services (e.g., daycare assistance) B. Core Compensation 1. Six types: a. Base pay b. Cost-of-living adjustments c. Seniority pay d. Merit pay e. Incentive pay f. Pay-for-knowledge and/or skill-based pay 2. Base pay (more in Chapter 7) a. Includes: i. Hourly pay wage ii. Salary c. Is recurring d. Is governed by Fair Labor Standards Act of 1938 (more in Chapter 2) e. In 2012, the average weekly rate for workers was $818.1 On an annual basis, this figure translates to $42,537 (based on a 40-hour work week over 52 calendar weeks) f. Is influenced by four compensable factors: i. An employee’s skill level ii. An employee’s effort iii. An employee’s level of responsibility 3 © Pearson Education Limited 2015

3.

4.

5.

6.

7.

iv. The severity of the working conditions (more in Chapters 2 and 6) g. Because of the Equal Pay Act of 1963, compensable factors are used to: i. Determine internal consistency (more in chapter 6) ii. Determine market competitiveness (more in chapter 7) iii. Recognize individual contributions (more in chapter 8) h. Is adjusted periodically for: i. Cost-of-living increases ii. Differences in an employee’s job performance iii. Increases in an employee’s skill level or job knowledge Includes cost-of-living adjustments (COLAs) which are: a. Base pay adjustments tied to the consumer price index (CPI) and inflation, which is used to set new hires’ pay b. The typical COLA has been 2-3% annually in recent years b. Designed to enable employees to maintain their purchasing power and standard of living c. Most common where unions represent workers Seniority pay is: a. Based on an employee’s length of service and increased value to the employer (more in Chapter 3) b. Designed according to the human capital theory: employees will become more productive as they refine existing skills and acquire new skills and knowledge through length of service Merit pay is: a. Permanent base pay increases granted because of job performance b. Designed to reward exemplary performance, to motivate future performance, and to retain valued employees Incentive pay is: a. Also known as variable pay b. Used for attaining predetermined work objectives c. Fluctuated according to: i. A pre-established formula ii. Individual or group goals iii. Company earnings Pay-for-knowledge and skill-based pay a. Pay-for-knowledge plans reward managerial, service, or professional workers for successfully learning specific curricula (more in Chapter 5) b. Skill-based pay is used mostly for employees who perform physical work and increases as workers master new skills (more in Chapter 5) 4 © Pearson Education Limited 2015

c. Reward employees for the range, depth, and types of knowledge and skills they are capable of applying productively to their jobs d. Reward employees for their potential for making meaningful contributions on the job C. Employee Benefits 1. Represent nonmonetary rewards a. Pay for time-not-worked b. Employee services c. Protection programs 2. Categorized a. Legally required benefits (more in Chapter 11) b. Discretionary benefits (more in Chapters 9 and 10) 3. Discretionary benefits a. Three broad categories i. Protection program ii. Pay for time-not-worked iii. Services (more in Chapter 10) b. Protection programs i. Provide family benefits ii. Promote health iii. Guard against income loss caused by unemployment, disability, and serious illness c. Pay for time-not-worked: provide employees time off with pay like i. Vacation ii. Medical leave d. Services: provide enhancements to employees and their families like: i. Tuition reimbursement ii. Daycare assistance 4. As of September 2012, employers spent an average of $30.84 per employee per hour worked, with only $21.35 of that going to actual wages 5. Legally-required benefits a. Are protection programs that attempt to: i. Promote worker safety and health ii. Maintain family income streams b. Assist families in crisis c. Provide assistance when employee is: i. Disabled ii. Unemployed d. Main, relevant laws include (more in Chapter 11): 5 © Pearson Education Limited 2015

i. Social Security Act of 1935 ii. Family and Medical Leave Act of 1993 III.

A Historical Perspective on Compensation: The Road toward Strategic Compensation A. Causes of Changes in Human Resources Practices 1. Industrial Revolution in the early 1900s 2. Positions in agrarian and small craft businesses giving way to large-scale manufacturing jobs a. Each employee is now just one of many for one business b. Less self-employed and family-owned work opportunities 3. Gave rise to divisions in labor 4. Necessitated activities referred to as personnel administration: a. Hiring/terminating b. Training c. Setting compensation benefits d. Handling grievances B. Initial Emphasis on Personnel Administration 1. Responsibilities a. Controlling labor costs b. Management control over labor 2. Base management control over labor on scientific management practices that: a. Gave rise to individual incentive pay b. Promoted labor cost control by replacing inefficient production methods with more efficient methods, using: i. Time-and-motion studies ii. Job analysis c. Use time and motion studies to analyze the time it takes employees to complete their assigned work d. Use job analysis for gathering, documenting, and analyzing information to describe jobs e. Gave rise to factory-related piecework plans where: i. Employee compensation is determined by units produced per time span ii. An individual’s hourly production is compared to an objective output standard iii. Incentives for exceeding standards is rewarded 3. Welfare practices were originated to: 6 © Pearson Education Limited 2015

a. Provide comfort and improvement, intellectual or social, to employees, over and above wages paid, which is not a necessity of the industry nor required by law b. Discourage unionization c. Promote effective management d. Enhance worker productivity 4. Under welfare practices, the number and types of compensation benefits offered varied per business, may have included: a. Use of libraries and recreational facilities b. Educational assistance c. Medical insurance 5. Government influences include: a. Implementing legislation to fair treatment by making employmentrelated decisions according to job performance b. Requiring extensive documentation C. From Personnel Administration to Human Resources 1. Began in the 1980s 2. Went from mainly an administrative function to designing and implementing compensation programs that contribute to a company’s competitive advantage 3. Competitive advantage: refers to a company’s ability to maintain market share and profitability over a sustained period of several years 4. Employees now seen as a key resource instead of just an expense 5. Major factors include: a. Rapid technological changes i. Automation ii. Employee’s expanded range of required tasks, knowledge, and responsibilities b. Overseas competition i. Requires employers to hire and retain employees with leading-edge skills ii. Requires employees with broader, more in-depth work related knowledge iii. Research suggests that foreign workers are more productive than U.S. workers D. Compensation Practices That Contribute to Competitive Advantage 1. Titles a. Merit pay programs b. Incentive pay practices c. Pay-for-knowledge and skill-based pay programs 7 © Pearson Education Limited 2015

2.

3.

4.

5.

d. Executive compensation (more in Chapter 12) Merit pay programs reinforce excellent performance by awarding pay raises commensurably with performance attainments Incentive pay practices award one-time pay increases once work objectives have been attained Pay-for-knowledge and skill-based pay programs allow employees to acquire the knowledge and skills to remain productive Employees use discretionary benefits to increase worker productivity

Quick Note: Just as prior economic shifts and governmental regulations have caused alterations in the field of compensation administration, the recessions in the first part of the 21st century might well lead to future dramatic shifts to which compensation managers will need to adapt.

IV.

Strategic versus Tactical Decisions A. Strategic Compensation Defined 1. Strategic decisions guide the activities of a company in the market 2. Tactical decisions support the fulfillment of strategic decisions 3. Strategic compensation consists of two categories a. Strategic management b. Strategic planning 4. Strategic management a. Entails making a series of judgments, under uncertainty, which companies direct toward achieving specific goals b. Strategy formulation based on environmental scanning activities c. Environmental scanning is used to discern between threats and opportunities 5. Strategic planning a. Supports business objectives b. Executives communicate business objectives through competitive strategy statements c. Competitive strategy: planned use of company resources—technology, capital, and human in order to promote and sustain competitive advantage d. Has a time span that generally exceeds two years 6. Human resource strategies: use of multiple HR practices a. Compensation and benefits executives work with the lead HR executives and the company’s chief budget officer to prepare total compensation strategies 8 © Pearson Education Limited 2015

b. Total compensation strategies describe the use of compensation and benefits practices that support both HR strategies and competitive strategies

9 © Pearson Education Limited 2015

Example: Competitive Strategy • Eli Lilly • Leading, innovation-driven corporation is developing a growing portfolio of pharmaceutical products by applying the latest research • Creates value for all stakeholders by accelerating the flow of innovative medicines • Provides answers through medicines and information for the world’s most urgent medical needs • Total compensation strategies describe the use of compensation and benefits practices that support both human resources strategies and competitive strategies

Example: Strategic Decisions • Mercedes-Benz—has established a reputation as being a high-end luxury car maker • Prices generally $50,000 or more per automobile • Target market are those 40 years and older • Mercedes-Benz introduced a new car, outside their established reputation • $25,000 to $30,000 price range • Target market is 20 to 30 year old age range • Seeking opportunity to establish brand loyalty • Mercedes-Benz was unsuccessful in attracting this younger market segment, and ultimately decided to discontinue this new model after only a few short years.

B. Competitive Strategy Choices 1. Kinds a. Lowest cost strategy b. Differentiation strategy 2. Lowest cost (cost leadership) strategy a. Focuses on gaining competitive advantage by: i. Being the lowest cost producer within the marketplace ii. Selling goods or services at a price advantage relative to the industry average b. Requires aggressive construction of efficient-scale facilities, and vigorous pursuit of cost minimization in areas like: i. Operations ii. Marketing iii. HR

10 © Pearson Education Limited 2015

Example: Ryanair • Pursues lowest cost by reducing operating costs • Aircraft training and maintenance costs minimized because they use only one aircraft: Boeing 737s • Seating cost and labor costs minimized because seats do not recline and seat-back pockets stowed under the seat • Includes one toilet to make room for additional seats • Baggage handling costs are reduced because passengers are required to carry their luggage 3. Differentiation strategy is: a. A competitive strategy where companies develop products or services that are unique from those of its competition b. Used by companies to make themselves unique in many ways, such as: i. Design or brand image ii. Use of technology iii. Providing additional features iv. Providing better customer service v. Offering their product or service at a better price, and so on Example: Differentiation Strategies: Brand Image and Price Premiums • P&G Corporation (manufactures, markets, and distributes consumer goods products including dog food) • Two product lines: • Iams: Offers nutritionally well-balanced food for dogs that is made from quality ingredients. Iams is considered a super-premium product line • Eukanuba: An ultra-premium line that contains more chicken and vital nutrients that promotes shiny and healthy coats. P&G charges premium prices for this line which allows it to invest more in research and product development C. Tactical Decisions That Support the Firm’s Competitive Strategy 1. Include HR tactics and practices in other functional areas that include: a. Manufacturing b. Engineering c. Research and development d. Management information systems e. Human resources f. Marketing 11 © Pearson Education Limited 2015

2. HR practices support competitive advantage through energizing employees to perform the jobs for which they are hired 3. Tactics in other functional areas: might help determine which functional capabilities are most crucial to maintaining a competitive advantage 4. Employee roles associated with competitive strategy: HR professionals must decide which employee roles are instrumental to the attainment of competitive strategies 5. In a company that uses the lowest cost strategy a. Might include reducing the output cost per employee b. It is generally used for jobs that: i. Include repetitive and predictable behaviors ii. Have a relatively short-term focus iii. Require autonomous or individual activity iv. Involve a high concern for quantity of output 6. For companies using differentiation strategies a. The main emphasis is generally not on increasing employee productivity b. Employees usually have jobs that require: i. Highly creative behaviors ii. A relatively long-term focus iii. Cooperation and independence iv. A greater degree of risk-taking V.

Compensation Professionals’ Goals A. How HR Professionals Fit into the Corporate Hierarchy 1. Corporations categorize employees in two main functional areas a. Line employees b. Staff employees 2. Line employees a. Are workers who are directly involved in producing a company’s goods or services b. Might include: i. Assemblers ii. Salespeople iii. Production workers 3. Staff employees a. Are workers whose job it is to support the line functions b. Might include: i. Human resources professionals 12 © Pearson Education Limited 2015

ii. Accountants c. Promote the effective use of all employees 4. HR’s role: Example: HR’s Role • A quotation from Jay Hannah of BancFirst Corporation. (PowerPoint 1-14) • “The HR department is the source and keeper of critical information, which is key in today’s workplace. With the information they provide, we in turn can build and design strategies to hire and retain the best workforce possible. And this may sound cliché, but it’s very true—the real competitive advantage is our company’s human resources.”

5. In addition to compensation, HR practices include: a. Recruitment b. Selection c. Performance appraisal d. Training e. Career development f. Labor-management relations g. Employment termination h. Managing HR within the context of legislation 6. Traditionally HR was considered an administrative or staff function because HR’s financial and market value was not yet easily quantifiable B. How the Compensation Function Fits into HR Departments 1. Compensation, recruitment, and selection a. Ways companies attract job candidates i. Career opportunities ii. Training opportunities iii. Reputation iv. Location v. Compensation b. Compensation benefits are used to sign qualified candidates by (more in Chapter 7): i. Communicating positive features of compensation programs: Core and fringe ii. Offering signing bonuses 2. Compensation and performance appraisal a. Is key to effective merit pay programs b. Compensation rewards must be tied to attainment of: 13 © Pearson Education Limited 2015

i. Performance goals ii. Quality standards c. Be realistic d. Employees must perceive a strong relationship between attaining performance standards and pay increases e. Successful administration of merit pay programs depends on: i. Sound performance appraisal practices ii. The HR professional’s skills in designing and implementing the program 3. Compensation and training a. Successful pay-for-knowledge plans depend upon a company’s ability to develop and implement systematic training programs that: i. Should allow employees to learn the skills needed to increase their pay ii. Should be designed to allow employees to develop the skills necessary to teach and coach other employees at lower skill levels b. Companies implementing pay-for-knowledge plans typically: i. Increase the amount of classroom and on-the-job training ii. Make training necessary, rather than optional iii. Allow all employees equal access to the training for acquiring higher-level skills 4. Compensation and career development a. Two ways i. Lateral movement ii. Upward (vertical) movement b. Lateral i. Employee moves across a company’s hierarchy ii. Example: the supervisor of payroll clerks moving to the supervisor of inventory clerks c. Upward (Vertical) i. An employee maintains focus in one functional area ii. Takes on greater responsibility in that area iii. Example: payroll clerk, promoted to supervisor, promoted to payroll administrator 5. Compensation and labor-management relations (with unions) 1. Companies grant COLAs (more in Chapter 2) 2. Companies establish base pay on seniority pay (more in Chapter 4)

14 © Pearson Education Limited 2015

6. Compensation and employment termination a. Two types i. Involuntary ii. Voluntary b. Involuntary i. Terminations ii. Layoffs c. Terminations i. Company severs employment agreement for poor job performance, insubordination, and violation of work rules ii. Some companies offer severance pay iii. Some companies offer to continue medical insurance Example: Severance Pay at Delta Airlines •

Closed Boston reservation center

•

Offered employees only six weeks severance pay, regardless of seniority d. Layoffs i. Occur when a company severs an employment agreement because of reduced business activity, plant closings, or relocations ii. Companies generally provide outplacement counseling e. Voluntary terminations i. Are initiated by employees ii. Usually occur when employees choose to work elsewhere or retire f. Might include early retirement, which might include incentives like: i. Increased retirement income ii. Continued medical insurance coverage g. Retirement income programs i. Are company-sponsored pensions ii. Might include early retirement programs to reduce workforce size and trim compensation expenditures iii. Might include early retirement programs that contain incentives to encourage highly paid employees with substantial seniority to retire 7. Compensation and legislation a. Laws were enacted to: i. Establish acceptable employment practices ii. Protect employees’ rights 15 © Pearson Education Limited 2015

b. Are generally based on four main themes i. Income continuity, safety, and work hours ii. Pay discrimination iii. Accommodation of disabilities and family needs iv. Prevailing wage laws c. Relevant laws include: i. Fair Labor Standards Act of 1938 ii. Equal Pay Act of 1963 iii. Civil Rights Act of 1964 iv. Pregnancy Discrimination Act of 1978 v. Americans with Disabilities Act of 1990 (amended in 2008) vi. Family and Medical Leave Act of 1993 vii. Davis–Bacon Act of 1931 C. Compensation Department’s Main Goals 1. Goals include: a. Internal consistency b. Market competitiveness c. Recognizing individual contributions 2. Internal consistency a. Refers to compensation systems that clearly define the relative value of each job among all the jobs within a company b. Job structures (hierarchy) formally recognize differences in job characteristics c. Is based on the principle that employees working at jobs that require greater qualifications, more responsibilities, and/or more complex job duties should be paid more d. Is achieved using: i. Job analysis ii. Job evaluation e. Job analysis i. Is a systematic process for gathering, documenting, and analyzing information in order to describe jobs ii. Describes the content or job duties, worker requirements, and sometimes the job context or working conditions f. Job evaluation i. Is used to systematically recognize differences in the relative worth among a set of jobs ii. Is used to establish pay differentials

16 © Pearson Education Limited 2015

iii. Partly reflects the values and priorities that management places on various positions g. The results of a job analysis and a job evaluation are used to establish pay differentials for virtually all positions within the company 3. Market competitiveness a. Market-competitive pay systems i. Represent companies’ compensation policies that fit with their business objectives ii. Play a significant role in attracting and retaining the most qualified employees iii. Are based on market surveys and compensation surveys b. Strategic analyses i. Entail an examination of a company’s external market context and internal factors ii. External market context factors include: • Industry profile • Information about competitors • Long-term growth prospects iii. Internal market factors include: • A company’s financial condition • A company’s functional capabilities 4. Recognizing Individual Contributions a. Three main methods i. Pay structures ii. Pay grades iii. Pay ranges b Pay structures i. Represent pay rate differences for jobs of unequal worth ii. Are the framework for recognizing differences in employee contributions, such as credentials, job knowledge, and job performance iii. Should define the boundaries for recognizing employee contributions iv. Should promote the retention of valued employees c. Pay Grades i. Are a structural feature of pay structures ii. Group jobs for pay policy application iii. Are based on similar compensable factors and value 17 © Pearson Education Limited 2015

iv. Cannot use a single formula to determine what is sufficiently similar in terms of content and value to warrant grouping for all jobs d. Pay ranges i. Are a structural feature of pay structures ii. Include midpoint, minimum, and maximum pay rates iii. Build upon pay grades.

VI.

Stakeholders of the Compensation System A. Definition 1. Are individuals or entities that are directly affected by a company’s compensation practices 2. The success of HR departments depends on how they will serve various stakeholders which have: a. Their own set of expectations regarding the personnel departments’ activities b. Their own standards for effective performance c. Their own methods for assessing the extent to which the department’s activities meets their own expectations 3. Multiple stakeholders often compete for the attention and a priority status from the HR department B. Stakeholders include: 1. Employees 2. Line managers 3. Executives 4. Unions 5. U.S. government C. Employees rely on compensation professionals to: 1. Develop and implement systematic training programs 2. Be kept informed of: a. Available training b. Connections between the training and their pay c. Changes in compensation practices d. Advancement opportunities 3. Offer discretionary benefits that provide: a. Income protection b. Paid time off c. Services D. Line managers rely on compensation professionals to: 18 © Pearson Education Limited 2015

1. Use their knowledge of relevant laws to help them make sound compensation judgments 2. Advise them on establishing pay differentials 3. Train them how to properly evaluate jobs E. Executives rely on compensation professionals to: 1. Develop and manage sound compensation systems 2. Insure the company’s practices are: a. Legal b. Sufficiently attractive to recruit and retain c. Cost effective F. Unions rely on compensation professionals to: 1. Abide by their collective bargaining agreements 2. Insure they get their COLA adjustments and seniority pay G. U.S. government requires compensation professionals to: 1. Keep updated and comply with all employment legislation 2. Demonstrate that alleged discriminatory pay practices are a business necessity (more in Chapter 2) 3. Demonstrate that alleged discriminatory pay practices are not discriminatory VII.

Discussion Questions and Suggested Answers

1-1.

Define compensation.

Compensation represents both the intrinsic and extrinsic rewards employees receive for performing their jobs. Together, both intrinsic and extrinsic compensation describes a company’s total compensation level. Intrinsic compensation reflects an employee’s psychological mindsets that result from performing his or her job. Extrinsic compensation includes both monetary and nonmonetary rewards.

1-2.

Identify two companies—one that you believe pursues a lowest-cost strategy and another that pursues a differentiation strategy. Relying on personal knowledge, company annual reports, or articles in newspapers and business periodicals, discuss these companies’ competitive strategies.

The cost leadership or lowest-cost strategy focuses on gaining competitive advantage by being the lowest-cost producer of a product or service within the marketplace, while selling the product or service at a price advantage relative to the industry average.

Ryanair is an excellent illustration of an organization that pursues a lowest-cost strategy because its management successfully reduced operating costs. At least two noteworthy decisions have contributed to Ryanair’s goals. First, Ryanair’s training and aircraft 19 © Pearson Education Limited 2015

maintenance costs are lower than similar competitor’s costs because the airline uses only Boeing 737 aircraft. Ryanair enjoys substantial cost savings because it does not need to use different curricula for training flight attendants, mechanics, and pilots to learn about procedures specific to different aircraft models. Second, newer aircraft sport seats that do not recline, have seat-back pockets, or life jackets stowed under the seat. These cost less and also allow service personnel to clean aircraft more quickly, saving on labor costs.

Third, Ryanair airplanes include one toilet to make room for additional passenger seats.

Fourth, passengers are required to carry their luggage to the plane, reducing the cost of baggage handling.

Differentiation strategies are used to develop products or services that are unique from those of competitors. Differentiation strategies can take many forms, including design or brand image, technology, features, customer service, and price. P&G Corporation successfully pursues a differentiation strategy based on brand image and price premiums. The company offers two separate dog food lines—Iams, a superpremium line that is nutritionally well balanced for dogs and uses high quality ingredients and Eukanuba, which is an ultra-premium line that contains more chicken and vital nutrients than the Iams line, as well as additional fatty acids. Together, Iams and Eukanuba appeal to a substantial set of dog owners. The Iams Company distinguishes Eukanuba from Iams by claiming that Eukanuba is “Extraordinary Nutrition.” The Eukanuba slogan is the company’s basis for brand image.

1-3.

How do internally consistent compensation systems attract, motivate, and retain talents in an organization? Discuss the answer using an organization of your choice.

Internally consistent compensation systems ensure that employees are paid fairly and equitable within the organization. Employees under these systems are motivated to perform their jobs because they know that they are being compensated based on their job values, which are evaluated according to a set of compensable factors such as the impact on the organization, communication, innovation, and knowledge. Besides ensuring an internally aligned and equitable job structure that differentiates job values based on these compensable factors, the company also needs to establish how its internal jobs are paid in the external job market so that the pay rates for its internal jobs are market-competitive.

1-4.

Are the three main goals of compensation departments equally important, or do you believe that they differ in importance? Give your rationale.

Compensation professionals promote effective compensation systems by meeting important goals: internal consistency, market competitiveness, and recognition of individual contributions. Internally consistent compensation systems clearly define the relative value of each job among all jobs within a company. Market competitiveness plays a significant role in attracting and retaining the most qualified employees. It entails the examination of company external and internal context factors, as well as collecting and analyzing competitive compensation data. Recognizing individual contributors 20 © Pearson Education Limited 2015

requires pay structures that have pay rate differences for jobs of unequal worth and the framework for recognizing differences in employee contributions.

VIII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses Case Name: Competitive Strategy at Sportsman Shoes Instructor Notes The human resource planning process follows the company’s strategic planning process.

In this case, the company is shifting from a low-cost strategy to a differentiation strategy.

Under the low-cost strategy, human resource practices focused on controlling costs and working to hire and retain workers focused on efficiency and productivity. The differentiation strategy will require some employees with a different skill set. Certain functions will need high levels of creativity and innovation. Human resource practices must shift to support these needs by attracting the right talent, and motivating the right behaviors to produce shoes for the new niche markets.

Questions and Suggested Student Responses: 1-5.

Following Sportsman’s shift in competitive strategy, what are some considerations for the company’s human resource management practices?

Sportsman must focus on attracting and retaining employees in functional areas such as product development and operations. The focus of employees as a whole must shift for this new competitive environment. Under the low-cost strategy, human resource management practices focused on reducing output costs per employee. In the new environment, the company must emphasized cooperation and interdependent behavior.

As a result, training will be necessary to prepare employees to be successful in the new environment. Workers in all areas will need to be open to change and be willing to take risks and human resource management practices will need to be aligned with these needs.

1-6.

As a Human Resource practitioner, propose a holistic approach towards designing the compensation and benefits program at Sportsman Shoes.

The suggested holistic approach could be in the form of a “total rewards framework” that encompasses three key areas of total rewards: compensation, employee benefits, and work-life experience. It is necessary to ensure that the Sportsman Shoes “total rewards” policy and programs are legally compliant and market competitive in the country in which it operates so that the company is able to attach and retain the talents to support its new business model or business strategy.

21 © Pearson Education Limited 2015

MYLAB QUESTIONS 1-7.

What is merit pay? Explain the role of performance appraisals in merit pay programs.

Answer: According to merit pay programs, employees' compensation should be determined by differences in job performance. Under merit pay programs, employees get permanent increases to their base pay based on their performance. Performance appraisals are key issue in merit pay programs. In order to have a successful merit pay program, employees should be able to see the link between their performance and pay increases.

Merit pay systems require specific performance appraisal approaches, and choosing, designing, and implementing such plans are crucial for the success of merit pay programs.

1-8.

What is pay-for-knowledge plan? Explain the role of training in pay-forknowledge plans.

Answer: Pay-for-knowledge programs reward managerial, service, or professional workers for successfully learning specific curricula. This type of pay systems reward employees for the range, depth, and types of knowledge they are capable of applying to their jobs. Designing and implementing training programs are crucial in the success of pay-for-knowledge programs. Through training programs, employees learn the necessary skills and knowledge for performing their job, and this in turn increases their pay. In this type of pay systems, training is necessary rather than optional.

IX.

Additional Case from the MyManagementLab Website; Instructor Notes and Questions and Suggested Student Responses

Case Name: Is It Time to Hire a Compensation Expert?

Instructor Notes Organizations are challenged to ensure the right number of staff positions relative to line positions. As a company grows, their need for additional human resources staff will likely grow as well. Depending on the company’s goals, different types of human resources expertise may help the organization operate more effectively in order to obtain 22 © Pearson Education Limited 2015

those goals. Most organizations will hire a recruiter to help acquire new talent for the organization. But, with growth, the compensation-related issues the company faces also grows. Compensation expertise can benefit a growing company by creating a pay structure and competitive benefits that allows the company to attract and retain employees to support future company growth.

Questions and Suggested Student Responses: 1-9.

Do you think EasySpa would benefit from hiring a compensation professional? How?

As the organization plans continued growth, there are many benefits that a compensation professional can provide. Having compensation expertise can help support other practices such as recruitment. By designing a compensation structure that is attractive to candidates, EasySpa may be able to better recruit talent. Further, the pay structure can help hiring managers more effectively set pay rates for new hires. A compensation professional can also help design a benefits package that is both attractive and cost efficient.

1-10. How can Jay convince the CEO to hire a compensation professional?

A compensation professional can better structure the company’s compensation by ensuring pay levels are appropriate through ensuring internal consistency in pay while keeping pay levels competitive in the marketplace. Further, a compensation professional may be able to design incentive pay programs to motivate certain groups of employees.

By doing so, the company can ensure that funds spent on labor are used effectively.

Further, the company may be able to realize savings in benefit costs by using an expert to design the benefits package. Finally, as a key stakeholder in the success of the company, the CEO benefits from the expertise of a compensation professional because they can ensure the company is complying with relevant employment laws.

U.S. Bureau of Labor Statistics (2013). The Employment Situation – January 2013 (USDL 13-0144). Available: www.bls.gov, accessed March 3, 2013.

1

23 © Pearson Education Limited 2015

CHAPTER 2 Contextual Influences on Compensation Practice Learning Objectives 1. List four groups of federal laws that apply to compensation tactics.

2. Identify and describe at least one law in each of the four groups of federal laws that apply to compensation practice.

3. Define at least two federal laws that shape discretionary benefits practices and identify the relevant employee benefits practices to which they apply.

4. Summarize at least three laws that apply exclusively to federal employers’ compensation practices.

5. Explain how labor unions influence compensation practices.

Outline I.

Employment Laws That Influence Compensation Practices A. Legislative Actions B. Four Amendments to the U.S. Constitution C. Government Makeup D. Four Key Legislative Themes E. Income Continuity, Safety, and Work Hours Laws F. FLSA of 1938 G. Pay Discrimination Legislation H. Equal Pay Act of 1963 I. Title VII of Civil Rights Act of 1964 J. Bennett Amendment K. Executive Order 11246 L. ADEA of 1967 M. OWBPA N. Executive Order 11141 O. Civil Rights Act of 1991 P. Accommodating Disabilities and Family Needs Q. PDA of 1978 R. ADA of 1990 S. FMLA of 1993 T. Prevailing Wage Laws U. Davis–Bacon Act of 1931 V. Walsh–Healey Contracts Act of 1936 24 © Pearson Education Limited 2015

II.

Laws That Guide Discretionary Employee Benefits A. Internal Revenue Code (IRC) B. Employee Retirement Income Security Act of 1974 (ERISA) C. Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) D. Health Insurance Portability and Accountability Act of 1996 (HIPAA) E. Pension Protection Act of 2006 F. Patient Protection and Affordable Care Act of 2010 III. Contextual Influences on the Federal Government as an Employer IV. Labor Unions as Contextual Influences A. Labor Unions Overview B. National Labor Relations Act of 1935 C. Compensation Issues in Collective Bargaining V. Market Influences A. Inter-Industry Wage/Compensation Differentials B. Companies in Product Markets with Little Competition C. Capital Intensity D. Outsourcing VI. Discussion Questions and Suggested Answers VII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses VIII. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses.

Lecture Outline I.

Employment Laws That Influence Compensation Tactics A. Legislative Actions 1. Four Amendments to the U.S. Constitution i. Article I, Section 8 ii. First Amendment iii. Fifth Amendment iv. Fourteenth Amendment, Section 1 2. Income continuity, safety, and work hours 3. Fair Labor Standards Act of 1938 4. Work Hours and Safety Standards Act of 1962 5. McNamara–O’Hara Service Contract Act of 1965 6. Pay Discrimination Legislation 25 © Pearson Education Limited 2015

7. Equal Pay Act of 1963 8. Title VII of the Civil Rights Act of 1964 9. Bennett Amendment to Title VII 10. Executive Order 11246 11. Age Discrimination in Employment Act of 1967 (ADEA) 12. Older Workers Benefit Protection Act (OWBPA) 13. Executive Order 11141 14. Civil Rights Act of 1991 15. Lilly Ledbetter Fair Pay Act of 2009 16. The Paycheck Fairness Act 17. Americans with Disabilities Amendments Act of 2008 18. The American Recovery and Reinvestment Act of 2009 (ARRA) B. Four Amendments to the U.S. Constitution 1. Article 1, Section 8 (“The Congress shall have the power…to regulate Commerce with foreign nations, and among the several States, and with the Indian Tribes…”)

2. First Amendment (“Congress shall make no laws respecting an establishment of religion, or prohibiting the free exercise thereof; or abridging the freedom of speech, or of the press; or the right of the people peaceably to assemble, and to petition the Government for a redress of grievances.”)

3. Fifth Amendment (“No person shall...be deprived of life, liberty, or property without due process of law…”)

4. Fourteenth Amendment, Section 1 (“No state shall make or enforce any law which shall abridge the privileges or immunities of citizens of the United States, nor shall any State deprive any person of life, liberty, or property without due process of law; nor deny any person within its jurisdiction the equal protection of the law.”)

C. Government Makeup 1. Three levels a. Federal b. State c. Local i. County ii. City 2. Most compensation laws are federal 3. State and local legislations may be concurrent or exist in absence of similar federal laws 4. Three branches a. Legislative—makes laws 26 © Pearson Education Limited 2015

b. Executive—enforces laws c. Judicial—interprets laws D. Four Key Compensation-Related Legislative Themes 1. Income continuity, safety, and work hours 2. Pay discrimination 3. Accommodating disabilities and family needs 4. Prevailing wage laws E. Income Continuity, Safety, and Work Hours Laws 1. Three main factors a. Great Depression b. Family businesses to large factories c. Division of labor 2. The Great Depression of the 1930s led to: a. Large scale business failures b. Chronic unemployment c. Passage of the Social Security Act of 1935 (Title IX) d. Passage of workers’ compensation programs 3. The 20th century switch from an agrarian to industrial society led to: a. Families moving from small farms to urban areas for factory jobs b. Individuals losing control over their earnings and working conditions 4. Industrialization also led to: a. A division of labor characterized by differences in skills and responsibilities b. Companies sacrificing living wages and safe working conditions for short-term profits c. Passage of the Fair Labor Standards Act of 1938 F. Fair Labor Standards Act of 1938 (FLSA) 1. Addresses three main issues a. Minimum wage b. Overtime pay c. Child labor provisions 2. Enforced by the U.S. Department of Labor 3. Minimum wage a. Designed to ensure wages for a minimally acceptable standard of living b. Originally set at $0.25 per hour c. In 1996, was set at $5.15 d. In 2009, Congress passed an increase in federal minimum wage from $5.15 in increments to $7.25 27 © Pearson Education Limited 2015

e. 21 states specify higher minimum wage rates than federal level since 2009 f. Workers can legally earn less than minimum wage if they are: i.

Students employed in retail or service businesses, on farms, or in institutions of higher education ii. Trainees iii. Mentally or physically disabled Example: FLSA Definition of Trainees • The training, even though it includes actual operation of the employer’s facilities, is similar to that which would be provided in a vocational school • The training is for the benefit of the trainee • The trainee does not displace regular employees but works under closer supervision • The employer providing the training gains no immediate advantage from the trainees’ activities; on occasion, the employer’s operation may in fact be hindered • The trainee is not guaranteed a job at the completion of the training • The employer and the trainee understand that the employer is not obligated to pay wages during the training period 4. Overtime pay provisions a. Defined in FLSA b. Most employers must pay time and one-half for over 40 hours work in a period of 7 consecutive days c. FLSA Exempt Positions i. Executive ii. Administrative iii. Learned professional iv. Creative professional v. Computer system analyst, programmer, software engineer, or similarly skilled workers vi. Outside sales d. Classifying jobs as either exempt or nonexempt is not always clear-cut Example: Supreme Court Case: Exempt or Nonexempt Position • Aaron v. City of Wichita, Kansas ruling on whether fire chiefs were exempt 5. Exempt positions a. Redefined by U.S. Department of Labor’s Fair Pay Rules in 2004 i. Employees were considered exempt if they earned more than minimum wage and exercised independent judgment when working 28 © Pearson Education Limited 2015

ii. Now, employees earning less than $23,660 per year, or $455 per week are guaranteed overtime protection iii. More information available at http//www.dol.gov 6. Scope of FLSA broadened twice since 1938 a. Portal-to-Portal Act of 1947 i. Defined the term “hours worked” ii. For example, time spent by state correctional officers caring for police dogs at home is compensable (Andres v. DuBois) b. Equal Pay Act of 1963, which prohibits sex discrimination in pay for employees performing equal work 7. Compensable work activities a. Waiting time b. On-Call time c. Rest and meal periods d. Sleeping time and certain other activities e. Lectures, meetings, and training programs f. Travel time i. Home to work travel ii. Home to work on a special one day assignment, including employer-mandated training, in another city iii. Travel that is all in a day’s work iv. Travel away from home community 8. Child labor provisions a. Intended to protect children from: i. Being overworked ii. Working in a hazardous setting iii. Having their education jeopardized due to excessive work hours b. Children younger than age 14 usually cannot be employed c. Children ages 14 and 15 may work in safe occupations outside school hours, as long as their work does not exceed: i. 3 hours on a school day ii. 18 hours per week while school is in session iii. 40 hours when school is not in session d. Children ages 16 and 17 i. Do not have hourly restrictions ii. Cannot work in hazardous jobs (e.g., running heavy industrial equipment, working around harmful substances) G. Pay Discrimination Legislation 1. Came out of the Civil Rights Movement of the 1960s 29 © Pearson Education Limited 2015

2. Was designed to protect designated classes of employees, and to uphold their rights individually against discriminatory employment decisions 3. Equal Pay Act of 1963 4. Civil Rights Act of 1964 H. Equal Pay Act of 1963 1. Enforced by the Equal Employment Opportunity Commission (EEOC) 2. Applies to jobs of equal worth according to the Department of Labor’s definition of compensable factors, such as: a. Levels of skill b. Effort c. Responsibility d. Working conditions Example: Equal jobs?

• EEOC v. Madison Community Unit School District #12 court ruling • Female coaches of female sports teams were paid less than male coaches of male sports teams 3. Jobs must have “similar”, not necessarily the “same” working conditions 4. Pay differentials are not always illegal; are legal where such payments are made pursuant to: a. A seniority system b. A merit system c. A system which measures earnings by the quantity or quality of production d. A differential based on any factor other than gender I. Title VII of the Civil Rights Act of 1964 1. Legislators designed Title VII of this Act to promote equal employment opportunities for underrepresented minorities 2. Title VII distinguishes two types of discrimination a. Disparate treatment b. Disparate impact 3. Disparate treatment a. Represents intentional discrimination, occurring whenever employers intentionally treat some workers less favorably than others because of: i. Race ii. Color iii. Religion iv. Sex v. National origin 30 © Pearson Education Limited 2015

b. Example: awarding pay increases to blacks based on seniority whereas basing increases on performance for whites 4. Disparate impact a. Represents unintentional discrimination that occurs whenever an employer applies employment practices to all employees b. The practice leads to unequal treatment of protected employee groups 5. Title VII applies to: a. Companies with 15 or more employees b. Employment agencies c. Labor unions d. Labor management committees controlling apprenticeship and training

Example: Title VII mandates • “It shall be an unlawful employment practice for employers to: • Fail or refuse to hire or to discharge any individual, or otherwise to discriminate against any individual with respect to that individual’s compensation, terms, conditions, or privileges of employment, because of such individual’s race, color, religion, sex, or national origin • Limit, segregate, or classify a company’s employees or applicants for employment in any way which would deprive or tend to deprive any individual of employment opportunities or otherwise adversely affect that individual’s status as an employee, because of such individual’s race, color, religion, sex, or national origin” In 2009, Congress passed two major Acts to help further close the pay gap between men and women: • The Lilly Ledbetter Pay Act restored prior law—providing that a pay discrimination charge must simply be filed within 180 days of a discriminatory paycheck. This helped to reverse the Supreme Court Ledbetter decision, which made it harder for women and other workers to pursue pay discrimination claims • The Paycheck Fairness Act helps to strengthen the Equal Pay Act of 1963 by strengthening the remedies available to put sex-based pay discrimination on par with race-based pay discrimination. That is, employers are now required to justify unequal pay by showing that the pay disparity is not sex based, but, rather, job related. This Act also prohibits employers from retaliating against employees who share salary information with their coworkers

31 © Pearson Education Limited 2015

J. Bennett Amendment (to Title VII) 1. Allows female employees to charge employers with Title VII violations regarding pay only when the employer has violated the Equal Pay Act of 1963 2. Added to Title VII because legislators could not agree on: a. Whether or not Title VII incorporates both the Equal Pay Act of 1963’s equal pay standard and the four defenses for unequal work i. Seniority system ii. Merit system iii. Earnings based on quality or quantity of production iv. Pay differential not based on gender b. Whether or not Title VII includes only the aforementioned four Equal Pay Act of 1963 exceptions K. Executive Order 11246 1. Extends Title VII standards to companies holding federal government contracts worth more than $10,000 per year 2. Requires companies with federal contracts worth more than $50,000 per year and 50 or more employees to develop a written affirmative action plan that will specify how the companies will avoid or reduce Title VII discrimination violations over time L. Age Discrimination in Employment Act of 1967 (ADEA) 1. Amended in a. 1978 b. 1986 c. 1990 2. Designed to protect workers age 40 and older (“baby boomers”) from age discrimination a. “Baby boomers” are those born between 1942 and 1964 i. Represent the largest generation of the U.S. population ii. Will probably work past age 67 b. United States Census Bureau predicts that i. By 2001, those older than 65 will number about 25 million (12.4 percent of the population) ii. By 2050, that number will reach about 77 million (20.3 percent of the population)

32 © Pearson Education Limited 2015

Example: ADEA specifies that it is unlawful for an employer to: • Fail or refuse to hire or to discharge any individual or otherwise discriminate against any individual with respect to his compensation, terms, conditions, or privileges of employment, because of age • Limit, segregate, or classify a company’s employees in any way which would deprive or tend to deprive any individual of employment opportunities or otherwise adversely affect that individual’s status as an employee, because of age • Reduce the wage rate of any employee in order to comply with ADEA (29 USC 623; Section 4) ADEA applies to benefit practices as well: • Any employer must provide that any employee aged 65 or older, and any employee’s spouse aged 65 or older, shall be entitled to coverage under any group health plan offered to such employees under the same conditions as any employee, under age 65 (29 USC 623, Section 4, paragraph (g)(1)) 3. Sets limits on the development and implementation of employers’ early retirement practices a. Offered to employees age 55 or older b. Employee participation must be voluntary (EEOC v. Chrysler) M. Older Workers Benefit Protection Act (OWBPA) 1. 1990 amendment to ADEA 2. Places additional restrictions on employers’ benefits practices a. Employers may require older employees to pay more for health insurance or life insurance coverage if the cost is significantly greater than the cost for younger workers because these costs generally rise with age b. Equal benefit or equal cost principle which specifies that employers do not have to provide equal benefits to older workers if it costs them more to do so Example: OWBPA • Company has 3,000 employees • 750 employees (25 percent) are age 40 or older, 2,250 (75 percent) are under age 39 • Annual contribution of all employees is $120,000 • Workers age 40 and older paid $84,000 (70 percent) of contributions, workers age 39 and younger contributed $36,000 (30 percent) • Older workers paid disproportionately more (25 percent of the workforce paid 70 percent of the total contributions) c. An older employee may not be required to pay more for the benefit as a condition of employment 33 © Pearson Education Limited 2015

d. An older employee may be offered the option of paying—or paying more—for the benefit in order to avoid otherwise justified reductions in coverage e. An older employee who chooses to participate in a voluntary plan can be required to pay more for the benefit, but only if the employee does not pay a greater percentage of his or her premium cost than younger employees do f. Enacts the equal benefits or equal costs principle i. Employers must offer benefits to older workers equal to or more than the benefits given younger workers if the costs to do so are greater than it is for the younger workers g. Employers may make across-the-board cuts in benefits to save costs h. Covers: i. Private employers with 20 or more employees ii. Labor unions with 25 or more members iii. Employment agencies 3. Enforced by EEOC N. Executive Order 11141 which extends ADEA to federal contractors O. Civil Rights Act of 1991 1. Designed to overturn several Supreme Court rulings a. Atonio v. Ward Cove Packing Company i.

Ruling required employees to prove which employment practice created the disparate impact ii. Shifted the burden of proof from the employee to the employer b. Lorance v. AT&T Technologies i.

Ruling allowed employees to challenge the use of seniority systems within 180 days from the system’s implementation date ii. Allows employees to file a discrimination claim when the system is implemented or whenever the system negatively affects them c. Boureslan v. Aramco i.

Ruling stated that federal job discrimination laws did not apply to U.S. citizens working for U.S. companies in foreign countries (expatriates) ii. Allows expatriates to file discrimination lawsuits 2. Provides coverage to the same groups protected under the Civil Rights Act of 1964 3. This Act extends coverage to U.S. Senate employees and political appointees of the federal government’s Executive Branch 4. EEOC i. Enforces law 34 © Pearson Education Limited 2015

i. Assists employers avoid discrimination practices through the Technical Assistance Training Institute P. Accommodating Disabilities and Family Needs 1. Pregnancy Discrimination Act of 1978 (PDA) 2. Americans with Disabilities Act of 1990 (ADA) 3. Family and Medical Leave Act of 1993 (FMLA) Q. Pregnancy Discrimination Act of 1978 (PDA) 1. An amendment to Title VII of the Civil Rights Act of 1964 2. Prohibits disparate impact discrimination against pregnant women for all employment practices 3. Employers must not treat pregnancy less favorably than other medical conditions covered under employee benefits plans 4. Employers must treat pregnancy and childbirth the same way they treat other causes of disability 5. PDA protects women’s rights who take leave for pregnancy-related reasons a. Credit for previous service b. Accrued retirement benefits c. Accumulated seniority R. Americans with Disabilities Act of 1990 (ADA) 1. Prohibits discrimination against individuals with mental or physical disabilities within and outside employment settings including: a. Public services b. Transportation c. Public accommodations d. Employment 2. Applies to employers with 15 or more employees 3. EEOC is the enforcement agency Example: ADA and employment • The ruling states the ADA: • “…prohibits covered employers from discriminating against a ‘qualified individual with a disability’ in regard to job applications, hiring, advancement, discharge, compensation, training, or other terms, conditions, or privileges of employment.

Employers are required to make ‘reasonable accommodations’ to the known physical or mental limitations of an otherwise qualified individual with a disability unless to do so would impose and ‘undue hardship’” 4. “Reasonable accommodations” may include such efforts as: a. Making existing facilities readily accessible 35 © Pearson Education Limited 2015

b. Job restructuring c. Modifying work schedules 5. A “qualified individual with a disability” must be able to perform the “essential functions” of a job, which are those job duties that are critical to the job Example: ADA and reasonable accommodations • Producing printed memoranda is a key duty of a clerical worker’s job • Most clerical workers manually key the information into the computer • An employee comes down with crippling arthritis • Employer acquires voice recognition software for this employee to input information In September 2008, President George W. Bush signed into law the Americans with Disabilities Act of 2008. The main effect of this legislation is that it is now easier for an individual seeking protection under the ADA to establish that he or she has a disability within the meaning of the ADA. S. Family and Medical Leave Act of 1993 (FMLA) (more in chapter 12) 1. FMLA was designed to provide employees with job protection in cases of family or medical emergency 2. Guarantees unpaid leave and the right to return to either the same position or a similar position with the same pay, conditions, and benefits T. Prevailing Wage Laws 1. Davis–Bacon Act of 1931 2. Walsh–Healey Contracts Act of 1936 U. Davis–Bacon Act of 1931 1. Established employment standards for construction contractors holding federal government contracts valued at more than $2,000, including: a. Highway building b. Dredging c. Demolition d. Cleaning, painting, and/or decorating public buildings 2. Applies to laborers and mechanics who are employed on-site 3. Requires contractors to pay the prevailing wage in the local area 4. U.S. Secretary of Labor a. Determines prevailing wage rates b. Based on compensation surveys 5. Prevailing wage is the typical hourly wage paid to more than 50 percent of all laborers and mechanics employed in the local area 36 © Pearson Education Limited 2015

6. Requires contractors to offer fringe benefits equal in scope and value to those offered in the local area V. Walsh–Healey Contracts Act of 1936 1. Applies to contractors and manufacturers who sell supplies, material, and equipment to the federal government with contracts worth at least $10,000 2. Covers both construction and non-construction activities 3. Covers all contractor employees except: a. Office workers b. Supervisors c. Custodial workers d. Maintenance workers 4. Requires contractors to meet guidelines relating to: a. Wages b. Work hours c. Child labor d. Convict labor e. Hazardous working conditions 5. Contractors must observe the minimum wage and overtime provisions of FLSA 6. Prohibits employment of individuals a. Younger than 16 years old b. Convicted criminals 7. Prohibits contractors from exposing workers to conditions that violate the Occupational Safety and Health Act of 1970 8. Passed to assure safe and healthful working conditions for workers by authorizing enforcement of the standards II.

Laws That Guide Discretionary Employee Benefits A. Internal Revenue Code (IRC) 1. Regulations pertaining to taxation in the United States 2. Main source of revenue for funding federal, state, and local government programs 3. Internal Revenue Services a. Implements the IRC b. Levies penalties against companies and individuals who violate the IRC 4. Since 1916, the federal government has encouraged employers to provide retirement benefits to employees with tax breaks or deductions, thus reducing the amount of a company’s required tax payment 5. The IRC contains multiple regulations for legally required and discretionary benefits a. Federal Insurance Contributions Act (FICA) 37 © Pearson Education Limited 2015

b. Federal Unemployment Tax Act (FUTA) c. FICA taxes employees and employers to finance the Social Security Old-Age, Survivor, and Disability Insurance Program (OASDI) d. Unemployment insurance benefits are financed by federal and state taxes levied on employers e. Federal taxes are levied on employers under FUTA 6. Incentives for employers and employees a. An employee may deduct the cost of benefits from annual income, thereby reducing tax liability b. Employers may also deduct the cost of benefits from their annual income as a business or trade expense when the cost is an ordinary and necessary expense of the company’s trade or business c. Payroll costs and benefits costs also qualify as ordinary and necessary business expenses d. Companies can deduct these costs only during the current tax period. benefits costs incurred during 2008 may be deducted only for the 2008 tax year e. Benefits qualify for tax deductibility when they meet nondiscrimination rules set forth by the Employee Retirement Income Security Act of 1974 7. Nondiscrimination rules a. Prohibit employers from giving preferential treatment to key employees and highly compensated employees b. A key employee is one who at any time during a given year is: i. A five percent owner of the employer ii. A one percent owner of the employer having an annual compensation from the employer of more than $160,000 iii. An officer of the employer having an annual compensation greater than $165,000 in 2013 (indexed for inflation in increments of $5,000 beginning in 2003) c. The IRS defines a highly compensated employee as one of the following during the current or preceding year i. A five percent owner at any time during the year or the preceding year ii. For the preceding year had compensation from employer in excess of $ 115,000 in 2013 iii. If the employer elects the application of this clause for a plan year, was in the top-paid group of employees for the preceding year

38 © Pearson Education Limited 2015

U.S. Treasure Regulations define the term officer as follows: Generally, the term officer means an administrative executive who is in regular and continued service. The term officer implies continuity of service and excludes those employed for a special and single transaction. An employee who merely has the title of an officer but not the authority of an officer is not considered an officer for purposes of the key employee test.

Similarly, an employee who does not have the title of an officer but has the authority of an officer is an officer for purposes of the key employee test. In the case of one or more employers treated as a single employer under sections 414(b), (c), or (m), whether or not an individual is an officer shall be determined based upon his responsibilities with respect to the employer or employers for which he is directly employed, and not with respect to the controlled group of corporations, employers under common control, or affiliated service group.

B. Employee Retirement Income Security Act of 1974 (ERISA) 1. Established to regulate the implementation of various employee benefits programs, including: a. Medical b. Life c. Disability d. Pension 2. ERISA addresses: a. Employers’ reporting and disclosure duties b. Funding of benefits c. Fiduciary responsibilities of programs d. Vesting rights 3. Companies must: a. Provide their employees with straightforward descriptions of their employee benefit plans b. Provide updates when substantive changes to the plan are implemented c. Provide annual synopses on the financing and operation of the plans d. Provide advance notification if the company intends to terminate the benefits plan e. Meet strict guidelines to ensure having sufficient funds when employees reach retirement f. Not engage in transactions with parties having interests adverse to those of the recipients of the plan and not deal with the income or assets of the employee benefits plan in the company’s own interests 4. Vesting refers to an employee’s acquisition of non-forfeitable rights to an employer’s contributions to fund pension benefits a. Employees often must be 100 percent vested within three to six years of service, depending on the vesting schedule b. One hundred percent vested means that an employee cannot lose the pension benefits even if the employee leaves the job before retirement c. Two minimum criteria for eligibility under ERISA: 39 © Pearson Education Limited 2015

i. Employees must be allowed to participate in a pension plan after they reach age 21 ii. Employees must have completed 1 year of service based on at least 1,000 hours of work d. Since the passage of ERISA, there have been a number of amendments: i. Tax Equity and Fiscal Responsibility Act of 1982 ii. Deficit Reduction Act of 1984 iii. Tax Reform Act of 1986 iv. Economic Growth and Tax Relief Reconciliation Act of 2001 C. Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) 1. Enacted to provide employees with the opportunity to continue receiving their employer-sponsored medical care insurance temporarily under their employer’s plan if their coverage otherwise ceases due to: a. Termination b. Layoff c. Other change in employment status 2. Employers exempt from COBRA a. Companies with fewer than 20 workers b. Church plans c. U.S. government plans 3. Coverage a. Individuals may continue their coverage, as well as coverage for their spouses and dependents, for up to 18 months b. Coverage may extend for up to 36 months for spouses and dependents facing a loss of employer-provided coverage because of an employee’s: i. Death ii. Divorce iii. Legal separation iv. Other qualifying events (termination, retirement, layoff) c. Companies are permitted to charge COBRA beneficiaries a premium for continuation coverage of up to 102 percent of the cost of the coverage to the plan 4. COBRA violations a. Employers that violate COBRA requirements are subject to an excise tax per affected employee for each day that the violation continues b. Plan administrators who fail to provide required COBRA notices to employees may be personally liable for a civil penalty for each day the notice is not provided 5. COBRA was signed into law on April 7, 1986 6. COBRA went into effect for members and their dependents on July 1, 1986

40 © Pearson Education Limited 2015

a. The employer must provide covered members and their dependents that would lose coverage under the plan the option to continue coverage b. The mandate is restricted to certain conditions under which coverage is lost, and the election to continue must be made within a specified election period D. Health Insurance Portability and Accountability Act of 1996 (HIPAA) 1. Four main provisions a. The first provision is intended to guarantee that employees and their dependents that leave their employer’s group health plan will have ready access to coverage under a subsequent employer’s health plan, regardless of their health or claims experience b. The second provision sets limits on the length of time that health plans and health insurance issuers may impose preexisting conditions, and identify conditions to which no preexisting condition may apply c. The third provision counts periods of continuous coverage under another form of comprehensive health coverage toward a preexisting condition limit d. The fourth provision protects the transfer, disclosure, and use of health care information E. Pension Protection Act of 2006 1. Designed to strengthen protections for employees’ company-sponsored retirement plans in at least two ways a. The first consideration refers to defined benefit plans (guarantee monthly income for the duration of a retiree’s life) i. Law should strengthen the financial condition of the PBGC by requiring that private sector companies that underfund their defined benefit plans pay substantially higher premiums (that is, cost to provide insurance protection) to insure retirement benefits ii. The increase in underfunded plans poses a greater risk to the financial solvency of the PBGC iii. Aims to shore up the PBGC’s financial condition by making it more difficult for companies to skip making premium payments iv. Raises the amount that employers can contribute to pension funding with tax advantages, creating an additional incentive to adequately fund pension plans b. The second refers to defined contribution plans (savings plans that employees may contribute to for use during their retirement) i. Makes it easier for employees to participate in such employersponsored defined contribution plans as 401(k) plans ii. Millions of workers who are eligible to participate in their employers’ defined contribution plans do not contribute to them because they feel they do not have sufficient knowledge about how to choose investment options (e.g., a high-risk mutual fund versus a fixed rate annuity) that will help them earn sufficient money for retirement 41 © Pearson Education Limited 2015

iv. Pension Protection Act enables companies to enroll their employees automatically in defined contribution plans and provides greater access to professional advice about investing for retirement v. Requires that companies give multiple investment options to allow employees to select how much risk they are willing to bear F. Patient Protection and Affordable Care Act of 2010 1. PPACA was signed into law by President Barack Obama on March 23, 2010 2. The act was amended by the passage of the Health Care and Education Reconciliation Act of 2010 3. These laws provide the basis for health care reform in the United States 4. PPACA is expected to extend coverage to more people by: a. Providing incentives to businesses to offer health insurance or by imposing penalties on companies that do not provide coverage b. Requiring individuals without insurance to purchase reasonably priced policies through health insurance exchanges 5. PPACA distinguishes between health plans that existed prior to March 23, 2012 (grandfathered plans) and ones that come into existence afterwards (non-grandfathered plans) a. Grandfathered plans are exempt from many of the requirements set forth by PPACA while non-grandfathered plans do not have exemption status b. Significant modifications to the provisions of grandfathered plans could result in the loss of grandfathered status III.

Contextual Influences on the Federal Government as an Employer A. Federal Government Employees are not Protected by: 1. Title VII of the Civil Rights Act 2. ADEA 3. Equal Pay Act of 1963 B. Federal Workers Include: 1. Civilian military service employees 2. Executive agency employees 3. U.S. Postal Service employees 4. Library of Congress employees 5. Federal Judicial and Legislative Branch employees C. Executive Orders and Laws that Cover Federal Employees Include (refer to Table 2-5): 1. Executive Order 11478, which prohibits employment discrimination on the basis of race, color, religion, sex, national origin, handicap, and age (401 FEP Manual 4061)

42 © Pearson Education Limited 2015

2. Executive Order 11935, which prohibits employment of nonresidents in U.S. civil service jobs (401 FEP Manual 4121) 3. Rehabilitation Act, which mandates that federal government agencies take affirmative action in providing jobs for individuals with disabilities (401 FEP Manual 325) 4. Vietnam Era Veterans Readjustment Assistance Act, applies the principles of the Rehabilitation Act to veterans with disabilities and veterans of the Vietnam War (401 FEP Manual 379) 5. Government Employee Rights Act of 1991, which protects U.S. Senate employees from employment discrimination on the basis of race, color, age, and disability (401 FEP Manual 851) 6. Family and Medical Leave Act of 1993, which grants civil service employees, U.S. Senate employees, and U.S. House of Representatives employees a maximum 12-week unpaid leave in any 12-month period to care for a newborn or a seriously ill family member (401 FEP Manual 891) IV.

Labor Unions as Contextual Influences A. Labor Unions Overview 1. Workers join unions to influence employment-related decisions, especially when they are dissatisfied with: a. Job security b. Wages c. Benefits d. Supervisory practices 2. From 1954 when union representation was at its highest, the percentage of civilian workers in both the public and private sectors represented by unions has steadily declined a. In 1954, union representation of civilian workforce was 28.3 percent b. In 1983, union representation of civilian workforce was 20.1 percent c. In 2012, union representation of civilian workforce was 11.3 percent B. National Labor Relations Act of 1935 (NLRA) 1. Designed to remove barriers to free commerce and to restore equality of bargaining power between employees and employers a. Employers were denying workers collective bargaining rights on: i. Wages ii. Hours iii. Working conditions b. Employees experienced: i. Poor working conditions ii. Substandard wage rates 43 © Pearson Education Limited 2015

iii Excessive work hours 2. Section I, NLRA states that “…by encouraging the practice and procedure of collective bargaining and by protecting the exercise of full freedom of association, self-organization, and designation of representatives of their own choosing for the purpose of negotiating the terms and conditions of employment…”

3. Section 8(a)(5), NLRA provides that it is unfair labor practice for an employer “…to refuse to bargain collectively with the representatives of the company’s employees subject to the provisions of Section 9(a)” 4. Section 8(d), NRLA defines the phrase “to bargain collectively” as the “performance of the mutual obligation of the employer and the representative of the employees to meet at reasonable times and confer in good faith with respect to wages, hours, and other terms and conditions of employment…”

5. Section 9(a), NRLA declares that “representatives designated or selected for the purposes of collective bargaining by the majority of employees in a unit appropriate for such purposes, shall be the exclusive representatives of all the employees in such unit for the purposes of collective bargaining in respect to rates of pay, wages, hours of employment, or other conditions of employment…”

6. The President appoints members to the National Labor Relations Board (NLRB) a. To oversee enforcement of NLRA b. For a five year term C. Compensation Issues in Collective Bargaining 1. Union influence a. They negotiate with management for general pay increases and costof-living adjustments to maintain memberships’ loyalty and support b. Through the early 1980s, union members earned as much as 30 percent more than nonunion workers c. Negotiated for sound retirement income programs 2. Cost-of-living-adjustments (COLAs) a. Automatic pay increases based on changes in prices, as indexed by the consumer price index (CPI) b. Enables workers to maintain their standards of living by adjusting wages for inflation 3. Union influence has declined because: a. Union companies demonstrated consistently lower profits than nonunion companies b. Major employment cuts in highly unionized companies, like: i. Automobile industry ii. Steel industry 44 © Pearson Education Limited 2015

c. Foreign automobile manufacturers produced high quality vehicles 4. Spillover effect, the benefit packages that are similar to local union benefits that nonunion employers give employees in the hopes of keeping their employees from unionizing 5. Union switch to concessionary bargaining where the bargaining focuses more heavily on promoting job security than on securing large pay increases Effects of the Recession on Ford Motor Company Companies with labor unions often try to avoid instituting mass layoffs whenever possible because of recall features in the collective bargaining agreement. In other words, management is expected to rehire most of its laid off workers when business conditions rebound. However, with the deep recessionary period that began in December 2007 and ended in June 2009, companies still are trying to make permanent cuts to their workforces for substantial labor force savings.

In early 2009, in response to this dire situation, Ford Motor Company announced to local union leaders that it would make buyout or early retirement offers to all of its 42,000 U.S. hourly workers. These cuts were part of a series of contract concessions in a tentative agreement reached between the United Auto Workers union and Ford Motor Company’s management. In addition, the union agreed to a suspension of cost-of-living pay raises and lump-sum performance bonuses in the remaining three years of the recently negotiated collective bargaining agreement.

Example: General Motors Corporation In 2011, the management of General Motors Corporation argued the need to adopt payfor-performance programs for its union workforce. Pay-for-performance systems apply to nonunion salaried workers; thus, the union workforce is not being singled out within the company. If the United Auto Workers were to agree to the use of a pay-for-performance program, this change would represent yet another noteworthy concession.

45 © Pearson Education Limited 2015

Example: Teamsters’ Pension Plan Even more recently, the Teamsters’ union pension plan has become critically underfunded. Critical underfunding raises concerns that the plan will not be able to meet all of its future obligations to pay retirees the pension benefits they have earned. As a result, many of the 1,900 companies that employ Teamsters’ workers are considering whether to withdraw participation in the plan. Withdrawing from participation in the plan means that lower contributions will be made to fund the plan, which increases the risk of failure. This example adds to many recent instances in which unions’ ability to represent the interests of its members is being diminished. Pension plans represent one of the attractive features of joining a labor union, particularly because the prevalence of pension plans (compared to defined contribution plans such as less generous 401(k) savings plans) is much lower in nonunion settings than union settings. As a result, it may be more difficult for the Teamsters union to increase its membership because it has less to offer.

V.

Market Influences A. Inter-Industry Wage/Compensation Differentials 1. The differences in wages and benefits across industries 2. Attributed to: a. The industry’s product market b. The degree of capital intensity c. The profitability of the industry d. Unionization e. Gender mix of the workforce Industry

Mining Construction Manufacturing Retail trade

2005

2007

2011

2013

$800 750 673 377

$946 794 707 380

$1276 988 969 506

$1276 1010 976 516

B. Companies in Product Markets with Little Competition 1. Generally pay higher wages 2. Exhibit substantial profits 3. Exhibit limited new competition because of: a. Higher barriers to entry b. Insignificant influence of foreign competition 4. Government regulations and extremely expensive equipment represent entry barriers 5. Examples a. U.S. defense industry 46 © Pearson Education Limited 2015

b. Public utilities C. Capital Intensity 1. Defined as the extent to which companies’ operations are based on the use of large-scale equipment 2. The amount of average pay varies with the degree of capital intensity a. Generally manufacturing jobs are capital intensive, service jobs are not b. Generally, the more profitable the industry, the higher the compensation D. Outsourcing 1. Jobs to people from other companies have had a significant impact on compensation in the United States 2. Done because of lower labor costs, and fewer government regulations 3. Factory jobs go to places like Mexico and Southeast Asian countries 4. Professional and white collar jobs go to places like India where the labor costs are one-fifth as high as in the United States

VI.

Discussion Questions and Suggested Answers

2-1.

Identify the contextual influence that you believe will pose the greatest challenge to companies’ competitiveness and identify the contextual influence that will pose the least challenge to companies’ competitiveness. Explain your answer.

This is a very subjective question and answers can include things ranging from discussions of laws, politics, economics or other contextual influences.

2-2.

In your opinion, how has your local government played an important role in raising the minimum wage? How can other stakeholders influence the decision on minimum wage?

The answer to this question varies from country to country because the governments in different countries have different employment laws that regulate the minimum wages for its workers.

Some countries like China, Indonesia, Thailand and others have minimum wage laws that must be followed by employers to ensure workers are paid according to this minimum wage level so that low-income workers are able to cope with the rising cost of living or inflation in that country.

In countries like Singapore, there is no minimum wage law. Instead, the Singapore government prefers to engage in a consultative approach with the Union Association (i.e., the National Trade Union Congress) and the Employer Association (i.e., the Singapore 47 © Pearson Education Limited 2015

National Employer Federation) through the National Wage Council in coming up with wage guidelines for adoption by the employers.

The stakeholders who could influence wage negotiation typically involve the employer, the union, and the Government, and the approach to deciding the minimum wage level would vary from country to country.

2-3.

Describe the salient features of your country’s employment laws that provide the minimum coverage in terms of pay, benefits and working conditions that safeguard the workers’ or employees’ employment condition.

The answer to this question varies from country to country because the each country has its own set of employment laws that provide the minimum coverage in terms of pay, benefits and working conditions that protect workers’ pay and benefits as well as their well-being in that country. Students are encouraged to do some research on their own country’s employment laws and to bring it to class for discussion which is to be facilitated by the Instructor/lecturer during lesson.

2-4.

Select one of the contextual influences presented in this chapter. Identify a company that has dealt with this influence, and conduct some research on the company’s experience. Be prepared to present a summary of the company’s experience in class.

A sample answer: There have been many compensation issues in collective bargaining, such as the steady decline in wages after the 1980s. Delta Air Line pilots went on strike to try and increase their wages, but ended up agreeing to substantial cuts in base pay as well as in future retirement income in order to help the company avoid dissolution. This sort of agreement is called concessionary bargaining, for the company spent more heavily on job security than large pay increases. The main reason why the pilots agreed to these terms was because they did not want to lose their jobs.

2-5.

Some people argue that there is too much government intervention, whereas others say there is not enough. Based on the presentation of laws in this chapter, do you think there is too little or too much government intervention? Explain your answer.

One could argue that the government doesn’t do enough to intervene based on the fact that although many laws, acts, and decrees protect employees and employers alike, it is difficult to focus attention on some matters. Increases in wages, for example, may be something that the government ought to look into more closely and with more severity.

Wages are a great source of struggle and anguish for many people. If the government increases wages in line living costs, then all would be well, but this is not always the case. However, one could also argue that the government gets involved in such issues too readily, and that sometimes it’s best for the employees and employers to work out their differences on their own.

48 © Pearson Education Limited 2015

VII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses Case Name: Exempt or Nonexempt?

Instructor Notes The Fair Labor Standards Act (FLSA) addresses the issues of minimum wage, overtime pay and child labor. The FLSA requires employers to properly classify employees as Non-exempt (covered by the Act) or Exempt (not covered by the Act). Many companies want to classify workers as Exempt to avoid the requirement to pay overtime. While the company has the responsibility to properly classify employees, the decision needs to be made based on the responsibilities of the job. The Department of Labor (DOL) has interpreted Exemptions from the Fair Labor Standards Act (FLSA) narrowly. Students can find more details on the exemptions on the DOL’s website at http://www.dol.gov .

Many companies wrongly assume that all supervisors or managers in an organization are Exempt from the FLSA. Aaron v. City of Wichita provides some guidance on classifying supervisors: • • • •

Relative importance of management as opposed to other duties Frequency with which they exercised discretionary powers Relative freedom from supervision Relationship between their salaries and wages paid to other employees offer similar nonexempt workers

In examining all of these factors, it is clear that Jane Swift and the other Shift Leaders should be classified as Non-exempt.

Suggested Student Responses: 2-6.

Why did Amy classify the Shift Leaders are Exempt? Are there any advantages to Jones Department Store to having the Shift Leaders classified as Exempt?

Amy most likely assumed that the Shift Leaders met the Executive exemption under the FLSA. Classifying the Shift Leaders as Exempt was advantageous to the store management, as they did not have to pay the Shift Leaders overtime pay. Further, management saved some extra administrative work because they did not need to track the hours of the Shift Leaders.

2-7.

Do you think that the Shift Leaders are properly classified as Exempt? Why or why not?

49 © Pearson Education Limited 2015

Most likely the Shift Leaders should be Non-exempt. Under the guidance set forth by Aaron v. City of Wichita, the Shift Managers do not meet the criteria to be classified as Exempt.

2-8.

If you were the store manager, what would you offer Jane to compensate her for the loss of earnings?

One approach would be to offer Jane other forms of rewards such as a flexible work arrangement, time off for the extra working hours she has put in her job, learning opportunities to pick up new skills and capabilities (such as management courses and technical courses), and promotion opportunities. Jane would feel appreciated and may consider those intangible rewards as a form of recognition for the extra effort she put into the company.

MYLAB QUESTIONS 2-9.

How would the compensation system change if the minimum wage provision of the Fair Labor Standards Act of 1938 were repealed?

Answer: The Fair Labor Standards Act addresses three broad issues: the minimum wage, overtime pay, and child labor provisions. Clearly, in the absence of such legislation, employers may return to the days where substandard pay was the norm. On one hand, without a minimum wage provision, employers would likely lower the wage for many of these jobs. Further, specific FLSA exemptions already allow employers to pay some workers less than the minimum wage. On the other hand, employers may have difficulty recruiting employees to fill these positions, especially in geographic areas where the cost of living is higher than the national average.

2-10. Distinguish between disparate treatment and disparate impact in a compensation context.

Answer: Disparate treatment refers to intentional discrimination by employers in treating some workers less favorably than others because of their race, color, sex, religion, or national origin. Paying African Americans less than whites for the same job, other factors being equal, is an example of disparate treatment. Disparate impact refers to unintentional discrimination in which an employment practice geared toward all employees leads to unequal treatment of protected employee groups. Awarding seniority pay could lead to disparate impact if females had less seniority, on average, than men.

50 © Pearson Education Limited 2015

VIII. Additional Case from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses Case Name: Preparing for Growth at Waxman Candles Instructor Notes In determining a company’s compensation strategy, a company must analyze both external and internal factors that may impact the strategy. Such an analysis can help support a company’s compensation tactics and ensure effective practices are in place to attract and retain the right talent. This is especially important for companies that are in the growth stage as they can ensure that compensation decisions are made deliberately and the company is positioned well for future growth.

Suggested Student Responses: 2-11. What are some competitive forces that human resource management consultant will consider in conducting a strategic analysis to determine compensation practices?

The consultant should examine the external market environment. In searching for some experienced staff, such as marketing professionals, it is important to understand how to position the company to compete for talent. The consultant should also make an assessment of the labor market. As many of the positions require little skill, understanding the available labor pool and typical earnings ranges will help determine the compensation strategy. Internally, the consultant should examine the necessary capabilities for the different functional areas. For example, because the customization of the product is what differentiates the product from competitors, the customer service function is crucial to business success. Further, the financial condition of the company will help set the parameters of the compensation strategy.

2-12. How will being in the growth stage impact the company’s compensation practices?

Even though the company appears to be financial stable, as a company in the growth stage they must still be aware of cash flow concerns as they determine compensation tactics. Further, they will likely limit discretionary benefits as they have a high cost.

The company may choose to emphasize incentive pay, which ties pay to the company’s profitability as they grow.

51 © Pearson Education Limited 2015

CHAPTER 3 Traditional Bases for Pay: Seniority and Merit Learning Objectives 1. Describe seniority and longevity pay practices.

2. List at least three elements of merit pay.

3. Give examples and definitions of performance appraisal methods.

4. Explain at least three ways compensation professionals can strengthen the pay-forperformance link and summarize each one.

5. Discuss three possible limitations of merit pay programs.

Outline I.

Seniority and Longevity Pay A. Overview B. Historical Overview C. Who Participates?

D. Effectiveness of Seniority Pay Systems E. Design of Seniority Pay Plans F. Advantages of Seniority Pay G. Fitting Seniority Pay with Competitive Strategies II. Merit Pay A. Overview B. Who Participates C. Exploring the Elements of Merit Pay III. Performance Appraisal A. Types B. Trait Systems C. Comparison Systems D. Behavioral Systems E. Goal-Oriented Systems F. Exploring the Performance Appraisal Process IV. Strengthening the Pay-for-Performance Link A. Activities B. Link Performance Appraisals to Business Goals C. Analyze Jobs D. Communicate E. Establish Effective Appraisals F. Empower Employees G. Differentiate Among Performers 52 © Pearson Education Limited 2015

V.

Possible Limitations of Merit Pay Programs A. Potential Problems B. Failure to Differentiate Among Performers C. Poor Performance Measures D. Supervisors’ Biased Ratings of Employee Job Performance E. Lack of Open Communication between Management and Employees F. Undesirable Social Structures G. Factors Other Than Merit H. Undesirable Competition I. Little Motivational Value VI. Discussion Questions and Suggested Answers VII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses VIII. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses.

• • • • •

MAIN POINTS TO TAKE HOME Seniority pay is a fixed pay system that rewards employees based on the amount of time they have accrued in their position.

Merit pay rewards employees on measurable accomplishments as displayed on the job.

Merit pay requires having an effective appraisal system that is linked to pay.

Companies should seek to incorporate merit pay into their compensation structure in order to encourage superior performance.

Merit pay systems are by no means infallible, and require active employee monitoring by compensation professionals in order to reward workers for performing at exemplary levels.

Lecture Outline I.

Seniority and Longevity Pay A. Overview 1. Reward employees with periodic additions to base pay according to length of service 2. Assume that: a. Employees become more valuable over time b. Good employees may leave if not compensated fairly 3. Rationale based on the human capital theory 4. Human capital theory based on belief that: 53 © Pearson Education Limited 2015

a. Employees’ knowledge and skills generate productive capital b. Knowledge and skills can be developed through formal education and training B. Historical Overview 1. National Labor Relations Act of 1935 (NLRA) a. President Franklin D. Roosevelt’s response to: i. Economic disaster caused by the Great Depression of 1929 ii. Desire for balance of power between labor and management b. Established the collective bargaining system 2. Collective Bargaining a. Led to job control unionism b. Collective bargaining units to: i. Negotiate formal work contracts ii. Provide quasi-judicial grievance procedures to adjudicate disputes between union members and employers c. Union shops i. Establish workers’ rights and obligations ii. Describe and delineate jobs d. May determine specific type of seniority system used to decide job i. Scheduling ii. Transfer iii. Layoffs iv. Compensation v. Promotions 3. Seniority pay systems a. Essentially provide automatic pay increases b. Performance assessments tend to be subjective c. The automatic pay adjustments were used to protect public sector employees from political quirks C. Who Participates?

1. Most unionized private and public sector organizations a. Union rank-and-file and clerical workers b. Public sector positions include: i. Administrative ii. Professional iii. Managerial 2. Public employers include: i. Municipal governments ii. State governments 54 © Pearson Education Limited 2015

iii. Federal government D. Effectiveness of Seniority Pay Systems 1. Virtually no systematic research demonstrating seniority pay system plans’ effectiveness or prevalence in the private sector 2. Will probably disappear from for-profit companies in the future due to: a. Increased global competition b. Rapid technological advances c. Skill deficits of new and current workers 3. Until recently, public sector employers had less reason to change pay systems, since their purpose is service not profit a. Since 1949, federal pay based on the General Schedule b. Its effectiveness is now under scrutiny c. The federal government has extensively considered the strategic importance of moving beyond seniority-based pay d. The current pay system has not been modified yet E. Design of Seniority Pay and Longevity Pay Plans 1. Seniority pay a. Object is to reward job tenure through permanent increases to base salary b. Employees start at set base pay then receive time-designated pay increases c. Employees can reach a maximum pay level for a position, but are expected to be promoted and qualify for a new, higher pay structure d. Aging “baby boomer” generation which would make these plans cost prohibitive 2. Longevity pay a. Rewards employees who have reached pay grade maximums and who are not likely to move into higher grades b. Used by state and local governments as an incentive to: i.

Reduce employee turnover ii. Reward employees for continuous years of service c. Can take the form of: i.

A percentage of base pay ii. A flat dollar amount iii. A special step increase based on the number of years the employee has spent with the organization d. Federal employees are subject to longevity pay via the General Schedule (GS) system (refer to Salary Table 2013 GS) i.

Classifies federal government jobs into 15 steps (GS 1 through GS 15) 55 © Pearson Education Limited 2015

ii. iii.

II.

Is based on such factors as skill, education, and experience levels Jobs that require high levels of specialized education, have significant influence on public policy, or require executive decision making are classified separately (e.g., Senior Level, Scientific and Professional, Senior Executive Service) iv. Employees are eligible for 10 within-grade step pay increases which can take approximately 18 years to achieve v. Waiting periods within each step are: Steps 1–3 = 1 year per step; Steps 4–6 = 2 years per step; Steps 7–9 = 3 years per step F. Advantages of Seniority Pay Plans 1. Employees may perceive that they are treated fairly because they earn pay increases by an objective standard instead of supervisory judgment 2. Set pay increases facilitate the administration of pay programs for employers 3. Avoids the perception, by employees, of favoritism G. Fitting Seniority Pay with Competitive Strategies 1. Seniority pay does not fit well with the imperatives of competitive strategies because employees can count on receiving the same pay raises regardless of performance 2. Seniority pay does not fit well with the imperatives of competitive strategies because employees can count on receiving the same pay raises regardless of whether or not companies are meeting their differentiation or cost goals 3. With the exception of companies that are shielded from competitive pressures (e.g., public utilities), it is likely that companies that intend to remain competitive will set aside seniority pay practices 4. Although seniority pay plans reflect employees’ increased worth, they measure such contributions indirectly rather than based on tangible contributions or the successful acquisition of job-related knowledge or skills Merit Pay A. Overview 1. Pay programs that assume that employees’ compensation over time should be determined, at least in part, by differences in job performance 2. Permanent increases are based on performance 3. Rewards excellent effort or results 4. Motivates future performance 5. Helps employers retain valued employees 6. Usually expressed as a percentage of: a. Hourly wages of nonexempt employees b. Annual salaries of exempt employees 56 © Pearson Education Limited 2015

7. In 2013, employees earned average merit increase of 2.8 percent and 2.5 percent 8. The highest performers earned 4.6 percent to base pay, average performers earned 2.6 percent, and the lowest performers earned 0.2 percent B. Who Participates?

1. Merit pay is one of the most commonly used forms of compensation in the United States 2. Fits into the U.S. cultural ideal of rewarding individual achievement 3. Used more in the private for-profit sector than the not-for-profit and public sectors C. Exploring the Elements of Merit Pay 1. Based on objective and subjective indicators of an employee’s job performance 2. Periodic review, by supervisors, of employees’ job performance compared to performance standards and goals 3. Accurate performance appraisals are key to effective merit pay programs 4. To be effective, standards and goals must be realistic and employees must be prepared to meet job goals with respect to their skills and abilities 5. Employees must perceive a strong relationship between attaining performance standards and pay increases 6. Important considerations for deciding on using merit pay a. Adequate funds should be available to fulfill promises to compensate employees (more in chapter 8) b. Adjustments to base pay should be made according to changes in the cost of living or inflation before awarding merit pay raises i.

Inflation represents the increases in the cost of goods and services ii. To minimize the effects of inflation cost-of-living adjustments (COLAs) are added to base pay c. Merit pay raises should be based on performance d. Two important factors i.

Commitment of top management ii. Job design e. Do employees have control over their performance without outside influences that can affect the attainment of performance goals? f. Have employers set explicit performance standards that specify the procedures or outcomes against which employees’ job performance can be clearly evaluated?

6. The amount of merit increase should: a. Reflect prior job performance b. Motivate employees toward improved performance 57 © Pearson Education Limited 2015

c. Be meaningful to employees; “just-meaningful pay increase” which refers to the minimum pay increase that employees will see as making a meaningful change in compensation III.

Performance Appraisal A. Types of Performance Appraisal Plans 1. Trait systems 2. Comparison systems 3. Behavioral systems 4. Goal-oriented systems B. Trait Systems 1. Are based on having raters evaluate each employee’s traits or characteristics such as: a. Quality of work b. Quantity of work c. Appearance d. Dependability e. Cooperation f. Initiative g. Judgment h. Leadership responsibility i. Decision-making ability j. Creativity 2. Appraisals are typically scored using descriptors ranging from unsatisfactory to outstanding 3. They are easy to construct, use, and apply to a wide range of jobs 4. They are easy to quantify 5. They are common in companies that rely on customer service 6. Drawbacks a. Can be highly subjective b. These systems rate individuals on subjective personality factors rather than objective job performance data C. Comparison Systems 1. Types a. Ranking b. Forced distribution c. Paired comparison 2. Ranking a. Designed to evaluate an employee’s performance against the performance of other employees 58 © Pearson Education Limited 2015

b. Performance ratings are then ranked from best to poorest c. Can be based on overall performance or individual traits d. Pay increases are based on ranking 2. Forced distribution performance appraisal systems a. Assign employees to groups that represent the entire range of performance (such as best, moderate, and poor performers) b. Used to minimize the tendency for supervisors to rate most employees as excellent performers, because of supervisors’ self-promotion motives c. Used by some supervisors to avoid alienating employees by judging them negatively d. Can be problematic when the actual distribution is substantially different from the forced one Example: Distorted Ratings due to Forced Distribution • Supervisor required to use the following forced distribution scale 15% well below average 25% below average 40% average 15% above average 5% well above average • If 35 percent of the employees’ actual performance ratings were “above average” or “well above average” then 15 percent of those employees’ performances would be underrated because only 20 percent can be rated as above average or better.

4. Paired comparisons a. Each employee is compared to all others b. Each employee is ranked according to the number of times they are identified as being the better performer c. This method is best suited for small groups of employees who perform the same or similar jobs 5. Drawbacks a. These methods tend to encourage subjective judgments b. The chance for rater errors and biases increase c. Small differences in performance between employees may become exaggerated if supervisors feel compelled to distinguish among levels of employee performance

59 © Pearson Education Limited 2015

D. Behavioral Systems 1. Rate employees on the extent to which they display successful job performance behaviors 2. These objective job behavioral methods, when developed and applied correctly, provide results that are relatively free of rater errors and biases 3. Three main types a. Critical incident technique (CIT) b. Behaviorally-anchored rating scales (BARS) c. Behavioral observation scales (BOS) 4. CIT a. Requires job incumbents and their supervisors to identify performance incidents that distinguish successful performance from unsuccessful ones i. On-the-job behaviors ii. Behavioral outcomes b. Supervisors then observe employees and record their performance on these critical job aspects c. Employees are then rated on how often they display the behaviors in each critical incident (refer to Table 3-7) d. Requires extensive observations and documentation that: i. Identifies successful and unsuccessful job performance behaviors ii. Is recorded by both employees and supervisors 5. BARS a. Similar to CIT, except the incidents are written as expectations instead of achieved behaviors b. Only the most representative behaviors are documented; generally eight to ten behaviors c. Each behavior is then numerically scaled d. Advantages i. Most highly defensible in court because it is based on actual observable job behaviors ii. Encourages all raters to make evaluations in similar ways e. Disadvantages i. Difficult to maintain the volume of data ii. Each job must have distinct appraisal documents iii. As jobs change, so must documentation 6. BOS a. Displays illustrations of positive incidents (or behaviors) of job performance for various job dimensions

60 © Pearson Education Limited 2015

b. Evaluators rate the employee on each behavior according to the extent to which the employee performs in a manner consistent with each behavioral description c. Scores are then averaged to provide an overall rating number d. Developed similar to BARS, except that only positive behaviors are recorded e. Difficult and time consuming to develop and maintain, especially for the supervisor who must observe the behaviors E. Goal-Oriented Systems 1. Management by objectives (MBO) perhaps is the most effective performance appraisal technique because: a. Supervisors and employees determine objectives for employees to meet b. Employees rate themselves on how well they think they met the objectives 2. Used mainly for managerial and professional positions 3. Evaluates employees’ progress toward strategic planning objectives 4. Employees are expected to meet the objectives during the rating period 5. At the end of the rating period, employees will write a report explaining their progress 6. Supervisors appraise performances based on accomplishment of the objectives 7. Can promote effective communication between employees and supervisors 8. Drawbacks a. Companies generally do not fully describe the scope of managerial positions b. Time consuming c. Requires extensive communication between supervisor and employee d. Focuses on specific goals at the exclusion of other vital outcomes, which is referred to as a “results at any cost” mentality 9. Often they are components of broader development programs

61 © Pearson Education Limited 2015

Example: Goal-Oriented Systems • ExxonMobil • Blends goal-oriented systems with performance discussions between managers and employees in the HR function • HR career paths are marked by assignments of increasing responsibility • Employees progress from analyst to supervisory and management positions and are facilitated by a strong commitment to mentoring and coaching • HR functions are integrated into many different businesses F.

Exploring the Performance Appraisal Process 1. Purposes a. Represents a company’s way of telling employees the company’s expectations of them b. Informs employees how well they are meeting those goals 2. Typical process includes supervisors a. Monitoring employees’ performance b. Documenting observations on appraisal forms c. Sharing appraisals with employees d. Basing merit pay increases on job performance 3. Issues a. Merit pay increases based on factors other than job performance can lead to charges of illegal pay discrimination (violation of the Equal Pay Act of 1963), except for: i. A seniority system ii. A merit system iii. Quality or quantity of production iv. Any factor other than gender

Example: Illegal Pay Discrimination • Two female sawyers v. Cascade Wood Components Company • Male sawyers received pay increases before more experienced female sawyers • Cascade could not prove the raises were awarded because of: • Differences in job performance • Seniority • A merit system based on quality or quantity of production • Anything other than gender • Courts found Cascade in violation of Equal Pay Act

62 © Pearson Education Limited 2015

b. Appraisals must be based on job-related factors not on any discriminatory factors 4. Four activities to promote nondiscriminatory performance appraisal practices a. Conduct job analyses to ascertain characteristics necessary for a content valid performance appraisal system i. Accurately define parameters of the job ii. Define behaviors necessary to perform the job effectively iii. Content validity displays the connection between a. and b. (above) iv. Periodically review the appraisal instrument for validity Example: Legislation and Performance Appraisal • Brito v. Zia Company (478 F2d 1200, CA 10, 1973) • Zia violated Title VII because: • A disproportionate number of protected class individuals were laid off, based on low performance appraisal scores • Zia could not prove the appraisal instrument was valid because it did not assess any job-related criteria based on quality or quantity of work b. Incorporate these characteristics into a rating instrument c. Train supervisors to use the rating instrument properly d. Set up formal appeal mechanisms and have upper-level personnel review the ratings to insure accuracy and effectiveness i. Allowing employees to question ratings opens a dialogue with supervisors ii. Employees may point out overlooked performance or explain why a performance was below standard 5. Sources of performance appraisal information a. Five main sources are the employee’s: i. Self ii. Supervisor iii. Coworkers iv. Subordinates (if applicable) v. Customers or clients (if applicable) b. 360-degree performance appraisals i. Are performance appraisal systems that rely on many appropriate sources of performance related information ii. Help companies develop a more complete understanding of current employee performance iii. Help companies reduce the costs of: 63 © Pearson Education Limited 2015

• Recruiting • Hiring iv. Criteria for determining appropriateness of the information source • Is the evaluator aware of the objectives of the employee’s job?

• Has the evaluator frequently observed the employee?

• Is the evaluator qualified to determine if the performance is satisfactory? v. The use of 360-degree performance appraisals is on the rise in the United States because: • Downsizing - organizational structures are becoming less hierarchical • Managers and supervisors are responsible for a larger number of employees, affording less appraisal time for each • These instruments are more conducive to the increased prevalence of work teams, since employees can rate each other • Companies are able to get and use feedback from customers, which increases customer satisfaction 6. Errors in the performance appraisal process a. Rating errors reflect differences between human judgment processes versus objective, accurate assessments uncolored by bias, prejudice, or other subjective, extraneous influences b. Rating errors occur because raters must make subjective judgments c. Most common types of raters’ errors include: i. Bias errors ii. Contrast errors iii. Errors of central tendency iv. Errors of leniency or strictness d. Bias errors i. Happen when rater evaluates employees based on a negative or positive opinion of the employee rather than on the employee’s actual performance ii. Four types • First-impression effect • Halo effects (positive and negative) • Similar-to-me effect • Illegal discriminatory iii. First-impression effect—a manager would have a tendency to make an initial judgment about an employee, and allows that to affect their appraisal

64 © Pearson Education Limited 2015

IV.

iv. Halo effects—rater generalizes behavior on one aspect of the job to all aspects of the job v. Similar-to-me effect • Tendency on the part of raters to favorably judge employees whom they perceive as similar to themselves • Supervisors rate more favorably employees similar to them in such things as attitudes, values, backgrounds, or interests vi. Illegal discriminatory bias occurs when supervisors allow an employee’s race, gender, nationality, or religion influence their performance ratings e. Contrast errors i. Take place when the rater compares the employee to other employees rather than to specific performance standards ii. This is an error because the employee is required to perform only at minimally acceptable standards f. Errors of central tendency i. Occur when a supervisor rates all employees as average or close to average ii. Most often committed when raters are forced to justify only extreme behavior iii. It usually is a good idea to require justification at every level of the scale and not just the extremes g. Errors of leniency or strictness i. Reflect the tendency to rate every employee at the high end or low end of the scale, regardless of actual performance ii. With a leniency error, managers rate employees’ performances more highly than they would rate them using objective criteria iii. Leniency errors cause employees to believe they are going to receive larger pay raises than deserved iv. The opposite occurs with errors of strictness v. These errors mitigate the beliefs that effort varies positively with performance, and that performance influences the amount of pay raises Strengthening the Pay-for-Performance Link A. Activities 1. Link performance appraisals to business goals 2. Analyze jobs 3. Communicate 3. Establish effective appraisals 4. Empower employees 5. Differentiate among performers 65 © Pearson Education Limited 2015

V.

B. Link Performance Appraisals to Business Goals 1. Employee performance should be linked to the company’s competitive strategy 2. For example, everyone in the marketing department working on a specific product should get a merit raise if sales goal are met C. Analyze Jobs 1. Job analysis is important for establishing internally consistent compensation systems (more in chapter 6) 2. Supervisors should match the employees’ performance to the job description a. Descriptions are a product of job analyses b. Descriptions note the duties, requirements, and relative importance of a job within the company 3. May help to reduce arbitrary decisions about merit increases by clarifying the performance standards D. Communicate 1. Employees must clearly understand the link between performance and merit increases 2. Employees need to trust the system and the evaluators E. Establish Effective Appraisals 1. Should be tied to employee’s future performance goals and career plans 2. Deficiencies in performance should include methods to remedy 3. Performance standards should be used for establishing performance targets F. Empower Employees 1. Encourage employee self-appraisals 2. Supervisors as coaches a. By ensuring that employees have access to the resources to perform their job b. By allowing employees to interpret and respond to work problems as they occur G. Differentiate Among Performers 1. Merit increases should consist of meaningful increments 2. Merit increases should clearly reflect differences in actual job performance 2. Rewards can be other than base pay increases like: a. Additional vacation days b. Higher company discounts Possible Limitations of Merit Pay Programs A. Eight Potential Problems 1. Failure to differentiate among performers 66 © Pearson Education Limited 2015

2. Poor performance measures 3. Supervisors’ biased ratings of employee job performance 4. Lack of open communication between management and employees 5. Undesirable social structures 6. Factors other than merit 7. Undesirable competition 8. Little motivational value B. Failure to Differentiate among Performers 1. Poor performers may receive merit increases even though they’re not warranted 2. Poor performers may view increases as entitlements 3. Superior performers may lose motivation to excel C. Poor Performance Measures 1. May be too subjective 2. Developing performance measures for every job is difficult and expensive D. Supervisors’ Biased Ratings of Employee Job Performance 1. Supervisors are subject to a number of errors when they make subjective assessments 2. These errors can undermine the credibility of the performance evaluation process and give employees the perception that pay does not reflect performance E. Lack of Open Communication between Management and Employees 1. Lack of good communication can lead employees to mistrust the performance appraisal process 2. Mistrust can lead to accusations of bias F. Undesirable Social Structures 1. Pay grades can reflect status differentials 2. Permanent merit increases may rigidify the relative pay status of employees over time 3. Lower-paid employees may resent never being able to “catch-up” G. Factors Other Than Merit 1. Supervisors may subconsciously use age or seniority instead of merit 2. Supervisors may let personal feeling determine pay increases 3. Company politics that puts focus on supervisors’ agendas or goals instead of work goals H. Undesirable Competition 1. Between individual employees for limited funds 2. Between individuals in team settings, which may hinder teamwork

67 © Pearson Education Limited 2015

I. Little Motivational Value 1. When employers and employees disagree on what is a “large enough” increase 2. When the yearly increase seems negligible on each paycheck VI.

Discussion Questions and Suggested Answers

3-1.

Human capital theory has been advanced as a rationale underlying seniority pay. Identify two individuals you know who have performed the same job for at least two years. Ask them to describe the changes in knowledge and skills they experienced from the time they assumed their jobs to the present.

Orrin B. Darl has worked at the White Plains library in New York as its head of staff for 20 years. When Orrin first started the job young people asked him many different questions about books. But as time moved on and computers became more important in society, many children stopped coming to the library all together, and when they did all they wanted to do was play on the computer. Orrin didn’t know too much about computers, but he had to learn in order to keep up his relationship with the modern youth.

Francis O. Nylon has worked as a schoolteacher at Princeton Friends in Princeton New Jersey for almost 18 years. When he first began teaching his kids they would come to class everyday with their textbooks and writing utensils and be eager to learn whatever he had to teach them. Francis noticed, however, that as time moved on kids began to bring in laptops and the overall attention span of the children began to decrease. In order to keep the kids engaged, Francis had to learn many programs on the computer so that he could incorporate changing technology into the classroom. As time passed, however, Francis was forced to find another job, for his pay had reached such a substantial level that the school was unwilling to have him work there anymore.

3-2.

Subjective performance evaluations are subject to several rater errors, which makes objective measures seem a better alternative. Discuss when subjective performance evaluations might be better (or more feasible) than objective ratings.

Subjective performance evaluations might be better than objective ratings when clear measurements are not available. Certain subjectivity may also enter in planning for succession and development as subjective characteristics such as compatibility with organizational culture are important. However, in general, objective performance evaluations support better equity and employee understanding.

3-3.

Consider a summer job that you have held. Write a detailed job description for that job. Then, develop a behaviorally anchored rating scale (BARS) that can be used to evaluate an individual who performs that job in the future.

BARS are based on the critical incident technique. Scales are developed in the same fashion with one exception. For the CIT, a critical incident would be written as “the 68 © Pearson Education Limited 2015

incumbent completed the task in a timely fashion.” A good example of applying BARS to a summer job would be that of a kitchen assistant. A kitchen assistant has to be on time and show up for work prepared with the proper clothing and sanitation. The kitchen assistant has to make sure to keep their work area and the work area of everyone else clean, so as to provide fresh food that does not cause health problems or violate any health codes. If these basic rules are not followed then food preparation could be contaminated by unwanted bacteria or would not be prepared in a timely manner, thus harming business.

3-4.

This chapter indicates that merit pay plans appear to be the most common form of compensation in the United States. Although widely used, these systems are not suitable for all kinds of jobs. Based on your knowledge of merit pay systems, identify at least three jobs for which merit pay is inappropriate. Be sure to provide your rationale given the information in this chapter.

Temporary workers do jobs that are not well suited for merit pay because there is no long term opportunity to measure performance. Repetitive assembly line work is not well suited to merit pay because there is limited ability to vary performance (piece work pay may be appropriate). Certain sales jobs may not be suitable for merit pay if employees are paid based mostly on commissions.

3-5.

What are some of the challenges faced by employees in implementing merit pay plans from various perspectives such as business and cultural factors?

From the business perspective, merit pay plan is costly to the company because base pay increase is permanently built into the employee’s pay plan and does not necessarily translate into improved employee’s performance or productivity. The cost of base pay increase is perpetual and compounded because future merit increase is based on higher base salary. From the cultural perspective, employees may view merit increase as an indication of how their employers value their performance and contribution to the company, especially in countries where monetary rewards are treated as more important than intangible rewards like work-life balance.

VII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses Case Name: Appraising Performance at Precision

69 © Pearson Education Limited 2015

Instructor Notes A merit pay program provides employees with an annual pay increase that is awarded based on the individual employee’s performance. In order for the program to work effectively, the company must have the ability to measure employee performance.

Further, employees must know that their effort will lead to pay increases. An effective performance appraisal process must be able to recognize employee performance that is in line with the company’s productivity goals and/or business strategy. Ultimately the company must ensure that there is a strong link between pay and performance.

Suggested Student Responses: 3-6.

What are some problems with Precision’s performance appraisal process that might cause challenges for Jackson to implement a merit pay program?

There are many problems with the current appraisal process. Because the same form is used for all employees, it is clear that the performance measures used are not clearly tied to individual productivity and performance expectations. Supervisors make several errors in the process as well, such as central tendency in ratings, and failure to communicate with employees on a regular basis about their performance.

3-7.

As an HR professional, how would you advise Jack on improving the current performance appraisal process and aligning it to the pay-for-performance plan?

The process should first establish clear performance objectives for the employees individually and ensure the supervisors and employees have discussed and mutually agreed on performance objectives aligned to the pay-for-performance plan. The progress of the employees’ performance objectives should be reviewed on a regular basis so that there is sufficient feedback given to them to improve on their performance before the end of the performance period. Supervisors should provide coaching and guidance for their employees to close any performance gaps either through on-the-job training, direct supervision, or class-room training. Employees would thus be fully apprised and prepared when their supervisors conduct the performance review discussion to determine the rewards for achievement of performance targets or objectives.

MYLAB QUESTIONS 3-8.

Discuss the concept of "just-meaningful pay increase." How can it can strengthen the pay-for-performance link?

Answer: A successful answer should contain several elements. First, a student should discuss the notion of perception. The pay increase must be seen by employees as making a meaningful change in compensation. A discussion of equity theory would be appropriate. Second, students should discuss cost-of-living differences among individuals. Students may also want to discuss the link between pay and motivation. Will 70 © Pearson Education Limited 2015

the pay increase necessarily have the performance effects a company is looking for?

Distinction between top performers and full performance should be clear so that top performance continue their performance. When merit increases do not reflect differences in actual job performance, companies may provide alternative rewards such as additional vacation days to complement merit pay increases.

3-9.

A company of 15 employees has recently decided to overhaul its performance appraisal system. Which plan would be most appropriate for the company to adopt? Why?

Answer: An answer should consider why the size of the company is of importance in considering the adoption of a performance appraisal plan. Further, the students should discuss the relative merits and liabilities of the different categories of performance appraisal methods (trait systems, comparison systems, behavioral systems, and goaloriented systems). Students may also consider the supervisors' appraisal approaches as well as the compensation specialists' skills in designing and implementing such plans.

The corporate and compensation strategies, respectively, are also important.

VIII. Additional Case from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses Case Name: Pay Overtime or Hire More Staff?

Instructor Notes Under the Fair Labor Standards Act (FLSA), employers are required to pay overtime pay to non-exempt workers for hours worked in excess of 40 hours in one workweek. Part of the original intent of the FLSA was to encourage employment by creating an incentive for employers to hire additional workers by requiring overtime pay. Often, it is more cost efficient to hire additional workers instead of consistently paying overtime pay to current workers. However, it is important to consider all of the costs associated with hiring a new employee when evaluating the need for additional staff.

Suggested Student Responses: 3-10. What are some factors that Heidi should consider as she determines whether or not she should hire an additional worker?

Heidi needs to understand the company’s long-term workload expectations.

Sometimes paying overtime is more cost efficient than hiring additional workers.

Students may actually do some calculations in determining the response to this question. They may want to consider the number of employees, the average amount of overtime and the costs of paying overtime. As they consider the cost of overtime, they should consider the cost of producing a product. At $20 per hour, 40 hours of 71 © Pearson Education Limited 2015

work costs $800, but $800 provides only about 26 hours of overtime work.

Therefore, overtime pay adds to the overall cost of producing a product. Students should also consider the other fixed costs of hiring a new employee including benefits.

3-11. Based on the information provided, do you think Heidi should hire an additional worker?

If each of the twenty-five workers works just 8 hours of overtime each month, the company is paying nearly $6,000 per month in overtime pay. Hiring one additional worker would only cost about $3,200 per month. After considering the added productivity that another worker could add, even with relatively high benefit costs, it would seem logical to hire at least one additional staff member. However, Heidi should first examine demand forecasts to determine if current demand levels will be maintained over time.

72 © Pearson Education Limited 2015

CHAPTER 4 Incentive Pay Learning Objectives 1. Explain two reasons why companies use incentive pay.

2. Concisely provide a contrast between incentive pay methods and traditional pay methods.

3. List three categories of incentive pay plans.

4. Define individual incentive plans and give one example.

5. Provide the definition group incentives and summarize two examples of group incentive plans.

6. Discuss the advantages and disadvantages of group incentive plans.

7. Offer a definition of company-wide incentive plans with an example.

8. List and summarize five factors in the design of incentive pay programs.

Outline I. Exploring Incentive Pay II. Contrasting Incentive Pay with Traditional Pay III. Individual Incentive Plans A. Defining Individual Incentives B. Types of Individual Incentive Plans C. Piecework Plans D. Management Incentive Plans E. Behavioral Encouragement Plans F. Referral Plans G. Advantages of Individual Incentive Plans H. Disadvantages of Individual Incentive Plans IV. Group Incentives A. Defining Group Incentives B. Types of Group Incentive Plans C. Team-based or Small Group Incentive Plans D. Gain Sharing Plans E. Scanlon Plan F. Rucker Plan G. Improshare H. Comparison of Plans I. Advantages of Group-Incentive Plans J. Disadvantages of Group-Incentive Plans 73 © Pearson Education Limited 2015

V.

Companywide Incentives A. Defining Companywide Incentives B. Types of Companywide Incentive Plans C. Profit Sharing Plans D. Calculating Profit Sharing Awards E. Advantages of Profit Sharing Plans F. Disadvantages of Profit Sharing Plans G. Employee Stock Option Plans VI. Designing Incentive Pay Programs A. Five Key Considerations B. Group versus Individual Incentives C. Level of Risk D. Complementing or Replacing Base Pay E. Performance Criteria F. Time Horizon VII. Discussion Questions and Suggested Answers VIII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses IX. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses.

Lecture Outline I.

Exploring Incentive Pay 1. Compensation, other than base wages or salaries, which fluctuates according to employees’ attainment of some standard such as: a. A pre-established formula b. Individual or group goals c. Company earnings 2. Also known as variable pay, rewards employees for partially or completely attaining predetermined work objectives 3. Effectiveness based on three assumptions a. Individual employees and work teams differ in how much they contribute to the company, and in how well they do it b. The company’s overall performance depends on the performance of its employees c. How well it attracts, retains, and motivates high performers d. How well it rewards all employees for their relative performance 4. Adds to base pay as a one-time payment 74 © Pearson Education Limited 2015

5. Usually, employees receive a combination of recurring base pay and incentive pay, with base pay representing the greatest portion of core compensation 6. Designed to: a. Control costs i. By replacing annual merit or seniority increases, or fixed salaries ii. With pay raises based on a rise in productivity, profits, or other measure of business success b. Motivate employee productivity 7. Increased use for: a. Production workers b. Technical employees c. Service workers d. Professionals e. Managers f. Executives 8. Employees’ earnings potential is increased Examples: Incentive Program • Lincoln Electric Company • Awards based on five performance criteria • Quality • Output • Dependability • Cooperation • Ideas • Job importance based on job evaluation techniques, five criteria • Skill • Responsibility • Mental aptitude • Physical application • Working conditions • The company has awarded incentive payments for the last 75 years in both good and bad economies. The average annual incentive payment per employee amounts to 40 percent of annual salary

75 © Pearson Education Limited 2015

Examples: Incentive Program • H. Lee Moffitt Cancer Center and Research Institute, at the University of South Florida • Goals are to improve patient care and control costs • Incentives tied to the company’s: • Net income or operating surplus • Quality of care measures • Patient satisfaction scores • Operating efficiencies II.

Contrasting Incentive Pay with Traditional Pay 1. Traditional pay plans based on: a. Fixed hourly wage or annual salary that is determined by: i. Relative worth of positions to the company ii. The going industry rate b. Raises based on: i. Seniority ii. Past performance iii. Supervisor’s appraisals iv. Percentage of base pay, currently from two to six percent c. Merit pay performance standards should be: i. Measurable ii. Objective

Example: Incentive Pay Plan • Taco Bell Restaurants • Offer managers biannual bonus based on attainment of: • Target profit levels • Quality of customer service • Store sales • These incentives are used to motivate managers as they know about them ahead of time d. Incentive pay programs replace all, or a portion, of base pay to: i. Control payroll expenditures ii. Link pay with performance 2. Incentive pay a. Designed to reward employees and teams for performance b. Classified into three categories 76 © Pearson Education Limited 2015

i. Individual-incentive plans ii. Group-incentive plans iii. Company-incentive plans c. Levels tend to be based on even more objective criteria d. Awards are communicated in advance, merit awards are not Example: Typical Performance Measures per Incentive Plan • Individual-incentive plan • Quantity of work output • Quality of work output • Monthly sales • Work safety record • Work attendance • Group-incentive plan • Customer satisfaction • Labor cost savings • Materials cost savings • Reduction in accidents • Services cost savings • Companywide incentive plan • Company profits • Cost containment • Market share • Sales revenue III.

Individual Incentive Plans A. Defining Individual Incentives 1. A system to reward employees for meeting work-related performance standards, such as: a. Quality b. Productivity c. Customer satisfaction d. Safety e. Attendance 2. Appropriate when: a. Performance can be measured objectively, like: i. Units produced ii. Sales volume 77 © Pearson Education Limited 2015

iii. Reduction in error rate b. Employees have sufficient control over work outcomes i. Factors like frequent equipment breakdowns and delays in receiving raw materials are not under employees’ control ii. Employees are not likely to be diligent when they encounter these types of interferences c. The incentives do not create a level of unhealthy competition among workers Example: Unhealthy Competition • Company limits awards to 10 percent of employees who have demonstrated high levels of performance • If performance is judged on quantity not quality, quality might suffer • High performers might receive intimidation from low performers • Unions may use these intimidation tactics to prevent plan standards from being raised B. Types of Individual Incentive Plans 1. Piecework plans 2. Management incentive plans 3. Behavior encouragement plans 4. Referral plans C. Piecework Plans 1. Two common types a. Rewards based on individual production against an objective standard b. Rewards based on individual performance standards that include both objective and subjective criteria 2. Rewards based on individual hourly production against an objective output standard a. Usually found in manufacturing settings like: i. Textiles ii. Apparel b. Usually includes guaranteed hourly rate and incentives c. Quality may also be a consideration d. Used when the time to production is short and the cycle repeats continuously e. Awards are not granted for producing defective products 3. Rewards based on individual performance standards that include both objective and subjective criteria a. Usually found in service industries 78 © Pearson Education Limited 2015

b. Units produced represent the objective standard c. Quality (i.e., customer service) is the subjective standard and is determined by supervisors’ interpretations and judgments 4. Two advantages to companies using piecework plans in manufacturing settings a. Incentive effect b. Sorting effect 5. Incentive effect refers to a worker’s willingness to work diligently to produce more quality output 6. Sorting effect refers to an employee’s choice to stay versus leave for another job, probably one without an incentive pay contingency D. Management Incentive Plans 1. Awards bonuses to managers when they meet or exceed objectives based on: a. Sales b. Profit c. Production d. Other measures for their: i. Division ii. Department iii. Unit 2. Is based on superiors communicating the amount of incentive pay managers can receive if goals are met 3. Differ from piecework plans in that: a. Piecework plans base rewards on one specific objective b. Management incentive plans often require multiple complex objectives 4. Management by Objectives (MBO) a. Best known management incentive plan b. Is an outcome-oriented performance appraisal technique for merit pay systems i. Superiors make subjective assessments of performances ii. Assessments determine permanent merit pay increases c. When used in an incentive program, the award amounts and goals needed to receive them are communicated ahead of time E. Behavioral Encouragement Plans 1. Awards employees for specific behavioral accomplishments like: a. Good attendance b. Safety records 2. Employees are generally informed of possibilities ahead of time to motivate them to reach the goals 3. Have the potential to save companies substantially more money than the 79 © Pearson Education Limited 2015

cost of these awards F. Referral Plans 1. Companies rely on referral bonuses to enhance the recruitment of highly qualified employees 2. Employees awarded bonus for referring new customers 3. Employees awarded bonus for referring new employees if the new hires remain employed for a designated period (e.g., 30 days) Example: Referrals • Recruiting Nurses • Tremendous shortage of nurses • Some hospitals offer $15,000 sign-on bonuses to nurses and a $5,000 referral bonus to those who referred them 4. Based on the idea that referring employees’ familiarity with the organizational culture will lead them to refer prospects who would fit into the culture G. Advantages of Individual Incentive Plans 1. Can promote the relationship between pay and performance 2. Can promote an equitable distribution of compensation within companies 3. Equitable pay enables companies to retain the best performers 4. These plans are compatible with the individualistic cultures H. Disadvantages of Individual Incentive Plans 1. Have the potential to promote inflexibility 2. Supervisors set performance standards 3. Loses motivational effect when goals are too low or too high 4. May encourage undesirable workplace behaviors Example: Disadvantage • Predetermined maximum incentive award . . . . $500 • Predetermined standard for award . . . . . . . . . 15% above productivity level • No incentive to work above 15% IV.

Group Incentives A. Defining Group Incentives 1. An employee incentive pay program that rewards employees for their collective performance 2. Not used for each employee’s individual performance 3. Used more now because, since the 1980s a. U.S. companies have realized the improved quality of the team-based 80 © Pearson Education Limited 2015

Japanese automobile companies that were manufacturing cars in this country b. U.S. companies have realized that team-based job design promotes innovation in the work place Example: Group Incentive Plan • RubberMaid • Manufactures plastic household products • Product innovation has become the rule since the implementation of project teams • Teams might include employees from: research and development, finance, marketing, and manufacturing 4. Team-based pay plans should: a. Emphasize cooperation between and within teams b. Compensate employees for additional responsibilities c. Encourage team members to attain predetermined objectives for the team 5. Merit, seniority, or individual incentives do not encourage, and may limit effective team behaviors 6. Used to encourage team members to learn new skills and assume broader responsibility 7. All group members contribute, even though the individual contributions might not be equal 2. The plan reinforces teamwork 3. The plan cultivates loyalty to the company 4. The plan increases productivity Example: Unequal Contributions to a Team • Boeing • Aircraft manufacturer • 200 manufacturing teams build the 777 jumbo jet • Teams that install the interior trim features are not quite as essential as the teams ensuring the aerodynamic integrity of the aircraft

81 © Pearson Education Limited 2015

Example: Loyalty • Volvo’s Uddevalla manufacturing facility • Renowned quality of Volvo automobiles has been attributed to using teams effectively • Each team is responsible for: • Managing itself • Managing its own budget • Hiring its own team members B. Types of Group Incentive Plans 1. Two main types a. Team-based or small group incentive plans b. Gain sharing plans C. Team-based or Small Group Incentive Plans 1. Each team member receives a financial reward upon completion of the group goal 2. Types of teams that fall under team incentive plans a. Work (process) teams i. Organizational units that perform the work of the organization on an ongoing basis ii. Membership is relatively permanent iii. Members work full time in the team iv. Goal is to maintain consistency of performance v. Performance sharing b. Project teams i. Group of people assigned to complete a one-time project ii. Well-defined roles in specific parts of the project iii. Either full time or in addition to other responsibilities c. Parallel teams or task forces i. Employees assigned to work on a specific task in addition to normal work duties ii. Operate on a temporary basis iii. Used to evaluate existing systems and processes, select new technology, and improve existing products 3. The kinds of programs are defined according to the performance criteria a. Customer satisfaction b. Safety records c. Quality d. Production records 4. Rewards allocated three ways a. Equal incentive payments to all team members b. Differential payments to team members based on their contributions to 82 © Pearson Education Limited 2015

the goal c. Differential payments determined by a ratio of each team members’ base pay to the total base pay of the group 5. Equal incentive payments to all team members a. Reinforces cooperation among team members, except when team members perceive differences in members’ contributions or performance 6. Differential payments to team members based on their contributions to the goal a. Can hinder cooperative behavior b. Can be modified to include both individual and team incentives 7. Differential payments determined by a ratio of each team members’ base pay to the total base pay of the group a. Rewards each team member in proportion to their base pay b. Assumes that employees with higher base pay contribute more to the company, so they should be rewarded accordingly D. Gain Sharing Plans 1. Defined as group incentive systems that provide employees an incentive based on improved company performance in areas such as: a. Increased productivity b. Increased customer satisfaction c. Lower costs d. Better safety records 2. Reflects management philosophy that emphasizes employee involvement and suggestions 3. Most appropriate where work place technology does not constrain productivity improvements 4. Not appropriate for companies that have variable annual profits, because excess cash for bonuses is limited 5. Three main components a. Leadership philosophy, which refers to a cooperative organizational climate that promotes high levels of trust, open communication, and participation b. Employee involvement systems, drives organizational productivity and includes improvement suggestions and problem-solving ideas c. Bonuses, which are awarded when actual productivity exceeds targeted productivity levels 6. Bonuses a. Are based on a formula that the employer believes fairly measures employees and will result in improvements in company performance 83 © Pearson Education Limited 2015

b. Are awarded on a monthly basis c. Generally range between 5–10 percent of an employee’s base annual pay d. AmeriSteel’s gain sharing plan pays between 35–45 percent of base pay 7. There has been no comprehensive, soundly designed investigation on the effectiveness of gain sharing programs 8. Causes of plan failures a. Organizational factors b. External environment factors c. Financial information factors d. Factors such as poor communications, highly competitive product markets, variable corporate profits 9. Three most common forms a. Scanlon plan b. Rucker plan c. Improshare E. Scanlon Plan 1. Developed by Joseph Scanlon in 1935 a. Emphasized employee involvement b. Did not involve monetary rewards c. Based on the belief that employees will: i. Exercise self-direction and self-control if they are committed to company objectives ii. Accept and seek out responsibility if given the opportunity 2. Current plan’s main components a. Includes monetary rewards to employees for productivity improvements b. Assumes that companies will be able to: i. Offer higher pay to workers ii. Generate increased profits for stockholders iii. Lower prices for consumers c. Emphasis on teamwork to reduce costs, assisted by managementsupplied information on production concerns d. A two-tiered cost-savings suggestion system i. Production-level committees ii. Companywide screening committees e. Production-level committees i. Usually include a supervisor and one worker 84 © Pearson Education Limited 2015

ii. Communicate the suggestion program and its reward features to employees iii. Encourage and assist workers making suggestions and formally records suggestions for consideration iv. Forward appropriate suggestions to companywide screening committee v. May reject suggestions that are not feasible, if they put the reasons in writing f. Companywide screening committees i. Review employees’ suggestions from the production committee ii. Serve as the communication link between employees and management iii. Review the company’s performance each month g. Monetary rewards for productivity improvements i. Based on a ratio of labor costs and sales value of production (SVOP) ii. SVOP is the sum of sales revenue plus the value of goods in inventory iii. Scanlon Ratio = Labor Costs/SVOP h. Smaller Scanlon ratios indicate that labor costs are lower relative to SVOP F. Rucker Plan 1. Developed by Allan W. Rucker in 1933 2. Emphasizes employee involvement and provides monetary incentives 3. Uses a value-added formula to measure productivity, which is the difference between the value of the sales price and the value of materials used to make the product (refer to Table 4-6) 4. Larger Rucker ratio indicates that the value added is greater than the total employment costs 5. Rucker Ratio = Value added/Total employment costs Example: Rucker Plan’s Value-Added Formula • The making and selling of bread • Farmer grows wheat and sells to miller (added value = farmer’s income – costs of seed, fertilizer, fuel, and other supplies) • Miller processes wheat and sells to baker (added value = cost of wheat – price received from baker) • Baker mixes wheat flour with other ingredients, bakes bread, and sells to retailer (added value = cost of ingredients and baking process – price of bread sold to retailer) • Retailer transports, advertises, and displays bread to consumers (added value = cost of bread from baker – price sold to consumer) 85 © Pearson Education Limited 2015

G. Improshare 1. Invented by Mitchell Fein in 1973 2. Defined as “Improved Productivity through Sharing” it measures productivity physically rather than in terms of dollar savings 3. Aims to produce more products with fewer labor hours 4. Emphasis on providing employees with an incentive to finish products 5. Improshare bonuses are based on a labor hour ratio formula a. A standard based on analyzing the historic relationship between the number of labor hours needed to complete a product is determined b. Productivity is then measured as a ratio of the standard hours compared to the actual hours it takes to produce the product now c. Unlike the Scanlon and Rucker Plans, employee participation is not a feature and workers receive bonuses on a weekly basis 6. Includes a buy-back provision a. The provision is a maximum productivity improvement pay out level that is placed on productivity gains b. When the productivity goal is consistently reached or exceeded i. The productivity improvement is bought back by the company and given to employees’ as a one-time payment ii. New, higher maximum productivity levels are set iii. Any bonus money generated by the improvements are placed in a reserve c. The company must ensure that the new productivity levels are reachable d. In union settings, management’s discretion may be challenged when union leadership believes that management is exploiting workers by making it more difficult for them to receive bonuses H. Comparison of the Scanlon, Rucker, and Improshare Plans 1. Program goals a. Scanlon: productivity improvement b. Rucker: productivity improvement c. Improshare: productivity improvement 2. Basis for savings a. Scanlon: labor costs b. Rucker: labor costs + raw materials costs + service costs c. Improshare: completing work at or before target standard 3. Employee involvement a. Scanlon: required b. Rucker: required 86 © Pearson Education Limited 2015

c. Improshare: NA 4. Type of involvement a. Scanlon: screening and production committees b. Rucker: screening and production committees c. Improshare: NA 5. Bonus pay-out frequency a. Scanlon: monthly b. Rucker: monthly c. Improshare: weekly 6. Increasingly, companies combine gain-sharing plans with other approaches to boost productivity and cost savings I. Advantages of Group-Incentive Plans 1. Companies can more easily develop performance measures for group plans than individual plans a. There are fewer groups and individuals b. Therefore, companies need fewer resources to develop the performance measures 2. Judging the quality of the final product helps ensure market competitiveness 3. Greater group cohesion J. Disadvantages of Group-Incentive Plans 1. May lead to higher employee turnover because of the free-rider effect a. Employee contributions to the group vary because of skill, ability, experience, or motivation b. The most productive employees may leave when equal rewards are given for unequal contributions 2. Dissatisfaction may be heightened where incentive compensation represents the lion’s share of core compensation V.

Companywide Incentive Plans A. Defining Companywide Incentives 1. Instituted in the 19th century as a way for companies to ease workers’: a. Dissatisfaction with low pay b. Belief that company management paid them substandard wages while earning substantial profits 2. Defined as systems that reward employees when the company exceeds minimally acceptable performance standards 3. Advocates believe that well-designed programs make workers’ and owners’ goals more compatible as workers strive toward increasing company profits or value 87 © Pearson Education Limited 2015

B. Types of Companywide Incentive Plans 1. Profit sharing plans 2. Employee stock option plans C. Profit Sharing Plans 1. Pay a portion of company profits to employees, separate from: a. Base pay b. Cost-of-living adjustments c. Permanent merit pay increases 2. Two basic kinds a. Current profit sharing plans b. Deferred profit sharing plans 3. Current profit sharing plans a. Award cash to employees typically on a quarterly or annual basis as part of their core compensation b. Are subject to IRS taxation when earned 4. Deferred profit sharing plans (more in Chapter 10) a. Place cash awards in trust accounts for employees for retirement b. Are not taxed until the employee withdraws money from their account, usually at retirement c. Can withdraw money early, but will be subject to a stiff tax penalty D. Calculating Profit Sharing Awards 1. Fixed first-dollar-of-profits formula 2. Graduated first-dollar-of-profits formula 3. Profitability threshold formulas 4. Fixed first-dollar-of-profits formula a. Based on a specific percentage of either pre- or post-tax annual profits b. Contingent upon successful attainment of a company goal 5. Graduated first-dollar-of-profits formula a. Based on percentages of pre- or post-tax profits b. The percentage increases as profits increase c. Motivates employees to strive for extraordinary profit targets by sharing even more of the incremental gain with them Example: Graduated Profit Sharing Plan • Employees receive 3 percent of the first $8 million of profits • Employees receive 6 percent of profits over $8 million

88 © Pearson Education Limited 2015

6. Profitability threshold formulas a. Fund profit sharing pools when profits fall within predetermined minimum and maximum levels b. Minimum levels are established to ensure a return for shareholders c. Maximum levels are set with the belief that profits above these levels are due to reasons other than employee productivity 7. Three common distribution methods a. Equal payments i. To all employees ii. Promotes cooperation among employees, despite contribution to profits b. Proportional payments based on annual salary i. Presumes that higher salaries equate to more contributions to profit levels ii. Most higher salaries generally relate to higher performance or seniority c. Proportional payments based on contribution to profits i. Generally, based on performance ii. Not widely used, as it may be difficult to quantify each employee’s contribution 8. Profit sharing and core compensation a. Profit sharing amount treated as a bonus when base pay is market competitive b. Profit sharing viewed as pay at risk when i Base pay is below market average ii. The incentive amount is expected to bring base pay up to or above the market average E. Advantages of Profit Sharing Plans 1. Enables employees to share in companies’ profits 2. Allows companies greater financial flexibility 3. During economic downturns, payout levels are significantly lower than during economic boom periods which enables companies to use limited cash reserves where needed F. Disadvantages of Profit Sharing Plans 1. For employees a. Can undermine their economic security, especially when: i. Its provided as a pay at risk award ii. It represents a sizable portion of direct compensation b. May fail to motivate them if they do not see a direct link between their efforts and corporate profits 89 © Pearson Education Limited 2015

2. For employers, it may lead to high turnover of productive employees, if awards are predominately small G. Employee Stock Option Plans 1. Overview a. Companies grant employees the right to purchase shares of company stock b. Company represents total equity of a company stock c. Company stock shares represent equity segments of equal value d. Equity interest increases positively with the number of stock shares e. Stock options i. Describe an employee’s right to purchase company stock ii. Employees do not own the stock until they exercise the stock option rights, by purchasing stock at a designated price after a company-chosen time period lapses, usually no more than five years iii. Provide an incentive for employees to work productively with the expectation that collective employees’ productivity will increase the value of company stock over time iv. Employees earn monetary compensation when they sell the stock at a higher price than they originally paid for it 2. Other types of general stock compensation plans a. Employee stock ownership plans (ESOP) (more in Chapter 10) i. Places company stock in trust accounts for employees ii. Similar to deferred profit sharing because these trusts are set aside as a source of retirement income b. Stock compensation plans (more in Chapter 10) i. A form of deferred compensation for executives ii. Are supposed to create a sense of ownership, aligning the interests of the executive with those of the owners or shareholders (more in Chapter 12) VI.

Designing Incentive Pay Programs A. Five Key Considerations 1. Should the plan be based on group or individual employee performance?

2. What level of risk will the employees be willing to accept in their overall compensation package?

3. Should the incentive pay replace or complement traditional pay?

4. What criteria should be used to judge performance?

5. Which time horizon for meeting goals would be most effective?

90 © Pearson Education Limited 2015

a. Long-term? b. Short-term? c. Some combination?

B. Group versus Individual Incentives 1. Group incentives are most suitable where: a. The nature of work is interdependent b. The contributions of individual employees are difficult to measure 2. Individual incentives a. Reward employees for meeting or surpassing predetermined individual goals b. Are most suitable for employees whose work is independent not interdependent, such as: i. Meeting production goals ii. Sales quotas 3. Both options require goals that are attainable C. Level of Risk 1. Increases as incentive pay represents a greater proportion of total core compensation 2. Is usually greater among employees with higher level jobs 3. Should be dependent on the extent to which an employee controls the attainment of the desired goal D. Complementing or Replacing Base Pay 1. When complementing base pay, the company awards incentive pay in addition to base pay and fringe benefits 2. Companies may reduce base pay by placing the reduced portion at risk in an incentive plan 3. Depends on the level or risk the employees are willing to accept 4. Depends on how cyclical the business is a. Cycles determine the amount of money available b. Cycles determine the employees’ ability to meet incentive goals 5. During slow business periods a. Increases in base pay in regular merit pay programs can create budget problems b. With incentive pay programs, the pay increases can be tied to the profitability of the company

91 © Pearson Education Limited 2015

Example: Incentive Pay and Base Pay • A company offers employees a 10 percent raise each year • Instead it could offer employees a • 4 percent cost-of-living increase • Awarding none of the remaining 6 percent to below average workers • 3 percent to average workers • 6 percent to high performing workers • The 6 percent is no longer a guarantee because that potential salary is placed at risk • Therefore high performers could earn more than 6 percent getting some of the money not earned by the lower producers E. Performance Criteria 1. Measures used to appraise performance should be quantifiable and accessible 2. Measures should include: a. Company profits b. Sales revenue or units of production 3. Measures should relate to the company’s competitive strategy 4. If more than one measure is relevant, each should be weighed to reflect its relative importance to the company’s competitive strategy Example: Weighing Performance Measures • When the amount of employees’ incentive pay is based on: • Company performance = 10% • Unit performance = 40% • Individual performance = 50% • The level of risk is minimal • When the amount of employees’ incentive pay is based on: • Company performance = 50% • Unit performance = 35% • Individual performance = 15% • The level of risk is much higher F. Time Horizon: Short-Term versus Long-Term 1. “Rule-of-thumb” is that short-term is five years or fewer 2. Incentives for lower-level employees are: a. Usually short-term b. Goals are within the control of the employees 92 © Pearson Education Limited 2015

3. Incentives for professionals’ and executives’ are generally long-term VII.

Discussion Questions and Suggested Answers

4-1.

Indicate whether you agree or disagree with the following statement: “Individual incentive plans are less preferable than group incentives and companywide incentives.”

Individual incentive plans reward employees whose work is performed independently.

Some companies have piecework plans, typically for their production employees. Under piecework plans, an employee’s compensation depends on the number of units she or he produces over a given period. Group incentive plans promote supportive, collaborative behavior among employees. Companywide plans tie employee compensation to a company’s performance over a short time frame, usually from a three-month period to a five-year period. Individual incentive plans are actually more preferable than group incentive plans and companywide incentive plans because they influence the employee to work there hardest. The downside to group incentive plans and companywide plans is that the overall pay is reflected by how the company performs as a whole, which is not necessarily reflective of individual effort.

4-2.

There is currently a tendency among business professionals to endorse the use of incentive pay plans. Identify two jobs for which individual incentive pay is appropriate and two jobs for which individual incentive pay is inappropriate. Be sure to include your justification.

Two jobs in which individual incentive pay is appropriate are occupations that have to do with production or sales, such as a salesman or an ice cream factory worker. Occupations such as these would benefit most from individual incentive pay because the performance of the individual would be based on how hard they worked and it is easy to determine someone’s effort by how many sales or products they produce. Two jobs in which individual incentive pay would be inappropriate are concert violinist or firefighter. A violinist is a member of a team and individual performance can not be measured. A firefighter needs to perform at the same high level no matter what and individual performance should not be measured.

4-3.

The piece-rate pay plan is commonly adopted by multi-national companies that have manufacturing operations worldwide. How do these companies adapt its piece-rate pay plan to the local country?

This answer varies from country to country. Nonetheless, the piece pay plan, in general, means that companies generally use one of two piecework plans. The first, which is typically found in manufacturing settings, rewards employees based on their individual hourly production against an objective output standard, and is determined by the pace at which manufacturing equipment operates. For each hour, workers receive piecework incentives for every item produced over the designated production standard. Workers also receive a guaranteed hourly pay rate regardless of whether they meet the designated 93 © Pearson Education Limited 2015

production standard. Companies use piecework plans when the time to produce a unit is relatively short, usually less than 15 minutes, and the cycle repeats continuously.

Piecework plans are usually found in such manufacturing industries as textiles and apparel. Quality is also an important consideration. Companies do not reward employees for producing defective products. For example, in the apparel industry, manufacturers attempt to minimize defect rates because they cannot sell defective clothing for the same price as non-defective clothing. Selling defective clothing at a lower price reduces company profits.

4-4.

Unlike individual incentive programs, group and companywide incentive programs reward individuals based on the group and companywide performance standards, respectively. Under group and companywide incentive programs, it is possible for poor performers to benefit without making substantial contributions to group or company goals. What can companies do to ensure that poor performers do not benefit?

Companies can do several things to ensure that poor performers do not benefit from group plans. One is to have appraisal methods such as employee coworker, so as to make sure that if someone is performing well they are recognized, but if someone is not, they are noted and do not receive benefits. Other methods include manager involvement with individual employee performance throughout the working process, with special emphasis on making sure that everyone is performing well.

4-5.

What are your views on the use of team-based pay plan by companies in different countries? Justify your answer.

Answers will vary. Team-based incentive plan works best in a collectivist culture where employees are connected to one another through family kinship. It has been said that team-based incentives are similar to individual incentives with one exception: each group member receives a financial reward for the attainment of a group goal. For example, the timely completion of a market survey report depends on the collaborative efforts of several individual employees: some group members design the survey, another set collects the survey data, and a third set analyses the data and writes the report. It is the timely completion of the market survey report, not the completion of any one of the jobs that are required to produce it, that determines whether group members will receive incentive pay.

VIII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses Case Name: Individual or Team Reward?

Instructor Notes Companies often consider incentive pay plans to reward employees for their performance. A well-designed incentive pay plan can help a company achieve objectives through improved productivity, quality and customer service. In order to accomplish 94 © Pearson Education Limited 2015

this, the incentive pay plan must be appropriate for the particular objective. At Metropolitan Furniture, there is a need for high individual productivity and also a level of teamwork that allows the company to meet delivery dates for furniture sets that involve the effort of multiple workers. These differing needs create a challenge for management to determine the right approach in designing an incentive pay plan.

Suggested Student Responses: 4-6.

What are some advantages of offering an individual piecerate pay plan to the furniture builders at Metropolitan Furniture?

The individual piece rate pay plan emphasizes the link between pay and performance in the organization, providing an incentive for the furniture makers to work harder.

Further, by providing such rewards, Metropolitan will be able to retain top performers, contributing to the company’s success through higher productivity and lower turnover. An individual incentive plan could eliminate concerns that one member of a team may not contribute as much as another member does. Employees may feel more comfortable with their pay if they are not relying on the performance of others.

4-7.

What are some advantages of offering a team-based incentive pay plan?

The team-based incentive may eliminate concerns that an individual incentive program could bring such as one worker refusing to help out another worker in order to boost his or her own pay by working on his or her own pieces. Further, as on-time delivery is essential to the success of the company, a team-based plan rewards an important behavior within the organization. A team-based incentive program would also be easier to administer as rewards would be based on a few teams instead of several individuals.

4-8.

Which factors should Sally consider when designing an incentive pay plan?

How would they influence the effectiveness of its plan design?

Some of the factors which Sally could consider when designing an incentive pay plan are (1) the need to understand how the incentive pay plan is able to support the company’s business needs in terms of fulfilling on-time delivery of customers’ preordered furniture sets, (2) how employees could work together as a team as well as individually, and (3) how to motivate employees to achieve the company’s goals or objectives. The effectiveness of the plan design depends on the types of performance targets that Sally determines for the team as well as for the individual employees. A good balance between individual employee’s performance targets and team-based targets would help to promote both the individual employees’ and team’s performance.

95 © Pearson Education Limited 2015

MYLAB QUESTIONS 4-9.

How can incentive pay systems, when properly applied, contribute to companies meeting the goals of lowest cost and differentiation strategies?

Answer: Incentive pay systems can meet the goals of both strategies. For companies pursuing a lowest cost strategy, a large concern is reducing output costs per employee.

Piecework plans can tie compensation with employee output. Behavioral encouragement plans can lead to decreases in excessive absenteeism or improve safety. Group incentives also contribute to lower costs, particularly through increased employee involvement.

Profit-sharing plans are probably the least likely form of incentive to support this plan.

For companies pursuing a differentiation strategy, creativity is stressed, and rewards are more likely to be long-term in their delivery. Team-based incentives and gain-sharing programs can meet this imperative. They promote interaction among coworkers and autonomy in order to find a superior way to meet management objectives. But, one should use caution in making a blanket statement in support of all incentive plans to meet this strategy. Piecework plans and profit-sharing plans do little to support this approach.

4-10. Compare and contrast individual and group incentive plans.

Answer: Individual incentive plans reward employees whose work is performed independently. Employees are rewarded for meeting such work-related performance standards as quality, productivity, customer satisfaction, safety, or attendance. When designed and implemented well, employees are rewarded based on results for which they are directly responsible under this incentive plan. Paying more money for employees who demonstrate higher performance helps companies to retain best performers. Group incentive plans reward employees for their collective performance and reinforce teamwork, cultivate loyalty to the company, and increase productivity. Group incentive programs may lead to turnover due to free-rider effect. It can be hard to keep the best performer under this plan.

VIII. Additional Case from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses Case Name: Merit Increases at Diverse Prints Instructor Notes A well-designed merit pay program should recognize employee performance and adjust employee pay accordingly. If a company has an effective performance appraisal process in place, they should be able to accomplish this goal. But, if they are unable to give merit pay increases that differentiate between different levels of performance, employees may question their own efforts to achieve superior performance. This case is unique in the 96 © Pearson Education Limited 2015

fact that historically the company has used their merit pay increases effectively. With an uncertain future and limited funds, the decision on how to handle pay increases is a challenging one.

Suggested Student Responses: 4-11. Do you think the company should offer merit pay increases? Why or why not?

Students may argue for or against the merit increase. Those arguing for the merit increases may suggest that while the program may not have its desired effect this year, it may be more appropriate to continue with merit pay increases as they will likely return to appropriate levels next year. It may be easier to explain to employees and they will still see some differences in pay raises for superior performers and average performers. In fact, those with superior performance may feel it is better to recognize their performance with an increase slightly more than others as opposed to everyone receiving the same increase, regardless of performance. On the other hand, the differences may be so small that they are indeed insignificant. Therefore, suggesting that no merit pay increases this year may be the better approach.

4-12. If the company chooses not to offer the merit pay increases, how should they approach explaining the decision to the employees?

It is important for the company to clearly explain why the company is not offering the merit pay increases. The employees should be aware of the company’s downturn, and the temporary elimination of the merit pay increases should be emphasized as a cost-saving measure that will help the organization continue to operate. Further, the company should emphasize the value of the performance appraisals, even without the subsequent merit pay increases. While the performance appraisals do serve as a basis for merit pay decisions, they are also a tool to provide employees feedback on their performance and guidance in improving their performance. The company may also want to consider alternate awards for those with superior performance such as additional vacation days.

97 © Pearson Education Limited 2015

CHAPTER 5 Person-Focused Pay Learning Objectives 1. Explain the concept and practice of person-focused pay.

2. Describe the type of setting in which person-focused pay is most likely to be used.

3. Name and explain the reasons companies adopt person-focused pay programs.

4. Summarize the varieties of person-focused pay programs.

5. Contrast person-focused pay with job-based pay.

6. Provide an explanation of the advantages and disadvantages of person-focused pay plans.

Outline I.

Defining Person-Focused Pay: Competency-Based, Pay-for-Knowledge, and Skill-Based A. Person-Focused Pay Plans B. Pay-for-Knowledge Plans C. Skill-Based Pay D. What Is a “Competency”?

II. Usage of Person-Focused Pay Programs III. Reasons to Adopt Person-Focused Pay Programs A. Overarching Reasons B. Technological Innovation C. Increased Global Competition IV. Varieties of Person-Focused Pay Programs A. Four Main Types B. Stair-Step Model C. Skill-Blocks Model D. Job-Point Accrual Model E. Cross-Departmental Models V. Contrasting Person-Focused Pay with Job-Based Pay A. Person-Focused Pay B. Job-Based Pay VI. Advantages of Person-Focused Pay Programs A. To Employees B. To Employers VII. Disadvantages of Pay-for-Knowledge Pay Programs VIII. Discussion Questions and Suggested Answers 98 © Pearson Education Limited 2015

IX. X.

End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses Lecture Outline

I.

Defining Person-Focused Pay: Competency-Based, Pay-for-Knowledge, and Skill-Based A. Person-Focused Pay Plans 1. Rewards employees for acquiring job-related: a. Competencies b. Knowledge c. Skills 2. Not compensated for demonstrating successful job performance 3. Competency-based pay programs a. Pay-for-knowledge pay b. Skill-based pay c. A combination of both 4. When combined with merit-pay programs, base pay increases are tied to how well employees demonstrate the competencies 5. Since the 1990s, person-focused pay has been adopted in a variety of work settings in a variety of company departments such as back-office operations, call centers, retail, and managerial and professional settings 6. Reward employees for acquiring: a. Horizontal skills b. Vertical skills c. Greater depth of knowledge or skills 7. Horizontal skills (knowledge) a. Similar skills b. Like clerical employees learning several kinds of record-keeping tasks 8. Vertical skills (knowledge) a. Traditionally considered supervisory, like: i. Scheduling ii. Coordinating iii. Training iv. Leading others b. Often emphasized in self-managed work teams c. Self-managed work teams i. Also known as semi-autonomous work groups 99 © Pearson Education Limited 2015

ii. Brings employees together from various functional areas to plan, design, and complete one product or service 9. Greater depth of knowledge (skills) a. Refers to level of specialization or expertise an employee brings to a particular job b. Like an HR professional specializing in: i. Compensation ii. Benefits iii. Administration iv. Training v. Evaluation vi. New employee orientation B. Pay-for-Knowledge Plans 1. Rewards certain employees for increasing and applying job related knowledge, like: a. Managers b. Service employees c. Professionals C. Skill-Based Pay 1. Mainly for employees who perform manual labor 2. Pay increase based on mastery and use of new job skills Example: Food Processing Plant Requiring Vertical Skills • In this plant, good hiring systems and excellent training systems were critical, including systems for training operators in maintenance skills • All training materials were put on their intranet, making it accessible to employees at any time • Several plants also invested heavily in documentation of training and required practical skills demonstration D. What Is a “Competency”?

1. Two definitions a. Uniquely combined characteristics that enable an employee to fulfill job requirements, including: i. Personality ii. Attitudes iii. Knowledge iv. Skills 100 © Pearson Education Limited 2015

v. Behaviors b. Synonymous with skills and knowledge 2. Core competencies are often derived from companies’ strategic statements 3. Competency-based-pay programs are for employees for whom it is hard to define job performance according to observable or concrete behaviors, like: a. Technicians b. Managers c. Service personnel d. Professionals Example: Competency-Based-Pay Program • General Electric • Three strategic goals for corporate growth • Globalization • Product Services • Six Sigma (quality improvement) • Four core competencies “Four Es” • Energy (high) • Energizing (others) • Edge (ability to make touch calls) • Execute (ability to turn vision into results) • Offers comprehensive training for entry-level professionals II.

Usage of Person-Focused Pay Programs 1. No systematic survey data available on actual number 2. No evaluative data to determine whether the size of the company is related to the success of these programs 3. The lack of data is due, in part, to the fact that person-focused pay systems did not become popular until the 1990s, giving little opportunity to determine their long-term effectiveness 4. One study found that a skilled-based pay plan in a manufacturing setting increased plant productivity by 58 percent 5. More than half of the companies that use them employ between 150–2,000 employees 6. Mostly found in continuous process settings, like manufacturing in which a. Assembly lines are used b. One employee’s job depends on the work of at least one other worker 7. Vertical skills programs a. Work well in manufacturing companies that organize work flow around high-performance work teams where employees are expected to: i. Learn functional tasks 101 © Pearson Education Limited 2015

ii. Perform managerial tasks like: • Work scheduling • Budgeting • Quality control b.

Examples i. Motorola (cell phone division) ii. Steelcase (office furniture) 8. Adopted most widely in: a. Service companies b. Manufacturing companies c. For: i. Professional employees ii. Clerical employees iii. Skilled trade employees like: • Carpenters • Electricians Example: Pay-for-Knowledge Program • Bell Sports • Manufacturer of motorcycle safety helmets • Assembly process includes enameling the helmets and attaching visors • Enameling requires • The ability to use automated sprayers • Strong literacy skills to interpret read-outs from the sprayers and suggest possible problems • Attaching visors requires: • Proficient motor skills • Good eye-hand coordination • Employees are cross-trained to provide flexibility III.

Reasons to Adopt Person-Focused Pay Programs A. Overarching Reasons 1. Remove the view of pay as an entitlement 2. Establish the view of pay as a reward for acquiring and implementing jobrelevant knowledge and skills B. Technological Innovation 1. Making some jobs obsolete, because of: a. Robots 102 © Pearson Education Limited 2015

b. Telecommunications c. Artificial intelligence d. Software e. Lasers 2. Fostering increased autonomy and team-oriented work places where: a. Employees must learn to manage themselves and their time b. Teams require members with technical and interpersonal skills c. Teams are responsible for determining client needs and providing customer service Example: Technological Innovations Changing Job Responsibilities • Automobile industry • Auto mechanics • Used to assemble and repair carburetors • Now must know how to use computerized diagnostic systems to repair electronic fuel injection systems • Assembly line workers • Employees used to work as laborers, material handlers, operator-assemblers, or maintenance persons • Now, all job responsibilities grouped into one position titled “manufacturing technician” • Job demands higher levels of reading, writing, and computation skills Example: Technological Advancements • Long distance providers AT&T and Verizon • Seek competitive advantage by serving clients’ needs and anticipating possible changes in customers’ needs • Must adapt to cellular phone services that include free long distance • Now offer programs designed to meet the specific needs of customers • Customer service associates must remain current on services available and be able to match service plans to customers’ needs C. Increased Global Competition 1. To sustain competitive advantage, companies must: a. Provide employees with leading-edge skills b. Encourage employees to apply their skills proficiently 2. European Common Market and Pacific Rim

103 © Pearson Education Limited 2015

a. Employers emphasize learning, therefore their employees are better skilled and more productive b. Cultures emphasize and provide better learning and workplace instruction for non-college-bound students 3. Western European employers emphasize apprenticeship programs that mix academic and applied learning to instruct employees 4. HR managers must tailor compensation programs to the particular skills they wish to foster 5. Training is at the heart of person-focused programs IV.

Varieties of Person-Focused Pay Programs A. Four Main Types 1. Stair-step model 2. Skill-block model 3. Job-point accrual model 4. Cross-departmental model B. Stair-Step Model 1. Each step represents jobs from a particular job family that differ in terms of complexity 2. Each position differs according to the number of skills needed to perform the job 3. Each “step-up” requires more skills than the position “below” it

104 © Pearson Education Limited 2015

Examples: Stair-Step Models • Assembly technician (AT) steps • AT 1 requires employees to have two skills: • Line restocking • Pallet breakdown • AT 3 requires six skills: • Line restocking • Pallet breakdown • Burr removal • Line jockey • Major assembly • Soldering • Assembly technician pay increases • ABC Manufacturing Company hires AT trainees at $8.00 • After successfully completing three core AT 1 training workshops, pay increases to $8.50, and the employee is promoted to an AT 2 • Company orientation • Safety workshop • Quality workshop • After successfully completing two core elective AT training courses, pay increases to $9.15, and the employee is promoted to an AT 1 • Line restocking • Pallet breakdown • Employees can continue to receive training to earn “steps” up to AT 2 and AT 3, and earn more pay

4. Training can be conducted either: a. In-house by the company’s own training department i. Specialized courses ii. Work that bears upon company’s competitive advantage b. Outsourced to such organizations as: community colleges, vocational schools, four-year universities, training consulting firms, or suppliers’ client training programs for: i. Common skills ii. Skills that do not bear upon competitive advantage C. Skill-Blocks Model 1. Applies to jobs within one job family per model 2. Employees progress to increasingly complex jobs 3. Skills do not necessarily build on each other 4. Emphasizes the development of both horizontal and vertical knowledge and/or skill depth 105 © Pearson Education Limited 2015

Example: Skill-Based Model • Pro Company • Offers a pay-for-knowledge program • Bobby Smith hired as a Clerk 1, because of test proficiency in filing, typing, and word processing, all Clerk 1 core requirements • Taking Clerk 2, 3, or 4 curricula would enhance Bobby’s horizontal skills • Taking Clerk 5 curriculum, Bobby would increase her vertical skills D. Job-Point Accrual Model 1. Encourages employees to develop skills and learn to perform jobs from different job families a. The number of jobs they can be trained to do is limited b. Companies want to avoid “jack of all trades” employees 2. Creates organizational flexibility and promotes company goals by assigning a relatively greater number of points to skills that address key company concerns 3. The more points an employee accrues, the higher that employee’s compensation level will be Example: Job-Point Accrual Model • ZIP-MAIL, an express mail delivery service company • Hopes to benefit from a person-focused pay program • To differentiate themselves from competition (Fed Ex, UPS), they: • Promise delivery by 7:30 a.m.

• Train couriers in customer relations skills to convey a professional image and establish an open rapport with clients • Award couriers with points and pay increases for completing training E. Cross-Departmental Models 1. Promote staffing flexibility by training employees in one department with some of the critical skills they would need to perform effectively in other departments 2. Can help production companies manage sporadic, short-term staffing shortages 3. Can help companies meet seasonal fluctuations in demands for their products or services 4. Similar to the job-point accrual model, except for their intent a. Job-point accrual models encourage employees to learn skills and acquire knowledge that bears directly on the competitive advantages of companies 106 © Pearson Education Limited 2015

b. Cross-departmental models promote staffing flexibility by training employees in one department with critical skills they would need to perform effectively in other departments Examples: Cross-Departmental Model • A custom-made shoe manufacturer and distributor • Prior to the Chanukah and Christmas holiday season, production and sales employees are busy • As Chanukah and Christmas Day draw near, sales and production drops off, and distribution increases • Company trained production and sales employees in distribution-related skills V.

Contrasting Person-Focused Pay with Job-Based Pay A. Person-Focused Pay 1. Compensates employees for developing the flexibility and skills to perform a number of jobs effectively 2. Rewards employees on their potential to make positive contributions to the workplace, based on the successful acquisition of work-related skills or knowledge 3. Person-focused pay plans apply in limited contexts, because not all jobs can be assessed based on skill or knowledge B. Job-Based Pay 1. Compensates employees for jobs they currently perform 2. Pay levels are set depending on the job a. Merit pay i. Managers evaluate employees’ performances based on how well they fulfilled their designated roles as specified in their job descriptions and periodic objectives ii. Managers then award a permanent addition to base pay, based on performance b. Incentive pay i. Managers award one-time additions to base pay ii. Pay raise amounts based on the attainment of predefined work goals 3. Apply in an organization-wide context since employees earn base pay rates for the jobs they perform

Example: Comparison between Skill-Based and Job-Based Pay Programs • Feature • Level determination

Person-focused

Job-based

Market-based for skill

Market based for job

107 © Pearson Education Limited 2015

• Base pay • Pay raises • Job promotion • Advantages to employees • Advantage to employers

valuation Based on skills or knowledge level Based on gains in skills or knowledge Based on skills base and proficiency on past work Job variety and enrichment Work schedule flexibility

valuation Based on value of compensable factors Based on attaining jobdefined goal or seniority Based on exceeding job performance standards Perform work and receive pay for a defined job Easy pay administration

Example: Incentive Pay • Acme Manufacturing Company • Makes disk drives for computers • Has unacceptably high defect rate • Wants rates lower than Do-Rite • 6,500 defects compared to 3,000 • Manufacturing, their competitor • Employees receive bonus based on their monthly defect rate VI.

Advantages of Person-Focused Pay Programs A. To Employees 1. Two main benefits a. Job enrichment b. Job security 2. Job enrichment a. Refers to a job design approach that creates more intrinsically motivating and interesting work environments

108 © Pearson Education Limited 2015

Example: Pay-for-Knowledge Pay Programs • Volvo • Uddevalla manufacturing facility in Sweden uses teams of 7–10 hourly workers • Workers produce entire vehicles which expands the horizontal dimensions (skill variety) of workers’ jobs • Some teams are empowered to manage themselves, managing duties that represent the vertical dimensions (autonomy) of work and include: • Controlling schedules • Dividing up tasks • Learning multiple jobs • Training one another b. Can be accomplished by combining narrowly designed tasks to allow employees to produce an entire product or service i. Contributing to all aspects of the manufacturing process expands the horizontal dimensions (skill variety) of the workers’ jobs ii. When teams are allowed to manage themselves by controlling schedules, dividing up tasks, learning multiple jobs, or training one another it represents the vertical dimensions (autonomy) of work Description: Job Characteristics Theory • Employees will be motivated to perform jobs that contain a high degree of four core characteristics • Skill variety: the degree to which the job requires the person to do different tasks and involves the use of a number of different skills, abilities, and talents • Task identity: the degree to which the job enables an employee to complete the entire job from start to finish • Autonomy: the amount of freedom, independence, and discretion the employee enjoys in determining how to do the job • Feedback: the degree to which the job or employer provides the employee with clear and direct information about job outcomes and performance c. Expand both horizontal and vertical work dimensions d. Promote skill variety and autonomy 3. Job security a. Creates more flexible workers who can work another position in case of: i. Low product demand ii. Slow sales periods 109 © Pearson Education Limited 2015

iii. Layoffs b. Makes workers more attractive to other employers B. To Employers 1. Can lead to enhanced job performance a. Better quality work b. More productive workers 2. Can lead to reduced staffing 3. Can lead to greater flexibility a. Develop employees’ horizontal skills b. Develop employees’ vertical skills VII.

Disadvantages of Person-Focused Pay Programs 1. Increased Costs a. Hourly labor b. Training i. Training programs ii. Regular pay during training iii. Increase in base pay when completed c. Overhead 2. May not mesh well with existing incentive pay programs a. Employees may not want to learn new skills if increase for new skills is less than incentive award earned for existing skills i. A short-term focus on employees’ part: may have to be laid-off instead of transferred during slow period ii. Example: an assembly line worker makes more than the inventory controller position for which she is training b. Time taken to learn new skills may take time away from time to meet production goals needed to receive incentive pay 3. Depend in large part on well-designed training programs a. Person-focused pay systems include costly training programs b. Require that employers bear the price of base pay and benefits while employees attend training during regular work hours c. Companies must wait patiently before realizing a return on investment for training 4. Companies struggle with determining the monetary value of skill and knowledge sets a. Knowledge and skill sets are usually company-specific making comparability difficult

110 © Pearson Education Limited 2015

VIII. Discussion Questions and Suggested Answers 5-1.

“Person-focused pay plans are least preferable compared with individual incentive pay programs.” Indicate whether you agree or disagree with this statement. Detail your arguments to support your position.

Individual incentive pay programs are indeed more preferable than pay-for-knowledge in the fact that they pay employees based upon performance and completion or obtainment of certain goals. Individual incentive plans promote an equitable distribution of compensation within companies, promote the relationship between pay and performance, and are compatible with the individualistic culture in the United States. However, payfor-knowledge plans may be better used when a company is in a skill-based industry.

5-2.

Person-focused pay is becoming more prevalent in companies; however, person-focused pay programs are not always an appropriate basis for compensation. Discuss the conditions under which incentive pay is more appropriate than pay-for-knowledge pay programs. Be sure to include your justification.

Pay incentive programs are more appropriate than pay-for-knowledge programs when the employees are more interested in the short term than the long term. When both pay-forknowledge and incentive pay systems are in operation, employees may not want to learn new skills when the pay increase associated with learning a new skill is less than an incentive award employees could earn based on skills they already possess. Employees often place greater emphasis on maximizing rewards in the short term rather than preparing themselves to maximize the level of rewards over time, which can be facilitated through person-focused programs. For example, an assembly line worker chooses to focus on his or her work because he or she receives monetary incentives for meeting weekly production goals set by management rather than taking skills training in inventory control for which he or she will earn additional pay upon successful completion of the training. In the short term, this worker is earning a relatively large sum of money. Besides the fact that many employees are less inclined to earn money through the pay-forknowledge programs, there is also the potential problem of an employee learning a new skill, but then defecting to a competitor and using such skills for the benefit of the rival company. Although safety contracts can be put in place to avoid such problems, they still occur.

5-3.

Name at least three jobs that have been influenced by such technological advances as robotics, word processing software, fax machines, and electronic mail. Describe the jobs prior to the technological advances and explain how these jobs have changed or will change because of the technological advances.

111 © Pearson Education Limited 2015

For each job, list the new skills that you feel are relevant for person-focused pay programs.

A good example of a job that has changed due to electronic mail, fax machines, and telephones is the mailman. Prior to such technological advances postmen would ride by and drop off mail on a regular basis. People depended upon the mailman in order to communicate over large distances. As technology advanced the mailman became less and less of an instrumental figure. In the future the mailman may become obsolete and we may simply depend on electricity and technology as our sources of correspondence and communication. Another good example of a job that has been influenced by technological advances is the secretary. Prior to the invention of the typewriter or computer people would record information using writing utensils and paper. But as technology advanced, the job of the secretary changed to include typing skills and experience with certain computing programs such as Microsoft Excel. Such technical knowledge and skill is relevant to the person-focused pay programs. The security guard occupation has greatly changed as a result of technology. Before advancements in surveillance technology, guards had to be posted at every entry way and exit of a given building for maximum security. But now, because of cameras, one or two guards are needed to oversee the entirety of a building. Prior to the camera, guards would have to patrol but now because of technological advancements, guards can sit and watch surveillance monitors so as to scan for potential criminal activity.

5-4.

Many companies adopted the person-focused pay plan for their business operations internationally. Examine the job vacancy advertisements placed by companies at your local shopping mall and explain how they implemented the person-focused pay plan.

The ways to implement a person-focused pay plan depend on the types of competencies or skills that the company would want to use as compensable factors for its job evaluation. For skills-based jobs, the company could identify the types of skills necessary for the job to be done and then determine their complexity. Next, the skills sets of similar degrees of complexity would be bundled together as core skills or elective skills options, and employees who possessed or acquired certain combinations of these skill sets would be paid according to the pay structure set for that combination by the company. This means that the greater the number of relevant skills that the employee acquired and applied on the job, the higher would be the pay for the job performed. For competencybased pay structure, employees are evaluated based on a set of behavioral indicators or anchors for a given set of competency needed for the job and employees are rewarded based on their demonstrated behaviors on the job.

5-5.

As discussed in the chapter, person-focused pay programs are not suitable for all kinds of jobs. Based on your understanding of person-focused pay concepts, identify at least three jobs for which this basis for pay is 112 © Pearson Education Limited 2015

inappropriate. Be sure to provide your rationale, given the information in the chapter.

Person-focused pay programs are not suitable for jobs such as store cashier, docker, mover, and so on, because they are occupations that are better suited for incentive pay programs of working harder, not necessarily knowing more.

IX. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses Case Name: Person-focused Pay at Mitron Computers Instructor Notes A well-designed person-focused pay system has the potential to increase employee commitment, enhance motivation and improve employee satisfaction because they promote skill variety and autonomy. In this case, there is no incentive for the Technicians to further their skill development, which creates problems when a limited number of Technicians are able to complete the more complex steps in the computer building process. A person-focused pay system would create an incentive for the Technicians to attend training to develop their skills. However, the system is in conflict with their current team incentives and this issue would need to be addressed.

Suggested Student Responses: 5-6.

What are some advantages of a person-focused pay system at Mitron?

Such a system could create an incentive to broaden the Technician’s skills and as a result, they will have more variety in their work, which could lead to higher levels of motivation and job satisfaction. Employees will also have more job security because of the flexibility of skills. Mitron also benefits from the flexibility that a better-trained staff provides. This will most likely solve the problem of delayed shipments.

5-7.

What are some disadvantages?

The system could cause an increase in labor costs for Mitron. As more Technicians raise their pay rates, their labor costs will rise. The company’s training costs will also increase as more Technicians attend the training. The company must ensure that the increased efficiency and quality they gain from the system would outweigh this increased cost.

The system is also in conflict with the team-based incentive pay plan. The Technicians miss out on some team-based incentive pay when they leave work to attend the training.

Holly would need to resolve the conflict before implementing the new system.

113 © Pearson Education Limited 2015

5-8.

If you are the HR Director for Mitron Computers, what would you recommend to solve the company’s problem on shortage of higher-level skilled workers? Justify your recommendations.

The company could introduce a skills-based pay structure so that employees are motivated to attend training and be certified for more skills that they could apply on the job, which would result in earning higher pay due to the greater number of skills acquired and applied. Thus, Mitron Computers could overcome the problem of skills shortages in its workforce for completing the 10 to 18 different steps needed to assemble the computers.

MYLAB QUESTIONS 5-9.

Compare and contrast the stair-step model and the skill blocks model. What kinds of skills are applicable in each model?

A stair-step model actually resembles a flight of stairs. The steps represent jobs from a particular job family that differs in terms of complexity. Jobs that require more skills are more complex than jobs with fewer skills. For example, an Assembly Technician 1 job requires employees to possess two skills: line restocking and pallet breakdown. An Assembly Technician 3 job requires employees to possess six skills: line restocking, pallet breakdown, burr removal, line jockey, major assembly, and soldering. In terms of the stairs, higher steps represent jobs that require more skills than lower steps.

Compensation specialists develop separate stair-step models for individual job families (e.g., clerks or accountants). Thus, a company may have more than one stair-step model, each corresponding to a particular job family such as accounting, finance, or clerical.

The skill blocks model also applies to jobs from within the same job family. Just as in the stair-step model, employees progress to increasingly complex jobs; however, in a skill blocks program, skills do not necessarily build on each other. Thus, an employee may progress two or more steps, earning the pay that corresponds with each step.

Although similar, the stair-step model and the skill blocks model differ in an important way. The stair-step model addresses the development of knowledge or skills depth. In particular, an employee could develop his skills depth as an assembly technician by taking separate curricula (for example, Knowledge block 1: basic financial accounting principles, intermediate financial accounting principles, and advanced financial accounting principles; and, Knowledge Block 2: basic marketing fundamentals and intermediate marketing fundamentals). With the successful completion of each curriculum, the employee will enhance the depth of his knowledge.

114 © Pearson Education Limited 2015

5-10. Compare and contrast person focused pay and job-based pay. Discuss the advantages of person-focused pay to employers.

Companies institute job-based pay plans or person-focused pay plans based on very different fundamental principles and goals. Table 5-2 from the text (repeated below) lists the key differences between these two pay programs. Job-based pay compensates employees for jobs they currently perform. Human resource professionals establish a minimum and maximum acceptable amount of pay for each job. In the case of merit pay, managers evaluate employees based on how well they fulfilled their designated roles as specified by their job descriptions and periodic objectives. Managers then award a permanent merit addition to base pay, based on employee performance.

TABLE 5-2 Person-Focused and Job-Based Pay: A Comparison Feature

Person-Focused

Job-Based

Pay level determination

Market basis for skill valuation

Market basis for job valuation

Base pay

Awarded on how much an

Awarded on the value of

employee knows or on skill

compensable factors

level Base pay increases

Job promotion

Awarded on an employee’s

Awarded on attaining a job-

gain in knowledge or skills

defined goal

Awarded on an employee’s

Awarded on exceeding job

skills base and proficiency on

performance standards

past work Key advantage to employees

Job variety and enrichment

Perform work and receive pay for a defined job

Key advantage to employers

Work scheduling flexibility

Easy pay system administration

115 © Pearson Education Limited 2015

X.

Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses

Case: Gain Sharing at CircleWorks Instructor Notes Gain sharing plans reward employees with an incentive payment that is passed on factors such as improved performance, productivity, lower costs or better safety. However, gain sharing plans must have a supportive leadership philosophy and an opportunity for employee involvement in order to be successful. If a supportive organizational culture does not exist, an alternative group incentive plan may be more appropriate such as team bonuses.

Suggested Student Responses: 5-11. What are some factors that will influence the success of a gain sharing plan in improving employee involvement and productivity?

Gain sharing plans work in a cooperative organizational environment characterized by open communication, trust and employee participation. Employees must have the opportunity to provide input into production processes so that they can have an impact on productivity. In environments that require frequent changes in production methods or where production methods are rigid in nature, employees may not have enough opportunity to impact productivity to make a gain sharing plan effective.

Further, open communication is needed so that employees feel encouraged to make suggestions.

5-12. Do you think a gain sharing plan would be successful at CircleWorks?

At this time it seems that the organizational culture at CircleWorks does not align with a gain-sharing plan. The management philosophy does not seem open to employee input and this would make a gain-sharing plan a challenge. Further, the nature of the production process appears to be very structured, relying upon engineers for changes in the production process. As a result, employees do not have the opportunity to provide input to impact productivity. In this case Sheila may want to recommend a team-based bonus that has a more simple structure to start with if CircleWorks is interested in introducing incentive pay.

116 © Pearson Education Limited 2015

CHAPTER 6 Building Internally Consistent Compensation Systems Learning Objectives 1. Explain the concept of internally consistent compensation systems.

2. Summarize the practice of job analysis.

3. Describe the practice of job evaluation.

4. Give two examples of job evaluation techniques and briefly summarize each one.

5. Explain how internally consistent compensation systems and competitive strategy relate to each other.

Outline I. II.

Internal Consistency Job Analysis A. Definition B. Steps in Job Analysis Process C. Legal Considerations D. Job Analysis Techniques E. O*NET III. Job Evaluation A. Definition B. Compensable Factors C. The Job Evaluation Process IV. Job Evaluation Techniques A. Two General Types B. The Point Method C. Alternative Job-Content Evaluation Approaches D. Alternatives to Job Evaluation V. Internally Consistent Compensation Systems and Competitive Strategy VI. Discussion Questions and Suggested Answers VII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses VIII. Additional Case from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses.

116 © Pearson Education Limited 2015

Lecture Outline I.

Internal Consistency 1. Clearly define the relative value of each job among all jobs within a company to represent the job structure or hierarchy 2. Based on a fundamental principle that states jobs that require greater qualifications, more responsibilities, and more complex job duties should offer more pay than those jobs that require less 3. Internally consistent job structures a. Recognize differences in job characteristics b. Enable compensation managers to set pay 4. Developed using two processes a. Job analysis i. Mostly a descriptive procedure ii. Highlight the key similarities and differences between jobs b. Job evaluation i. The key for casting internally consistent compensation systems as strategic tools ii. Is used to establish pay differentials among employees within a company 5. Process lead by HR specialists who a. Solicit involvement of employees and supervisors b. Use the information to write job descriptions that: i. Describe job duties ii. Set minimum qualifications for employees

II.

Job Analysis A. Definition 1. A systematic process for gathering, documenting, and analyzing information in order to describe jobs 2. Identifies and defines job content a. Job duties that employees must perform b. Worker requirements (compensable factors) needed to perform the job like: i. Knowledge, skills, and abilities (KSAs) ii. Education iii. Experience iv. Licenses v. Permits 117 © Pearson Education Limited 2015

vi. Specific abilities Example: Worker Requirements for HR Managers • Knowledge of principles and procedures for: • Recruitment • Selection • Training • Compensation and benefits • Labor relations and negotiations • Human resource information systems • Active listening and critical thinking • Oral and written comprehension 3. Job context or working conditions, like: a. Social context b. Physical environment i. Noise level ii. Exposure to hazardous conditions or chemicals iii. Work equipment B. Steps in the Job Analysis Process 1. Five main activities a. Determine a job analysis program b. Select and train analysts c. Job analyst orientation d. Conduct the study: data collection methods and sources of data e. Summarize the results: writing job descriptions 2. Determine a job analysis program a. Decide between using an established system or developing its own b. Decide which data gathering method to use i. Questionnaires ii. Interviews iii. Observation iv. Participation c. Administrative costs usually a determining factor 3. Select and train analysts a. Select someone who will be able to: i. Collect job-related information through various methods ii. Relate to a wide variety of employees 118 © Pearson Education Limited 2015

iii. Analyze the information iv. Write clearly and succinctly b. Ideally, a task force of representatives from throughout the company conducts the analysis, while HR staff members coordinate it c. Training employees to be analysts should include: i. Learning the basic assumptions of the model and the procedures ii. Details of a study’s objectives iii. How the information will be used iv. Methodology overviews v. Discussions and demonstrations of the information-gathering techniques vi. Learning to minimize the chance they will conduct ineffective job analyses vii. Familiarization of the structure of pertinent job data Example: Units of Analysis in the Job Analysis Process • Element: the smallest step (e.g., inserting a diskette into a floppy disk drive) • Task: one or more elements (e.g., keyboarding text into memo format) • Position: a collection of tasks constituting a total work assignment (e.g., clerk typist) • Job: a group of positions with similar tasks (e.g., several clerk typists) • Job family: a group of two or more jobs with similar worker characteristics or work tasks (e.g., clerical job family) • Occupation: a group of jobs, at different companies, with common sets of tasks with similar objectives, methodologies, materials, products, worker actions, or worker characteristics (e.g., office support occupation) d. Analysts need to know how to use and understand the Standard Occupational Classification System (SOC) i. Published by the U.S. Office of Management and Budget ii. Replaces the Dictionary of Occupational Titles (DOT) iii. Lists 23 major occupational groups based on the 2010 edition iv. Available at www.bls.gov/soc/ e. Units of analysis may influence judgments about job similarities and differences

119 © Pearson Education Limited 2015

Example: Job Similarities/Differences • Dissimilar • HR managers, purchasing managers, and payroll clerks all perform different duties • Similar • HR managers and purchasing managers are both management • HR manager and payroll clerk are both in HR 4. Direct job analysts orientation a. Before starting job analysis techniques the analyst must analyze the context in which employees perform their work b. Analysts should obtain and review: i. Organizational charts ii. Listings of job titles iii. Classifications of each position iv. Job incumbent names and pay rates v. Instructional booklets or handbooks for operating equipment vi. Job information from SOC, trade associations, professional societies, and trade unions 5. Conduct the study: data collection methods and sources of data a. Gather and record information for each job i. Using appropriate methods ii. Using appropriate sources b. The most common methods of data collection are: i. Questionnaires ii. Observation Example: Common Questionnaire Questions and Statements • Describe the task you perform most frequently.

• How often do you perform this task?

• List any licenses, permits, or certifications required to perform duties assigned to your position.

• List any equipment, machines, or tools you normally operate as part of your position’s duties.

• Does your job require any contacts with other department personnel, other departments, outside companies, or agencies? If so, please describe.

• Does your job require supervisory responsibilities? If yes, for which jobs and for how many employees?

120 © Pearson Education Limited 2015

c. Observations require analysts to record perceptions formed while watching employees perform d. Most common sources of data are: i. Job incumbents, for extensive and detailed information about how the job is performed ii. Supervisors, for the interrelationship among jobs and employees iii. Job analysts, for perceptions from past and current analyses e. Job analysts i. Use observations, to write descriptions ii. Use questionnaires, to ask follow-up questions for clarification iii. Strive to provide reliable and valid job evaluation results iv. Strive to obtain reliable job evaluation results that would yield consistent results under similar conditions f. A valid job analysis method accurately assesses each job’s duties i. From multiple sources ii. Using multiple methods g. Reliable and valid job analyses are essential because: i. Inadequate pay may lead to dysfunctional turnover ii. Excessive pay represents a cost burden to the company iii. Basing pay on factors that do not relate to job duties leaves the company vulnerable to allegations of illegal discrimination h. Including multiple data collection methods and sources minimizes the inherent biases associated with any particular method or source 6. Summarize the results: writing job descriptions a. Should include: i. The job’s purpose ii. A list of a job’s tasks, duties, and responsibilities iii. A list of the skills, knowledge, and abilities necessary to perform the job at a minimal level b. Should explain: i. What the employee must do to perform the job ii. How the employee performs the job iii. Why the employee performs the job, in terms of its contribution to the functioning of the company iv. Supervisory responsibilities, if any v. Contacts (and purpose of these contacts) with other employees inside or outside the company vi. The skills, knowledge, and abilities the employee should have or must have to perform the job duties 121 © Pearson Education Limited 2015

vii. The physical and social conditions under which the employee must perform the job c. Should contain: i. Job title to indicate the job designation ii. Job summary with two to four concise, descriptive statements Example: Equal Employment Opportunity Commission (EEOC) Guidelines • Concise, descriptive writing guidelines • Education: refers to formal training; GED and high school diploma through Ph.D. • Skill: refers to an observable competence to perform a learned psychomotor act • Ability: refers to a present competence to perform an observable behavior or a behavior that results in an observable product • Knowledge: refers to a body of information applied directly to the performance of a function iii. Job duties to describe the major work activities and supervisory responsibilities iv. Worker specification to list the education, skills, abilities, knowledge, and other qualifications needed to perform the job C. Legal Considerations for Job Analysis 1. Job analyses are not required by the government, but can increase the chance that employment decisions are based on pertinent job requirements 2. The Equal Pay Act requires that companies justify pay differences between men and women who perform equal work a. A different job title alone is not a legal justification (refer to Chapter 3) b. Job analysis helps discern if substantive differences between job functions exist 3. Can be used to determine if a job is exempt or nonexempt under the Fair Labor Standards Act (more in Chapter 2) 4. Can be used to insure compliance with the American with Disabilities Act a. As long as disabled applicants can perform the essential functions of a job with reasonable accommodation, companies may not discriminate against these applicants by paying them less than nondisabled employees performing the same job b. Can be used to systematically define job functions and consult the EEOC interpretive guidelines to determine if they are essential

122 © Pearson Education Limited 2015

Americans with Disabilities Act “Guidelines for Essential Job Functions” Based on the original Act passed in 1990 • The reason the position exists is to perform the function • The function is essential or possibly essential. If other employees are available to perform the function, the function probably is not essential • A high degree of expertise or skill is required to perform the function • Whether a particular job function is essential is a determination that must be made on a case-by-case basis and should be addressed during job analysis. Any job functions that are not essential are determined to be marginal. Marginal job functions could be traded to another position or not done at all

New Effects Based on Revisions to the Original Act passed in 2008 • • • • • • •

It is now easier for an individual seeking protection under the ADA to establish that he or she has a disability within the meaning of the ADA Directs EEOC to revise that portion of its regulations defining the term “substantially limits” Expands the definition of “major life activities” by including two nonexhaustive lists: one which includes activities such as reading and bending that were not formally recognized before; and one including major body functions States that mitigating measures other than “ordinary eyeglasses or contact lenses” shall not be considered in assessing whether an individual has a disability Clarifies that an impairment that is episodic or in remission is a disability if it would substantially limit a major life activity when active Changes the definition of “regarded as” so that it no longer requires a showing that the employer perceived the individual to be substantially limited in a major life activity Provides that individuals covered only under the “regarded as” prong are not entitled to reasonable accommodation D. Job Analysis Techniques 1. Two main types a. Established job analysis techniques b. Custom designed techniques 2. Established job analysis techniques a. Are less expensive than custom designed techniques b. Choosing one depends on: i. Applicability ii. Cost 123 © Pearson Education Limited 2015

c. Applicability i. Some apply only to a particular job family ii. Others apply to a broad range iii. Most are already tested and refined d. Costs i. Some are proprietary ii. Some are available to the public at no charge iii. Private consultants charge high fees for using their methods iv. The U.S. Department of Labor does not charge for using its methods E. The U.S. Department of Labor’s Occupational Information Network (O*NET) 1. O*NET a. Developed by the U.S. Department of Labor’s Employment and Training Administration during the 1990s 2. Is a database created for two reasons a. To describe jobs in the relatively new service sector b. To more accurately describe jobs that evolved as the result of technological advances 3. Content Model a. Was developed using research on job and organizational analyses b. Reflects the character of occupations by using job-oriented descriptors c. Reflects the character of employees by using worker-oriented descriptors d. Allows occupational information to be applied across: i. Jobs ii. Sectors iii. Industries (cross-occupational descriptors) iv. Within occupations 4. O*NET is comprehensive a. It incorporates information about both jobs and workers b. The O*NET content model lists six categories of job and worker information

124 © Pearson Education Limited 2015

O*NET Categories • Experience requirements • Occupational requirements • Occupation specific requirements • Worker requirements • Worker characteristics • Labor market characteristics c. Job information contains the components that relate to the actual work activities of a job that should be included in: i. The job summary ii. The job duties sections of job descriptions b. Worker information represent characteristics of employees that contribute to successful job performance 5. Experience requirements a. Experience and training i. Related work experience ii. On-site or in-plant training iii. On-the-job training b. Licensing i. License, certificate, or registration required ii. Education, training, examination, or other requirements for license, certificate, or registration iii. Post-secondary degree, graduate degree, on-the-job training iv. Organization and agency requirements v. Additional education and training c. Organizational and agency requirements i. Legal requirements ii. Employer requirements iii. Union, guild, or professional association requirements 6. Occupation requirements a. Generalized work activities - describes general types of job behaviors on multiple jobs b. Organizational context - indicates the characteristics of the organization that influence how people do their work c. Work context - describes physical and social factors that influence the nature of work

125 © Pearson Education Limited 2015

7. Occupation specific requirements a. Describe the characteristics of a particular occupation b. Seven categories of particular requirements i. Occupational skills ii. Occupational knowledge iii. Tasks iv. Duties v. Machines vi. Tools vii. Equipment 8. Workforce characteristics a. Describe: i. Labor market information ii. Occupational outlook iii. Wages b. Data available from other sources such as: i. The U.S. Bureau of Labor Statistics ii. The Department of Commerce iii. Career One Stop iv. The U.S. Bureau of Census 9. Worker characteristics a. Abilities - the enduring attributes of an individual that influence performance b. Interests - describe preferences for work environments and outcomes c. Work styles - personal characteristics that describe important interpersonal and work style requirements in jobs and occupations 10. Worker requirements a. Basic skills - describe developed capacities that facilitate learning or the more rapid acquisition of knowledge b. Cross-functional skills - indicates developed capacities that facilitate performance of activities that occur across jobs c. Knowledge - describes organized sets of principles and facts applying in general domains d. Education - details prior educational experience required to perform the job

126 © Pearson Education Limited 2015

III.

11. Using O*NET a. HR professionals consult the O*NET User’s Guide and most current O*NET Database b. Get the information on the Web, from the U.S. Department of Labor Employment and Training Administration at http://online.onetcenter.org Job Evaluation A. Definition 1. It is a technique used to systematically recognize differences in the relative worth among a set of jobs, and establish differentials accordingly 2. It reflects the values and priorities that management places on various positions 3. It is based on job content and the firm’s priorities, managers establish pay differentials for virtually all positions within the company B. Compensable Factors 1. Defined as salient job characteristics by which companies establish relative pay rates 2. Universal compensable factors a. Skill b. Effort c. Responsibility d. Working conditions e. Are derived from the Equal Pay Act f. Are used to determine whether dissimilar jobs are “equal” g. Considered universal because virtually every job contains these factors i. Most jobs can be described broadly in terms of these factors given the evolution of jobs that require greater cognitive skills and mental effort ii. A working conditions compensable factor is most helpful when a company expects a substantial difference in working conditions for similar jobs 3. Two considerations when selecting which factors to use when evaluating a job a. Which factors are job-related? b. Which factors further the company’s strategies?

127 © Pearson Education Limited 2015

C. The Job Evaluation Process 1. Six steps a. Determining single versus multiple job evaluation techniques b. Choosing the job evaluation committee c. Training employees to conduct job evaluation d. Documenting the job evaluation plan e. Communicating with employees f. Setting up an appeals process 2. Determining single versus multiple job evaluation techniques a. Determine how many techniques are sufficiently broad to assess a diverse set of jobs b. It is not reasonable to expect that a single job evaluation technique based on a single set of compensable factors can adequately assess diverse sets of jobs 3. Choosing the job evaluation committee a. Usually chosen by the HR professional b. Consists of rank and file employees, supervisors, managers, and union representatives, each with their own motivations i. Employees want fair compensation for contributions ii. Supervisors and managers want to control costs iii. Union representatives want union members to enjoy a quality standard of living c. Purpose is to review job descriptions and analyses and then evaluate jobs d. Helps ensure commitment from employees e. Provides a check and balance system f. A committee allows for a consensus of human judgments g. Functions, duties, responsibilities, and authority vary by company h. In large companies, separate committees are established to evaluate particular job classifications such as: i. Exempt jobs ii. Nonexempt jobs iii. Managerial positions iv. Executive positions

128 © Pearson Education Limited 2015

4. Training employees to conduct job evaluations, by ensuring that they: a. Understand the process objectives b. Know company objectives c. Know job evaluation procedures d. Understand that their decisions must be based on sound job and business-related rationales to make sure their decisions are legal 5. Documenting the job evaluation plan a. Important for legal and training purposes b. Should clearly specify the job and business-related criteria used to evaluate the jobs c. Should clearly describe how the jobs were evaluated and how the outcomes were derived d. Should provide guidelines for clarifying ambiguities in the event of employee appeals or legal challenges 6. Communicating with employees a. Should be done formally and personally throughout the process about: i. How the process works ii. The results b. Employees should have a chance to respond positively and negatively 7. Appeals process: a. Appeals procedures should allow reviews on a case-by-case basis to provide a check on the process through reexamination and such appeals may reduce charges of illegal discrimination b. Compensation professionals usually review employee appeals c. Committee decisions should reflect the varied perspectives of participants rather than the judgment of one individual Practitioner’s Note: Even though much of what is described in the job analysis and job evaluation section is formalized, there is still a tremendous amount of subjectivity on the part of the compensation manager. The compensation manager should carefully weigh the costs and benefits presented, and make his or her decisions based upon what best helps the firm to achieve a competitive advantage.

IV.

Job Evaluation Techniques A. Two general types 1. Market-based evaluations 2. Job-content evaluations 3. Market-based evaluations (more in Chapter 7) a. Use market data to determine differences in job worth 129 © Pearson Education Limited 2015

b. Allow companies to assign pay rates that are neither too low nor too high relative to the market c. Compensation professionals use compensation surveys to determine the prevailing pay rates in the relevant job markets 4. Job-content evaluations a. Emphasize the company’s internal value system to establish a hierarchy of internal job worth based on each job’s role in the company strategy b. Compensation professionals i. Review preliminary structures for consistency with market pay rates on a representative sample of jobs (benchmark jobs) ii. Judge the adequacy of pay differentials by comparing market rates with in-house rates iii. Consult with an HR official and chief financial officer, especially if their rates are lower 5. Must balance external market considerations with internal consistency objectives B. The Point Method (more in Chapter 7) 1. The most popular job-content method because it gives compensation professionals better control over balancing internal and market considerations 2. A quantitative method that assigns numerical values to compensable factors which are summed to indicate the overall value of the job 3. The relative worth of the job is established by the magnitude of its overall numeric value 4. Evaluates jobs by comparing compensable factors a. Each factor is defined and assigned a range of points based on the factor’s relative value to the company b. Compensable factors are weighted to represent the relative importance of each factor to the job 5. The seven-step process a. Select benchmark jobs b. Choose compensable factors based on benchmark jobs c. Define factor degrees d. Determine the weight of each factor e. Determine point values for each compensable factor f. Verify factor degrees and point values g. Evaluate all jobs

130 © Pearson Education Limited 2015

Benchmark Jobs Characteristics • • • •

The contents are well-known, relatively stable over time, and agreed upon by the employees involved The jobs are common across a number of different employers The jobs represent the entire range of jobs that are being evaluated within a company The jobs are generally accepted in the labor market for the purposes of setting pay levels 6. Step 1: Select benchmark jobs a. Used to develop factors and their definitions to select jobs to represent the entire range of jobs in the company b. Benchmark jobs found outside the company, provide reference points against which jobs within the company are judged 7. Step 2: Choose compensable factors based on benchmark jobs a. Managers must define compensable factors that adequately represent the scope of jobs slated for evaluation b. Each benchmark job should be described by these factors that help distinguish it from the value of all other jobs c. Universal factors may be broken down d. Additional factors may be developed to the extent that they are job or business related Example: Compensable Factor Breakdowns • Skill may include job knowledge, education, mental ability, physical ability, accuracy, and dexterity • Effort may include factors relating to physical and mental exertion • Responsibility may include considerations related to fiscal, material, or personnel responsibilities • Working conditions may be unpleasant because of extreme temperatures or possible exposure to hazardous chemicals 8. Step 3: Define factor degrees a. Used to identify the level of a factor present in each job b. Definitions should set forth and limit the meaning of each degree c. The number of degrees will vary depending on the comprehensiveness of the plan d. Most analyses anchor minimum and maximum degrees, with specific jobs representing these points 131 © Pearson Education Limited 2015

Example: Factor Degrees • Educational levels • For clerical positions, a high school diploma or equivalent and an associate’s degree • For administrative, production managerial, and professional jobs, it might be a high school diploma or equivalent, associate’s degree, bachelor’s degree, master’s degree, or doctorate 9. Step 4: Determine the weight of each factor a. Represents the importance of the factor to the overall value of the job b. Weighting often done by management or by a job evaluation committee c. Usually expressed as percentages d. All factors are ranked according to their relative importance and final weights are assigned after discussion and consensus Example: Weighted Factors • Working at ABC Manufacturing Corporation • Skills . . . . . . . . . . . . . 60% • Responsibility . . . . . . 25% • Effort . . . . . . . . . . . . .10% • Working conditions . . 5% 10. Step 5: Determine point values for each compensable factor in three stages a. Establish the maximum possible point values (generally the number of factors times 250) b. Determine point value by multiplying point total by percentage c. Distribute these points across degree statements within each compensable factor for use in a regression analysis (more in Chapter 7) Example: Weighing and assigning points to compensable factors (see page 30) • ABC Manufacturing Corporation 4 factors X 250 points = 1000 points • Skill is the most highly valued at 60% (1000 pts) = 600 points • Responsibility is the next important at 25% (1000 pts) = 250 points • Effort is weighted at 10% (1000 pts) = 100 points • Working conditions at 5% (1000 pts) = 50 points

132 © Pearson Education Limited 2015

Example: Assigning degree point values • Skill has 5 degree statements, with l being the most basic skill and 5 representing the most advanced • 600 point maximum/5 degree statements = 120 points per degree • Degree 1 = 120 points Degree 3 = 360 points • Degree 2 = 240 points Degree 4 = 480 points Degree 5 = 600 points

11. Step 6: Verify factor degrees and point values a. Committee members should review the point totals for each job b. Determine whether the hierarchy of jobs makes sense in the context of the company’s strategy plan as well as the inherent content of the jobs Example: Factor Degrees and Point Values • Sales jobs should rank high in the pharmaceutical industry • Research scientist jobs ought to rank high in a company that pursues a differentiation strategy • Claims analyst rank higher than messengers in the insurance industry 12. Step 7: Evaluate all jobs a. Once the evaluation system has been tested and refined b. By determining which degree definition best fits the job and assigning the corresponding point factors c. By totaling the points for each job, which are then ranked according to their point values 13. Balancing internal and market considerations using the point method a. By converting point values into the market value of jobs through regression analysis (more in Chapter 7) i. Regression analyses enable compensation professionals to set base pay rates in line with market rates for benchmark or representative jobs ii. Companies get market pay rates through compensation surveys iii. A company’s value structure for jobs based on the point method will probably differ from the market rates b. Results of the regression analysis will indicate base pay rates that minimize the differences between the company’s point method results and the market pay rates 133 © Pearson Education Limited 2015

C. Alternative Job-Content Evaluation Approaches 1. Qualitative methods a. Qualitative methods evaluate the entire job and typically compare jobs to one another or some general criteria b. Four main types i. Simple ranking plan ii. Paired comparisons iii. Alternation ranking iv. Classification plans 2. Simple ranking plan a. This plan orders all jobs from lowest to highest according to a single criterion, such as: i. Job complexity ii. The centrality of the job to the company’s competitive strategy b. In small companies, this approach considers each job in its entirety c. In large companies, jobs are ranked on a departmental basis i. Different rankings may result ii. Committees resolve differences by consensus d. Three limitations i. Ranking results rely on purely subjective data • The process lacks objective standards, guidelines, and principles that might aid in resolving differences of opinion among committee members • Companies do not always fully define their ranking criteria ii. Ranking methods use neither job analyses nor job descriptions, making them difficult to legally defend iii. Ranking methods do not incorporate objective scales that indicate how different in value one job is from another 3. Paired comparison ranking a. Useful when there are many (20 or more) jobs to rate b. Every job is paired with every other job i. The job with the highest value is given a point ii. The other job gets nothing c. After all pairs are rated, the jobs are ranked by total points received i. The job with the most points is the most valuable ii. The jobs with the least points is the least valuable

134 © Pearson Education Limited 2015

4. Alternation ranking a. Orders jobs by extremes b. The relative value of each job is judged by a single criterion, such as: i. Job complexity ii. Centrality of the job to the company’s competitive strategy c. Ranking begins by determining which job is the most then least valuable d. The ranking then goes from second most and least valuable, to third, fourth, and so on, until all jobs are evaluated Example: Alternation Ranking • Training and development professional • Listed most valuable to least • Director of training and development • Manager of training and development • Senior training and development specialist • Training and development specialist • Training and development assistant • Not knowing “how much different” the values are makes it difficult to establish pay levels according to job content differences 5. Classification plans a. Place jobs into categories based on compensable factors b. Public sector organizations, such as the civil service systems, use this plan c. The federal government uses the General Schedule (GS) classification plan (refer to Chapter 3) i. 15 classifications GS-1 through GS-15, based on: • Skills • Education • Experience ii. Jobs that require high levels of specialized education, or executive decision making are classified differently • Senior Level • Scientific and Professional • Senior Executive Service 135 © Pearson Education Limited 2015

iii. Enables the federal government to set pay rates for thousands of unique jobs based on 18 classes, based on: • GS level • Relevant work seniority D. Alternatives to Job Evaluation 1. Market pay rates (more in Chapter 7) 2. Pay incentives (more in Chapter 4) 3. Individual rates 4. Collective bargaining (refer to Chapter 2) V.

Internally Consistent Compensation Systems and Competitive Strategy 1. Reduce a company’s inflexibility: a. In responding to changes in competitor’s pay practices b. Because job analysis leads to structured job descriptions and job structures 2. Relative worth a. Job evaluation establishes the relative worth of jobs within the company b. However, responding to the competition may necessitate that employees engage in duties that extend beyond what’s written in their job descriptions 3. Bureaucracy a. Establishing job hierarchies tends to create narrowly defined jobs, which leads to great numbers of: i. Jobs ii. Staffing levels b. Such structures promote heavy compensation burdens i. Core compensation depends on: • The job employees perform • How well employees perform • Skills employees possess ii. Employee benefits which are fixed cost

136 © Pearson Education Limited 2015

VI.

Discussion Questions and Suggested Answers

6-1.

Discuss the differences between job analysis and job evaluation. How do these practices help establish internally consistent job structures?

Job analysis is a systematic process for gathering, documenting, and analyzing information in order to describe jobs. A job analysis describes content or job duties, worker requirements, and sometimes, the job context or working conditions. Job evaluation, on the other hand, is used to systematically recognize differences in the relative worth among a set of jobs and establish pay differentials accordingly. Whereas job analysis is almost purely descriptive, job evaluation partly reflects the values and priorities that management places on various positions. Based on job content and the firm’s priorities, managers establish pay differentials for virtually all positions within the company. These practices help establish internally consistent job structures by setting guidelines and expectations for both employees and employers alike.

6-2.

Conduct a job analysis of a person you know, and write a complete job description according to the principles described in this chapter. In class, be prepared to discuss the method you used for conducting the job analysis and some of the challenges you encountered.

Sally Walker is a member of Geek Squads technical assistance team. The minimum qualification for this job is a high school education. She is required to work with accuracy and speed while on the job. Sally is a field technician, which means she receives calls from her department and then goes to the designated customer to subsequently fix the problem as cleanly and as efficiently as possible. Sally gets paid based on the number of hours she’s on call, and is evaluated according to the customer satisfaction level.

6-3.

What are the factors that determine how actively human resource professionals are engaged in making valid and reliable job analysis? Explain your answer.

Valid and reliable job analysis means that each job’s duties are accurately assessed relying on multiple sources and multiple methods. They are essential because if insufficient analysis could lead to inadequate pay, which in turn may lead to dysfunctional turnover and excessive pay, which would represent a cost burden to the company. Analyses should include multiple data collection methods and sources to minimize the inherent biases associated with any particular method or source.

6-4.

Respond to the statement “Building an internally consistent job structure is burdensome to companies. Instead, it is best to simply define and evaluate the worth of jobs by surveying the market.”

Internally consistent pay systems may reduce a company’s flexibility to respond to changes in competitors’ pay practices because job analysis leads to structured job descriptions and job structures. In addition, job evaluation establishes the relative worth 137 © Pearson Education Limited 2015

of jobs within the company. Responding to the competition may require employees to engage in duties that extend beyond what’s written in their job descriptions whenever competitive pressures demand. In the process, the definitions of jobs become more fluid, which makes equity assessments more difficult. In this sense it may just be better to simply define and evaluate the worth of jobs by surveying the market.

6-5.

Do you consider job evaluation to be an art or a science? Please explain.

Job evaluation is more of a science than an art, for the evaluation process consists of basic formulas and guidelines that are in essence quite rigid. In order to accurately evaluate a job, it is necessary to evaluate by the rules of job evaluation. For example, various job evaluation techniques require certain formulas and numbers. In order to determine point values for each compensable factor, for instance, one must use certain number parameters in order to get an accurate evaluation: “The maximum possible total points for skills equal 600 points (60% x 1,000 points).”

VII.

End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses

Case Name: Internal Consistency at Customers First Instructor Notes Many organizations that experience rapid growth set pay in response to the external market. Such a strategy can be useful in recruiting the right talent for a start-up organization. However, internal consistency of pay rates is often overlooked leading to more long-term concerns for an organization. Such inconsistency can cause feelings of inequity among employees and can lead to employee dissatisfaction and turnover.

Further, if the inconsistencies fall along a particular protected class (i.e. those who feel they are paid less are in workgroups comprised mostly of females), a company could face some legal challenges. A formal job analysis and job evaluation process that establishes an internally consistent pay structure can alleviate these concerns.

Suggested Student Responses: 6-6.

Do you think that job analysis and job evaluation will benefit Customers First?

The potential pay inequities at Customers First are a concern. As noted, the employees have concerns about their pay and this could lead to potential turnover.

Further, the inequities could cause some legal concerns if pay decisions have adverse impact against a protected class. The lack of pay structure also makes setting the pay of new hires time consuming. Job analysis and job evaluation leading to a pay structure would help ensure that there is internal consistency in pay rates.

138 © Pearson Education Limited 2015

6-7.

What would you recommend to make the job analysis and job evaluation process less tedious and less time consuming for line managers?

Line managers should be trained on the job analysis and job evaluation methodology so that they are familiar with the process and be more efficient and effective in performing these activities. In addition, instead of evaluating all the jobs in the company, the number of jobs to be analyzed and evaluated could be reduced by using benchmark jobs that are representative of the company’s business.

6-8.

What do you recommend Customers First do? Why?

While some of Joan’s concerns are legitimate, if the company is planning continued growth, a more formal pay structure would be helpful to avoid pay inequities and help support pay decisions at hire. While it would be time consuming to take on, after the initial job analysis and job evaluation process is completed, the resulting pay structure would ultimately benefit the company.

MYLAB QUESTIONS 6-9.

Why must a job analysis be reliable and valid? What can a compensation professional do to ensure that a job analysis is reliable and valid?

Answer: A reliable job analysis is one that yields consistent results under similar conditions. A valid job analysis method accurately assesses each job's duties. Having a job analysis method that is both reliable and valid is essential to building an internally consistent compensation system. A poorly chosen method may lead to inadequate or excessive pay rates. Although there is no "best" approach to job analysis, compensation professionals who use more than one data collection method and collect data from more than one source can significantly improve the likelihood of reliability and validity.

6-10. After completing the job analysis, your boss has asked you to conduct a job evaluation of the various positions in the company. Detail the steps you would take in accomplishing this task.

Answer: The first step is to determine whether a single job evaluation technique is sufficiently broad to assess a diverse set of jobs. It is not reasonable to expect that a single job evaluation technique, based on a single set of compensable factors, can adequately assess diverse sets of jobs.

The second step is to choose the job evaluation committee. This committee will review job descriptions and analyses and evaluate jobs. The size of the organization may 139 © Pearson Education Limited 2015

warrant the use of more than one committee. Choosing a consensus of employees will help to minimize the biases of individual job evaluators.

The third step is to train employees to conduct job evaluations. Employees who have an understanding of the process will have a vested interest in finding valid results.

The fourth step is to document the job evaluation plan. For the employer, this step will specify job- and business-related criteria against which jobs are evaluated. For employees, this step allows them to understand how their jobs were evaluated and the outcome of the process.

The fifth step is to communicate the process to the employees. This will increase the understanding of the process as well as give employees the opportunity to respond to what they believe are either unsatisfactory procedures or outcomes of the job evaluation procedures.

Finally, a company should set up an appeals process that will provide a check on the system.

VIII. Additional Case from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses.

Case Name: Shifting Incentives at TechEx Repair Instructor Notes Companies should design pay systems to direct employees to behave in a way that benefits the company. In this case, the technicians’ inability to perform multiple types of repairs affects the company’s overall productivity. While the current bonus system encourages hard work, if some technicians are idle while work is waiting, the company is not reaching optimum productivity levels. In order for a pay-for-knowledge program to be effective, it must be carefully designed and the company must be willing and able to put the right resources in place to provide the necessary training and support.

Suggested Student Responses: 6-11. What are advantages of shifting to a pay-for-knowledge program at TechEx Repair?

Employees may find their jobs more satisfying as they will expand the type of work they do. Performing different types of repairs will lead to task variety for the technicians. The company benefits by having a better-trained workforce that is more flexible in work assignments. As a result, the employees will also benefit as well as they will have more security in their jobs and in their pay.

140 © Pearson Education Limited 2015

6-12. What are advantages of keeping the company’s current bonus plan?

A pay-for-knowledge program can increase overall training and labor costs, without the immediate tie to productivity that the current bonus plan likely provides.

Employees will most likely favor the current bonus plan because they see the immediate benefits of the plan. Finally, the current bonus plan allows employees to be successful without the additional cost and effort of training. If the right resources are not in place to support training when a pay-for-knowledge program is initiated, employees may become frustrated.

6-13. What do you think TechEx should do?

Student answers may vary here, but they should provide support for their opinion.

Some students may recommend implementing the pay-for-knowledge program to set more appropriate base pay, but also leave some form of a productivity incentive bonus plan in place. However, doing so would be a challenge. It would be important to take steps to ensure employees understood the long-term rewards of taking time to learn new repairs.

141 © Pearson Education Limited 2015

CHAPTER 7 Building Market-Competitive Compensation Systems Learning Objectives 1. Explain the concept of market-competitive compensation systems and summarize the four activities compensation professionals engage in to create these systems.

2. Discuss how compensation professionals integrate job structures with external market pay rates.

3. Present the basic concepts of two compensation policy types: pay mix and pay level.

Outline I.

Market-Competitive Pay Systems: The Basic Building Blocks A. Definition B. Market-Competitive Pay Systems II. Compensation Surveys A. Purposes B. Preliminary Considerations C. Using Published Compensation Survey Data D. Compensation Surveys: Strategic Considerations E. Compensation Survey Data III. Integrating Internal Job Structures with External Market Pay Rates IV. Compensation Policies and Strategy Mandates V. Discussion Questions and Suggested Answers VI. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses VII. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses.

Quick Note: Throughout this chapter, students should bear in mind that it is important to remember the firm’s competitive strategy when making compensation recommendations.

Two companies could have entirely different market-competitive pay systems, and have those both be ideal strategies for their respective firms.

142 © Pearson Education Limited 2015

Lecture Outline I.

Market-Competitive Pay Systems: The Basic Building Blocks A. Definition 1. Market-competitive pay systems represent companies’ compensation policies that fit the imperatives of their competitive advantage 2. These systems play a significant role in attracting and retaining the most qualified employees 3. Should promote companies’ attainment of competitive strategies 4. Excess pay levels can: a. Represent an undue burden b. Undermine lowest-cost strategies c. Restrict a company’s ability to invest in other important strategy activities 5. Companies with differentiation strategies must strike a balance between: a. Offering attractive pay incentives to hire and retain good employees b. Providing sufficient resources for employees to excel B. Market-Competitive Pay Systems 1. Based on four activities a. Conducting strategic analyses b. Assessments of competitors’ pay practices with compensation surveys c. Integrating the internal job structure with external market pay rates d. Determining compensation policies 2. Conducting strategic analyses a. Entail an examination of a company’s external market factors like: i. Industry profile ii. Information about competitors iii. Long-term growth prospects b. Require an examination of a company’s internal factors like: i. Its financial condition ii. Its functional capabilities, such as marketing and human resources 3. Assessments of competitors’ pay practices with compensation surveys a. Involve the collection and analysis of competitors’ compensation data i. Wages and salary practices ii. Fringe compensation practices - a key element of marketcompetitive pay systems b. The surveys allow compensation professionals to obtain realistic views of competitors’ pay practices.

143 © Pearson Education Limited 2015

4. Integrating the internal job structure with external market pay rates with the external market pay rates identified through compensation survey a. Results in pay rates that reflect both the company’s and the external market’s valuation of jobs b. The integration is generally achieved by using regression analysis 5. Determining compensation policies a. The policies should fit with the company’s standing and competitive advantage b. The policies must strike a balance between managing costs and attracting and retaining the best qualified workers II.

Compensation Surveys A. Purposes 1. Consulting or developing compensation surveys is the second step in assessing external competitiveness 2. These are tools used to gather data about competing companies’ compensation practices B. Preliminary Considerations 1. Main considerations a. What companies hope to gain from compensation surveys b. Which type of survey to use 2. What companies hope to gain from compensation surveys a. Competitors’ compensation practices b. Employee’s preferences for alternative forms of compensation due to economic changes 3. Competitors’ compensation practices a. Base pay b. Incentive award structures c. Both mix and level of discretionary benefits i. Mix refers to the percentage of employer compensation costs to provide compensation and benefits ii. Level refers to amounts actually or potentially paid to employees or beneficiaries d. Ability to make sound judgments about pay levels i. Sound decisions promote employers’ efforts to sustain competitive advantage ii. Poor decisions compromise competitive advantage

144 © Pearson Education Limited 2015

4. Which type of survey to use a. Custom developed surveys b. Published compensation data surveys 5. Custom Developed Surveys a. Preferable because the questions can be tailored specifically for each company b. Can provide the most useful and informative data c. Not always practical because of the specialized knowledge and skills needed to develop effective ones d. Not always effective because businesses are reluctant to give information directly to competitors e. The staffing and design costs can be prohibitive C. Using Published Compensation Survey Data 1. Two important considerations a. Survey focus: core or fringe compensation b. Sources of published survey data 2. Survey focus a. Base pay b. Employee benefits c. Both i. Historically companies competed for employees only on base pay because benefits were similar ii. Now, high costs of benefits have differentiated benefit offering from company to company Example: Discretionary Benefits • As of 2012, companies spent an average $20,000 per employee annually for discretionary benefits • Discretionary benefits account for as much as 30.8 percent of employers’ total payroll costs 3. Sources of published surveys a. Professional associations b. Industry associations c. Consulting firms d. Federal government 4. Associations, professional and industry a. Survey members about salaries, compile information in summary form, and disseminate the results to members 145 © Pearson Education Limited 2015

b. Survey data from associations tends to be accurate because participants (association members) benefit from the results c. Membership fees often entitle members to survey information at no additional cost Example: Existing Professional Compensation Surveys SIOP • The Society for Industrial and Organizational Psychology (SIOP) periodically publishes salary data relevant for its members • Members are primarily college and university faculty and practitioners who specialize in management-related fields (selection, training, performance appraisal, career development) • Provides information based on: • Gender • Age • Employment status • Years since earning degree • Geographic region according to metropolitan area • Employers use results to determine market-competitiveness of their compensation packages World at Work • 2009–2010 Total Salary Increase Budget Survey • Collects comprehensive data annually • Topics include • Salary structures • Promotions • Incentive practices 5. Consulting firms a. Some firms offer specialized (e.g., occupational, industry) data b. Data can be from recent surveys c. Data can be gathered and customized for each client i. More expensive ii. Higher quality d. Examples include: i. AON Consultants ii. Buck Consultants iii. Frederic W. Cook & Company iv. Hay Associates v. Pearl Meyer & Partners vi. Towers Watson 146 © Pearson Education Limited 2015

vii. William M. Mercer

6. Federal government’s survey sources a. History of data collecting i. Bureau of Labor Statistics (BLS) began collecting data in the 1890s ii. Free to the public iii. Assess the effects of tariff legislation on wages and prices b. Currently, BLS surveys include: i. National Compensation Survey (wages and benefits) ii. Employment Cost Index (compensation cost trends) iii. Employer Costs for Employee Compensation (compensation cost trends) c. National Compensation Survey (NCS) provides measures of occupational wages; employment cost trends, benefit incidence, and detailed plan provisions. The data include: i. Average hourly wages for over 800 occupations in approximately 80 metropolitan and selected nonmetropolitan localities ii. Weekly and annual earnings and hours for full-time workers iii. Earnings by work level that permit wage comparisons across occupational groups iv. Data at three levels: localities, broad regions, and the nation v. Workers are shown as a total (all workers) and broken out by private industry, and state and local government vi. Wage data are shown by industry, occupational group, full-time and part-time status, union and nonunion status, establishment size, time and incentive status, and job level d. Employment cost trends are measured by two quarterly indexes i. Employment Cost Index (ECI) ii. Employer Cost for Employee Compensation (ECEC) e. ECI: i.

Quarterly measure of changes in labor costs including wages and salaries, benefits, as well as changes in total compensation ii. A principal economic indicator used by the Federal Reserve Bank iii. Presents data as a total for all workers and separately for private industry, and state and local government employees iv. Reports compensation changes in industry, occupational group, union and nonunion status, region, and metropolitan and nonmetropolitan status 147 © Pearson Education Limited 2015

v.

Provides seasonally adjusted and unadjusted data vi. Presents historical data on changes in labor costs vii. Uses fixed weights to control for shifts among occupations and industries viii. Was developed in mid 1970s, in response to the rapid acceleration of both wages and prices, benefits, and total compensation added in 1981 ix. Provides a more accurate measure of the actual changes in employers labor costs f. ECEC i. Is a survey that shows the employers’ average hourly cost for total compensation and its components ii. Shows compensation costs broken down by wages and salaries, total benefits costs, and separate benefits costs iii. Provides data in dollar amounts and as percentages of compensation iv. Breaks out data on civilian workers, state government employees, and local government employees into estimates for white-collar, blue-collar, and service groups v. Reports compensation costs by major occupation, industry, region, union and nonunion status, establishment size, and full- or parttime status g. Employee benefits covered by National Compensations Survey (NCS) i.

Covers the incidence and detailed provisions of selected employee benefit plans ii. Data are presented as the percentage of employees who have access to or participate in certain benefits, or as average benefit provisions iii. Estimates are published by broad occupational groups, full- and part-time status, union and nonunion status, workers with average wages by selected percentiles, selected goods-producing and service-providing industries, establishments by selected employment sizes, and census divisions iv. Provides incidence and extensive provisions data for health insurance and retirement D. Compensation Surveys: Strategic Considerations 1. Two essential strategic considerations a. Defining the relevant labor market b. Choosing benchmark jobs

148 © Pearson Education Limited 2015

2. Defining the relevant labor market a. Relevant labor markets represent the fields of potentially qualified candidates for particular jobs b. Defined on the basis of: i. Occupational classification ii. Geography iii. Product or service market competitors c. Occupational classification refers to a group of two or more jobs that are based on similar work characteristics and responsibilities d. Information available in the BLS’s “Standard Occupational Classification Manual” from the BLS Website at http://www.bls.gov/ocsm/commain.html i. Classified by: • Occupation • Geographic scope • Competitors ii. Classifications used singularly and in combination • A company may use competitors and geographic scope to recruit product managers • Many professional, technical, and management positions may recruit using all three e. Companies search a wider geographic area for candidates: i. For jobs that require specialized skills ii. When the supply of workers for less-skilled jobs is low f. Companies use competitors to define the relevant labor market when: i. Industry specific knowledge is key ii. Competition for market share is keen Example: Strategic Considerations • • •

Hospitals might search nation-wide for neurosurgeons because the skills needed are rare An insurance company restricts its search for clerical employees to the immediate area AT&T would prefer recruiting a competitor’s marketing manager than looking for one from an unrelated industry

149 © Pearson Education Limited 2015

3. Choosing benchmark jobs (more in Chapter 6) a. Used to: i. Conduct effective job evaluations ii. Conduct compensation surveys iii. Determine pay levels based on typical market pay b. Four characteristics i. The contents are well-known, relatively stable over time, and agreed upon by the employees involved ii. The jobs are common across a number of different employers iii. The jobs represent the entire range of jobs that are being evaluated within a company iv. The jobs are generally accepted in the labor market for the purposes of setting pay levels c. Necessary because matches between a company’s position to a position in a survey is not always possible since: i. Large companies may have hundreds of unique jobs ii. Companies adapt job duties and scope to fit their specific needs d. Rating scales are sometimes used to adapt a company’s compensation package for a job from the benchmark jobs mentioned in surveys e. Surveys now include data about pay rates i. United States ii. Foreign countries E. Compensation Survey Data 1. Three compensation survey data characteristics a. Contains immense amounts of information i. May be a wide variety of pay rates across companies, making it hard to build market-competitive pay systems ii. Statistics needed to describe large sets of data b. The data is generally outdated because of the lag time between data collection and use c. Statistical analysis should be used to integrate internal job structures (based on job evaluation points) with the external market (based on the survey data) (more in Chapter 6) 2. Data analysis 1. Begins with basic tabulation of survey data which: a. Helps organize the data b. Promotes decision makers’ familiarization with the data c. Reveals possible extreme observations (outliers)

150 © Pearson Education Limited 2015

3. Two properties that describe numerical data sets a. Central tendency b Variation 4. Central tendency a. Represents the fact that a set of data cluster (or center) around a central point b. Is the number that represents the typical numerical value in the data set c. Two central tendency measures i. Arithmetic mean ii. Median d. Mean is calculated by: i. Adding all the salaries together ii. Dividing the sum by the number of salaries added Example: Salary Means • Accountants I, II, III • Accountant I—less than two years on the job • Accountant II—two to four years on the job • Accountant III—four to six years on the job • 7 Atlanta-based companies • 35 salaries totaling $1,337,500 • Mean is $38,214.29 ($1,337,500/35) • Represents the going market-rate iii. One or more outliers can lead to a distorted representation of the typical value • The mean underestimates the “true” typical value when there is one or more small values • The mean overestimates the “true” typical value when there is more than one large value • Underestimated mean salaries can set salaries too low to be competitive • Overestimated mean salaries can become cost burdens to companies e. Median is determined by: i. Ranking the salaries in numerical order and finding the middle salary amount (when there is an odd number of salaries) ii. Ranking the salaries in numerical order, adding the middle two salaries, then dividing them by two 151 © Pearson Education Limited 2015

Example: Finding the Median of an Even-Numbered Data Set • Data set salaries: $25,000 $28,000 $29,500 $33,000 • Two middle salaries: $28,000 and $29,500 • Median: $28,000 + $29,500/2 = $28,750

iii. Does not distort the typical value because its calculation is independent of the magnitude of each value 5. Variation a. Represents the amount of spread or dispersion in a set of data b. Compensation professional use three measures of variation i. Standard deviation ii. Quartile iii. Percentile c. Standard deviation i. Refers to the mean distance of each salary from the mean • How larger observations fluctuate above the mean, and • How small observations fluctuate below the mean Example: Central Tendency • Mean—$38,214.29 • Standard Deviation—$5,074.86 • Irwin Katz’s salary $27,500 which is below the typical average • Difference between mean salary and Katz’s salary $10,714.29 ($38,214.29 - $27,500) • Majority of salaries between $33,139,43 and $43,289.29 ($33,139.43 + / - $5, 074.86) ii. Used as a reference point to judge whether employees’ compensation is below or above the market iii. Indicates the range for the majority of salaries, so it can be used to judge how a company’s salary range compares to the market d. Quartile i. Describe dispersion by indicating the percentage of figures that fall below certain points ii. Allows compensation professionals to describe the distribution of data based on four points • Quartile 1 at 25% • Quartile 2 at 50% • Quartile 3 at 75% 152 © Pearson Education Limited 2015

• Quartile 4 at 100% e. Percentiles ii. Describe dispersion by indicating the percentage of figures that fall below certain points ii. Based on 100 points Example: Quartile and Percentile Quartile • Quartile 1—$34,500 (25%) • Quartile 2—$36,000 (50%) • Quartile 3—$43,500 (75%) • Quartile 4—$55,000 (100%) Percentile • 10 Percentile—$33,000 • 9th Percentile—$45,000 th

f. When the distribution of data is skewed to the left (higher frequency of larger values) the mean will be less than the median g. When the distribution of data is skewed to the right (higher frequency of smaller values) the mean will be greater than the median Example: Mean & Median • Company A’s production workers’ hourly wage mean $8.72 • Company B’s production workers’ hourly wage mean $9.02 • Wages $8.15 $8.39 $8.51 $8.60 $10.25 $10.72 / 6 • Company A’s mean wage ($8.72) is higher than the median wage rate of Company B’s workers ($8.55) 6. Updating the survey data a. Necessary because of the lag-time between data collection and data use Example: Need for Updating Salary Data • Pay needs to be determined for the January 1, 2010–December 31, 2010 pay period • Data was collected in October 2009 • Data represented pay in 2008 • Data will be 12 and 24 months old b. Factors that influence the update include: i. Economic forecasts 153 © Pearson Education Limited 2015

ii. Changes in the costs of consumer goods and services • Information available in the Consumer Price Index (CPI) • CPI published monthly by the BLS in “The CPI Detailed Report” • CPI also available on the Web at http://www.bls.gov iii. Employers generally award small permanent pay increases when the economic forecast is pessimistic due to • The possibility of recession • Higher unemployment levels iv. Changes in the cost of living tend to make survey data obsolete fairly quickly III.

Integrating Internal Job Structures with External Market Pay Rates 1. To attract and retain the most qualified workers a. Use of job evaluation methods to establish internally consistent job structures b. Companies value jobs that possess higher degrees of compensable factors 2. To keep compensation policies in line with the company’s competitive strategy a. Paying well above or below the typical market rate for jobs can create a competitive disadvantage for companies b. Companies should set pay rates by using market pay rates as reference points 3. Regression analysis is used to establish pay rates 4. Regression analysis a. Uses market pay rates as reference points for determining internal pay structures b. Enables decision makers to predict the values of one variable from another c. Can’t just “eyeball” the salaries to identify market rates i. When companies pay different rates for the same jobs ii. When there are a large number of rates d. Finds the best fitting line (market pay line) between two variables i. Job evaluation points of benchmark jobs ii. Salary survey data for the benchmark jobs e. Equation i. Y = a + bX ii. Y = predicted salary iii. X = job evaluation points 154 © Pearson Education Limited 2015

iv. a = the Y intercept: the Y value at which X = 0 v. b = the slope • Represents the change in Y for every change in the job evaluation points • Represents the dollar value of each job evaluation point Example: Regression Analysis • Y = a + bX • Y = $32,315.66 + $12.21X • Job evaluation points: • Accountant I = 100 points • Accountant II = 500 points • Accountant III = 1000 points • Accountant I: Y = $32,315.66 + $12.21 (100) = $33,536.66 • Accountant II: Y = $32,315.66 + $12.21 (500) = $38,420.66 • Accountant III: Y = $32,315.66 + $12.21 (1000) = $44,525.66 f. R2 i. Tells how well the variation of jobs based on job evaluation points explains the variation in market pay rates from the survey ii. Ranges from 0 to 1 iii. Represents the percentage variation in Y values that can be explained by the X values • Y = market pay rates • X = job evaluation points iv. Values • R2 = 0 means that none of the variation in market pay rates can be explained by the company’s job structure • R2 -= 1 means that all the variation in market pay rates can be explained by the company’s job structure • R2 between 0 and .30 represents a small amount of variation • R2 between .31 and .70 represents a medium amount of variation • R2 above .71 represents a large amount of variation Example: R2 Values • R2 ivalue = .71 • The difference = .29 (1.0 - .71) • .29 means that 29 percent of the variation in market pay rates cannot be explained by 155 © Pearson Education Limited 2015

the company’s job structure

IV.

Compensation Policies and Strategic Mandates 1. Companies can choose from three pay level policies a. Market lead b. Market lag c. Market match i. Most often, market lead policies are set to the 3rd quartile (the 75th percentile) ranking in the salary survey. Similarly, market match policies are set to the 2nd quartile (the 50th percentile or median) ranking, and market lag policies are set to the 1st quartile (the 25th percentile) ranking 2. Market lead policy: a. It distinguishes companies from the competition by compensating employees more highly than most competitors b. Leading the market denotes that pay levels are above the market pay line c. It is most appropriate for companies that pursue differentiation strategies d. How much above depends on two factors i. How much is sufficient to attract and retain the most qualified workers ii. How much funding should go to employee compensation as opposed to other activities that promote differentiation strategies like research and development 3. Market lag policy: a. It distinguishes companies from the competition b. Lagging the market indicates that pay levels fall below the market pay line c. It is most appropriate with lowest-cost strategies because companies realize cost savings by paying lower than the market pay line d. Short-term cost savings may, however, be offset by higher long-term costs e. Companies may experience difficulties in recruiting and retaining highly qualified employees f. Companies that adopt the policy need to balance cost savings with productivity and quality concerns 4. Market match policy: a. Most closely follows the typical market pay rates because companies pay according to the market pay line 156 © Pearson Education Limited 2015

b. Most appropriate with a differentiation strategy when the company follows a market policy to fund expensive operating or capital needs that support the differentiation like research equipment and research laboratories 5. Pay policy levels in combination a. Market match and market lead policies for professional and managerial talent because these employees contribute most directly to the competitive advantage of companies b. Market match and market lag policies for clerical, administrative, and unskilled employees because of the abundance of available workers and their less direct contributions to the attainment of competitive advantage 6. Pay policy mix a. Pay mix policies refer to the combination of core compensation and employee benefits components that make up an employee’s total compensation package b. Pay mix may policies may be expressed in dollars (or other currency as relevant) or as a percentage of total dollars allocated for an employee’s total compensation. The following is an example of a pay policy mix:

Base Wage

27%

Short-Term Incentives

57%

Long-Term Incentives

10%

Benefits

6%

c. This example indicates that base pay accounts for 57 percent of the money allocated to an employee’s total compensation. Let’s assume that the company spends $200,000 annually to fund a particular employee’s total compensation package. Of the total, an employee receives base pay in the amount of $114,000 (that is, $200,000 x 57 percent) 157 © Pearson Education Limited 2015

7. What is an appropriate pay mix? a. For policy purposes, it makes sense to consider guidelines for jobs within a particular structure (for example, managerial, administrative, or sales) because of the common job content and worker requirements of jobs within a particular structure. b. For example, in a technology company, a greater portion of bonus compensation might be allocated to engineers than to administrative staff. Engineers possess crucial skills relating to the company’s ability to find innovative applications of technology, and bonus incentives throughout the year may promote innovation initiatives. On the other hand, the administrative staff, though important to the company, may not play as important a role in determining the company’s profitability or objectives. c. Therefore, less of their total compensation would likely be devoted to bonus funds. Also, some job structures, such as sales, employees may receive the majority of their compensation in the form of bonuses. In order to motivate a sales force to continually exceed quarterly targets, quarterly bonuses equal to or exceeding their annual base salaries might be used.

V.

Discussion Questions and Suggested Answers

7-1.

You are a compensation analyst for Worry-Not Insurance Company, which is located in Hartford, Connecticut. Define the relevant labor market for insurance claims adjusters and for data entry clerks. Describe the rationale for your definitions.

Relevant labor markets represent the fields of potentially qualified candidates for particular jobs. Companies collect compensation survey data from the appropriate relevant labor markets. Relevant labor markets are defined on the basis of occupational classification, geography, and product or service market competitors.

The relevant labor market for claims adjusters might be the entire state of Connecticut and other insurance companies employing adjusters. The relevant labor market for data entry clerks might be just the city of Hartford and any company employing data entry clerks.

7-2.

Can companies easily develop compensation systems that are both internally consistent and market competitive? What are some of the challenges to this goal?

Although not easy, companies do try to develop compensation systems that are both internally consistent and market competitive. Compensation professionals integrate the internal job structure with the external market pay rates identified through compensation surveys. The valuation of jobs that results from this integration 158 © Pearson Education Limited 2015

considers both the company’s and the external market’s perspective. Most often, compensation professionals rely on regression analysis, a statistical method to achieve this integration. Compensation professionals also recommend pay policies that fit with their companies’ competitive strategies. Compensation professionals must strike a balance between managing costs and attracting and retaining the bestqualified employees.

7-3.

Which do you believe is most important for a company’s competitive advantage: internal consistency or market competitiveness? Explain your answer.

Market competitiveness, for it is important to meet the growing demands of the market and stay ahead of the competition in order to make the most profit for the company.

7-4.

Refer to the regression equation presented earlier in this chapter. When b = 0, the market pay line is parallel to the x-axis. Provide your interpretation.

When b = 0 the market line is indeed parallel to the x-axis, only when the slope is greater or less than 0 is the line not parallel to the x axis.

7-5.

Why do multinational companies that operate globally often adopt generic pay policy statements on its external market competitiveness instead of specific pay policy positioning for its different job families or job functions?

Multinational companies often adopt generic pay policy statements because the market pay rates and market pay levels vary from country to country depending on several factors, such as supply and demand of different talents and skills in the different functions, the economic conditions of the country, inflation or cost-of-living in the country, and the country’s employment laws and regulations.

VI. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses Case Name: Nutriment’s New Hires Instructor Notes Nutriment is pursuing a differentiation strategy in order to create product that is not offered by their competitors. In order to successfully attract the right staff to ensure Nutriment has a competitive advantage, the company must ensure that their pay structure is competitive in the local market while also managing costs. Nutriment has different job categories that may require different pay strategies. The administrative positions only 159 © Pearson Education Limited 2015

require Nutriment to match the compensation of their competitors. However, the scientists will be more difficult to attract. As such, it is likely that they will need to take a pay lead strategy for their scientist. Nutriment may also have some concerns with internal consistency of compensation as the market will likely drive them to offer the scientists pay that is significantly more than that of the administrative staff members.

Suggested Student Responses: 7-6.

What are some strategic considerations in establishing a pay structure at Nutriment?

In considering a pay structure that is competitive in the market place, Nutriment should consider their industry, competitors and other external market factors. They must also consider their financial resources. Nutriment’s business strategy is a differentiation strategy as they are looking to develop a unique product. As such, recruiting and retaining talented staff members, particularly the scientists, will be essential in order for the business to succeed. They currently have an edge in the market place because of their scientific discoveries; however, it is a competitive market place for talent.

7-7.

What would be your recommendation on the pay level strategy or pay positioning for the different job families or job functions, and why?

Jack could peg the pay level for administrative staff position at market median or below because the current labor market for this group of employees could easily generate a pool of qualified applicants. However, scientists will be challenging to find as they need specific expertise related to agriculture biotechnology and genetic engineering.

Therefore, the pay level strategy for scientists should be higher than market median.

MYLAB QUESTIONS 7-8.

Explain the role of compensation surveys. Why is it important to update survey data?

Answer: Compensation professionals assess competitors' pay practices with compensation surveys. Compensation surveys are important because instead of guessing, compensation professionals can gather realistic views of competitors' wage and salary practices. This information is crucial to build competitive compensation systems.

When companies establish pay structures, they are anticipating the future costs to the company. Compensation professionals typically use historical survey data to build said structures. Unfortunately, this data may not accurately reflect the changes that may 160 © Pearson Education Limited 2015

occur in the economy and the fortunes of the company. So, companies update survey data to correct for any lags that may occur.

7-9.

Explain market pay line. How is it used in the context of pay level policies such as market lead, market lag, and market match?

Answer: Paying well below or well above the typical market rate for jobs can create a competitive disadvantage for companies. Regression analysis helps to establish pay rates for a set of jobs that are consistent with the typical pay rates of the external market.

Regression analysis finds the best-fitting line between two variables and the best fitting line is referred to as market pay line. The typical market pay rate is represented by market pay line. Market lead policies refer to the pay levels that fall above the market pay line, whereas market lag policies refer to the pay levels that fall below the market line. Market match policy follows the market pay line.

VII.

Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses

Case Name: Analyzing Jobs at Custom Carpet Cleaning Instructor Notes Many smaller companies must manage their staff with limited human resource management expertise. In this case, the company is making an effort to create written job descriptions, which will be useful in developing an internally consistent compensation system that is competitive in the market. However, it is unlikely that the process here will result in a valid and reliable job analysis. Developing job descriptions that are not thorough or entirely accurate will not effectively support the development of a compensation system. Many managers in small companies rely upon the Internet for information. In this case, it might be a good investment for the company to utilize an outside consultant or find an opportunity for formal training for the Office Manager in order to conduct an effective job analysis.

Suggested Student Responses: 7-10.

Do you think Bob’s approach to job analysis will be effective in creating useful job descriptions?

161 © Pearson Education Limited 2015

While Bob has established a good starting point, overall the process will not provide him with full information. He is only collecting information from one employee at each location. Further, his questionnaire lacks detail. This process will only provide him with a limited view of the jobs within the company.

7-11. What can be done to improve this job analysis process?

Bob should expand his data collection in several ways. First, he could create a more detailed questionnaire that could be distributed to more than one employee in each location. Because it is a small company, he could realistically collect information from all employees. Further, he may want to supplement the questionnaires through an additional data collection technique such as observation or follow-up interviews with employees. He should also collect information from another source such as the supervisors or possibly customers.

162 © Pearson Education Limited 2015

CHAPTER 8 Building Pay Structures That Recognize Employee Contributions Learning Objectives 1. Explain the concept of pay structures.

2. Specify and explain the five steps necessary to construct a pay structure.

3. Discuss at least two considerations in designing merit pay systems.

4. Explain at least two sales compensation plan design considerations.

5. Describe three main considerations of person-focused pay program design.

6. Present a summary of two pay structure variation practices.

Outline I.

Constructing a Pay Structure A. Overview B. Step 1: Deciding on the Number of Pay Structures C. Step 2: Determining a Market Pay Line D. Step 3: Defining Pay Grades E. Step 4: Calculating Pay Ranges for Each Pay Grade F. Step 5: Evaluate the Results II. Designing Merit Pay Systems A. Considerations B. Merit Increase Amounts C. Timing D. Recurring versus Nonrecurring Merit Pay Increases E. Present Level of Base Pay F. Rewarding Performance: The Merit Pay Grid G. Merit Pay Increase Budgets III. Designing Sales Incentive Compensation Plans A. Purposes of Sales Incentive Compensation Plans B. Alternative Sales Compensation Plans C. Sales Compensation Plans and Competitive Strategy D. Determining Fixed Pay and the Compensation Mix IV. Designing Person-focused Programs A. Overview B. Establishing Skill Blocks C. Transition Matters D. Training and Certification 163 © Pearson Education Limited 2015

V.

Pay Structure Variations A. Broadbanding B. Two-Tiered Pay Structures VI. Discussion Questions and Suggested Answers VII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses VIII. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses.

Big Picture: This chapter goes into great depth to explain pay structures, as well as the building blocks necessary to establish these pay structures. The entire purpose for compensation professionals to set up and administer pay structures as outlined in this chapter is to recognize and reward individual differences of employees in terms of their output on the job.

Lecture Outline I.

Constructing a Pay Structure A. Overview 1. Pay structures represent a. Pay rate differences for jobs of unequal worth b. The framework for recognizing differences in employee contributions 2. Companies recognize these differences by paying individuals according to their: a. Credentials b. Knowledge c. Job performance 3. Strategically, pay structures help promote retention of valued employees 4. Many companies support pay-for-performance systems 5. Based on five steps a. Deciding on how many pay structures to construct b. Determining a market pay line c. Defining pay grades d. Calculating pay ranges for each pay grade e. Evaluating the results B. Step 1: Deciding on the Number of Pay Structures 1. Usually more than one a. Depending upon 164 © Pearson Education Limited 2015

i. Market rates ii. Company’s job structure b. Common pay structures include i. Exempt and nonexempt structures ii. Pay structures based on job families iii. Pay structures based on geography 2. Exempt and nonexempt pay structures a. Most exempt jobs i. Are not subject to the overtime pay provisions in the Fair Labor Standards Act ii. Earn pay in the form of a salary iii. Are generally supervisory, managerial, or executive in nature b. Most nonexempt jobs i.

Are subject to the overtime pay provisions in the Fair Labor Standards Act ii. Earn pay in the form of wages at hourly pay rates iii. Are generally nonsupervisory, and the duties tend to be narrowly defined 3. Pay structures based on job family a. Pay structures are defined on the basis of job family which show a distinct pattern in the market Example: Use of Job Family Distinction • The Davis Bacon Act requires contractors and subcontractors, with federal contracts worth over $2,000, to pay wages at least equal to those prevailing in the area where the work is performed • Applies only to laborers and mechanics, excluding clerical, professional, and managerial employees • Limited latitude in setting pay b. Distinct job families include: i. Executive ii. Managerial iii. Professional iv Technical v. Clerical vi. Craft 4. Pay structures based on geography 165 © Pearson Education Limited 2015

a. The pay for similar positions that are within the same company, but are located in different parts of the country, can be paid differently b. Local influences, like cost-of-living, influence pay structures Example: Pay Structures Based on Geography • In 2009, an employee making $100,000 in Huntsville, Alabama would need to make $164,000 in Boston, Massachusetts to maintain a comparable standard of living C. Step 2: Determining a Market Pay Line 1. Market pay line is representative of typical market pay rates relative to a company’s job structure (refer to Chapter 7) 2. Pay levels that correspond with the market pay line are marketcompetitive pay rates 3. Pay rates that fall along the market pay line represent competitive pay rates on the company’s selection of a relevant labor market 4. These rates promote internal consistency because they increase with the value of jobs—based on job evaluation points D. Step 3: Defining Pay Grades 1. Pay grades group jobs for pay policy application based on similar compensable factors and value 2. There is no one formula for determining what is sufficiently similar in terms of content and value to warrant grouping into a pay grade 3. Job groupings are influenced by other factors such as management philosophy 4. Wider pay grades minimize hierarchy and social distance between employees 5. Narrower pay grades tend to promote hierarchy and social distance Example: Pay Grade Widths • Set absolute job evaluation point spreads • Grade 1 jobs range from 1–200 job evaluation points • Grade 2 jobs range from 201–400 job evaluation points • Varying absolute job evaluation point spreads • Grade 1 (trainees) jobs range from 1–150 job evaluation points • Grade 2 (basic worker) jobs range from 151–400 job evaluation points • Grade 3 (advanced worker) jobs range from 401–1000 job evaluation points 6. Pay grade widths are either: a. Absolute job evaluation point spreads where pay grades are based on a set number of job evaluation points 166 © Pearson Education Limited 2015

b. Percentage-based evaluation point spreads where the point spread increases as the jobs move up the pay structure in recognition of the broader range of skills that higher pay grades represent E. Step 4: Calculating Pay Ranges for Each Pay Grade 1. Pay ranges build upon pay grades a. Pay grades represent the horizontal dimension of pay structures (job evaluation points) b. Pay ranges represent the vertical dimension (pay rates) and are designated with the following pay rates i. Minimum - the lower bound of pay within a pay grade ii. Midpoint - generally represents the competitive market average or median (refer to Chapter 7) iii. Maximum - the upper bound of pay with a pay grade 2. Setting pay range midpoints a. Before minimums and maximums b. According to competitive pay policy c. If the company adopts a market lead policy, that company’s midpoint will be higher than the market average d. If the company adopts a market match policy, that company’s midpoint will be similar to the market average e. If the company adopts a market lag policy, that company’s midpoint will be lower than the market average 3. Setting pay range minimums and maximums a. According to the market averages b. By developing a range spread i. The difference between the minimum and maximum pay rates of a given pay grade ii. Expressed as a percentage of the difference between the minimum and maximum divided by the minimum Example: Typical Pay Range • 20% to 25%—lower-level service; production and maintenance • 30% to 40%—clerical, technical, paraprofessional • 40% to 50%—high-level professional, administration, middle management • 50% and above—high-level managerial, executive iii.

Progressively higher range spreads for pay grades that contain more valuable jobs in terms of a company’s criteria

167 © Pearson Education Limited 2015

iv.

Smaller range spreads characterize pay grades that contain narrowly defined jobs that require simple skills with relatively low responsibility c. Higher-level jobs afford employees greater promotion opportunities than entry level jobs i. Employees tend to remain in higher pay grades longer ii. Specialized skills associated with higher pay grade jobs are considered valuable d. Minimum and maximum can be calculated after the range is determined e. This approach is typically applied when a company chooses to base the rates on budgetary constraints f. Adjacent pay ranges usually overlap with other pay ranges so that the highest rate paid to one is greater than the lowest rate of the successive pay grade i.

Allows companies to promote employees to the next level without adding to their pay ii. Expressed as a percentage 4. Pay compression a. Minimum pay rate for a range is usually the lowest pay rate that the company will pay for jobs that fall within that particular pay grade i. In theory, newly hired employees often receive pay that is at or near the minimum ii. In practice, new employees often receive well above minimum pay rates, sometimes only slightly below or even higher than the pay of moderately paid employees b. Occurs whenever a company’s pay spread between new hires or less qualified employees and more qualified job incumbents is small i.

When a company fails to raise pay range minimum and maximums Example: Pay Compression; Not Raising Minimums and Maximums • TAX-IT, a small accounting firm • The salary of newly hired CPAs increased 7 percent annually over the last five years • Minimum and maximum pay levels for entry-level CPAs, over the last five years, did not increase due to low profits • CPAs hired five years ago make less than recently hired CPAs ii.

When the qualified job applicant pool is small

168 © Pearson Education Limited 2015

c. Can threaten a companies’ competitive advantage when it results in dysfunctional turnover (high performing employees voluntarily terminate their employment) d. Can be minimized by keeping the maximum level close to the market average for maximum pay 5. Green circle pay rates a. Are below-minimum pay range rates b. Are usually offered because applicants do not meet every minimum requirement in the job description 6. Red circle pay rates a. Are above maximum pay range rates b. Are given to retain highly-valued employees who have lucrative job offers elsewhere c. Are allowed for employees who are demoted to a position that has a pay grade maximum that is lower than the employee’s current salary d. May be offered to employees who exhibit exceptional job performance, but a promotion to a higher pay grade is not granted e. For exemplary performers, companies may provide lump sum pay awards that are not added to regular base pay F. Step 5: Evaluate the Results 1. To determine if there was any significant difference between the company’s internal values for jobs and the market’s value for the same jobs a. If the company’s valuation exceeds the market’s valuation, the company must decide whether its higher-than-market pay rates will undermine its attainment of competitive advantage b. If the company undervalues a position, it must determine if the discrepancy is limiting its ability to recruit quality employees 2. Compa-ratios a. Index the relative competitiveness of internal pay rates, based on pay range midpoints b. Provide invaluable information about the competitiveness of companies’ pay rates c. Are calculated by dividing the employee’s pay rate by the pay range midpoint d. A ratio of one means that the employee’s pay rate equals the pay range midpoint (which company’s with market match policies strive for) e. A ratio of less than one means the employee’s pay rate falls below the competitive pay rate for the job (which company’s with market lag policies strive for) 169 © Pearson Education Limited 2015

f. A ratio of more than one means that the employee’s pay rate exceeds the competitive pay rate for the job (which company’s with market lead policies strive for) g. Can be used to index job groups that fall within a particular pay grade by averaging the pay rates for each job incumbent II.

Designing Merit Pay Systems A. Considerations 1. Companies must insure that employees see definite links between pay and performance 2. Companies must avoid using ineffective performance appraisal methods and poor communication when discussing appraisals 3 Companies must: a. Determine fair merit increase amounts b. Decide when to award increases c. Decide on the most appropriate type of merit increase to award d. Settle on base pay levels relative to the base pay of functionally similar jobs B. Merit Increase Amounts 1. Should reflect prior job performance levels 2. Should motivate employees to perform their best 3. To be seen as meaningful, the amounts should account for increases in: a. Inflation b. Payroll deductions c. CPI (refer to Chapter 7) 4. The minimal amount seen as meaningful is referred to as “just-meaningful pay increases” (refer to Chapter 3) a. Research shows that boosting the merit increase amount will not necessarily improve productivity, since each additional dollar was associated with smaller increases in productivity b. The perception of a just-meaningful pay increase depends on an individual’s i.

Cost of living ii. Attitude toward the job iii. Expectation of rewards from the job c. For employees who value pay in order to meet economic necessity, just-meaningful pay increases tend to depend upon the cost of living d. For employees who value pay as a form of recognition, the size of the pay raise (versus the cost of living) is viewed as a just-meaningful difference 170 © Pearson Education Limited 2015

e. The increase will be seen as meaningful if the employee sees the size as substantive in a relative as well as absolute sense f. The equity theory i. Suggests that an employee must regard their ratio of merit increase to performance as similar to the ratio for other company employees ii. Largest merit pay increases awarded to best performing employees, smallest to the least productive iii. The difference between these merit increases should be approximately equal to the differences in performance g. Compensation budgets are blueprints that describe the allocation of monetary resources to fund pay structures i. Are indexed in percentage terms ii. The greater the increases, the greater the flexibility in developing innovative systems with substantial motivating potential C. Timing 1. Most increases given on an annual basis 2. Two main approaches a. Common review date/period b. Employee’s anniversary 3. Common review date/period a. All employees get reviewed at a predetermined time each year b. Best suited for small companies c. Reduces administrative burden 4. Employee’s anniversary a. Review on anniversary of hiring date b. Administratively burdensome because of varying dates D. Recurring versus Nonrecurring Merit Pay Increases 1. Recurring increases are permanently added to base pay 2. Nonrecurring increases: a. Are given as one-time lump sum bonuses b. Contain costs c. Are gaining favor with unions d. Strengthen pay-for-performance link e. Subsequent percentage increases are not based on higher base pay levels E. Present Level of Base Pay 1. Pay structures specify acceptable pay ranges for jobs within each pay grade a. Should fall within the minimum and maximum pay grade rates 171 © Pearson Education Limited 2015

b. Should be consistent for new hires with similar qualifications 2. Should be within federal guidelines of a. Title VII, Civil Rights Act of 1964 b. Equal Pay Act of 1963 c. Age Discrimination in Employment Act of 1967 F. Rewarding Performance: The Merit Pay Grid 1. Amounts are determined by two main factors a. Performance ratings b. The position of employees’ present base pay rates within pay ranges Example: Merit Pay Increases • Employee A and Employee B receive similar performance ratings • Employee A and Employee B each awarded a 5 percent merit pay increase • Employee A • Employee B • Hourly wage = $8.50 • Annual salary = $32,000 • 5% increase = $0.44 • 5% increase = $ 1,600 • New wage = $8.94 • New salary = $33,600 2. Employee performance ratings a. Overall performance ratings guide the pay raise decision b. Based on the principle of recognizing higher performance with greater rewards 3. Employees’ position within the pay range a. Salaries and hourly wages are indexed by quartile ranking b. The lower a person’s pay falls within its designated pay grade, the higher the percentage pay raise c. The higher a person’s pay falls within its designated pay grade, the lower the percentage pay raise d. Holding performance ratings constant, merit pay increase percentages are reduced as quartile ranks increase, to control employees’ progression through the pay ranges G. Merit Pay Increase Budgets 1. Budgets limit the merit pay increase percentages in each cell 2. Expressed as a percentage of the sum of employees’ current base pay 3. Varies according to performance level and position in the pay range 4. The sum of the individual pay increases must not exceed the allotted merit pay increase budget 5. Typical merit pay increase budget today ranges between 2 percent and 3 percent for the small proportion of the companies that have even awarded pay increases in the past few years 172 © Pearson Education Limited 2015

6. Steps to ensuring that merit pay increases do not exceed the limit a. Supervisors and managers determine how many employees fall within each performance category b. Determine the percentage of employees whose pay falls into each quartile c. Combine both sets of information (i and ii above) to determine the percentage of employees who fall into each cell d. Calculate the expected number of employees in each cell to provide an estimate of the employees’ performance distribution e. Use this formula: (Expected number of each cell) X (Desired pay increase for cell (%)) X (Current median pay level for quartile) f. Ensure the total amount is within budget Example: Merit Pay Increase • Let’s assume that a company’s top financial officers and compensation professionals agree to a 5 percent merit pay increase budget.

• Let’s also assume that the sum of all employees’ current base pay is $10 million based on an employee population of 350. o A 5 percent merit pay increase budget for this example equals $500,000 o This equals 5 percent of the sum of all employees’ current base pay totaling $10,000,000 (5%  $10,000,000) o In other words, the company will distribute $500,000 to increase the current base pay of its employees III.

Designing Sales Incentive Compensation Plans A. Purposes of Sales Incentive Compensation Plans 1. Help businesses meet their objectives by aligning the financial self-interest of sales professionals with the company’s marketing objectives 2. Help companies achieve strategic objectives by linking sales professional’s compensation to fulfilling customer needs or other marketing objectives such as increasing market share 3. Derive their objectives from strategic marketing objectives which are derived from strategic marketing objectives

173 © Pearson Education Limited 2015

Example: Sales Objectives • Sales volume - indicates the amount of sales that should be achieved for a specified period • New business - refers to making sales from customers who have not made previous purchases • Retaining sales - simply targets a level of sales from existing customers • Product mix - which rewards sales professionals for selling a pre-established mix of a company’s product goods or services • Win-back sales - designed to motivate sales professionals to regain business from former clients B. Alternative Sales Compensation Plans 1. Choosing the appropriate plan depends on the company’s competitive strategy 2. Five main alternatives a. Salary-only b. Salary-plus-bonus c. Salary-plus-commission d. Commission-plus-draw e. Commission-only 3. Salary-Only Plans a. Sales professionals receive fixed base compensation which does not vary with: i. Level of units sold ii. Increase in market share iii. Other indicators of sales performance b. Relatively risk-free compensation for employees c. Burdensome to employers d. Does not fit well with the directive to link pay with performance through at-risk pay e. Appropriate where i. Sales are of high-priced products and services, or technical products with long lead times for sales ii. Sales professionals are primarily responsible for generating demand whereas other employees actually close the sales iii. It is impossible to follow sales results for each sales professional since sales are accomplished through team efforts iv. Sales professionals are involved in training or other activities when they are not directly involved in making sales 174 © Pearson Education Limited 2015

4. Salary-plus-bonus plans a. Offer set base pay with an incentive bonus b. Give one-time bonuses, usually tied to meeting specific, exceptional goals 5. Salary-plus-commission plans a. A commission is a form of incentive compensation based upon a percentage of i. The products’ price ii. The services’ selling price b. These plans spread the risk of selling between the company and the sales professional i. The salary • Enhances the company’s ability to attract quality employees • Allows the employees to perform essential non-sales functions for the company ii. The commission serves as the employees’ share in the revenue gains they generated for the company 6. Commission-plus-draw plans a. Award sales professionals with: i. Incentives to excel (commissions) ii. Subsistence pay (draws) to cover basic living expenses b. The draws are just advances on the commissions the sales professional will earn in the future c. Two types of draws i. Recoverable draws act as company loans to employees that are carried forward indefinitely until the employee sells enough to repay ii. Non-recoverable draws act as salary because employees are not obligated to repay the loans if they do not sell enough • Represent risks to companies because these expenses are not repaid if employees’ sales performances are lackluster • Many companies stipulate a specified period of time that the sales quotas can go unmet before employees are terminated 7. Commission-only plans a. Sales professionals derive their entire income through commissions and therefore shoulder all the risk b. Three types i. Straight ii. Graduated iii. Multiple-tiered 175 © Pearson Education Limited 2015

c. Straight commissions award sales professionals with a fixed percentage of the sales revenue Example: Straight Commissions • The commission is 10% • Salesperson receives • $10 on $100 of sales • $55 on $550 of sales d. Graduated commissions award sales professionals with an increased percentage of the sales price as the volume increases Example: Graduated Commissions • 5% commission per unit for sales up to 100 units • 8% commission per unit for sales of 101–500 units • 12% commission per unit for sales in excess of 501 units e. Multiple-tiered commissions i. Award sales professionals with higher percentages of the sales made in a given period ii. Earned if the sales level exceeds a predetermined level Example: Multiple-Tiered Commissions • 8% commissions per unit for sales up to 1000 units • 12% commissions per unit for sales exceeding 1000 units f. Are appropriate when: i. The sales professional has substantial influence over the sales ii. Low to moderate training or expertise is required iii. The sales cycle—the time between identifying the prospect and closing the sale—is short iv. There are realistic sales goals and individual performance standards g. Drawbacks i. Salespeople shoulder all the risk • Earn no money, if no sales • Can earn a lot if sales are good ii. Can cause competitive behaviors between employees iii. Can undermine employees’ intrinsic motivation to sell 176 © Pearson Education Limited 2015

•

May lose their genuine interest for the challenge and enjoyment that selling brings • May “go through the motions” of selling and disregard quality and customer satisfaction C. Sales Compensation Plans and Competitive Strategy 1. Sales plans with salary components are most appropriate for differentiation strategies because: a. These plans do not require employees to focus solely on attaining sales volume goals or other volume indicators (market share) b. Sales professionals can provide clients with more presales and servicing support 2. Commission-oriented sales compensation plans are best suited for lowest cost strategies because: a. Compensation expenditures vary with sales revenue b. Servicing clients’ post- sales needs are generally handled by lower compensated employees Example: Sales Follow-up Service • Real estate business • Sales agents get compensated depending on • Number of sales • Selling price of each sell • Real estate assistants • Generally receive low pay • Assist clients after the sale, answering inquiries, and so on D. Determining Fixed Pay and the Compensation Mix 1. Depends mainly on three factors: a. Influence of the sales professional on the buying decision b. Competitive pay standards within the industry c. Amount of non-sales activities required 2. Influence of the sales professional on the buying decision a. The more influence sales professionals have on the “buying decisions”, the more the compensation mix will feature incentive pay i. Some are mere order-takers, so they get little incentive pay ii. Some serve as consultants, so their pay mix contains more incentive pay

177 © Pearson Education Limited 2015

Example: Salespersons’ Control over Buying Decision • Sears and Best Buy - large department stores • Sales clerks have little control over merchandise for sale • Store’s merchandise buyers purchase lines of clothing • Product displays and promotional efforts are determined by store management b. In some industries, it is the sales professional’s technical expertise, more than sales skills that influences the “buying decision” 3. Competitive pay standards within the industry a. The compensation mix must be competitive with market standards to attract and retain quality sales professionals, the mix includes: i. Industry norms ii. Selling situations b. Commission pay weighs heavily in highly competitive retail industries like: i. Furniture sales ii. Home electronics iii. Auto sales c. Salary represents a significant compensation component in such high entry-barrier industries as pharmaceuticals i. One barrier is FDA regulations on testing ii. Salary appropriate because new drugs face little risk of new competition 4. Amount of non-sales activities required a. The more non-sales duties sales professionals are required to perform the more their compensation packages should include a fixed pay component b. The more influence the sales professional’s technical/product knowledge or customer service activity has on the buying decision the more their compensation packages should include a fixed pay component IV.

Designing Person-focused Programs A. Overview 1. Person-focused programs refer to both knowledge and skills 2. Reward employees for acquisition of job-related knowledge and/or skills 3. A fundamental issue is whether investments in training provide measurable pay-offs to companies

178 © Pearson Education Limited 2015

Example: Training Investment Pay-offs • American Society for Training and Development research study, involving approximately 2500 companies, investigated the issue • Evidence indicated that training investments related positively to: • Future total stockholder returns • Gross profit margins • Income per employee B. Establishing Skill Blocks 1. “Skills” and “knowledge” used interchangeably, since both are components of performance improvement efforts 2. These “blocks” are sets of skills necessary to perform a specific job, or group of jobs 3. The number of blocks varies according to the variety of jobs within a company generally from two to several 4. Development should be based on three considerations: a. Job descriptions need to be developed that: i. Identify the major skills needed ii. Include the available training programs that will allow employees to acquire horizontal and vertical skills iii. Identify accurate performance measure that will be used b. Individual jobs should be organized into job families or groups i. To identify common skills that are unique to the grouping ii. To identify the tasks necessary to perform the jobs c. The skills should be grouped into blocks i. No hard, fast rules for determining blocks ii. General guideline is that the blocks should relate to specific job tasks and duties C. Transition Matters 1. Concerns moving from job-based pay exclusively to including personfocused knowledge plans 2. Major issues a. Skills assessment b. Aligning pay with the knowledge structure c. Access to training

179 © Pearson Education Limited 2015

3. Skills assessment a. Centers on who should assess: i. Whether employees possess skills at levels that justify a pay raise ii. On what basis assessments should be made iii. When assessments should be conducted b. Gaining trust is critical, since employees may view new systems as threats to job security c. Input should come from: i.

Peers ii. Self-assessment iii. Experts (e.g., supervisors) d. Performance measures i. Should reflect employees’ proficiency of skills used ii. Should be complemented by self-assessment iii. Using both is likely to increase an employee’s understanding of the system e. Performance should be assessed frequently to: i. Keep employees informed of how well they are doing under the new system ii. Reinforce the key aim of pay-for-knowledge—to encourage employees to learn more 4. Aligning pay with the knowledge structure a. Upon implementation, the employees’ core compensation must reflect their knowledge or skills the company incorporates into its personfocused structure b. If an employee’s actual earnings is more than the person-focused system indicates as being appropriate, managers must develop a reasonable course of action for that employee to acquire the skills or knowledge c. If employees are underpaid (over qualified), the company must provide pay adjustments quickly, depending on: i. The number of employees involved ii. The extent to which they are underpaid 5. Access to training a. Person-focused systems make training necessary rather than optional for employees motivated towards self-improvement b. Employees must have equal access to training i. To meet the intended aim of person-focused programs ii. To reward employees for enhancing their skills iii. To address legal imperatives 180 © Pearson Education Limited 2015

c. Restricting access to training can lead to violation of (refer to Chapter 3) i. Title VII, Civil Rights Act of 1964 ii. Age Discrimination in Employment Act of 1967 d. Employees must be formally informed of the options and rewards D. Training and Certification 1. Companies have adopted a continuously learning philosophy, because of: a. Intense domestic and global competition b. Rapid technological advancement c. Educational deficits of new hires 2. Effective, on-going training should allow employees to: a. Increase their: i. Knowledge/skills ii. Pay b. Apply their learning to assist/coach other employees 3. Should be based on accurate job descriptions 4. Training can be in-house or outsourced depending on: a. Four main criteria i. Expertise ii. Timeliness iii. Number of employees needing training iv. Proprietary nature of subject matter b. Expertise of trainers i. Specialized training topics require greater expertise ii. Employees turn to in-house trainers to draw on existing expertise iii. Training will be outsourced to fill a direct need or to train in-house trainers c. Timeliness i. Training will be outsourced if there is not enough time to develop and deliver it in-house ii. Training will be outsourced if there is high turnover and new employees must learn product/service-specific procedures quickly

181 © Pearson Education Limited 2015

Example: Outsourced Training • PeopleSoft, a business applications software development company • Trains clients on how to use the systems they install • Companies include • Exxon-Mobil • Wal-Mart • General Motors • AT&T • Ford • Citigroup • IBM • Verizon • Because of turnover, client companies need training-on-demand from PeopleSoft • Training available through DVDs and the internet d. Size of the employee population to be trained i. Large numbers make in-house more cost effective, resulting in economy of scale ii. High turnover may require constant training e. Sensitivity or proprietary nature of the subject matter i. Defined as training used to gain a competitive advantage or training that gives access to propriety, product, or strategic knowledge ii. The more sensitive the subject matter, the more likely the training will be in-house 5. Certification and recertification a. Certification ensures that employees possess minimal levels of skills proficiency b. If employees do not have an acceptable degree of skill, then the company wastes any skill-based compensation expenditure c. Certification methods may include: i. Work samples ii. Oral questioning iii. Written tests d. Recertification involves retraining or retesting employees to ensure employees have retained minimal skills proficiency i. Employees must demonstrate mastery or risk losing increased pay rates or certification ii. Is necessary to maintain workforce flexibility e. Recertification process is typically i. Handled by retesting employees ii. Retraining employees iii. Requiring employees to perform tasks, using learned skills

182 © Pearson Education Limited 2015

Example: Certification and Recertification • Society for Human Resource Management offers two types of professional certification • Professional in Human Resources • Senior Professional in Human Resources • To acquire certification, individuals must: • Have two years of work experience in exempt jobs • Pass a comprehensive examination of knowledge in the HR domain • For recertification, individuals must accumulate continuing education credits. Credits are earned through a variety of activities: • Course/conference attendance • Membership in professional organizations • Leadership with the association • Teaching • Speaking • Writing • Projects completed on the job V.

Pay Structure Variations A. Broadbanding 1. Chosen by companies to consolidate existing pay grades and ranges into fewer, wider pay grades 2. Represents the increasing organizational trend toward flatter, less hierarchical corporate structures that emphasize teamwork over individual contributions alone

Example: Implementing Broadbanding • Federal agencies that broadbanded in the 1980s • Navy • General Accounting Office • Private company • General Electric Corporation’s plastic business

• CIA

3. Uses only a few, large salary ranges spanning levels within the organization 4. Provides employees, in a single broadband, equal pay potential 5. Expands employees’ job duties and responsibilities 6. When applied to managerial staff, it eliminates management layers and promotes quicker decision making

183 © Pearson Education Limited 2015

7. Some broadbands are set according to job families a. Clerical b. Technical c. Administrative 8. Some broadbands are set according to functional areas, across job families: Example: Human Resources • Broadbanding can consolidate the following specialists • Training • Compensation • Recruitment • Performance appraisal • Should encourage employees to expand their knowledge and skills 9. Shifts greater responsibility to supervisors and managers for administering each employee’s compensation 10. Gives supervisors greater latitude in setting employees’ pay based on the tasks and duties they perform 11. Combining broadbanding with other pay programs may contribute to greater savings in labor costs 12. A single hybrid approach can offer simplicity and a clearer link between employee behaviors and rewards 11. Limitations of broadbanding a. Changes how compensation dollars are allocated, but not how much b. Broadbanding can increase compensation expenses, because managers have greater latitude in assigning pay to their employees c. Necessitates a trade-off between the flexibility to reward employees for their unique contributions and a perception among employees that fewer promotional opportunities are available d. Makes employees and employers rethink the idea of promotions as a positive step through the job hierarchy C. Two-Tiered Pay Structures 1. Reward new hires less than established employees on either a temporary or permanent basis a. Temporary two-tier systems allow employees to progress from lower entry-level rates to higher rates b. Permanent two-tier systems reinforce the pay-rate distinction by retaining separate pay scales c. Lower-paying scales apply to newly hired employees, whereas current employees enjoy higher-paying scales 184 © Pearson Education Limited 2015

d. Maximum rates to which newly hired employees can progress are always lower than more senior employees’ pay scales 2. Most prevalent in unionized companies a. Seen as a trade-off of lower compensation for more job security b. Seen as a cost control measure Example: Two-tiered • At Ford Motor Company, a two-tiered wage structure will compensate new hires substantially less than other employees, including an hourly base rate that is $10 below the previous one 3. Enable companies to reward long-service employees, while keeping costs down by paying lower rates to new hires who do not have established performance records 4. Limitations a. The lower pay scale for new hires may restrict a company’s ability to recruit and retain quality employees b. Lower tier employees may resent pay differential and not extend themselves beyond their job descriptions c. Can cause lower employee morale d. Can lead to excessive turnover VI.

Discussion Questions and Suggested Answers

8-1.

Respond to the following statement: “Pay grades limit a company’s ability to achieve competitive advantage.” Do you agree? Provide rationale for your position.

Pay grades group jobs for pay policy application. Human resource (HR) professionals typically group jobs into pay grades based on similar compensable factors and value.

Wider pay grades minimize hierarchy and social distance between employees. Narrower pay grades, however, tend to promote hierarchy and social distance. Pay grades can be seen as a limitation to a company’s competitive advantage for it forces employees into specific categories. However, if a particular employee wants to improve him- or herself and get paid more, he or she can strive to learn the skills of those who are of a higher pay grade. Therefore, pay grades improve a company’s advantage because they promotes competition in and around the job setting.

185 © Pearson Education Limited 2015

8-2.

Two employees perform the same job, and each received exemplary performance ratings. Is it fair to give one employee a smaller percentage merit because his pay falls within the third quartile but give a larger percentage merit increase to the other because his pay falls within the first quartile? Please explain your answer.

If company policy is to pay a market competitive wage and to trend toward that pay level than it is fair to accelerate base pay for a lower paid employee and slow base pay growth for a higher paid employee even if both have the same performance level.

8-3.

“Knowledge, skills, and abilities are key attributes to the pay structure.”

Discuss this statement.

Knowledge, skills, and abilities are key attributes to the pay structure because these are often treated as compensable factors (e.g. knowledge, skills and experience, accountability, impact on the organization, communication, etc.). They are used to ensure that the internally aligned job and pay structures in the company are also externally market competitive in order to attract, motivate, and retain talents in the organization.

8-4.

React to the statement: “Merit pay grids have the potential to undermine employee motivation.” Please discuss your views.

Merit pay grids do in fact have the potential to undermine employee motivation primarily in the case of employees in top quartiles in the range. Having a low pay increase opportunity can cause lack of motivation. Merit pay grids can also act as a deterrent to achieve more because the pay grid scale is skewed. However, the basic nature of merit pay is to promote working hard and drive employees to perform better. In most cases merit pay grids are great for increasing the motivation of employees.

8-5.

Compression represents a serious dysfunction of pay structures. Discuss some of the major ramifications of compression. Also, discuss how companies can minimize or avoid these ramifications.

Compression does indeed represent a serious dysfunction of pay structures. Dysfunctions such as reducing the number of skilled and experienced employees who wish to be hired at the starting salary is much lower than that of someone who has worked for a long time at the company. Another problem is the motivation of long standing employees whose pay levels are matched or even exceeded by newer employees. These ramifications can be avoided if companies make accommodations and are more flexible with their payment structures. Incorporating aspects of more than one pay structure variation may prove quite beneficial and at the same time minimize serious dysfunctions within a given pay structure.

186 © Pearson Education Limited 2015

VII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses Case Name: A New Sales Representative Instructor Notes This new position is the first outside sales position for UFS and John must carefully design a compensation package to motivate the Sales Representative to focus his or her efforts on the appropriate activities. John wants to expand his business and sees two distinct opportunities to do so. Expanding the business through adding new customers is one approach, and John also sees an opportunity to expand the business through further development of relationships with current customers. Both of these activities will take a great deal of time without promise of immediate sales and the compensation structure should recognize that requirement. However, as a small business, the company must closely monitor their salary budget and therefore, connecting at least part of the salary to actual sales will help ensure that the Sales Representative generates the revenue necessary to support his or her position.

Suggested Student Responses: 8-6.

What are the sales objectives for the new Sales Representative?

The sales objectives for the new Sales Representative include opening new accounts and growing sales with current accounts.

8-7.

How would you design the sales compensation plan for UFS based on John’s requirements? Justify your answer.

The service advisor’s compensation plan should be tied to customers’ satisfaction because the service advisors spend substantial amount of time processing incoming vehicle and communicating work progress with customers. The sales representative’s compensation should be tied to new sales orders because the focus is on securing new sales from current customers as well as new customers.

8-8.

What kind of sales incentive plan do you recommend? Why?

Because this position requires providing customer service to current customers, a compensation structure that includes a base pay is important. Further, to provide incentives to grow the customer base, part of the compensation should include salesbased incentive pay. Students could provide a wide range of creative designs that contain a base pay plus incentive pay structure.

MYLAB QUESTIONS 187 © Pearson Education Limited 2015

8-9.

Compare and contrast merit pay systems and sales compensation.

Answer: Employees earn permanent merit increases based on their performance. In sales incentive compensation plans, salespeople's compensation relies on incentives. The key in this compensation program is to align salespeople's financial interest with the company's marketing objectives. In merit based pay system, an employee's reward is generally based on someone else's subjective evaluation of the employee's past performance. However, in sales compensation programs, employees receive rewards when they meet pre-established levels of performance. Moreover, salespeople's compensation is variable to the extent that it is composed of incentives. In merit pay systems, employees earn base pay for their job that is increased periodically with permanent pay raises or one-time bonuses.

8-10. Briefly discuss designing job-based pay system (i.e. merit pay, sales incentive pay) and person-focused programs. What considerations arise when making a transition from using a job-based pay system to using pay-for-knowledge?

Answer: There are three matters that compensation and HR professionals need to consider when making this transition. A first consideration is skills assessment. This consists of three parts: 1) who should assess whether employees possess skills at levels that justify a pay raise, 2) on what basis the assessments should be made, and 3) when the assessments should be conducted. A second consideration is aligning pay with the knowledge structure. Core compensation must reflect the knowledge or skills the company incorporates into its pay-for-knowledge structure. If employees are underpaid, pay adjustments must be made as quickly as possible. A third consideration is employees' access to training. Companies must ensure that employees have equal access to the needed training for acquiring higher-level skills.

VIII. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses Instructor Notes Market-competitive pay systems play a significant role in attracting and retaining talented staff. When setting a pay policy, companies have the option of lagging behind the competition, matching the competition, or taking the lead and paying employees more than competitors. This decision depends on the competitive strategy of the company, the type of positions the company seeks to fill and the relevant qualified labor market, and the financial resources available. Most companies pursue more than one pay policy for different types of positions within a company.

Suggested Student Responses: 188 © Pearson Education Limited 2015

8-11. Should Docutrend use the same pay policy for all of its open positions?

Docutrend should not necessarily adopt the same pay policy for all of its open positions. It is clear that the labor market is more competitive for the software designers and will likely require a different approach. Carrie must carefully examine the relevant labor market for the different positions the company will be filling.

Further, some of the positions will not have as direct of impact on the success of the company. For example, the administrative support staff may not require as competitive of pay as the software designers. Docutrend must set pay at a competitive level, while still focusing on cost containment.

8-12. What pay policy would you recommend? Why? Docutrend may want to consider establishing a lead policy for paying the software designers. Because the company’s competitive strategy is a differentiation strategy, Docutrend needs to recruit talented software designers to ensure that that their software provides the unique solution to their client’s needs that Docutrend expects.

As the company is competing against several other companies for the designers, and Docutrend is not well known, a generous pay structure may be necessary to attract the needed designers. Depending on the talent available in the area, they may also want to pursue a lead strategy for other professional positions such as the sales and marketing professionals. This positions will likely be key in implementing the company’s business strategy. A match strategy is the best approach for the other positions such as the administrative staff. Pursuing the match strategy will allow them to remain competitive in the market place while containing some labor costs.

189 © Pearson Education Limited 2015

CHAPTER 9 Discretionary Benefits Learning Objectives 1. Give an overview of discretionary benefits.

2. List the three broad components of discretionary benefits.

3. Identify and define one example of income protection programs, paid time off, and services.

4. Explain the benefits and costs of discretionary benefits.

Outline I. II.

III. IV. V. VI.

An Overview of Discretionary Benefits Components of Discretionary Benefit Components A. Protection Programs B. Paid Time Off C. Services The Benefits and Costs Discretionary Benefits Discussion Questions and Suggested Answers End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses Lecture Outline

I.

An Overview of Discretionary Benefits 1. Discretionary benefits a. As of March 2012 i. Companies spent an average approximately $13,000 per employee to provide discretionary benefits ii. Discretionary benefits account for as much as 21.5 percent of payroll costs b. Are offered at the will of each company c. Employees view them as entitlements d. Employers reinforce the entitlement mentality by awarding them regardless of performance 2. Three types of benefits a. Types i. Protection programs ii. Paid time off 190 © Pearson Education Limited 2015

iii. Services b. Protection programs i. Provide family benefits ii. Promote health iii. Guard against income loss caused by catastrophic factors, like: • Unemployment • Disability • Serious illnesses c. Paid time off for such things as: i. Vacations ii. Holidays d. Services provide enhancements to employees, such as: i. Tuition reimbursement ii. Daycare assistance 3. History a. Originated in the 1940s i. During WW II and Korean War • U.S. Government would not let companies increase employees’ core compensation • Companies could increase fringe compensation expenditures ii. Companies began to offer welfare practices • Anything for the comfort and improvement, intellectual or social, of employees • Not a necessity of the industry nor required by law • Designed to promote good management and enhance worker productivity Example: Welfare Practices • Some employers offered libraries and recreational areas • Some provided financial assistance for education, home purchases, and home improvements • Employers’ sponsorship of health insurance coverage became common b. National Labor Relations Act of 1935 (NLRA) i. Legitimized bargaining for employee benefits ii. Contributed to the increase of employee welfare practices iii. Nonunion employers offered similar benefits in attempt to keep unions out 191 © Pearson Education Limited 2015

Status of Discretionary Benefits and Welfare Practices: Note that as global competition increases, companies are forced to further cut costs, which only naturally leads to less spending on discretionary benefits and programs to strengthen employee morale.

II.

Components of Discretionary Benefit Components A. Protection Programs 1. Income 2. Health 3. Income protection a. Disability insurance b. Life insurance c. Retirement programs d. Health protection programs 4. Disability insurance a. Replaces income when employee becomes hurt or ill b. Possibility of employee being disabled for at least 90 days, more likely than dying on the job c. One of three employees will experience a 90-day disability during lifetime d. May duplicate, but not replace disability benefits mandated by: i. Social Security Administration ii. State workers’ compensation laws iii. Employee Retirement Income Security Act of 1974 (ERISA) e. Two forms i. Short-term ii. Long-term f. Short-term i. Less than six months (26 weeks) ii. Unable to perform duties of one’s regular job iii. Benefit amount generally 50 percent–66.67 percent of pretax salary; however, it can be as high as 100 percent iv. Preexisting condition clause, two waiting periods, and exclusions of particular health conditions v. Preexisting condition is a mental or physical disability for which medical advice, diagnosis, care, or treatment was received during a designated period preceding the beginning of disability insurance coverage

192 © Pearson Education Limited 2015

vi. Two waiting periods include the preeligibility period and an elimination period • The preeligibility period spans from the initial date of hire to the time of eligibility for coverage in a disability insurance program • The elimination period refers to the minimum amount of time an employee must wait after becoming disabled before disability insurance payments begin vii. Exclusion provisions list the particular health conditions that are ineligible for coverage viii. Disabilities that result from self-inflicted injuries, most mental illnesses, or disabilities due to chemical dependencies (e.g., addictions to alcohol or illegal drugs) are excluded g. Long-term i. Benefits for six months to life ii. Unable to engage in any occupation employee is qualified for by reason of: • Training • Education • Experience iii. Benefit amount is generally 50 percent – 70 percent of pretax salary, subject to a maximum dollar amount iv. Usually a six to twelve month waiting period v. Employees may have to use up other benefits first • Sick leave • Short-term disability benefit vi. Payments usually begin after three to six months of disability vii. Many long-term disability insurance carriers have more recently also added partial disabilities viii. Include preexisting condition and exclusion clauses ix. Two waiting periods: preeligibility period and elimination period x. Preeligibility periods for short- and long-term plans are usually identical xi. Both short- and long-term disability plans may duplicate disability benefits mandated by the Social Security Act and state workers’ compensation laws (more in Chapter 11) 5. Life insurance a. Pays employees’ beneficiaries upon employee’s death b. May also include: i. Accidental death 193 © Pearson Education Limited 2015

ii. Dismemberment benefits c. Pays a multiple of the employee’s salary d. Three kinds i. Term life insurance ii. Whole life insurance iii. Universal life insurance e. Term life insurance i. Most common type offered ii. Provides income to employee’s beneficiaries only during a limited period based on a specified number of years subject to a maximum age f. Whole life insurance i. Pays an amount to the designated beneficiaries ii. Do not terminate until payment is made to beneficiaries g. Universal life insurance i. Provides protection to employees’ beneficiaries based on the insurance feature of term life insurance ii. Provides more flexible savings or cash accumulation plan than whole life insurance plans h. Types i. Individual policies • From independent insurance agents • Representatives of insurance companies ii. Group policies • Through their employers • Allows all participants covered to benefit from the coverage • Employers assume the burden of financing the plan either fully or partially • Allows more employees coverage at lower rates per employee 6. Retirement programs (more in Chapter 10) a. Often referred to as pension plans b. Provide income to employees and their beneficiaries during some or all of their retirement c. Individuals may participate in more than one pension program simultaneously d. Employees can participate in pension plans sponsored by their companies (e.g., 401(k) plans) as well as in pension plans that they establish themselves (e.g., the individual retirement account (IRA))

194 © Pearson Education Limited 2015

e. Pension programs’ design and implementation are quite complex, largely because of the many laws that govern their operations, particularly ERISA 7. Health protection programs (more in Chapter 10) a. Total health care expenditures rose by more than 5,000 percent from $26.9 billion in 1960 b. Costs to extend health insurance coverage to employees is rising quickly, thereby representing a substantial cost burden c. Companies recognize that offering comprehensive health insurance protection helps recruit and retain the best-qualified individuals, and employees stand to be more productive when they can afford to (and actually do) take care of health problems that could interfere with job performance B. Paid Time Off 1. Compensates employees when they are not performing their primary work duties 2. Usually offered as a matter of custom 3. Can be part of collective bargaining agreements in union settings, like: a. Holidays b. Vacation c. Sick leave d. Personal leave e. Jury duty f. Funeral leave g. Military leave h. Clean-up, preparation, or travel time i. Rest period “break” j. Lunch period k. Integrated time off policies l. Sabbatical leave m. Volunteerism 4. Advantages for employee a. Helps balance work and non-work activities b. Could result in a better attitude and sense of commitment towards the employer 5. Advantages for employer a. Reduced absenteeism b. Better productivity c. Positive employee attitudes and commitment 195 © Pearson Education Limited 2015

6. Integrated time off policies a. Combine holiday, vacation, sick leave, and personal leave policies into a single paid time off policy b. Provide individuals the freedom to schedule time off without justifying the reasons c. Reduce the incidence of unscheduled absences that can be disruptive to the workplace because these policies require advance notice unless sudden illness is the cause d. More effective in controlling unscheduled absenteeism than other types of absence control policies e. Relieve the administrative burden of managing separate plans and the necessity to process medical certifications in the case of sick leave policies f. Bereavement or funeral leave are not included because the death of a friend or relative is typically an unanticipated event beyond an employee’s control g. Jury duty and witness leave, military leave, and nonproduction time are influenced by law and nonproduction time is negotiated as part of a collective bargaining agreement h. Sabbatical leaves are also not included in paid time off banks because these are extended leaves provided as a reward to valued, long-service employees 7. Sabbatical leave a. Paid time off for such professional activities as a research project or curriculum development b. Common in college and university settings and apply most often to faculty members c. Granted to faculty members who meet minimum service requirements (e.g., three years of full-time service) with partial or full pay for up to an entire academic year d. The service requirement is applied each time, which limits the number of leaves taken per faculty member e. Outside academia, sabbatical leaves are usually limited to professional and managerial employees who stand to benefit from intensive training opportunities outside the company’s sponsorship. f. Most suitable for such employees as computer engineers whose standards of knowledge or practice are rapidly evolving g. Companies establish guidelines regarding qualification, length of leave, level of pay, and minimum length of employment following completion of a sabbatical

196 © Pearson Education Limited 2015

h. Companies require employees to remain employed for a minimum of one year following the sabbatical or repay part or all of one’s salary received during the sabbatical i. Necessary in order to protect a company’s investment and to limit moves to competitors 8. Volunteerism a. Refers to giving of one’s time to support a meaningful cause b. From a company’s standpoint, a meaningful cause is associated with the work of not-for-profit organizations such as the United Way to help improve the well-being of people. c. Multitude of meaningful causes throughout the world including: i. Improving literacy ii. Providing comfort to terminally ill patients iii. Serving food at shelters for individuals who cannot afford to feed themselves iv. Serving as a mentor to children who do not have one or more parents v. Spending time with elderly or disabled residents of nursing homes who may no longer have living friends or family d. Companies generally do not dictate the causes for which employees would receive paid time off, except they exclude political campaign and political action groups for eligibility because of possible conflicts of interest with company shareholders and management e. Companies favor providing paid time off for volunteer work for three reasons: i. First, volunteer opportunities allow employees to balance work and life demands ii. Second, giving employees the opportunity to contribute to charitable causes on company time represents positive corporate social responsibility, enhancing the company’s overall image in the public eye iii. Third, paid time off to volunteer is believed to help promote retention f. Employees are likely to feel that the employer shares similar values, possibly boosting commitment to the company g. The amount of time off ultimately varies considerably from company to company, ranging anywhere between one hour per week and, in limited cases for long-service employees, several weeks C. Services 1. Types a. Employee assistance programs b. Family assistance programs c. Flexible scheduling and leave d. Daycare 197 © Pearson Education Limited 2015

e. Tuition reimbursement f. Transportation services g. Outplacement assistance h. Wellness programs i. Smoking cessation j. Stress management k. Weight control and nutrition programs l. Financial education 2. Employee assistance programs a. Help employees cope with such personal problems that may impair their job performance such as: i. Alcohol or drug abuse ii. Domestic violence iii. Emotional impact of AIDS and other diseases iv. Clinical depression v. Eating disorders b. Employees are likely to experience difficulties that interfere with job performance c. Employee assistance programs’ costs are substantial d. Annual cost per employee of an EAP is approximately $50 to $60 e. Employers’ gains outweigh their out-of-pocket expenses for EAPs due to reduced costs of: i. Turnover ii. Absenteeism iii. Medical costs iv. Unemployment insurance rates v. Workers’ compensation rates vi. Accidents vii. Disability insurance f. In some companies, EAPs are informal programs developed and run on-site by in-house staff g. Other employers contract with outside firms to administer their EAPs, or they rely on a combination of their own resources and help from an outside firm 3. Family assistance programs a. Help employees provide elder care and child care b. Elder care provides physical, emotional, or financial assistance for aging parents, spouses, or other relatives who are not fully selfsufficient because they are too frail or disabled 198 © Pearson Education Limited 2015

c. Child care programs focus on supervising preschool-age dependent children whose parents work outside the home d. Many employees rely on elder care programs due to parents’ increasing longevity and the growing numbers of dual-income families e. Child care needs arise due to growing number of single parents and dual-career households with children f. Various programs i. Making referrals to on-site child or elder care centers ii. Company-sponsored daycare programs g. Vary in the amount of financial and human resources needed to administer them h. The least expensive and least labor-intensive programs are generally referral services i. Designed to help workers identify and take advantage of available community resources, conveyed through such media as educational workshops, videos, employee newsletters and magazines, and EAPs 4. Flexible scheduling and leave a. Allows employees the leeway to take time off during work hours to care for relatives or react to emergencies b. Flexible scheduling includes: i. Compressed work weeks (e.g., 10-hour days or 12-hour days) ii. Flextime iii. Job sharing c. Helps employees balance the demands of work and family d. Some companies allow employees to extend their legally mandated leave sanctioned by the Family and Medical Leave Act (more in Chapter 10) e. Under extended leave, employers typically continue to provide such employee benefits as insurance and promise to secure individuals comparable jobs upon their return 5. Daycare a. Companies subsidize child or elder day care in community-based centers b. Elder care programs usually provide self-help, meals, and entertainment activities for the participants c. Child care programs typically offer supervision, preschool preparation, and meals d. Facilities must usually maintain state or local licenses 6. Tuition reimbursement a. Promotes employees’ education 199 © Pearson Education Limited 2015

b. Employer fully or partially reimburses an employee for expenses incurred for education or training c. Substantial variability in the percentage of tuition an employer reimburses, based on the relevance of the course to the companies’ goals or the grades employees earn d. Not synonymous with pay-for-knowledge programs e. Employees choose the courses they wish to take, when they want to take them, and may enroll in courses that are not directly related to their work f. Companies establish set curricula that employees take, and they generally award pay increases to employees who successfully complete courses within the curricula g. Pay increases are not directly associated with tuition reimbursement programs 7. Transportation services a. Help bring employees to the workplace and back home again by using more energy-efficient forms of transportation b. Sponsor public transportation or vanpools: employer-sponsored vans or buses that transport employees between their homes and the workplace c. Provide transit subsidies to employees working in metropolitan and suburban areas served by mass transportation (e.g., buses, subways, and trains) d. Offer transit passes, tokens, or vouchers e. Practices vary from partial subsidy to full subsidy f. Many employers must offer transportation services to comply with the law g. The Clean Air Act Amendments of 1990 require employers in such large metropolitan areas as Los Angeles to comply with state and local commuter-trip reduction laws h. Transportation services enable companies to offset deficits in parking space availability, particularly in congested metropolitan areas i. For employees, using public transportation or joining a vanpool often saves money by eliminating such commuting costs as gas, insurance, car maintenance and repairs, and parking fees 8. Outplacement assistance a. Provides technical and emotional support to employees who are being laid off or terminated b. Variety of career and personal programs designed to develop employees’ job-hunting skills and strategies and to boost employees’ self-confidence c. Those best suited to outplacement assistance programs include: 200 © Pearson Education Limited 2015

i. Layoffs due to economic hardship ii. Mergers and acquisitions iii. Company reorganizations iv. Changes in management v. Plant closings or relocation vi. Elimination of specific positions, often the result of changes in technology d. Outplacement assistance provides such services as: i. Personal counseling ii. Career assessments and evaluations iii. Training in job search techniques iv. Resume and cover letter preparation v. Interviewing techniques vi. Training in the use of basic workplace technology e. Promote a positive image of the company among those being terminated, as well as their families and friends, by helping these employees prepare for employment opportunities 9. Wellness programs a. Started in the 1980s b. Promote and maintain employees’ physical and psychological health c. Offered on- or off-site d. Relatively new but some evidence already indicates that these innovations can save companies money and reduce employees’ needs for health care e. May emphasize weight loss, smoking cessation, and cardiovascular fitness 10. Smoking cessation a. Smoking cessation plans range from simple campaigns that stress the negative aspects of smoking to intensive programs directed at helping individuals to stop smoking b. Many employers offer courses and treatment to help and encourage smokers to quit c. Other options include offering nicotine replacement therapy (e.g., nicotine gum and patches) and self-help services d. Many companies sponsor such antismoking events as the Great American Smoke-Out, during which companies distribute T-shirts, buttons, and literature that discredit smoking 11. Stress management programs a. Help employees cope with many factors inside and outside work that contribute to stress b. Job conditions, health and personal problems, and personal and professional relationships can make employees anxious and therefore less productive c. Symptoms of stressful workplaces include low morale, chronic absenteeism, low productivity, and high turnover rates 201 © Pearson Education Limited 2015

d. Employers offer stress management programs to teach workers to cope with conditions and situations that cause stress e. Employers benefit from increased employee productivity, reduced absenteeism, and lower health care costs 12. Weight control and nutrition programs a. Educate employees about proper nutrition and weight loss, both of which are critical to good health b. Information from the medical community has clearly indicated that excess weight and poor nutrition are significant risk factors in cardiovascular disease, diabetes, high blood pressure, and cholesterol levels c. Over time, these programs should give employees better health, increased morale, and improved appearance d. For employers, these programs should result in improved productivity and lower health care costs e. Companies can contribute to employees’ weight control and proper nutrition by sponsoring memberships in such weight-loss programs as Weight Watchers 13. Financial education a. Provides employees with the resource for managing personal budgets and long-term savings (e.g., for retirement) b. Relatively low cost benefit that helps employees plan current and future (retirement) budgets III.

The Benefits and Costs of Discretionary Benefits 1. Discretionary benefits can promote competitive advantage 2. Discretionary benefits can also undermine the imperatives of strategic compensation 3. Companies that provide discretionary benefits as entitlements are less likely to promote competitive advantage than companies that design discretionary fringe compensation programs to fit the situation 4. Discretionary benefits offerings can promote particular employee behaviors that have strategic value 5. Discretionary benefits can attract quality employees by meeting the needs of a diverse workforce a. Flexible benefit plans: cafeteria plans b. Allows employees some control over meeting their own needs c. By meeting the diverse needs of its employees, companies can minimize dysfunctional behaviors, like absenteeism and turnover 6. Discretionary benefits can distinguish a company from its competition 7. Discretionary benefits have tax advantages a. Can translate into cost savings b. Companies pursuing differentiation strategies might invest more in research and development 202 © Pearson Education Limited 2015

c. Companies pursuing lowest cost strategies might be able to lower prices Final Note: Just as global competition cuts into discretionary benefits spending for a company, so to does a financial recession. The trend of companies cutting costs by reducing discretionary benefits is one that is likely to continue due to further global competition and the recent recessionary period.

IV.

Discussion Questions and Suggested Answers

9-1.

Many compensation professionals are faced with making choices about which discretionary benefits to drop because funds are limited and the costs of these benefits continually increase. Assume you make such choices. Rank order discretionary benefits, starting with the ones you would most likely drop to the ones you would least likely drop.

Answers will vary greatly based on the students’ values and what benefits are important to students. Voluntary benefits will generally be dropped first followed by supplemental programs then things like EAP, vision, and dental. Medical and retirement benefits will be last to be let go.

9-2.

Briefly describe some of the employee benefits offered by companies in your country that could be influenced by local laws, customs, or culture of the society.

The answer to this question varies because the each country has its own set of employee benefits laws that provide the minimum benefits coverage in terms of paid leave, overtime payment, and working conditions. Students are encouraged to do some research on their own country’s employment laws and to bring it to class for discussion.

9-3.

Assume that you are an HRM professional whose responsibility is to develop a brochure for the purpose of conveying the value of your company’s benefits program in a manner that will encourage recruits to join the company.

Develop a brochure (of no more than two pages) that meets this objective.

Conduct research (in such journals as Benefits Quarterly) on companies’ benefits practices as a basis for developing your brochure.

This is a practical exercise. Results will vary widely.

9-4.

Your instructor will assign you an industry. Conduct some research in order to identify the prevalent employee benefits practices for that industry. What factors (e.g., technology, competition, and government regulation) might influence the present practices? How will these practices change?

Depends on instructor assignment.

203 © Pearson Education Limited 2015

V.

End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses

Case Name: Time-off at Superior Software Services Instructor Notes Many employers believe restrictive sick day policies may increase unscheduled absences.

Superior’s time-off policy seems to create such a concern. Because the company is deadline driven, pre-scheduled absences would help supervisors better schedule work to meet those deadlines. While not all time off can be scheduled ahead, decreasing unscheduled absences could help avoid missed deadlines. A PTO bank could ultimately give employees more flexibility in scheduling their time-off needs.

Suggested Student Responses: 9-5.

Do you think changing Superior’s time-off policies will decrease unscheduled time-off?

Unscheduled absences seem to occur at Superior because of the structure of the timeoff benefits. Employees plan their vacation time at the beginning of the year and most likely do not want to sacrifice vacation time to take care of personal business.

The sick day policy encourages employees to call off from work with short notice.

The PTO option would provide employees more flexibility to schedule time off in advance when needed.

9-6.

What do companies in your country usually offer their employees in addition to paid time off (PTO) so that employees can better manage their personal commitments?

The case the benefits of PTO are relatively straightforward. As the name implies, such policies compensate employees when they are not performing their primary work duties. The major types of paid time off are public holidays, vacation, sick leave, personal leave, jury duty, funeral leave, military leave, clean-up, preparation, or travel time, rest period “break”, lunch period, integrated paid time-off policies, sabbatical leave, and volunteerism. Companies’ PTO benefits vary from country to country and this is sometimes driven by market practice. As such, students are encouraged to do some research of their country’s market practice on PTO.

204 © Pearson Education Limited 2015

9-7.

Are there any disadvantages to changing to PTO?

As the PTO policy is much different from the current policy, Superior would have to invest time and effort in guiding employees and supervisors on the new policy.

Further, some employees may choose to use all of their PTO for more short-term time-off needs instead of scheduling vacations at the beginning of the year. This preference might make some work planning efforts a challenge for supervisors.

MYLAB QUESTIONS 9-8.

What are the components of discretionary benefits? Provide two examples for each component of discretionary benefits.

Answer: There are three types of discretionary benefits: 1) protection, 2) paid time off, 3) services.

Protection: One example can be income protection programs such as disability insurance, life insurance, or retirement programs. Another protection program example is health protection programs.

Paid time off: These policies compensate employees when they are not performing their work duties. Examples: holidays, sick leave.

Services: There are a variety of services that companies provide such as wellness programs (smoking cessation, stress management) and family assistance programs (flexible scheduling, day care).

9-9.

What kind of discretionary benefits would help companies to have better control over absenteeism?

Answer: Integrated paid time off policies combine holiday, vacation, sick leave, and personal leave policies into a single paid time off policy. This allows employees to schedule time off without justifying the reasons. Family assistance programs can also be helpful in controlling employee absence. Flexible scheduling and leave allow employees to take time off during work hours so that they can take care of relatives or emergency situations. Flexible scheduling practices such as compressed work weeks and flextime help employees to balance the demands of work and family.

205 © Pearson Education Limited 2015

VI.

Additional Cases from the MyManagementLab Website; Instructor Notes, Questions and Suggested Student Responses

Case Name: Boosting Sales or Boosting Commissions?

Instructor Notes A commission pay plan is a common compensation approach for sales representatives because it recognizes the individual contributions of each sales representative. Further, if a company is pursuing a low-cost competitive strategy, a commission pay plan supports the strategy by only paying employees for activities that directly contribute to the bottom line success of the company. However, designing a commission pay plan is not as simple as just determining a percentage of sales to pay in commission. There are many factors that impact the effectiveness of a commission pay plan. In this case, while a commission pay plan makes sense, the design of the plan could lead to some unethical behavior on behalf of the sales representatives. While avoiding ethical issues can be addressed through other strategies such as effective hiring practices, it should also be a consideration when designing the commission pay plan structure.

Suggested Student Responses: 9-10. What are some potential problems with Aspect’s compensation structure for sales representatives?

Because the compensation is structured as commission only plan, there is no incentive for the sales representatives to work with a customer after the sale. In fact, doing so likely takes time away from activities that could lead to other sales. Further, the higher commission paid on add-on products and services may lead to some sales representatives aggressively selling extra services that are not needed. While these practices do support sales productivity, they do not provide incentives for the sales representatives to act in the best interest of the customers.

9-11. What changes do you recommend?

Aspect may want to consider offering some base salary to help encourage the sales representatives to provide service to recent customers. This could ultimately help the sales representatives because it will encourage them to spend some time working with recent customers who could become referral sources for future sales. Further, Aspect may want to make the commission for selling add-on services the same as the basic plan so there is not an incentive to unnecessarily sell features. As an alternative to provide additional incentives to the sales representatives, Aspect could consider a graduated commission pay plan so that the sales representatives received a higher commission rate for selling more units overall.

206 © Pearson Education Limited 2015

CHAPTER 10 Employer-Sponsored Retirement Plans and Health Insurance Programs Learning Objectives 1. State the definitions of qualified plans and nonqualified plans and indicate the main difference between them.

2. List nine minimum standards for qualified plans.

3. Explain what defined benefit plans are.

4. Explain what defined contribution plans are.

5. List and summarize two types of defined contribution plans.

6. Identify and summarize three broad classes of health insurance programs.

7. Briefly state the rationale for consumer-driven health care.

Outline I.

Exploring Retirement Plans A. Overview B. Origins of Employer-Sponsored Retirement Plans C. Trends in Retirement Plan Coverage and Costs II. Qualified Plans A. Overview B. Minimum Standards for Qualified Plans III. Defined Benefit Plans A. Overview B. Minimum Funding Standards C. Benefit Limits and Tax Deductions IV. Defined Contribution Plans A. Overview B. Individual Accounts C. Investments of Contributions D. Employee Participation in Investments E. Accrual Rules F. Minimum Funding Standards G. Contribution Limits and Tax Deductions V. Types of Defined Contribution Plans A. Types B. Section 401(k) Plans C. Profit-Sharing Plans D. Stock Bonus Plans E. Employee Stock Ownership Plans (ESOPs) 207 © Pearson Education Limited 2015

VI. Hybrid Plans: Cash Balance Plans A. Overview VII. Defining and Exploring Health Insurance Programs A. Overview B. Origins of Health Insurance Benefits C. Health Insurance Coverage and Costs VIII. Fee-for-Service Plans A. Overview B. Features of Fee-for-Service Plans IX. Managed Care Plans A. Overview B. Health Maintenance Organizations C. Features of Health Maintenance Organizations X. Preferred Provider Organizations A. Overview B. Features of Preferred Provider Organizations C. Deductibles D. Coinsurance XI. Point-of-Service Plans XII. Specialized Insurance Benefits A. Overview B. Prescription Drug Plans C. Mental Health and Substance Abuse D. Features of Mental Health and Substance Abuse Plans XIII. Consumer-Driven Health Care Plans A. Overview B. Flexible Spending Accounts XIV. Discussion Questions and Suggested Answers XV. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses XVI. Additional Cases from the MyManagementLab Website; Instructor Notes, and Suggested Student Responses

208 © Pearson Education Limited 2015

Lecture Outline I.

Exploring Retirement Plans A. Overview 1. Individuals may receive retirement benefits from as many as three sources a. Employer-sponsored retirement plans provide employees with income after they have met a minimum retirement age and have left the company b. The Social Security Old-Age, Survivor, and Disability Insurance (OASDI) program provides government-mandated retirement income to employees who have made sufficient contributions through payroll taxes (more in Chapter 11) c. Individuals may use their initiative to take advantage of tax regulations that have created such retirement programs as individual retirement accounts (IRAs) and Roth IRAs 2. Companies establish retirement or pension plans following one of three design configurations: a. Defined benefit plan b. Defined contribution plan c. Hybrid plan 3. Tax incentives encourage companies to offer pension programs 4. Employee Retirement Income Security Act of 1974 ERISA Title I and Title II provisions set the minimum standards required to “qualify” pension plans for favorable tax treatment 5. Failure to meet any of the minimum standard provisions “disqualifies” pension plans for favorable tax treatment 6. Pension plans that meet these minimum standards are known as qualified plans 7. Nonqualified plans refer to pension plans that do not meet at least one of the minimum standard provisions; typically, highly paid employees benefit from participation in nonqualified plans (more in Chapter 12) B. Origins of Employer-Sponsored Retirement Plans 1. Until World War II, pension plans were adopted primarily in the railroad, banking, and public utility industries 2. Favorable tax treatment of pensions was established through the passage of the Revenue Act of 1921 and government-imposed wage increase controls during World War II in the early 1940s 3. Led companies to adopt discretionary employee benefits plans such as pensions that were excluded from those wage increase restrictions 4. Current tax treatment of qualified plans continues to provide incentives both for employers to establish plans and for employees to participate in them 5. Contribution to a qualified plan is deductible in computing the employer’s or employee’s taxes based on who made the contribution 6. This preferential tax treatment is contingent on the employer’s compliance with the ERISA 209 © Pearson Education Limited 2015

C.

Trends in Retirement Plan Coverage and Costs 1. According to the U.S. Bureau of Labor Statistics, private sector participation in at least one company-sponsored retirement plans was: a. 55 percent in 1992–1993 b. 32 percent in 1992–1993 in defined contribution plans and slightly less in defined benefit plans c. 48 percent in 2012 in defined contribution plans d. Noticeable decline in defined benefit plans in the last several years 2. Two important explanations for these trends in participation a. Shift in the labor force toward different occupations and industries b. Costs 3. Shift in labor force a. Relative decline in employment among full-time workers, union workers, and workers in goods-producing businesses b. Decline in full-time workers and increase in part-time workers has led to fewer opportunities for participation in company-sponsored retirement plans c. Decline in union affiliation (i.e., union members or just part of the bargaining unit) also contributes to the overall trends i. In 2012, about 66 percent of employees affiliated with unions were eligible to participate in a defined benefit plan whereas only 12 percent of employees not affiliated with unions were eligible. ii. In 2012, about 45 percent of employees affiliated with unions were eligible to participate in a defined contribution plan whereas only 41 percent of employees not affiliated with unions were eligible. d. Expansion of service industries relative to somewhat stable employment in the goods-producing sector helps to explain retirement plan participation e. Fewer service-oriented workers have access to defined benefit plans (17 percent versus 27 percent) f. Percentage of workers with access to defined contribution plans is higher and similar in both industries (approximately 60 percent percent) g. Actual employee participation in defined contribution plans is drastically lower for service employers than for goods-producing companies 4. Costs a. Defined benefit plans are quite costly to employers compared with defined contribution plans b. The Pension Benefit Guaranty Corporation (PBGC) serves as the insurer by taking over pension obligations for companies that terminate their defined benefit plans because of severe financial stress c. Companies with defined benefit plans pay premiums to the PBGC to insure defined benefit plans in the event of severe financial distress d. The Pension Protection Act requires that companies that are at high risk of not meeting their pension obligations pay substantially more to insure defined benefit plans, adding to the substantial cost 210 © Pearson Education Limited 2015

II.

Qualified Plans A. Overview 1. Entitle employers and employees to substantial tax benefits 2. Employers and employees specifically do not pay tax on their contributions within dollar limits that differ for defined benefit and defined contribution plans 3. Investment earnings of the trust in which plan assets are held are generally exempt from tax 4. Participants or beneficiaries do not pay taxes on the value of retirement benefits until they receive distributions B. Minimum Standards for Qualified Plans 1. Thirteen fundamental characteristics: a. Participation requirements b. Coverage requirements c. Vesting rules d. Accrual rules e. Nondiscrimination rules: testing f. Key employee and top-heavy provisions g. Minimum funding standards h. Social Security integration i. Contribution and benefit limits j. Plan distribution rules k. Qualified survivor annuities l. Qualified domestics relations orders m. Plan termination rules and procedures 2. Participation requirements a. Age requirements - employees must be allowed to participate in pension plans after they have reached age 21 b. Service requirements - employees must be allowed to participate in pension plans after they have completed one year of service (based on 1,000 work hours) 3. Coverage requirements a. Limit the freedom of employers to exclude employees b. Qualified plans do not disproportionately favor highly compensated employees 4. Vesting rules a. Vesting refers to an employee’s non-forfeitable rights to pension benefits b. There are two aspects of vesting: i. First, employees are always vested in their contributions to pension plans ii. Second, companies must grant full vesting rights to employer contributions on one of the following two schedules - cliff vesting or six-year graduated schedule 211 © Pearson Education Limited 2015

c. Cliff vesting schedules must grant employees 100 percent vesting after no more than three years of service d. Known as cliff vesting because leaving one’s job prior to becoming vested under this schedule is tantamount to falling off a cliff because an employee loses all of the accrued employer contributions e. The six-year graduated schedule allows workers to become 20 percent vested after two years and to vest at a rate of 20 percent each year thereafter until they are 100 percent vested after six years of service f. Plans may have faster gradual schedules to 100 percent vesting in fewer than six years g. The graduated schedule is preferable to employees who anticipate changing jobs frequently because they will earn the rights to keep part of the employer’s contribution sooner. h. Employees recognize that layoffs are more common in today’s volatile business environment and they stand to benefit by earning partial vesting rights sooner than earning full vesting rights at a later date i. Employers prefer the cliff vesting schedule recognizing that many employees tend to change jobs more frequently than ever before, allowing them to reclaim non-vested contributions for employees who leave before becoming vested j. After six years of participation in the pension plan, an employee has the right to receive all of the contributions plus interest on the contributions made by the employer 5. Accrual rules a. Qualified plans are subject to minimum accrual rules based on the Internal Revenue Code (IRC) and ERISA b. Accrual rules specify the rate at which participants accumulate (or earn) benefits c. Defined benefit and defined contribution plans use different accrual rules 6. Nondiscrimination rules: Testing a. Nondiscrimination rules prohibit employers from discriminating in favor of highly compensated employees in contributions or benefits, availability of benefits, rights, or plan features b. Employers may not amend pension plans so that highly compensated employees are favored 7. Benefit and contribution limits a. Refer to the maximum annual amount an employee may receive from a qualified defined benefit plan during retirement b. Contribution limits apply to defined contribution plans: i. Employers are limited in the amount they may contribute to an employee’s defined contribution plan each year ii. The Economic Growth and Tax Relief Reconciliation Act of 2001 amended IRC Section 415, mandating increases in these limits effective after December 31, 2001, and indexing them each year for inflation to keep retirement savings from falling behind 212 © Pearson Education Limited 2015

8.

9.

10.

increases in the cost of goods and services, thereby making retirees less dependent on Social Security retirement benefits (more in Chapter 11) ii. The limits were set to expire after the year 2009, but the Pension Protection Act of 2006 made the limits permanent Allowable tax deductions for employers a. Employers may take tax deductions for contributions to employee retirement plans based on three conditions: i. Retirement plans must be qualified ii. The employer must make contributions before the due date for its federal income tax return for that year iii. Deductible contributions are based on designated amounts set forth by the IRC (as subsequently amended by the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Pension Protection Act of 2006) Plan distribution rules a. Refers to the payment of vested benefits to participants or beneficiaries b. Payable in a variety of ways i. Lump sum distributions are single payments of benefits ii. In defined contribution plans, lump sum distributions equal the vested amount (i.e., the sum of all employee and vested employer contributions, and interest on this sum) iii. In defined benefit plans, lump sum distributions equal the equivalent of the vested accrued benefit iv. Annuities represent a series of payments for the life of the participant and beneficiary v. Annuity contracts are usually purchased from insurance companies, which make payments according to the contract vi. Inherent risk of defined contribution plans has given rise to income annuities vii. Income annuities distribute income to retirees based on retirement savings paid to insurance companies in exchange for guaranteed monthly checks for life Plan termination rules and procedures a. Apply only to defined benefit plans b. Three types of plan terminations: i. Standard termination ii. Distress termination iii. Involuntary termination c. Qualified plans must follow strict guidelines for plan terminations including sufficient notification to plan participants, notification to the PBGC, and distribution of vested benefits to participants and beneficiaries in a reasonable amount of time

213 © Pearson Education Limited 2015

III. Defined Benefit Plans A. Overview 1. Guarantee retirement benefits specified in the plan document 2. Usually expressed in terms of a monthly sum equal to a percentage of a participant’s preretirement pay multiplied by the number of years he or she has worked for the employer 3. Benefit is fixed by a formula 4. Level of required employer contributions fluctuates from year to year 5. Level depends on the amount necessary to make certain that benefits promised will be available when participants and beneficiaries are eligible to receive them 6. Annual benefits are usually based on age, years of service, and final average wages or salary 7. Retirement plans based on unit benefit formulas specify annual retirement benefits as a percentage of final average salary Example: Unit Benefit Formulas Let’s assume Mary retires at age 59 with 35 years of service.

Let’s also assume her final average salary is $52,500.

Mary multiplies $52,500 by the annual percentage of 68.20%.

Her annual benefit is $35,805.00 ($52,500 X 68.20%) B.

C.

Minimum Funding Standards 1. Employers make an annual contribution that is sufficiently large to ensure that promised benefits will be available to retirees 2. Actuaries periodically review several kinds of information to determine a sufficient funding level a. Life expectancies of employees and their designated beneficiaries b. Projected compensation levels c. Likelihood of employees terminating their employment before they have earned benefits 3. ERISA imposes the reporting of actuarial information to the IRS, which in turn submits these data to the U.S. Department of Labor, which reviews the data to ensure compliance with ERISA regulations Benefit Limits and Tax Deductions 1. IRC sets a maximum annual benefit for defined benefit plans that is equal to the lesser of $205,000 in 2013, or 100 percent of the highest average compensation for three consecutive years 2. The limit is indexed for inflation in $5,000 increments each year beginning after 2006

IV. Defined Contribution Plans A. Overview 1. Employers and employees make annual contributions to separate accounts established for each participating employee, based on a formula contained in the plan document 214 © Pearson Education Limited 2015

B.

C.

D.

2. Formulas typically call for employers to contribute a given percentage of each participant’s compensation annually 3. Employers invest these funds on behalf of the employee, choosing from a variety of investment vehicles a. Company stocks b. Diversified stock market funds c. Federal government bond funds 4. Participants bear the risk of possible investment gain or loss, and benefit amounts depend upon several factors, including: a. Contribution amounts b. Performance of investments c. Forfeitures transferred to participant accounts Individual Accounts 1. Defined contribution plans contain accounts for each employee into which contributions are made, and losses are debited or gains are credited 2. Contributions to each employee’s account come from four possible sources: a. The first, employer contributions, are expressed as a percentage of an employee’s wage or salary b. The second, employee contributions, are usually expressed as a percentage of the employee’s wage or salary c. The third, forfeitures, come from the accounts of employees who terminated their employment prior to earning vesting rights d. The fourth contribution source is return on investments. In the case of negative returns (or loss), the corresponding amount is debited from employees’ accounts Investments of Contributions 1. ERISA requires that a named fiduciary manage investments into defined contribution plans 2. Fiduciaries are individuals who manage employee benefit plans and pension funds 3. Possess discretion in managing the assets of the plan, offering investment advice to employee participants, and administering the plan 4. Responsible for minimizing the risk of loss of assets 5. Possess the authority to delegate investment responsibility to an investment manager 6. Investment managers select investments based on a comparison of the risk and return potential of various investment options 7. May invest assets in a variety of investment vehicles, including equities, government bonds, cash, insurance, and real estate 8. Usually invest assets in more than one type of investment vehicle to balance risk and return potential Employee Participation in Investments 1. Some companies may allow plan participants to choose the investment of funds in their individual accounts 215 © Pearson Education Limited 2015

E.

F.

G.

V.

2. It is not uncommon for large companies to offer investment alternatives through such companies as Fidelity, Vanguard, and T. Rowe Price Accrual Rules 1. The accrued benefit equals the balance in an individual’s account 2. Companies must not reduce contribution amounts based on age 3. Companies may also not set maximum age limits for discontinuing contributions Minimum Funding Standards 1. The minimum funding standard for defined contribution plans is less complex than it is for defined benefit plans 2. This standard is met when contributions to the individual accounts of plan participants meet the minimum amounts as specified by the plan Contribution Limits and Tax Deductions 1. Employer contributions to defined contribution plans represent one factor in annual additions 2. Refers to the annual maximum allowable contribution to a participant’s account in a defined contribution plan 3. The annual addition includes employer contributions, employee contributions, and forfeitures allocated to the participant’s account 4. In 2013, annual additions were limited to the lesser of $51,000 or 100 percent of the participant’s compensation

Types of Defined Contribution Plans A. Types 1. Section 401(k) plans 2. Profit sharing 3. Stock bonus plans 4. Employee stock ownership plans (ESOPs) B. Section 401(k) Plans 1. Named after the section of the IRC that created them 2. Also known as cash or deferred arrangements (CODAs) 3. Permit employees to defer part of their compensation to the trust of a qualified defined contribution plan 4. Only private sector or tax-exempt employers are eligible to sponsor 401(k) plans 5. Three noteworthy tax benefits: a. Employees do not pay income taxes on their contributions to the plan until they withdraw funds b. Employers deduct their contributions to the plan from taxable income c. Investment gains are not taxed until participants receive payments C. Profit-Sharing Plans 1. Set up to distribute money to employees 2. Establish a profit-sharing pool (i.e., the money earmarked for distribution to employees) 3. May choose to fund profit-sharing plans based on gross sales revenue or some basis other than profits 216 © Pearson Education Limited 2015

D.

E.

4. May take a tax deduction for contributions not to exceed 25 percent of the plan participants’ compensation in 2013 5. Employer contributions a. Three common formulas establish employer contributions: i. Fixed first-dollar-of-profits ii. Graduated first-dollar-of-profits iii. Profitability threshold b. The fixed first-dollar-of-profits formula uses a specific percentage of either pretax or after-tax annual profits (alternatively, gross sales or some other basis) contingent upon the successful attainment of a company goal c. The graduated first-dollar-of-profits formula is not a fixed percentage and varies by profit levels d. Profitability threshold formulas fund profit-sharing pools only if profits exceed a predetermined minimum level, but fall below some established maximum level 6. Allocation formulas a. Companies usually make distributions in one of three ways: i. Equal payments ii. Proportional payments to employees based on their annual salary iii. Proportional payments to employees based on their contribution to profits b. Equal payments to all employees reflect a belief that all employees should share equally in the company’s gains in order to promote cooperation among employees c. For proportional payments to employees based on their annual salary, higher paying jobs presumably indicate the greatest potential to influence a company’s competitive position d. For proportional payments to employees based on their contribution to profits, some companies measure employee contributions to profits based on job performance; however, this approach is not very feasible because it is difficult to isolate each employee’s contributions to profits Stock Bonus Plans 1. May be the basis for a company’s 401(k) plan 2. Qualified stock bonus plans and qualified profit-sharing plans are similar because both plans invest in company securities 3. Reward employees with company stock (i.e., equity shares in the company) 4. Benefits are usually paid in shares of company stock 5. Participants of stock bonus plans possess the right to vote as shareholders 6. Voting rights differ based on whether company stock is traded in public stock exchanges Employee Stock Ownership Plans (ESOPs) 1. May be the basis for a company’s 401(k) plan 217 © Pearson Education Limited 2015

2. Invest in company securities, making them similar to profit-sharing plans and stock bonus plans 3. ESOPs and profit-sharing plans differ because ESOPs usually make distributions in company stock rather than cash 4. ESOPs are essentially stock bonus plans that use borrowed funds to purchase stock 5. Two types: a. Nonleveraged—company contributes stock or cash to buy stock which is then allocated to participants b. Leveraged—plan administrator borrows money from a financial institution to purchase company stock which may then be used for the financing of existing debt, estate planning, or financing an acquisition or divestiture VI. Hybrid Plans: Cash Balance Plans A. Overview 1. Combine features of traditional defined benefit and defined contribution plans 2. Cash balance plans are defined benefit plans that define benefits for each employee by reference to the amount of the employee’s hypothetical account balance 3. Many companies have chosen to convert their defined benefit plans to cash balance plans for two key reasons: a. Cash balance plans are less costly to employers than defined benefit plans b. They pay out benefits in a lump sum instead of a series of payments and increase the portability of pension benefits from company to company Why Cash Balance Plans: •

•

In January 2012, employees had worked for their current employer for a median value of 4.4 years; those aged 45 to 54 had worked for their current employer a median value of 7.8 years. Younger workers aged 25 to 34 had worked a median value of 3.2 years.

These data suggest workers may be accumulating retirement benefits from several jobs; employers have attempted to deal with these changing needs by seeking alternative approaches to providing retirement income.

4. Most common approaches include a fixed percentage of earnings and percentages that vary by age, length of service, or earnings 5. Participants receive credits expressed as a percentage of annual pay, and these credits earn interest at a designated rate

218 © Pearson Education Limited 2015

6. Amounts stated in these individual accounts are strictly hypothetical because the employer contributes money to the plan as a whole covering all employees 7. Complex federal rules require that employers have sufficient assets to cover the amounts expressed in every employee’s hypothetical account VII. Defining and Exploring Health Insurance Programs A. Overview 1. Covers the costs of a variety of services that promote sound physical and mental health, including physical examinations, diagnostic testing, surgery, hospitalization, psychotherapy, dental treatments, and corrective prescription lenses for vision deficiencies 2. Employers usually enter into a contractual relationship with one or more insurance companies to provide health-related services for their employees and, if specified, employees’ dependents 3. The insurance policy specifies the amount of money the insurance company will pay for such particular services as physical examinations 4. Employers pay insurance companies a negotiated amount, or premium, to establish and maintain insurance policies; the term insured refers to employees covered by the insurance policy 5. In the United States, companies can choose from three broad classes of health insurance programs: a. Fee-for-service programs b. Managed care plans c. Point-of-service plans 6. An emerging class of health insurance programs is based on consumerdriven health care, where employees: a. play a greater role in decisions on their health care b. have better access to information c. share more in the costs B. Origins of Health Insurance Benefits 1. Great Depression of the 1930s gave rise to employer-sponsored health insurance programs 2. Congress proposed the Social Security Act of 1935 to address many of the social maladies caused by the adverse economic conditions, incorporating health insurance programs 3. President Franklin D. Roosevelt, however, opposed the inclusion of health coverage under the Social Security Act. Health insurance did not become part of the Social Security Act until an amendment to the Act in 1965 established the Medicare program 4. In the 1930s, hospitals controlled nonprofit companies that inspired today’s Blue Cross and Blue Shield plans 5. In the 1940s, local medical associations created nonprofit Blue Shield plans, which were prepayment plans for physician services 6. The federal government also imposed wage freezes during World War II, which did not extend to employee benefit plans 219 © Pearson Education Limited 2015

C.

7. Many employers began offering health care benefits to help compete for and retain the best employees, particularly during the labor shortage when U.S. troops were overseas fighting in World War II 8. In the 1960s, the federal government amended the Social Security Act. Titles XVIII and XIX of the Act established the Medicare and Medicaid programs, respectively 9. The Health Maintenance Organization Act of 1973 (HMO Act) promoted the use of health maintenance organizations 10. Since the 1970s there has been substantial emphasis on managing costs, and consideration has been given to providing coverage to the uninsured (e.g., the failed national health care proposal under former President Bill Clinton) Health Insurance Coverage and Costs 1. Companies stand to gain from sponsoring these benefits in at least two ways: a. Healthier workforce should experience a lower incidence of sickness absenteeism b. Health insurance offerings should help the recruitment and retention of employees 2. Most recent comprehensive national data indicate that more than half (70 percent) of all private sector employees had access to at least one employer-sponsored health insurance program in 2012 3. Varies by employer size, industry group, and union presence 4. A larger percentage of employees in larger companies, goods-producing companies, and union employees had coverage 5. Employee contributions represent a relatively small percentage of the health insurance premiums as of March 2012 a. Single coverage - 21 percent b. Family coverage - 32 percent 6. Single coverage extends benefits only to the covered employee 7. Family coverage offers benefits to the covered employee and his or her family members as defined by the plan (usually, spouse and children)

VIII. Fee-for-Service Plans A. Overview 1. Provide protection against health care expenses in the form of a cash benefit paid to the insured or directly to the health care provider after the employee has received health care services 2. Three types of eligible health expenses: a. Hospital expenses b. Surgical expenses c. Physician charges 3. Policyholders (employees) may generally select any licensed physician, surgeon, or medical facility for treatment, and the insurer reimburses the policyholders after medical services are rendered 4. Two types of fee-for-service plans: 220 © Pearson Education Limited 2015

B.

a. Indemnity plans b. Self-funded plans 5. Indemnity plans are based on a contract between the employer and an insurance company which specifies the expenses that are covered and the rate 6. Self-funded plans are those in which companies pay benefits directly from their own assets, either current cash flow or funds set aside in advance for potential future claims 7. Self-funding makes sense when a company’s financial burden of covering employee medical expenses is less than the cost to subscribe to an insurance company for coverage 8. Three types of expenses: a. Hospitalization b. Surgical c. Physician 9. Companies sometimes select major medical plans to provide comprehensive medical coverage instead of limiting coverage to these three specific types of expenses or to supplement these specific benefits Features of Fee-for-Service Plans 1. Common fee-for-service stipulations include: a. Deductibles b. Coinsurance c. Out-of-pocket maximums d. Preexisting condition clauses e. Preadmission certification f. Second surgical opinions g. Maximum benefits limits 2. Deductibles a. Employees must pay for services (i.e., meet a deductible) before insurance benefits become active b. The amount is modest, usually a fixed amount ranging anywhere between $100 and $500 depending on the plan c. Amounts may also depend on annual earnings, either expressed as a fixed amount for a range of earnings or as a percentage of income 3. Coinsurance a. Refers to the percentage of covered expenses paid by the insured b. Most indemnity plans stipulate 20 percent coinsurance c. This means the plan will pay 80 percent of covered expenses; the policyholder is responsible for the difference, in this case 20 percent d. Insurance plans most commonly apply no coinsurance for diagnostic testing and 20 percent for other medical services; coinsurance rates for these services tend to be the highest, usually 50 percent.

4. Out-of-pocket maximum a. Protects individuals from catastrophic medical expenses or expenses associated with recurring episodes of the same illness 221 © Pearson Education Limited 2015

b. Usually stated as a fixed dollar amount and apply to expenses beyond the deductible amount c. Unmarried individuals often have an annual out-of-pocket maximum of $1,000, and family out-of-pocket maximums are as high as $3,500 5. Preexisting condition clauses a. Condition for which medical advice, diagnosis, care, or treatment was received or recommended during a designated period preceding the beginning of coverage b. Designated period for preexisting conditions usually spans between three months and one year c. Imposed by insurance companies in order to limit their liabilities for serious medical conditions that predate an individual’s coverage 6. Preadmission certification a. Physicians must receive approval from a registered nurse or medical doctor employed by an insurance company before admitting patients to the hospital on a nonemergency basis (i.e., when a patient’s life is not in imminent danger) b. Insurance company doctors and nurses judge whether hospitalization or alternative care is necessary c. They determine the length of stay appropriate for the medical condition d. Precertification requirements reserve the right for insurance companies not to pay for unauthorized admissions or hospital stays that extend beyond the approved period 7. Second surgical options a. Reduce unnecessary surgical procedures (and costs) by encouraging an individual to seek an independent opinion from another doctor b. Insurance companies cover the cost of this consultation 8. Maximum benefit limits a. Expressed as a dollar amount over the course of one year or over an insured’s lifetime b. Setting annual maximums provide insurance companies with greater control over total cost expenditures IX. Managed Care Plans A. Overview 1. Emphasize cost control by limiting an employee’s choice of doctors and hospitals 2. Three kinds: a. Health maintenance organizations (HMOs) b. Preferred provider organizations (PPOs) c. Point-of-service plans (POS) B. Health Maintenance Organizations 1. Prepaid medical services—fixed periodic enrollment fees cover HMO members for all medically necessary services only if the services are delivered or approved by the HMO 222 © Pearson Education Limited 2015

C.

X.

2. Generally provide inpatient and outpatient care as well as services from physicians, surgeons, and other health care professionals 3. Most medical services are either fully covered or, in the case of some HMOs, participants are required to make nominal copayments 4. Common copayment amounts vary between $15 and $50 for each doctor’s office visit, and $10 to $50 per prescription drug Features of Health Maintenance Organizations 1. Share several features in common with fee-for-service plans (out-ofpocket maximums, preexisting condition clauses, preadmission certification, second surgical opinions, and maximum benefits limits) 2. HMOs differ from fee-for-service plans in three important ways: a. HMOs offer prepaid services, whereas fee-for-service plans operate on a reimbursement basis b. HMOs include the use of primary care physicians as a cost-control measure c. HMO coinsurance rates are generally lower than fee-for-service plans 3. HMOs designate some of their physicians, usually general or family practitioners, as primary care physicians 4. Primary care physicians determine when patients need the care of specialists 5. The most important duty is perhaps to diagnose the nature and seriousness of an illness promptly and accurately, after which the primary care physician refers the patient to the appropriate specialist 6. The most common HMO copayments apply to physician office visits, hospital admissions, prescription drugs, and emergency room services 7. Office visits are nominal amounts, usually $25 to $50 per visit; hospital admissions and emergency room services are higher, ranging between $50 and $150 for each occurrence 8. Inpatient services require copayments that are similar in amount to those for hospital admissions for medical treatment; however, copayments for outpatient services (e.g., psychotherapy, consultation with a psychiatrist, or treatment at a substance abuse facility) are generally expressed as a fixed percentage of the fee for each visit or treatment. HMOs usually charge a copayment ranging between 15 percent and 25 percent

Preferred Provider Organizations A. Overview 1. Select group of health care providers agrees to furnish health care services to a given population at a higher level of reimbursement than under feefor-service plans 2. Physicians qualify as preferred providers by meeting quality standards, agreeing to follow cost-containment procedures implemented by the PPO, and accepting the PPOs reimbursement structure 3. The employer, insurance company, or third-party administrator helps guarantee provider physicians’ minimum patient loads by furnishing employees with financial incentives to use the preferred providers 223 © Pearson Education Limited 2015

B.

C.

D.

Features of Preferred Provider Organizations 1. Features most similar to fee-for-service plans are out-of-pocket maximums and coinsurance, and those most similar to HMOs include the use of nominal copayments 2. Preexisting condition clauses, preadmission certification, second surgical opinions, and maximum benefits limits are similar to those in fee-forservice and HMO plans 3. PPOs contain deductible and coinsurance provisions that differ somewhat from other plans Deductibles 1. Unlike fee-for-service plans, PPOs often apply different deductible amounts for services rendered within and outside the approved network 2. Higher deductibles are set for services rendered by non-network providers to discourage participants from using services outside the network Coinsurance 1. PPOs calculate coinsurance as a percentage of fees for covered services 2. PPOs also use two sets of coinsurance payments: a. The first set applies to services rendered within the network of care providers b. The second to services rendered outside the network 3. Coinsurance rates for network services are substantially lower than they are for non-network services.

4. Coinsurance rates for network services range between 10 percent and 20 percent 5. Non-network coinsurance rates run between 60 percent and 80 percent

XI. Point-of-Service Plans 1. Combines features of fee-for-service systems and health maintenance organizations 2. Employees pay a nominal copayment for each visit to a designated network of physicians 3. Employees possess the option to receive care from health care providers outside the designated network of physicians, but they pay somewhat more for this choice XII. Specialized Insurance Benefits A. Overview 1. Carve-out plans are set up to cover dental care, vision care, prescription drugs, mental health and substance abuse, and maternity care 2. Specialty HMOs or PPOs usually manage carve-out plans based on the expectation that single-specialty practices may control costs more effectively than multispecialty medical practices B. Prescription Drug Plans 1. Cover the costs of drugs 2. Apply exclusively to drugs that state or federal laws require to be dispensed by licensed pharmacists 224 © Pearson Education Limited 2015

C.

D.

3. Prescription drugs dispensed to individuals during hospitalization or treatment in long-term care facilities are not covered by prescription drug plans 4. Three kinds of prescription drug programs: a. Medical reimbursement plans i. Reimburse employees for some or all of the cost of prescription drugs ii. Usually associated with self-funded or independent indemnity plans b. Prescription card programs i. Offer prepaid benefits with nominal copayments ii. Limit benefits to prescriptions filled at participating pharmacies, similar to managed care arrangements for medical treatment c. Mail order prescription drug programs i. Dispense expensive medications used to treat chronic health conditions such as HIV infection or such neurological disorders as Parkinson’s disease ii. Offer a cost advantage because they purchase medications at discounted prices in large volumes Mental Health and Substance Abuse 1. Twenty percent of Americans experience some form of mental illness (e.g., clinical depression) at least once during their lifetimes 2. Nearly 20 percent develop a substance abuse problem 3. Employee Assistance Programs (EAPs) represent a portal to taking advantage of employer-sponsored mental health and substance abuse treatment options 4. EAPs help employees cope with personal problems that may impair their personal lives or job performance, including alcohol or drug abuse, domestic violence, the emotional impact of AIDS and other diseases, clinical depression, and eating disorders Features of Mental Health and Substance Abuse Plans 1. Cover the costs of a variety of treatments, including: a. Prescription psychiatric drugs (e.g., antidepressant medication) b. Psychological testing c. Inpatient hospital care d. Outpatient care (e.g., individual or group therapy) 2. Diagnostic and Statistical Manual of Mental Disorders (DSM-V) used to diagnose mental disorders based on symptoms, and both fee-for-service and managed care plans rely on the DSM-V to authorize payment of benefits 3. From the employee’s perspective, coinsurance and maximum benefits amounts are generally less generous than general health plans in three ways: a. First, coinsurance amounts for mental health and substance abuse benefits, expressed as a percentage of treatment cost for both 225 © Pearson Education Limited 2015

indemnity and managed care plans, range between 40 percent and 50 percent b. Second, mental health and substance abuse plans limit the annual number of outpatient visits or days of inpatient care c. Third, annual and lifetime maximum benefits were set significantly lower 4. The Mental Health Parity Act and Addiction Equity Act of 2008 requires that any group health plan that includes mental health and substance use disorder benefits along with standard medical and surgical coverage must treat them equally in terms of: a. out-of-pocket costs b. benefit limits and practices (such as prior authorization and utilization review) XIII. Consumer-Driven Health Care Plans A. Overview 1. Refers to the objective of helping companies maintain control over costs while also enabling employees to make greater choices about health care 2. Enables employers to lower the cost of insurance premiums by selecting plans with higher employee deductibles 3. The most popular consumer-driven approaches are flexible spending accounts and health reimbursement accounts 4. Provide employees with resources to pay for medical and related expenses not covered by higher deductible insurance plans at substantially lower costs to employers B. Flexible Spending Accounts 1. Permit employees to pay for specified health care costs that are not covered by an employer’s insurance plan 2. Prior to each plan year, employees elect the amount of pay they wish to allocate to this kind of plan 3. Employers then use these monies to reimburse employees for expenses incurred during the plan year that qualify for repayment 4. Qualifying expenses include: a. Out-of-pocket costs for medical treatments b. Products or services related to mental or physical defect or disease along with certain associated costs 5. The advantage to employees is the ability to make contributions to their FSAs on a pretax basis 6. The disadvantage is the “use it or lose it” provision of FSAs 7. Employers may establish health reimbursement accounts 8. Three differences between HRAs and FSAs: a. Employers make the contributions to each employee’s HRA whereas employees fund FSAs with pretax contributions deducted from their pay. HRA arrangements are particularly appealing to employees with relatively low salaries or hourly wage rates because they do not contribute to them 226 © Pearson Education Limited 2015

b. HRAs permit employees to carry over unused account balances from year to year, whereas employees forfeit unused FSA account balances present at the end of the year c. Employers may offer employees HRAs as well as FSAs, and the use of these accounts are not limited to participation in high-deductible health care plans, which is the case for HSAs 9. The idea of consumer-driven health care has most recently received substantially greater attention than before because of the Bush Administration (President George W. Bush) and the Republican-led congress who favor greater employee involvement in their medical care and reducing the cost burden for companies to help maintain competitiveness in the global market 10. The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 added section 223 to the IRC, effective January 1, 2004, to permit eligible individuals to establish HSAs to help employees pay for medical expenses 11. Employers offer HSAs along with a high deductible insurance policy, established for employees. High-deductible health insurance plans require substantial deductibles and low out-of-pocket maximums a. For individual coverage, the minimum annual deductible was $1,250 with maximum out-of-pocket limits at or below $6,250 in 2013 b. For family coverage, the deductible was $2,500 with maximum out-ofpocket limits at or below $12,500 12. HSAs offer four main advantages to employees relative to FSAs and HRAs: a. First, HSAs are portable, which means that the employee owns the account balance after the employment relationship ends b. Second, HSAs are subject to inflation-adjusted funding limits c. Third, employees may receive medical services from doctors, hospitals, and other health care providers of their choice, and they may choose the type of medical services they purchase, including such items as long-term care, eye care, and prescription drugs d. Fourth, HSA assets must be held in trust and cannot be subject to forfeiture. That is, any unspent balances in the HSA can be rolled over annually and accumulate tax-free until the participant’s death. FSAs and HRAs have no legal vesting requirement, which means employees do not possess the right to claim unused balances when they terminate employment HSAs: • In 2013, an employer, an employee, or both may contribute as much as: a. $3,250 annually for unmarried employees without dependent children or b. $6,450 for married or unmarried employees with dependent children • Employers may require employees to contribute toward these limits.

• Employee contributions would be withheld from an employee’s pay on a pretax basis.

227 © Pearson Education Limited 2015

XIV. Discussion Questions and Suggested Answers 10-1. Are employees more likely to favor defined contribution plans over defined benefit plans? How about employers? Explain your answer.

Employees are more likely to favor defined benefit plans because they guarantee retirement benefits. This benefit is usually expressed in terms of a monthly sum equal to a percentage of a participant’s preretirement pay multiplied by the number of years he or she has worked for the employer. Defined contribution plans, on the other hand, contain accounts for each employee based on contributions that are made, losses that are debited or gains that are credited. This is why defined contribution plans are more likely to be favored by employers because these plans build strong incentives to perform well throughout the entirety of the given employees’ employment in the company.

10-2. Summarize the controversial issues regarding cash balance plans.

There are two key controversies surrounding cash balance plans. The first issue centers on favorable treatment to younger workers and unfavorable treatment to older employees.

The second issue is based on the practice of converting traditional defined benefit plans to cash balance plans and reducing benefits.

10-3. Discuss the basic concept of insurance. How does this concept apply to health care?

Insurance is the pooling of risk. In order to have such insurance people often pay monthly or yearly premiums in order to ensure that when an accident or incident does occur, they are prepared to deal with the consequences economically. In health care, insurance covers the cost of a variety of services that promote sound physical and mental health, including physical examinations, diagnostic testing, surgery, hospitalization, psychotherapy, dental treatments, and corrective prescription lenses for vision deficiencies. Some participants consume less than they contribute and some consume more than they contribute.

However, because need is unpredictable, all are protected.

10-4. Describe the principles of fee-for-service plans and managed care plans.

What are the similarities and differences?

Fee-for-service plans provide protection against health care expenses in the form of a cash benefit paid to the insured or directly to the health care provider after the employee has received health care services. These plans pay benefits on a reimbursement basis.

Three types of eligible health expenses are hospital expenses, surgical expenses, and physician charges. Under fee-for-service plans, policyholders may generally select any licensed physician, surgeon, or medical facility for treatment, and the insurer reimburses 228 © Pearson Education Limited 2015

the policyholders after medical services are rendered. Managed care plans emphasize cost control by limiting an employee’s choice of doctors and hospitals. Three common forms of managed care are health maintenance organizations, preferred provider organizations, and point-of-service plans. The main difference between these fee-for-service and managed care plans is that fee-for-service allows employees to pick any doctor or hospital they choose, whereas managed care plans limit those choices.

10-5. Describe some of the actions taken by companies or the government in your country to tackle rising health care costs and the impact of these measures on the various stakeholders.

Some of the actions taken by companies to tackle rising health care costs include cosharing of medical cost between employees and employers, promotion of wellness programs in the company, and encouraging employees to adopt a healthy lifestyle.

XV.

End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses

Case Name: A Health Savings Account at Frontline PR Instructor Notes The high cost of healthcare insurance is a challenge that many employers are facing.

Controlling costs, while providing employees with an affordable option that is competitive with other employers, is important. Consumer-driven healthcare means that employees have more responsibility in their medical spending. The use of HSA's combined with a high-deductible health insurance plan will likely reduce costs for employers. However, it is a new approach to healthcare insurance and employers will likely initially receive resistance from employees who do not understand the option.

Suggested Student Responses: 10-6. What are some advantages of the implementing the HSA option?

The HSA coupled with the high deductible healthcare insurance plan offers the company cost savings and also may reduce overall healthcare costs as the employees will be more involved in their healthcare decisions. While the insurance plan has a high deductible, there is a low out-of-pocket maximum expense to the employee. The HSA offers several advantages over the FSA currently offered by Frontline. The HSA allows employees to roll over funds to the next year if they aren’t used. Because FSA’s are ‘use or lose,’ if employees set aside too much money, at the end of the year they may seek out medical treatment that isn’t really necessary. Further, employees find HSA’s attractive because 229 © Pearson Education Limited 2015

they are portable and the employee can take their balance with them when they leave a company. Further, there are some tax advantages for the employees with the HSA option.

10-7. Describe some of the challenges Susan might face in recommending the HSA option to her CEO or management team and employees.

Susan would have to convince the CEO and the management team, because any change in the plan needs to be carefully evaluated by them in terms of the cost impact to the business as well as impact on employees’ morale and motivation. She would also need to communicate and gain acceptance from employees that HSA can bring benefits to them.

10-8. What do you recommend? Why? Student responses may vary here. If the HSA option is recommended, the student may determine that the cost savings is the most important aspect. The student may also suggest that Susan first explore other options such as a preferred provider organization or a managed care plan such as a health maintenance organization before making a decision.

A full analysis of both the cost to Frontline, as well as the impact on the employee’s costs should be conducted before making a decision.

MYLAB QUESTIONS 10-9.

Compare and contrast defined contribution plans with defined benefit plans.

Answer: Under defined contribution plans, employers and employees make annual contributions to separate accounts established for each participating employee, based on a formula contained in the plan document. These formulas typically call for employers to annually contribute a given percentage of each participant's compensation. The most common types of these plans are profit-sharing plans, employee stock ownership plans (ESOPs), deferred 401(k) plans, and savings and thrift plans.

Under defined benefit plans, employees are guaranteed retirement benefits as spelled out in the plan document. This benefit is expressed in terms of a monthly sum equal to a percentage of a participant's preretirement pay multiplied by the number of years he or she has worked for the employer. The contributions an employer makes typically fluctuate from year to year.

Defined benefit and defined contribution plans differ in a number of ways. One difference is the likelihood an employee will achieve retirement income objectives. With a defined benefit plan, the employees know what amount of benefits they will receive upon retirement. With a defined contribution plan, employees will not know this in advance. Another difference is the cost of the two types of plans. With a defined contribution plan, employers know the plan's cost on a year-to-year basis; this is 230 © Pearson Education Limited 2015

unknown with a defined benefit plan. A third difference is that although both plans are complex to administer, companies find that defined benefit plans are more burdensome.

10-10. Define health insurance concepts such as insurance policy and premium and explain the different types of health insurance programs. What are the differences among these programs?

Answer: Insurance policy specifies the amount of money the insurance company will pay for particular services such as physical examinations. Premium is the negotiated amount that employers pay insurance companies to establish insurance policies. Broadly there are three health insurance programs: 1) fee-for-service plans, 2) managed care plans, and 3) point-of-service plans.

Fee-for-service plans pay benefits on a reimbursement basis. A cash benefit is paid to the insured or directly to the healthcare provider for the healthcare services.

Hospital expenses, surgical expenses, and physician charges are considered eligible health expenses.

Managed care plans limit employees' choice of doctors and hospitals to control costs. Health maintenance organizations, a common form of managed care plans, offer prepaid services. On the contrary, fee-for-service plans offer reimbursement. Also, coinsurance rates are generally lower in HMO plans.

Point-of-service plans combine the features of fee-for-service plans and HMOs. Like HMOs, employees pay a nominal copayment for each visit to a designated network of physicians. However, employees can receive care from providers outside the designated network of physicians with paying somewhat more for this choice.

XVI. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses Case Name: Cutting Costs at VentaCare Instructor Notes Cost containment is a challenging concern for companies trying to attract and retain talented staff through offering an attractive benefits program. Employees may find benefit offerings attractive, but it is challenging for a company to determine if they are getting a positive return on their investment in a benefits program. Employers should take a strategic approach in determining their benefits program by targeting benefits that promote employee behaviors that add value to the company.

231 © Pearson Education Limited 2015

Suggested Student Responses: 10-11. How should Allison approach evaluating VentaCare’s benefit program?

Allison should first identify what the objectives are of the benefits program. If staying ahead of their competition is important, she should identify what benefits competitors offer. If they are trying to promote certain employee behaviors, she should specifically identify those behaviors. For example, in the nursing home setting, they most likely want employees to stay healthy so they do not miss work and do not deter the health of the residents. Therefore, wellness programs and other health-related benefits are important.

She should also undertake an analysis of actual usage of benefits to make sure all of the benefits they currently offer are being used. For example, if the company finds that the Employee Assistance Program is rarely used, cutting this benefit may be an appropriate cost saving measure.

10-12. What are some benefits Allison should consider changing or eliminating?

Why? Student responses may vary here. Their recommendations should focus on maintaining as much of the program as possible, but limiting the costs. Further, the company should examine the tax advantages that some benefits offer before considering eliminating them.

One suggestion may be to reduce some of the benefits without eliminating them entirely.

For example, they may want to limit the tuition reimbursement program to only coursework that is relevant to the nursing home business. Or the company could maintain the short and long term disability insurance programs, but ask employees to contribute some toward the premiums.

232 © Pearson Education Limited 2015

CHAPTER 11 Legally Required Benefits Learning Objectives 1. In a historical context, discuss at least two main reasons why the U.S. government required certain employee benefits.

2. Summarize three main components of legally required benefits.

3. Indicate the main benefits and costs of legally required benefits.

4. Summarize the five fundamental objectives of employee benefits program design.

Outline I. II.

III. IV.

V. VI. VII.

An Overview of Legally Required Benefits Components of Legally Required Benefits A. SSA B. Unemployment Insurance C. OASDI D. Medicare E. State Compulsory Disability Laws (Workers’ Compensation) F. FMLA The Benefits and Costs of Legally Required Benefits Designing and Planning the Benefits Program A. Overview B. Determining Who Received Coverage C. Financing D. Employee Choice E. Cost Containment F. Communication Discussion Questions and Suggested Answers End of Chapter Case; Instructor Notes, and Questions, and Questions and Suggested Student Responses Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses

Lecture Outline I.

An Overview of Legally Required Benefits 1. Established to protect individuals from catastrophic events a. Disability b. Unemployment 233 © Pearson Education Limited 2015

2. Protection programs to: a. Promote worker safety and health b. Maintain family income streams c. Assist families in crisis d. Enable retirees to maintain subsistence income levels 3. Provided a form of social insurance 4. Reasons for implementation a. Rapid growth of industrialization in early 1900s b. Hardships caused by the Great Depression in the 1930s 5. Apply to virtually all U.S. companies a. Does not factor directly into a competitive advantage b. Can indirectly promote competitive advantage i. Enables unemployed and disabled individuals and their families to participate in economy as consumers ii. Helps promote a vigorous economy 6. As of September 2012, U.S. companies spent an average of $4,950 annually to provide legally required benefits II.

Components of Legally Required Benefits A. SSA 1. Historic background a. Great Depression lead to chronic unemployment b. Chronic unemployment caused further hardships on U.S. economy c. Companies forced to shift focus from just profits to staying solvent d. SSA allowed the unemployed and injured to contribute to the U.S. economy by continuing to purchase goods e. Chronic unemployment also prevented workers from being able to save for retirement and medical insurance, but the SSA provided these workers with subsistence levels of both 2. Programs a. Unemployment Insurance b. OASDI c. Medicare B. Unemployment Insurance 1. For those unemployed through no fault of their own 2. States administer within federal parameters 3. States pay into a (federal) central unemployment fund, federal government invests, then disburse funds back to states 4. Does not cover most agricultural or domestic workers 234 © Pearson Education Limited 2015

5. Criteria to qualify for benefits a. Varies from state to state b. In general, workers must have been employed for a minimum period of time before filing a claim (base period) c. Base period tends to be the first four of the last five completed calendar quarters immediately prior to becoming unemployed d. Workers’ have to make a minimal amount of income (around $1,000) during the previous four calendar quarters e. Must not have left job voluntarily f. Must be able and available for work g. Must be actively seeking work h. Must not have refused an offer for work i. Must not be unemployed because of a labor dispute j. Must not be fired because of gross misconduct 6. Benefits a. Based on a weekly schedule b. States vary amounts c. Amounts generally calculated as a fraction of the workers’ weekly earnings during the highest quarter of the worker’s base period d. Unemployed individuals usually collect unemployment insurance benefits for several weeks i. Since 1972, the average duration of benefits has ranged between twelve and eighteen weeks ii. The average duration refers to the mean number of weeks for which unemployment insurance claimants collect benefits under regular state programs e. Legislation after deep economic recession beginning in late 2007 i. The Emergency Unemployment Insurance (EUC) Program of 2008 provided thirteen additional weeks of federally funded unemployment insurance benefits to the unemployed who had exhausted all state unemployment insurance benefits for which they were eligible ii. The Unemployment Compensation Act of 2008 expanded the EUC benefits to twenty weeks nationwide (from thirteen weeks) and it provided for thirteen more weeks of EUC (for a total of thirty-three weeks) to individuals who reside in states (such as Michigan) with high unemployment rates iii. This temporary program was extended three times, most recently in January 2013 under the American Taxpayers Relief Act of 2012 iv. Under the extension, unemployment insurance benefits are available to individuals for weeks of unemployment ending on or 235 © Pearson Education Limited 2015

before January 3, 2012. The number of weeks for which an individual is eligible to receive unemployment insurance benefits depends upon the unemployment rate of the state in which unemployed individual resides v. Under the extension, unemployment insurance benefits are available to individuals for spells of unemployment ending on or before January 1, 2014 7. Financed by federal and state taxes levied on employers under the Federal Unemployment Tax Act (FUTA) a. Exempt from FUTA i. State and local governments ii. Not-for-profit companies b. Employers contribute 6.2 percent of first $7,000 of each worker’s wages i. 5.4 percent is disbursed to states ii. 0.8 percent covers administrative costs and to maintain a reserve to bail out states with very low balances in their accounts c. States set the taxable wage base according to the average wage level in 2013, states’ taxable wage base ranged from $7,000 to $39,800 d. The more a company lays-off workers, the more tax the company must pay - experience rating system i. A company that lays-off a large percentage of employees will have a higher tax rate than a company that lays off relatively few or none of its employees C. OASDI 1. Amendments a. Old age (retirement) was in the original bill b. Survivor benefits added in 1939 c. Disability insurance in 1965 2. Three classes of workers exempt from Social Security Administration a. Civilian employees working for federal government, and railroad workers with over ten years of service b. Workers for state or local governments covered by other retirement plans c. Children i. Younger than age 21 who work for a parent ii. Except those 18 years and older who work in parent’s business 3. Old age (retirement) benefits a. Determined by how much credit each worker has earned i. Based on “quarters of coverage” ii. Through eligible payroll deductions 236 © Pearson Education Limited 2015

b. In 2013, a worker earns credit for one quarter of coverage for each quarter in which she makes $1,160 of Social Security taxable income c. Will be fully insured after earning credit for 40 quarters of coverage, or 10 years of employment d. Once eligible, individuals remain fully insured during their lifetime e. To receive benefits, the retired worker must: i. Be at least 62 years of age to receive reduced benefits ii. Be at least 65 years of age to receive full benefits iii. The U.S. Bureau of Census estimated that individuals age 65 in 1997 would live and additional 17.7 years and in 2007, this estimate increased to 22.5 years iv. Between 2000–2022 age will increase to 67 (to receive fullbenefits) v. The average monthly benefit for all retired workers was $1,261 in 2013 vi. The Social Security Administration increases retirement benefits by a designated percent of each month worked beyond full retirement until age of 70 (subject to maximum percentage increase) Example: • Let’s assume that an individual’s full retirement age is 66 years and his benefit at that age is $1,000.

• His monthly benefit would be $750 if he were to take retirement at 62.

• His monthly benefit would be $1,320 if he were to delay his retirement until age 70.

4. Survivor benefits a. Based on insured’s employment status and survivor’s relationship to deceased i. Spouse (at least age 60) ii. Dependent, unmarried children iii. Parent (at least age 62) b. Deceased must be fully insured for dependents to receive full benefits c. In 2013, the average monthly benefit was $1,214 5. Disability benefits a. Worker must be fully insured when disabled b. Two criteria for seriously disabled workers: i. Worker must have accumulated at least 40 credits ii. Worker must have earned at least 20 credits of the last 40 calendar quarters in the last 10 years ending with the year of disablement 237 © Pearson Education Limited 2015

D.

c. Worker must be disabled for at least a year, or the injury diagnosed as terminal d. In 2013, $1,132 average monthly disability Medicare 1. For citizens at least 65 years of age 2. To provide them with insurance coverage for: a. Hospitalization b. Convalescent care c. Major doctor bills d. Prescription drug costs 3. Five Separate Plans a. Medicare Part A—hospital insurance b. Medicare Part B—medical insurance c. Medigap—voluntary supplemental insurance to pay for services not covered in Parts A and B d. Medicare Part C: Medicare Advantage—choices in health care providers, such as through HMOs and PPOs e. Medicare Part D: Medicare Prescription Drug Benefit— prescription drug coverage 4. Part A a. Compulsory hospitalization insurance b. Covers: i. In/out patient hospital care and services ii. Skilled nursing facility iii. Some home health care c. Those eligible include: i. Social Security beneficiaries ii. Retirees iii. Voluntary enrollees iv. Disabled individuals d. Financed by both employer and employee contributions of 1.45 percent of all earnings e. In 2013, the monthly Part A premium was $441

238 © Pearson Education Limited 2015

Example: Medicare Part A Coverage • Inpatient hospital care in a semiprivate room, meals, general nursing, and other hospital supplies and services.

• Home health services limited to reasonable and essential part-time or intermittent skilled nursing care and home health aide services, and physical therapy, occupational therapy, and speech-language pathology ordered by a doctor.

• Skilled nursing facility care, including semiprivate room, meals, skilled nursing and rehabilitative services, and supplies for up to 100 days per year. Examples of skilled nursing care include physical therapy after a stroke or serious accident.

5. Part B a. A voluntary supplementary medical insurance i. An annual deductible ii. Covers 80 percent of physicians’ services and medical supplies b. Pays for medical care such as doctors’ services, outpatient care, clinical laboratory services (e.g., blood tests, urinalysis) and some preventive health services (e.g., cardiovascular screenings, bone mass measurement), and ambulatory services when alternate transportation would endanger one’s health c. Part A coverage automatically qualifies an individual to enroll in Part B coverage for a monthly premium d. Enrollees’ monthly premiums (in 2013, ranged from $104.90 to $335.70) 6. Medigap insurance a. Supplements Parts A and B b. Available through private insurance companies c. Federal and state laws limit plans to ten standardized choices d. Medicare Select offers lower premiums in exchange for limiting the choice of providers e. Three states do not subscribe to this system for offering Medigap insurance i. Massachusetts ii. Minnesota iii. Wisconsin 7. Part C or Medicare + Choice a. Established as part of the Balanced Budget Act of 1997 b. Also known as Medicare Advantage c. An alternative to Parts A and B d. Allows beneficiaries the opportunity to receive health care from a variety of options 239 © Pearson Education Limited 2015

i. Private fee-for-service plans ii. Managed care plans iii. Medical savings accounts e. Fee-for-service plans provide protection against health care expenses in the form of cash benefits paid to: i. The insured ii. The health care provider f. Managed care plans often pay a higher level of benefits if approved providers are used 8. Part D or Medicare Prescription Drug Program a. Instituted in 2003, with passage of the Medicare Prescription Drug, Improvement and Modernization Act b. Effective in 2006 c. Covers 75% of prescription drug costs after the enrollee pays the $295 deductible, up to $2,930 in 2013 d. After that, expenditures up to $4,750 are not covered and all costs are “out of pocket” e. This gap is known as the “donut hole” f. Pays 95 percent after enrollees total $4,750 of out-of-pocket expenditures g. The Patient Protection and Affordable Care Act of 2010: i. many provisions to make health care more affordable ii. this law will slowly eliminate the “donut hole” coverage gap over several years iii. In 2011, Medicare participants who reached the coverage gap received a 50 percent discount on brand-name prescription drugs iv. Additional savings will be provided each year to eliminate “donut hole” coverage gap 9. Financing OASDI and Medicare programs a. Requires equal employer and employee contributions under the Federal Insurance Contributions Act (FICA) b. FICA requires that employers pay a tax based on their payroll c. Employees contribute a tax based on earnings, which is withheld from each pay check d. Self-Employment Contributions Act (SECA) requires that selfemployed individuals contribute to the OASDI and Medicare programs, but at a different tax rate e. The tax rate is subject to an increase each year in order to fund OASDI programs sufficiently

240 © Pearson Education Limited 2015

f. FICA requires employers and employees to contribute 7.65 percent each; self-employed individuals generally pay twice that amount, or 15.3 percent in 2013 g. The largest share of the FICA tax funds OASDI programs h. In 2013, 6.20 percent of the contributions of employers and employees were set aside; self-employed individuals contributed 12.40 percent i. OASDI taxes are subject to a taxable wage base j. Taxable wage bases limit the amount of annual wages or payroll cost per employee subject to taxation and may increase over time to account for increases in the cost of living k. In 2013, the taxable wage base was $113,700 for everyone l. Annual wages, payroll costs per employee, and self-employed earnings above this level were not taxed m. Medicare tax, or hospital insurance tax, supports the Medicare Part A program n. Employers, employees, and self-employed individuals contribute 1.45 percent; self-employed individuals contribute double the amount, or 2.9 percent o. The Medicare tax is not subject to a taxable wage base—all payroll amounts and wages are taxed p. Beginning in 2013, an additional HI tax of 0.9 percent is assessed an earned income i. exceeding $200,000 for individuals ii. $250,000 for married couples filing jointly q. Under the new projections for the OASDI program, there should be sufficient resources to pay full retirement benefits until through 2033 r From 2034 through 2086, the OASDI program will be able to pay only 75 percent of recipients’ annual benefits s. The disability insurance program trust fund is projected to be exhausted in 2016 t. Medicare program’s financial status is stronger than the other programs because the HI tax will increase for high-income individuals beginning in 2013 u. It is expected that there will be sufficient funding to meet benefits obligations through 2024 E. State Compulsory Disability Laws (Workers’ Compensation) 1. First law enacted in 1911 2. By 1920, all but six states had laws 3. Based on the principle of “liability without fault” a. Employer is liable for providing benefits that result from occupational disabilities or injuries regardless of fault b. Employers should assume costs of occupational injuries and accidents as a cost of production 241 © Pearson Education Limited 2015

4. Program run by states a. Compulsory in 49 states b. Elective in Texas, where employers’ are not required to provide workers’ compensation insurance 5. Maritime, federal civilian, agricultural, and small businesses (less than twelve employees) are not covered a. Maritime workers are covered by the Longshore and Harborworkers’ Compensation Act b. Federal civilian workers are covered by the Federal Employees’ Compensation Act 6. Workers’ compensation objectives and obligations a. Provide sure, prompt, and reasonable income and medical benefits to work-accident victims, or income benefits to their dependents, regardless of fault b. Provide a single remedy and reduce court delays, costs, and workloads arising out of personal injury litigation c. Relieve public and private charities of financial drains d. Eliminate payment of fees to lawyers and witnesses as well as timeconsuming trials and appeals e. Encourage maximum employer interest in safety and rehabilitation through appropriate experience-rating mechanisms f. Promote frank study of causes of accidents (rather than concealment of fault), reducing preventable accidents and human suffering 7. Financing the program a. According to state guidelines b. Options i. Private carriers ii. State funds iii. Self-insurance c. Self-insurance plans i. Requires companies to deposit a surety bond ii. Companies pay their own workers’ claims directly iii. Gives employers greater discretion in administering their own risks iv. Benefits must be similar to other plans 8. National Commission on State Workmens’ Compensation Laws (NCSWCL) specifies six primary obligations of the program a. Take initiative in administering the law b. Continually review performance of the program and be willing to change procedures and to request the state legislature to make needed amendments 242 © Pearson Education Limited 2015

c. Advise workers of their rights and obligations and assure that they receive the benefits to which they are entitled d. Appraise employers and insurance carriers of their rights and obligations; inform other parties in the delivery system (e.g., health care providers) of their obligations and privileges e. Assist in voluntary and informal resolution of disputes that are consistent with the law f. Adjudicate claims that cannot be resolved voluntarily Workers’ Compensation versus Social Security Benefits: Workers’ compensation pays for medical care for work-related injuries beginning immediately after the injury occurs, and it pays temporary disability benefits after a waiting period of three to seven days. Social Security, in contrast, pays benefits to workers with long-term disabilities from any cause, but only when the disabilities preclude work. Also, Social Security begins after a five-month waiting period and Medicare begins twenty-nine months after the onset of a medically-verified inability to work.

9. Recent trends in workers’ compensation a. Number and amount have increased dramatically b. The dramatic increase in repetitive strain injuries is a major cause of increases c. In 2012, workers’ compensation cost nearly 19 percent of all legally required benefits for all civilian employees 10. Employers’ rights under workers’ compensation programs a. Participation in workers’ compensation programs and compliance with applicable regulations protects employers from torts initiated by injured workers based on the no-fault principles of these programs b. Four possible exceptions: i. An employer’s intentional acts ii. Lawsuits alleging employer retaliation for filing a workers’ compensation claim iii. Lawsuits against non-complying employers iv. Lawsuits relating to “dual capacity” relationships 11. An employer’s intentional acts a. Most state courts consider intentional actions to harm employees as reasonable cause for holding an employer liable b. Two kinds of lawsuits: i. Deliberate and knowing torts—entail an employer’s deliberate and knowing intent to harm at least one employee

243 © Pearson Education Limited 2015

ii. Violations of an affirmative duty—take place when an employer fails to reveal the exposure of one or more workers to harmful substances, or the employer does not disclose a medical condition typically caused by exposure; in particular, failure to notify violates an employer’s affirmative duty when the illness is either correctable at the point of discovery or its progress may be stopped by removing employees from further exposure 12. Retaliation against workers who filed claims a. In most states, employees possess the right to sue employers who retaliate against them for either filing a workers’ compensation claim or pursuing their rights established in workers’ compensation programs b. Retaliation usually entails an adverse effect upon a worker’s status (e.g., a demotion or pay cut) or termination of a worker’s employment c. Employees may initiate these lawsuits by claiming retaliatory action d. Employers then possess the burden of proof to establish their actions as a legally sanctioned business necessity 13. Employer noncompliance a. Workers’ compensation laws oblige employers to comply with applicable state laws b. Employers begin to fulfill their obligations by purchasing insurance from state funds, private insurance carriers, or through self-insurance c. Failure to carry workers’ compensation insurance may lead to one or more consequences such as monetary and criminal penalties 14. Dual capacity a. Legal doctrine that applies to the relationship between employers and employees b. A company may specifically fulfill a role for an employee that is completely different from its role as employer c. Even though an employer meets its obligations under workers’ compensation laws, it may be susceptible to common-law actions d. An employer’s immunity does not protect it from common-law actions by employees when the company also serves a dual capacity that confers duties unrelated to and independent of those imposed upon it as an employer 15. Financing workers’ compensation programs a. Employers generally subscribe to workers’ compensation insurance through private carriers, or, in some instances, through state funds b. A third funding option, self-insurance, requires companies to deposit a surety bond, enabling them to pay their own workers’ claims directly c. In most states, the insurance commissioner sets the maximum allowable workers’ compensation insurance premium rates for private insurance carriers; rates are based on each $100 of payroll d. Increasingly, some states permit insurance carriers to set rates on a competitive basis 244 © Pearson Education Limited 2015

e. Ratemaking service organizations collect data on workplace accidents and put together rating manuals f. Rating manuals specify insurance rates based on classifications of businesses g. A few states possess independent rating organizations; the remainder consults with the National Council on Compensation Insurance, a forprofit company located in Boca Raton, Florida; this organization prepares three separate manuals for state insurance agencies h. Independent rating bureaus used by a few states compile manuals that correspond to the National Council’s manuals i. Second-injury funds represent an important funding element of workers’ compensation programs—these funds cover a portion or all of the costs of a current workers’ compensation claim associated with preexisting conditions from a work-related injury during prior employment elsewhere 16. Employer and employee tax obligations a. Employees do not pay any income taxes on the amount of workers’ compensation benefits b. Survivors of deceased workers do not pay any taxes on death benefits c. Three circumstances may require payment of taxes: i. First, employees pay taxes on their workers’ compensation benefits when they return to work for light duty ii. Second, workers’ compensation benefits are taxable when they offset (reduce) Social Security OASDI benefits iii. Third, employees pay taxes on workers’ compensation benefits when they do not directly result from work-related illness or injury d. Employers typically do not pay taxes on workers’ compensation benefits, with one main exception: workers’ compensation benefits for nonwork-related illnesses or injuries e. For this circumstance, the Federal Insurance Contributions Act (FICA) and the Federal Unemployment Tax Act (FUTA) apply f. FICA requires that an employer pay a tax based on its payroll; employees contribute a tax based on earnings, which is withheld from each paycheck g. FUTA requires that employers contribute 6.2 percent of the taxable wage base, currently $7,000 F. FMLA 1. To guarantee employees the right to return to either their same position or a comparable one, if they are off work because of a family or medical emergency 2. Provide fathers with the same protections mothers were guaranteed in the Pregnancy Discrimination Act of 1978 a. Credit for previous service b. Accrued retirement benefits 245 © Pearson Education Limited 2015

c. Accumulated seniority 3. Reason needed—more two-income families 4. Elderly living longer and needing care 5. Men taking on more child-rearing responsibilities 6. Title I eligibility rules allowed up to 12 weeks of unpaid leave in a 12 month period if: a. Absence is due to the family size increasing due to a birth or a child placement, and is applied for within 12 months of the addition b. There is a family member suffering from a serious medical condition c. The employee suffers from a serious medical problem 7. Covers both men and women 8. Eligibility rules a. Must be a private employer with fifty or more employees, or b. A civilian unit of the federal government c. Must have put in at least 1,250 hours in a 12 month period prior to application 9. Benefits a. Twelve weeks of unpaid leave, but may be required to first use up all: i. Sick leave ii. Vacation time iii. Personal days b. Retention of all: i. Earned seniority ii. Health insurance coverage iii. Credit for previous service iv. Accrued retirement benefits c. Employees cannot add any benefits while on leave d. Employees may be entitled to receive health benefits if they do not return from leave because of: i. Serious health conditions ii. Factors beyond their control 10. Major Revisions to FMLA instituted in January of 2009 include: a. Relatives of seriously injured members of the military may take up to 26 weeks off to care for their injured military family members b. Relatives of members of the National Guard or reserves who are called to activity duty may receive up to 12 weeks of leave to attend military programs (official send off of the family member’s troop), arrange child care, or make financial arrangements

246 © Pearson Education Limited 2015

c. Nonmilitary workers who claim to have chronic health conditions (for example, ongoing back pain) must see their doctor at least twice per year for documentation d. President Barack Obama may ask Congress to extend coverage by including companies that employ at least twenty-five workers (as opposed to fifty workers as the law currently stands) III.

The Benefits and Costs of Legally Required Benefits 1. Benefits tend to emphasize social adequacy—benefits are designed to provide subsistence income to all beneficiaries regardless of their performance in the workplace 2. Legally required benefits may be a hindrance to companies in the short term because these offerings require substantial employee expenditures (e.g., contributions mandated by the SSA and various state workers’ compensation laws) 3. Companies could choose to invest these funds in direct compensation programs designed to boost productivity and product or service quality 4. HR managers and other business professionals minimize the cost burden associated with legally required benefits: a. Reducing the likelihood of workers’ compensation claims i. Implementation of workplace safety programs is one strategy for reducing workers’ compensation claims ii. Health promotion programs that include inspections of the workplace to identify health risks (e.g., high levels of exposure to toxic substances), and then to eliminate of those risks b. Integrating workers’ compensation benefits into the rest of the benefits program 5. Employers can contain costs for unemployment insurance—systematically monitor the reasons they terminate workers’ employment and avoiding terminations that lead to unemployment insurance claims

IV.

Designing and Planning the Benefits Program A. Overview 1. Employee input is key to developing a “successful” program 2. Helps companies target the limited resources they have available for employee benefits to those areas that best meet employees’ needs 3. Involving employees in program development will lead them most likely to accept and appreciate the benefits they receive 4. Companies can involve employees in the benefits determination process in such ways as surveys, interviews, and focus groups 5. Fundamental issues to be addressed by HR professionals: a. Who receives coverage b. Whether to include retirees in the plan 247 © Pearson Education Limited 2015

c. Whether to deny benefits to employees during their probationary period d. Financing benefits e. Degree of employee choice in determining benefits f. Cost containment g. Communication B. Determining who receives coverage 1. Companies decide whether to extend benefits coverage to: a. Full-time and part-time employees b. Only full-time employees 2. Trend is toward not offering benefits to part-time employees 3. Deciding whether to include retirees in the program a. Depends on whether to extend medical insurance coverage to employees beyond the COBRA-mandated coverage period b. Employers usually finance these benefits either wholly or partly, enabling many retirees on limited earnings to receive adequate medical protection c. Starting in 1997, employers’ contributions to extend medical coverage to retirees are no longer tax deductible, which means that such expenses will reduce company earnings in the short-term—as a result, fewer employers are expected to finance medical insurance coverage for retirees in the future d. Rapidly rising cost of retiree health care benefits have created a tremendous financial strain on companies that choose to offer them e. The various sources of economic uncertainty since 2001 have made it more difficult for companies to support full workforces, as evidenced by sluggish pay increases, reductions in benefits offerings, and layoffs 4. Deciding whether to include employees in the probationary period a. Employees’ initial term of employment (usually shorter than six months) is deemed a probationary period, and companies view such periods as an opportunity to ensure that they have made sound hiring decisions b. Many companies choose to withhold discretionary employee benefits for all probationary employees c. Companies benefit directly through lower administration-of-benefits costs for these employees during the probationary period; however, probationary employees may experience financial hardships if they require medical attention C. Financing 1. HR decisions based on: a. Available resources b. Financial goals 2. Types of programs managers can decide on: a. Noncontributory b. Contributory 248 © Pearson Education Limited 2015

c. Employee-financed d. Some combination 3. Noncontributory financing implies that the company assumes the total cost for each discretionary benefit 4. Contributory financing implies that the company and its employees share the costs 5. Employee-financed benefits implies that employers do not contribute to the financing of discretionary benefits 6. The majority of benefit plans today are contributory, largely because the costs of benefits have risen so dramatically D. Employee Choice 1. Human resource professionals must decide on the degree of choice employees should have in determining the set of benefits they will receive 2. If employees within a company can choose from among a set of benefits, as opposed to all employees receiving the same set of benefits, the company is using a flexible benefits plan or cafeteria plan 3. Companies implement cafeteria plans to meet the challenges of diversity 4. Benefit satisfaction, overall job satisfaction, pay satisfaction, and understanding of benefits increased after the implementation of a flexible benefits plan 5. FSAs permit employees to pay for certain benefits expenses (e.g., child care) with pretax dollars 6. Core plus option plans extend a pre-established set of such benefits as medical insurance as a program core, which is usually mandatory for all employees 7. Beyond the core, employees may choose from an array of benefits options that suit their personal needs E. Cost Containment 1. HR managers today try to contain costs 2. In 2011, employee benefits accounted for nearly 30.4 percent 3. The current amount has risen dramatically over the past few decades 4. This increase would not necessarily raise concerns if total compensation budgets were increasing commensurably 5. Growth in funds available to support all compensation programs has stagnated 6. As a consequence, employers face difficult trade-offs between employee benefits offerings and increases to core compensation F. Communication 1. Employees often either are not aware of or undervalue the employee benefits they receive 2. Given the significant costs associated with offering employee benefits, companies should try to convey to employees the value they are likely to derive from having such benefits 3. An effective communication program should have three primary objectives: 249 © Pearson Education Limited 2015

a. Create an awareness of and appreciation for the way current benefits improve the financial security and the physical and mental well-being of employees b. Provide a high level of understanding about available benefits c. Encourage the wise use of benefits 4. Use a variety of media to communication benefits information a. Printed brochures to convey the “big picture” of the key benefits to potential employees b. Small group meetings, using audio-visual presentations, for new employees c. Individual meetings, with benefits administrators (counselors), to select benefits options d. Personal benefits statements that detail the scope of coverage and the value of each component selected e. Written updates of changes to benefits with newsletters 5. Intranet a. Useful in communicating benefits information to employees on an ongoing basis beyond the legally-required written documents b. Each paragraph contains a hyperlink that leads to more detailed information Final Thoughts: The inevitably of Social Security running out in its current state is of huge concern to those administering it, and will certainly impact the majority of students reading this textbook. In the coming years, employees, employers, unions, and the government will pay greater attention to the adequacy of Social Security benefits for the succeeding generations. How effective the new additions to FMLA are will also be of great concern to a multitude of interests in the years ahead.

V.

Discussion Questions and Suggested Answers

11-1. Except for the Family and Medical Leave Act, the remaining legally required benefits were conceived decades ago. What changes in the business environment and society might affect the relevance or perhaps the viability of any of these benefits? Discuss your ideas.

Social Security is going to be experiencing a large shift on an economic standpoint as begins to give out more money than it’s taking in, which will cause numerous cuts in Social Security benefits for the future. Other changes or rather lack of changes could affect benefits, such as the FUTA not raising or lowering the taxable wage base as the economy shifts. This potential change or lack of change could cause an unfair advantage for certain wage earners and begin to skew the potential income of employees to a new level.

250 © Pearson Education Limited 2015

11-2. What can employers in your country do to overcome the “entitlement mentality” of employees with regard to benefits offered to them?

Employees often regard employee benefits as an entitlement because they are unaware of the costs associated with employee benefits as well as the value employees are likely to derive. A detailed benefits communication plan would create an awareness of and appreciation for the way current benefits improve the financial security and the physical and mental well-being of employees. The company could also implement co-sharing of benefits cost between the employee and employer.

11-3. Conduct some research on the future of the Social Security program. Based on your research, prepare a statement not to exceed 250 words that describes your view of the Social Security program. Refer to the information obtained from your research efforts, indicating how it influenced your views.

The future of the Social Security program is in jeopardy, for although currently Social Security’s intake exceeds the amount it is giving out, soon that will change and the Social Security program will have to be changed in order to meet the shifting economic budget.

As a result Social Security could potentially be done away with, or completely rewritten under a new premise.

VI.

End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses

Case Name: Benefits for Part-time Workers Instructor Notes While the trend in the workplace is toward not offering benefits to part-time workers, as more companies discover the benefits of engaging part-time workers, companies must consider the their benefit policies for part-time workers. Extending part-time workers benefits could be costly for companies. However, the need to attract and retain talented part-time workers may influence companies to extend their benefits to part-timers. In doing so, companies should carefully consider which benefits to offer based on the nature of the position, the costs to the company and employee preferences. Further, if a company offers benefits to part-time workers, it is important that they clearly communicate the value of such benefits in order to ensure that part-time workers understand the value of the benefits in their total compensation.

Suggested Student Responses: 11-4. What are some factors that Alan should consider when determining whether or not to offer benefits to part-time workers?

251 © Pearson Education Limited 2015

Alan should consider the costs associated with extending part-time workers benefits.

In doing so, he should estimate the number of part-time workers the firm is likely to hire. He must also look at the type of workers that will be part-time (i.e. administrative or CPA) and whether or not offering benefits is important to attract and retain these workers.

11-5. Do you think the firm should offer benefits to part-time workers? If yes, should they offer paid time-off, the 401(k) plan and health insurance? Or only one or two of the benefits? Explain your recommendation.

Students should provide a response and support for their position. If in support of offering benefits, students should cite the need to attract and retain talent, particularly CPA’s. Those opposing most likely will examine the cost issue. Some students may recommend offering partial benefits, particularly paid time-off and the 401(k) as the costs are more in line with the expected return from offering these benefits. If a company is considering only offering partial benefits, getting feedback from the parttime workers may be useful to understand which benefits they value.

MYLAB QUESTIONS 11-6. How does a state determine if an individual is eligible for unemployment insurance benefits?

Answer: Being unemployed does not necessarily entitle one to qualify for unemployment insurance benefits. Several criteria have been developed for individuals to qualify for these benefits. To be eligible, an individual must: 1) not have left a job voluntarily, 2) be able and available to work, 3) be actively seeking work, 4) not have refused an offer of suitable employment, 5) not be unemployed because of a labor dispute (except in a few states), and 6) not have had employment terminated because of gross violations of conduct established within the workplace. In addition, all states require sufficient previous earnings, typically $1,000 during the last four quarter periods combined.

11-7.

Explain disability benefits under OASDI. Compare it with the workers' compensation.

Answer: The SSA pays benefits to seriously disabled workers and family members.

Social Security pays only for total disability. The disability must last for at least 1 year or it should result in death. Workers' compensation insurance programs are designed to cover expenses due to work-related accidents. For work-related injuries, workers' compensation pays medical care immediately. It pays temporary disability benefits after 3-7 days of waiting period. Workers' compensation pays permanent, partial, and total disability benefits to employees. It also pays benefits to survivors of workers who die due to work-related issues. On the contrary, in Social Security workers receive pay benefits for long-term disabilities when the disabilities preclude work. Social Security begins after 252 © Pearson Education Limited 2015

a 5-month waiting period.

VII.

Additional Cases from the MyManagementLab Website; Instructor Notes, and Suggested Student Responses

Case Name: Cutting Costs at Elite Financial Services Instructor Notes The rising cost of healthcare insurance is prompting many employers to take proactive steps to lower their costs. In addition to seeking better premiums through seeking alternate providers and looking at different coverage options, many employers are examining opportunities to improve the overall health of their workforce. Educating the workforce on wise usage of healthcare benefits can help keep experience ratings in check.

Taking proactive steps to keep employees healthy and help them make wise decisions on healthcare can help keep costs under control.

Suggested Student Responses: 11-9. What can Elite do to lower their healthcare insurance costs?

There are many opportunities for Elite to lower their healthcare insurance costs.

First, they may want to consider examining alternate healthcare insurance options such as managed care plans, preferred provider organizations or point-of-service plans. These options will likely be less costly. Elite should also consider changing plan deductibles and coinsurance rates to help control costs. The company could also have employees contribute more toward premiums. Finally, Elite should consider opportunities to educate employees about their health so they make wiser choices on using healthcare. If the employees are contributing more to the cost, they may also make wiser choices as well. Wellness programs to improve the overall health of their employees may also improve healthcare usage rates.

11-10. Will making changes to the company’s healthcare insurance benefit affect the company’s ability to recruit and retain employees?

The company should be cautious about making drastic changes to healthcare insurance all at one time. If the employees believe the company is taking away a significant part of their benefit, they may become frustrated and consider leaving the company. The company may want to consider offering the employees options in their healthcare insurance so that the employees feel as if they have more 253 © Pearson Education Limited 2015

control. For example, they could keep the fee-for-service indemnity plan as an option, with a higher employee contribution. Then, they could offer an option such as a preferred provider organization and require a much lower employee contribution, encouraging the employee to take the less costly option.

254 © Pearson Education Limited 2015

CHAPTER 12 Compensating Executives Learning Objectives 1. Explain the difference between executive pay with pay for nonexecutives.

2. List the main components of executive compensation packages.

3. Discuss with examples the principles and processes of setting executive compensation, including the key players and the theoretical explanations for setting executive compensation.

4. Summarize the executive compensation disclosure rules and the reasons why they have been established.

5. Concisely present the “say on pay” practice.

6. Briefly explain the executive compensation controversy as it relates to whether U.S. executives are paid too much.

Outline I. Contrasting Executive Pay with Pay for Nonexecutive Employees II. Principles of Executive Compensation: Implications for Competitive Strategy III. Defining Executive Status A. Who Are Executives?

B. Key Employees C. Highly Compensated Employees IV. Executive Compensation Packages A. Overview B. Components of Current Core Compensation C. Short-Term Incentives D. Components of Deferred Core Compensation E. Employee Benefits: Enhanced Protection Program Benefits and Perquisites V. Principles and Processes for Setting Executive Compensation A. The Key Players in Setting Executive Compensation B. Theoretical Explanations for Setting Executive Compensation VI. Executive Compensation Disclosure Rules VII. Say on Pay VIII. Executive Compensation: Are U.S. Executives Paid Too Much?

A. Comparison between Executive Compensation and Compensation for Other Worker Groups B. Strategic Questions: Is Pay for Performance?

C. Ethical Considerations: Is Executive Compensation Fair?

D. International Competitiveness IX. Discussion Questions and Suggested Answers 254 © Pearson Education Limited 2015

X. XI.

End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses

Lecture Outline I.

Contrasting Executive Pay with Pay for Nonexecutive Employees 1. CEO is the seller of his/her services 2. Compensation committee is the buyer 3. Classic Economic Theory a. Reasonable price (of goods and services) is obtained through negotiations b. The negotiators (informed buyer and informed seller) should be an “arm’s length apart” 4. CEO hires a professional compensation consultant to determine own compensation a. Consultant performs an objective analysis of the company’s current executive pay package b. Consultant makes appropriate recommendations c. Consultant believed to be representing shareholders’ interests 5. Shareholders and compensation committee are the buyers of the CEO’s services 6. Compensation committees generally accept consultant’s recommendations

II.

Principles of Executive Compensation: Implications for Competitive Strategy 1. Key role executives play in promoting competitive advantage 2. Public scrutiny of executive compensation packages intensified during the 1990s (carrying into today) because of heightened concerns about global competitiveness, rampant corporate downsizing, and the more recent practice of relocating jobs to countries with lower labor costs (i.e., offshoring) that has left hundreds of thousands of former employees jobless 3. The number of layoff events initiated by companies and the number of employees who have lost their jobs has risen to unprecedented levels most months since September 2008, following the start of perhaps the deepest economic recession in the United States a. An alarming trend is that the period of layoff is lengthening with significantly more spells that exceed 31 days

255 © Pearson Education Limited 2015

III.

Defining Executive Status A. Who are executives?

1. The Internal Revenue Service (IRS) recognizes two groups of employees 2. They play a major role in a company’s policy decisions a. Highly compensated employees b. Key employees 3. The IRS uses “key employees” to determine the necessity of top-heavy provisions in employer-sponsored qualified retirement plans that cover most nonexecutive employees 4. The IRS uses “highly compensated employees” for nondiscrimination rules in employer-sponsored health insurance benefits 5. Titles a. Chief executive officers (CEOs) b. Presidents c. Executive vice presidents d. Vice presidents of functional areas i. Human resources ii. Marketing 6. Key employees a. At any time during the year b. Must be: i. A 5 percent owner of the company ii. A 1 percent owner having an annual compensation of more than $165,000 iii. An officer having an annual compensation greater than $165,000 in 2013 Example: U.S. Treasury Regulations Definition of an Officer • Officer • An administrative executive who is in regular and continued service • Implies continuity of service and excludes those employed for a special and single transaction • An employee who merely has the title of an officer, but not the authority of an officer is not considered an officer for purposes of the key employee test • An employee who does not have the title of an officer, but has the authority of an officer is an officer for purposes of the key employee test

256 © Pearson Education Limited 2015

7. Highly compensated employees are: a. 5 percent owners at any time during the year, or during the preceding year b. For the preceding year, had compensation from the employer in excess of $115,000 in 2013 c. If the employer elects the applicable of this clause for a plan year, was in the top paid group of employees for the preceding year IV.

Executive Compensation Packages A. Overview 1. Current or annual core compensation 2. Deferred core compensation: Stock compensation 3. Deferred core compensation: Golden parachutes and platinum parachutes 4. Employee benefits a. Enhanced protection programs b. Perquisites 5. Clawback provisions B. Components of Current Core Compensation 1. Base pay 2. Bonuses 3. Base Pay a. The fixed element of annual cash compensation b. Companies that use formal salary structures may use pay grades and ranges for all employees, except for the CEO c. There’s a progressively higher pay range spread for pay grades that contain more valuable jobs in terms of a company’s competitive strategies d. Most higher-level jobs i. Afford employees greater promotion opportunities than entry-level jobs ii. Tend to help companies retain employees longer iii. Require skills seen as valuable to employers e. CEOs are not included in the pay structure because i. CEO’s work is highly complex and unpredictable ii. It is not possible to specify discrete responsibilities and duties iii. The choice of competitive strategy and the influence of external and internal market factors make it tough to describe the CEO’s job

257 © Pearson Education Limited 2015

iv. Setting CEO’s compensation differs dramatically from the rational processes compensation professionals use to build marketcompetitive pay structures f. Banks with financial assistance from the federal government could deduct only the first $500,000 annually for an executive’s pay as a business expense as a result of the Troubled Assets Relief Program (TARP) 4. Bonuses a. Represent single-pay-for-performance payments used to reward employees for achievement of specific, exceptional goals b. Compensation professionals design bonuses for: i. Merit pay programs ii. Gain sharing plans iii. Referral plans iv. Sales incentive compensation programs c. Represents a key component of executive compensation packages d. Four common bonuses for executives i. Discretionary bonus ii. Performance-contingent bonus iii. Predetermined allocation bonus iv. Target plan bonus e. Discretionary bonuses are awarded on an elective basis with the amount based on four factors: i. Company profits ii. The financial condition of company iii. Business conditions iv. Future prospects f. Performance-contingent bonus i. Based on attainment of specific performance criteria ii. Similar to appraisal system used for determining merit increases or general performance salary reviews g. Predetermined allocation bonus i. Total bonus pool based on a fixed-formula ii. Company profits are a central factor in determining size of total bonus pool and individual bonuses iii. Amounts are fixed regardless of executive’s performance h. Target plan i. Ties bonus amount to executive’s performance ii. Amount increases commensurably with performance iii. No bonus awarded if the minimum level is not met 258 © Pearson Education Limited 2015

C. Short-Term Incentive Compensation 1. Used to recognize executives’ progress toward fulfilling competitive strategy goals 2. Uses current profit sharing plans and gain sharing plans 3. Designed to reward executives for meeting intermediate performance criteria that are dictated by competitive strategy, like: a. Change in company’s earnings per share over a one-year period b. Growth in profits c. Annual cost savings 4. Generally for a select group of executives 5. Actually applies to more than one executive because: a. Of the synergy that results from the efforts b. The expertise of top executives influences corporate performance 6. Board of directors distribute these based on rank and compensation level of executives Example: Short-Term Incentives • Chain of General Merchandise Retail Stores has a goal of becoming the lowest-cost chain in the industry • The CEO and Executive VP establish a five-year plan • Gain sharing program designed to reward top executives for contributing to the cost reduction objective • After one year, the corporation saved $10,000,000 • CEO received 2 percent of savings ($200,000) • VP received percent of savings ($100,000)

D. Components of Deferred Core Compensation 1. An agreement between an employee and a company to render payments to the employee at a future date 2. A hallmark of executive compensation packages designed to create a sense of ownership 3. Aligns the interests of the executive with those of the owners or shareholders over the long term 4. Provides tax advantages to executives a. Defers payment to executives until retirement should lead to lower taxation b. Executives do not pay taxes on deferred compensation until they receive it 5. Stock shares are the main form of deferred compensation 259 © Pearson Education Limited 2015

6. Stocks: a. Company stocks represent the total equity of the firm b. Company stock shares represent equity segments of equal value c. Equity interest increases positively with the number of stock shares d. They are bought and sold every business day in a public stock exchange e. The New York Stock Exchange is among the most well-known f. Stock compensation plans are designed to promote an executive’s sense of ownership of the company g. Stock value increases: i. With gains in company performance ii. In response to reports of profit gains h. Values that are outside the executive’s control include: i. Forecasts of economy-wide recession ii. Increases in the national unemployment rate iii. Threats to national security 7. Six forms of stock compensation: a. Incentive stock option plans b. Non-statutory stock option plans c. Restricted stock d. Phantom stock plans e. Discount stock options f. Stock appreciation rights Employee Stock Terminology • Stock option: A right granted by a company to an employee to purchase a number of stocks at a designated price within a specified period of time • Stock grant: A company’s offering of stock to an employee • Exercise of Stock grant: An employee’s purchase of stock, using stock options • Disposition: Sale of stock by the stockholder • Fair market value: The average value between the highest and lowest reported sales price of a stock on the New York Stock Exchange on any given date.

The Internal Revenue Service specified whether an option has a readily ascertainable fair market value at grant. An option has a readily ascertainable fair market value if the option is actively traded on an established stock exchange at the time the option is granted.

260 © Pearson Education Limited 2015

8. Incentive stock options a. Allow executives to purchase stock in the future at a predetermined price i. The predetermined price equals the price at the time an executive receives the stock option ii. Executives are generally purchasing the stock at a discounted price iii. Executives generally purchase the stock after the price increases dramatically b. Capital gains is the difference between the stock price at the time of purchase and the lower stock price at the time an executive receives the stock option c. Executives receive a tax benefit because the IRS doesn’t recognize capital gains until the disposition of the stock 9. Nonstatutory stock options a. Are awarded to executives at discounted prices b. Do not qualify for favorable tax treatment i. Executives pay income taxes on the difference between the discounted price and the stock’s fair market value at the time of the stock grant ii. Executives do not pay taxes in the future when they choose to exercise their non-statutory stock options c. Executives do get a tax advantage i. Tax liability is lower over the long term ii. Stock prices generally increase over time iii. Capital gains will likely be much greater in the future 10. Restricted stock a. Give executives no ownership control over the disposition of the stock for a predetermined period (5 –10 years) b. Must be sold back to the company for exactly the same discounted price that it was at the time of purchase c. Is not taxed until after the restriction period ends d. Is a common type of long-term executive compensation e. Is awarded by the board of directors to executives at considerable discounts 11. Phantom stock a. Boards of directors promise to pay a bonus in the form of the equivalent of either the value of company shares or the increase in that value over a period of time

261 © Pearson Education Limited 2015

Example: Phantom Stock • A company could promise Mary, its new employee that it would pay her a bonus every five years equal to the increase in the equity value of the firm times some percentage of total payroll at that time • The company could promise to pay her an amount equal to the value of a fixed number of shares set at the time the promise is made b. Can convert these into real shares, under two conditions: i. Executives must remain employed for anywhere from 5–20 years ii. Executives must retire from the company c. Capital gains are taxed when stocks are converted after retirement when the tax rate will be lower 12. Discount stock option plans a. Are similar to non-statutory stock option plans, except i. Companies grant stock options at rates far below the stock’s fair market value on the date the option is granted ii. The executive immediately receives a benefit equal to the difference between the exercise price and the fair market value of the employer’s stock 13. Stock appreciation rights a. Provide executives income at the end of a designated period, like restricted stock options b. Executives never have to exercise their stock rights to receive income c. Payments i. To executives based on the difference in stock price between the time the company granted the stock rights at fair market value to the end of the designated period ii. Executives get to keep the stock d. Taxation i. Executives pay tax on any income from gains in stock value when they exercise their stock rights after retirement when their tax rates are lower 14. Golden parachutes a. Provide pay and benefits to executives following their termination resulting from a change in ownership or corporate takeover, that is, the merger or combining of two separate companies

262 © Pearson Education Limited 2015

Example: Golden Parachutes • Anheuser-Busch: U.S. corporation known for brewing beer • InBev: Beer brewing company for Belgium • InBev purchased or acquired Anheuser-Busch in 2008, creating a merged or combined corporation named Anheuser-Busch InBev b. Extend pay and benefits anywhere between one and five years c. Boards of directors include these clauses for two reasons: i. They limit executives’ risks in the event of these events ii. They promote recruitment and retention of talented executives d. Companies can treat these as business expenses e. Companies can reduce their tax liability by increasing the parachute amount f. The total value of these far exceed executives’ annual income levels g. Changes i. Public outcry led to government-imposed intervention that limited tax benefits to companies ii. Companies may receive tax deductions that amount to several times an executive’s average annual compensation for the preceding five years 15. Platinum parachutes a. Lucrative awards that compensate departing executives with: i. Severance pay ii. Continuation of company benefits iii. Stock options b. Given in order to avoid legal battles or critical press reports c. Given in the event the CEO is terminated after a period of unsatisfactory performance as determined by the shareholders and other company executives 16. Clawback provisions a. Allow boards of directors to take back performance-based compensation if they were to subsequently learn that performance goals were not actually achieved b. These provisions are becoming more common: i. because of the increasing scrutiny of CEO compensation packages by the public and shareholders ii. particularly since the recent global financial crisis in the late 2000s 17. Tighter regulations on deferred compensation plans a. Corporate accounting scandals led to tighter restrictions 263 © Pearson Education Limited 2015

i. Executives were withdrawing deferred compensation money before their companies filed for bankruptcy, like: ii. Enron b. Led to passage of the Sarbanes-Oxley Act of 2002 i. Administered by the SEC ii. Imposes rigorous requirements for companies’ financial disclosure to limit the chance that covert misuses of corporate funds will occur E. Employee Benefits: Enhanced Protection 1. Executives receive discretionary benefits like other employees a. Protection program benefits b. Pay for time not worked c. Employee services 2. Executive discretionary benefits differ in two ways: a. Protection programs include supplemental coverage that provide enhanced benefit levels b. The services component contains benefits exclusively for executives called perquisites or perks 3 Legally-required benefits apply to executives with the exception of one provision of the Family and Medical Leave Act of 1993 4. Enhanced protection program benefits a. Supplemental life insurance b. Supplemental retirement 5. Supplemental life insurance a. Pays additional monetary benefits b. Provides executives favorable tax treatment 6. Supplemental retirement plans a. Are designed to restore benefits restricted under qualified plans b. Make up the monetary difference between IRS limits and desired compensation amounts

264 © Pearson Education Limited 2015

Qualified Plans Limits • Entitles employers to take current tax deductions for contributions to fund retirement income • Entitles employees to favorable tax treatment of the benefits they receive upon their retirement • The IRS limits annual earnings amount for determining qualified plans benefits to $250,000 (in 2013) • All earnings above this amount cannot be included in defined benefit plan formulas • All earnings above this amount cannot be calculated into the annual additions to defined contribution plans • The IRS limits annual benefit amounts for defined benefit plans to the lesser of $205,000 (in 2013) or 100 percent of the highest average compensation for three consecutive years • Limits on annual additions to defined contribution plans were the lesser of $51,000 (in 2013), or 100 percent of the participant’s compensation Examples: Supplemental Retirement • An executive’s three highest annual salaries were: • $690,000 • $775,000 • $1,100,000 • The average was $855,000 • The difference $855,000 - $195,000 = $660,000 • If the annual benefit under the executive’s qualified pension plan will be 60 percent of the final average salary of the last 15 years of service which was $400,000 • Annual retirement benefit should be $240,000 • The IRS only allows $205,000 • Supplemental retirement would be $35,000 ($240,000 – $205,000) 7.

Perquisites a. Also known as perks b. Integral part of executives’ compensation c. Are used for personal and business use d. Survey of executive compensation practices are offering perks to their CEOs i. 89.8 percent in 2009 ii. 77.6 percent in 2010

265 © Pearson Education Limited 2015

e. The common perks offered in 2010 i. supplemental life insurance (31.7 percent) ii. company cars (30.7 percent) iii. country club memberships (26.1 percent) f. Fewer perks offerings may be due to: i. greater economic uncertainties ii. the recent requirement that companies report perks valued at $10,000 or more apiece Example: Perquisites • Company car • Supplemental life insurance • Legal services (e.g., income tax preparation) • Recreational facilities (e.g., country club and athletic club membership) • Travel perks (e.g., use of corporate jets)

V.

Principles and Processes for Setting Executive Compensation A. The Key Players in Setting Executive Compensation 1. Executive compensation consultants 2. Board of Directors 3. Compensation committees 4. Executive compensation consultants a. Propose several recommendations for alternative pay packages that are based on strategic analysis b. Permits consultants to see where the company stands in the market c. Consultants can adjust recommendations accordingly

Strategic Analysis • An examination of a company’s external market context including • Industry profile • Information about competitors • Long-term growth prospects • An examination of a company’s internal factors like: • Its financial condition • Permits consultants to determine how their client company compares to the market 5. Many are employed by large consulting firms like: 266 © Pearson Education Limited 2015

a. AON Consultants b. Buck Consultants c. The Frederic W. Cook & Company d. Hay Associates e. Pearl Meyer & Partners f. Towers Watson g. William M Mercer 6. Possible conflict of interest a. Consultants are hired by CEOs b. If the CEO does not like the recommendations, the CEO can fire consultant c. Recommending lucrative packages could bring the consultant or consulting company more business 7. Board of Directors a. Supposed to represent shareholders’ interests 8. Most boards contain fifteen members that generally include: a. CEOs and top executives of other companies b. Distinguished community leaders c. Well-regarded professionals like i. Physicians ii. Lawyers d. Top-level executives of the company 9. Give final approval of the compensation committee’s recommendations 10. Possible conflict of interest a. CEOs use compensation to co-opt board independence b. CEOs often nominate candidates for board membership c. There is a statistical relationship between how highly the CEO is paid and how highly the outside members of the board of directors are paid 11. Board members receive compensation for serving such as a. Money i. more than $50,000 yearly ii. $10,000 or more per board meeting attended b. Stock compensation c. Discretionary benefits like: i. Medical insurance ii. Life insurance iii. Retirement benefits

267 © Pearson Education Limited 2015

12. SEC rulings and the passage of the Dodd-Franc Act have increased the transparency of how executives are compensated as well as board members’ accountability for approving sound executive compensation packages—supportive of shareholders’ best interests 13. The compensation committee a. Is comprised by Board of Directors members b. Inside company board members c. Outside board members i. Help to minimize conflicts of interest ii. Make up the majority of most committees 14. Perform three duties: a. Review consultants’ alternative recommendations b. Discuss the assets and liabilities of each recommendation c. Recommend the best proposal to the board of directors to consider B. Theoretical Explanations for Setting Executive Compensation 1. Three theories: a. Agency b. Tournament c. Social comparison 2. Agency theory a. Ownership is distributed among thousands of shareholders in large companies like: i. Microsoft ii. General Electric iii. General Motors iv. IBM b. Shareholders delegate control to top executives c. Shareholders negotiate executive employment contracts with executives i. To minimize loss of control ii. To define the terms of employment pertaining to performance standards and compensation iii. To specify current and deferred compensation and benefits d. The main objective is to protect the company’s competitive interests e. Shareholders use compensation to align executives’ interests with shareholders’ interest

268 © Pearson Education Limited 2015

f. Possible problems i. It could allow executives to pursue activities that benefit themselves ii. Executives may emphasize the attainment of short-term gains iii. The Board of Directors may provide executives with generous annual bonuses for the attainment of short-term gains that do not lead to long-term gains 3. Tournament theory a. Casts lucrative executive compensation as the prize in a series of tournaments among middle- and top-level managers who aspire to become a CEO b. Winners at one level enter into the next level c. Chances of winning decrease dramatically as winners rise through the ranks 4. Social comparison theory a. Individuals compare themselves to individuals of similar or greater stature b. Demographics and occupation are common comparative bases c. CEOs on compensation committees might rely on their own compensation packages and those of other compensation CEOs of equal or greater stature to determine executive compensation VI.

Executive Compensation Disclosure Rules 1. The Securities and Exchange Commission (SEC) requires companies that sell and exchange securities (i.e., stocks, bonds) to file a wide variety of information including executive compensation practices 2. The SEC is a nonpartisan, quasi-judicial federal government agency responsible for administering federal securities laws 3. The Securities Exchange Act of 1934 applies to the disclosure of executive compensation a. Modified in 1992 and 1993 b. Two main objectives: i. Clarify the presentation of the compensation paid to the CEO and the four most highly-paid executives ii. Increase the accountability of company boards of directors for executive compensation policies and decisions

269 © Pearson Education Limited 2015

SEC Disclosure Requirements for Executive Compensation • Stock option and stock appreciation right tables • Long-term incentive plan table • Pension plan table • Performance graph comparing the company’s stock price performances against a market index and a peer group • Report from the compensation committee of the Board of Directors explaining compensation levels and policies • Description of the directors’ compensation disclosing all amounts paid or payable • Disclosure of certain employment contracts and golden parachutes 4. Board of Directors’ members may be subject to personal liability for paying excessive compensation 5. Under securities law, publicly held corporations are required to disclose detailed information on executive compensation to shareholders and the public 6. Shareholders can bring derivative lawsuits on behalf of a corporation, claiming that executive compensation is excessive 7. The Summary Compensation Table discloses compensation information over a three-year period on: a. CEOs b. Four highest-paid executives 8. Contains main subheadings a. Annual compensation b. Long-term compensation 9. Annual compensation includes: a. Salary b. Bonus 10. Long-term compensation includes: a. Restricted stock awards b. Stock appreciation rights c. Long-term incentive payouts 11. All other compensation a. To record all other forms of compensation b. Must be described in a footnote 12. In 2008, the SEC unveiled additional rules for disclosing executive compensation that require companies to reveal how much executives are 270 © Pearson Education Limited 2015

paid making previously hard-to-find information as such as pension and estimated severance package totals, transparent 13. In 2009, the SEC Chairperson announced that the Commission would consider further changes in the disclosure of executive compensation in a company’s summary compensation table pertaining to the reported value of stock options and stock rewards 14. SEC disclosure rules will show components of compensation previously hidden as well as provide clarity into elements of compensation already disclosed. The most significant changes follow: a. Total: The Summary Compensation Table of a company’s proxy will now have a column that adds up and displays the total compensation an executive received for the previous year, shown in our pay database as SEC Total b. Change in Pension Value and Nonqualified Deferred Compensation: This column in the Summary Compensation Table shows the increase in actuarial value to the executive officer of all defined-benefit pension plans and earnings on nonqualified deferred compensation plans c. All Other: This column captures compensation that does not fit in any other column of the Summary Compensation Table including perquisites and other personal items (e.g., aircraft usage, car service, club memberships). Each item of compensation included in All Other that exceeds $10,000 will now be separately identified and quantified in a footnote d. Pension Benefits: The new rules require companies to disclose the present value of accumulated pension benefits showing the total lump sum amount of money an executive would receive in retirement e. Severance Benefits: Companies must disclose any termination or change-in-control agreements with executives. They must disclose the specific circumstances that will trigger payment and the estimated total payments and benefits provided for each circumstance VII.

Say on Pay 1. President Barack Obama signed the Wall Street Reform and Consumer Protection Act of 2010 to further enhance the transparency of executive compensation practices 2. Commonly referenced to as the Dodd-Frank Act 3. Three provisions for companies that trade stock on public exchanges: a. Requires say on pay i. Gives company shareholders the right to vote yes or no on executive compensation proposals ii. Includes current and deferred components, and golden parachute agreements at least once every three years 271 © Pearson Education Limited 2015

iii. Guarantees shareholders the right to vote on executive compensation proposals iv. The vote is not binding v. The outcome of shareholders’ voting does not overrule any compensation decision made by the board of directors b. Details independence requirements for compensation committee members and their advisors (e.g., compensation consultants and legal counsel) i. Possible violations of Dodd-Frank independence requirements may arise when at least one committee member also receives compensation as a company employee ii. A compensation committee member who does not receive compensation from the company as an employee or external consultant would not violate the independence requirement iii. The Dodd-Frank Act specifies independence requirements for advisors to the compensation committee. Compensation committee must consider whether the fees charged by advisors exceed unreasonable limits. Another consideration is whether an advisor has a business or personal relationship with committee members c. Requires that companies disclose the circumstances under which an executive would benefit from a golden parachute agreement VIII. Executive Compensation: Are U.S. Executives Paid Too Much?

A. Comparison between Executive Compensation and Compensation for Other Worker Groups 1. Median annual earnings for all civilian U.S. workers was $45,790 in 2012 a. Least paid nonexecutive—shampooers at $18,600 b. Highest paid nonexecutive—anesthesiologists at $232,830 2. Typical annual salary and bonus for chief executives earned in 2011 was about $3.5 million B. Strategic Question: Is Pay for Performance?

1. A simple statement cannot be made about the relationship between CEO pay and company performance 2. Shareholder returns most often describe company performance, but there are complex forces beyond the control of CEOs that may influence shareholder returns

272 © Pearson Education Limited 2015

Performance Measures • Size Sales Assets Profits Market value Number of employees •

Capital Markets Dividend yield Total return to shareholders Price/earnings ratio Payout

•

Growth Sales Assets Profits Market value Number of employees

•

Profitability Profit margin Return on assets Return on equity

•

Liquidity Current ratio Quick ratio Working capital Cash flow

•

Leverage Debt-to-equity ratio Short- v. long-term debt Cash flow v. interest payments

C. Ethical Considerations: Is Executive Compensation Fair?

1. Three main considerations: a. Company’s ability to attract and retain top executives b. Income disparity between executives and nonexecutive employees c. Layoffs of thousands of nonexecutive employees 2. Company’s ability to attract and retain top executives a. The Board of Directors and compensation professionals believe lucrative compensation for top executives is vital b. Presumably, executives’ decisions promote competitive advantage by positioning companies to achieve lowest-cost and differentiation strategies effectively 3. Income disparity a. Typically, annual earnings for the lowest-paid occupation (shampooers) amounted to a mere 0.53 percent of average CEO salary and bonus, in other words, CEO pay was 178 times greater b. Typically, annual earnings for the highest-paid occupation (anesthesiologists) amounted to a mere 6.7 percent of average CEO salary and bonus, CEO’s pay 21 times greater 4. Layoffs a. Between late 2008 and mid 2009 alone, more than two million employees lost their jobs b. Reasons include: 273 © Pearson Education Limited 2015

i. Global competition ii. Reduction in demand iii. Technological advances iv. Mergers and acquisitions v. Relocating production plants overseas vi. Steep economic downturn due to the 9/11 terrorist attack D. International Competitiveness 1. Has forced companies to a. Become more productive b. Reduce expenditures on compensation: i. When they outpace the quality and/or quantity of employees’ output ii. When the compensation expenditure amount far outpaces the competition 2. Comparisons based on two dimensions: a. Total compensation amounts b. Components 3. Comparisons difficult because foreign countries do not require same disclosure rules as SEC 4. U.S. CEOs earn the most 5. This undermines U.S. companies’ ability to compete a. No evidence that the high U.S. executive compensation practices have undermined efforts to compete internationally b. However, massive U.S. worker layoffs might i. Heightens workers’ job insecurities ii. Workers may lose faith in pay-for-performance system 6. CEO pay will not undermine U.S. companies’ ability to compete because CEO pay increased as company profits increased

274 © Pearson Education Limited 2015

IX.

Discussion Questions and Suggested Answers

12-1. What can be done to make the function of compensation committees consistent with shareholders’ interest? Explain your answer.

A compensation committee is made up of members within and outside the company, also known as the Board of Directors. The Board of Directors represent shareholders’ interests by weighing the pros and cons of top executive decisions. The Boards of Directors have members including CEOs and top executives of other successful companies, distinguished community leaders, well-regarded professionals, and possibly a few toplevel executives of the company. The best way for a compensation committee to be consistent with shareholder’s interest is to listen to shareholder pleas and reactions to certain decisions, as well as to perform the first three duties of being a compensation committee. These three duties are reviewing consultants alternate recommendations, discussing the assets and liabilities of the recommendations, then making recommendations of the best proposal to the Board of Directors for their consideration.

12-2. Which component of compensation is most essential to motivate executives to lead companies toward competitive advantage? Discuss your rationale.

Senior executive pay is essentially comprised of base pay, annual bonus, and long-term incentives. It can be argued that long-term incentives are the most essential motivators because today they make up the greatest portion of senior executive pay.

12-3. Why do companies pay exorbitant compensation packages to their senior executives even though such an approach may not necessarily guarantee business success under their leadership?

The senior executives’ role is to develop strategic goals for long-term survivability of the company and very often these strategic goals are subject to changes in the macroenvironment (e.g. economy, political, legal, technology, ecology) and competitive environment (e.g. rivals, new entrants, customers, suppliers, barriers to entry etc.), which may not necessarily translate into business success. Further, senior executives are highly paid in the market, and if the company adopts a market-based pay structure, it is inevitable that they need to match their senior executives’ pay to the external market in order to retain them in the company.

12-4. Discuss the differences between enhanced benefits and perquisites.

The main difference between enhanced benefits and perquisites is that in order to be eligible for perquisites one must be an executive. Enhanced benefits are a different matter, for although they are generally only accessible through protection programs that include supplementary coverage, they are not limited to executive ranking.

275 © Pearson Education Limited 2015

12-5. Consult three recent articles (from newspapers, Internet news sources, or business magazines) on executive pay. Using these articles, describe the main issues and then your opinion about whether (or how) executive pay practices should change.

Responses will depend on current news stories.

X.

End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses

Case Name: CEO Pay at in the News Instructor Notes The AFL-CIO posts executive pay information on their website under “Executive PayWatch.” This information is shared with U.S. workers in order to help boost union membership across the country. When workers are aware of the disparity between frontline and top level pay, they are more likely to become frustrated and open to union organization. The disparity is particularly troubling to workers when the company is facing financial difficulty. Beyond working to help determine executive pay levels, the compensation professional must also maintain company morale by communicating to employees about executive pay levels.

Suggested Student Responses: 12-6. What additional information about the CEO’s pay package should Don identify to potentially share with the employees?

Executive pay is comprised of several different components and Don should outline those specifically. Depending on the theory used to set the CEO’s pay, Don may want to collect different information. For example, under agency theory, he may want to emphasize the CEO’s ownership in the company. Under social comparison, he may want to obtain information on the market rates of CEO pay in Oakwood’s industry. Further, Don should identify the components of the CEO’s salary that are specifically tied to performance.

While the company is having financial difficulty, Don should identify performance data that indicates any success that CEO has had in leading the company. The case may be that while the company is struggling financially, without the leadership of the CEO, they could be doing much worse.

276 © Pearson Education Limited 2015

12-7. How can Don explain the pay disparity to the employees to ease their concerns about the fairness of the CEO’s pay?

Students may have a variety of responses to this question. Essentially, they should identify the type of information that they would want to know if they were employees of Oakwood. For example, Don should emphasize the tie between the CEO’s pay and company performance. If the CEO’s pay will be reduced due to the financial difficulties, this should be highlighted. Further, Don must explain why the high pay level is needed to retain the skills and expertise of the CEO. If such expertise is rare, and particularly if the CEO is helped move the company forward, this information should be shared.

MYLAB QUESTIONS 12-8.

Discuss the six forms of deferred (stock) compensation.

Answer: Incentive stock options provide executives with the opportunity to purchase company stock, often at a discounted price. As a result, executives realize capital gains with their purchase. Additionally, the federal government accords favorable tax treatment to these purchases in that these gains are not taxed until the disposition of the stock.

Nonstatutory stock options are similar to incentive stock options. However, the capital gains are taxed at the time of purchase. Despite this cost, executives' tax liability over the long term is lower.

Restricted stock provides ownership control to the executive after a predetermined period, often 5 to 10 years. A further restriction is that if executives terminate their employment prior to the end of the designated period, they must sell the stock back to the company at the original discounted price. However, similar to incentive stock options, the executive does not pay tax until the restriction period ends.

Phantom stock provides executives with "hypothetical" company stocks rather than actual shares of company stock. Like restricted stock, these shares are converted into company stock after a predetermined period. Executives must meet two conditions: 1) executives must remain employed for a specified period, and 2) executives must retire from the company. Upon meeting these requirements, executives will receive income equivalent to the value of the increase in stock to the date the phantom stock was first granted. As with several of the other deferred stock options, executives will pay a capital gains tax after they convert the phantom shares to real shares.

Discount stock option plans are similar to nonstatutory stock option plans.

However, the company grants stock options at rates far below the stock's fair market 277 © Pearson Education Limited 2015

value on the date the option is granted.

Stock appreciation rights grant the executive income at the end of a designated period without actually having to exercise their stock rights. Rather, the company grants the difference in price between the time the stock was granted and its current fair market value. Executives then pay tax on any income from gains in stock value when they exercise their stock rights.

12-9.

Briefly discuss the current core compensation and employee benefits of executive compensation.

Answer: Current core compensation includes annual base pay and bonuses. Base pay is the fixed element of annual cash compensation. CEO compensation does not follow formal pay structures since their work is unpredictable and very complex. Annual base pay is relatively a smaller part of the CEO compensation. There are four types of bonuses common in executive compensation. Discretionary bonuses are given to executives on an elective basis. Boards of directors look at such factors as company profits, the financial condition of the company, or business conditions and award such a bonus based on sound decisions in these areas. Performance-contingent bonuses are tied to the attainment of specific performance criteria. The performance appraisal system is often used to determine whether these criteria have been met. A third type of bonus is the predetermined allocation bonus. This is based on a fixed formula. Company profits are the main factor in determining the size and amount of the bonus. The target plan bonus is similar to the performance-contingent bonus in that the award is tied to performance, but differs in that it increases commensurably with performance. However, this type of bonus differs from the predetermined allocation bonus in that the predetermined allocation bonus is given regardless of how well executives perform.

Executives receive discretionary benefits like other employees, but their protection programs include supplemental coverage providing enhanced protection benefits and services include perquisites. Executives receive supplemental life insurance and supplemental retirement plans as part of their enhanced protection program benefits.

Executives receive perquisites covering a broad range of benefits such as use of corporate jets, company cars, or country club membership.

XI.

Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses

Case Name: Communicating Benefits at JSJ Publishing

278 © Pearson Education Limited 2015

Instructor Notes Many employers mistakenly assume that employees know what benefits the company is required to provide by law, and which benefits they voluntarily provide. Understanding the benefits program is also important in order for employees to make appropriate decisions about their benefit selections. Further, benefit offerings often comprise a significant part of employees’ total compensation. As companies invest significantly in benefits, they do not get full value from that investment if the employees do not understand the benefits.

Suggested Student Responses: 12-10. Why is it important to provide effective communication about employee benefits?

Companies invest significantly in employee benefits and it is important for employees to understand the value of their benefits. Effective communication should help employees understand the value, but also should help employees understand their benefit options so that they can make wise decisions on their benefit selections.

12-11. What is your opinion of JSJ’s current communication about their benefit program?

While JSJ provides thorough information to their employees, they have not made the information easily accessible. They may be providing employees with too much detail and as a result, the employees are not easily able to find the information they need. Further, because employees seem to view the benefits as an entitlement, it seems that JSJ has not communicated in a way that helps employees understand the value of their benefits. For example, they are not aware of what benefits are required by law, and what benefits JSJ provides voluntarily.

12-12. How can JSJ improve their benefits communication?

Students may provide a variety of responses or creative ideas on how to improve benefits communications. A personal statement of benefits would be a useful tool to help summarize the value of each employee’s benefit selections. Further, instead of the bulky information packets that the company currently provides, they should consider some more concise summary communications, supplemented with the availability of more detailed information. For example, the company Intranet could be use to organize and store important documents that the employees can access as needed. Finally, employees should be given an opportunity for face-to-face meetings to learn more about their benefit options. Andrea could hold open meetings where employees can come and learn more about their benefits and also ask specific questions.

279 © Pearson Education Limited 2015

280 © Pearson Education Limited 2015

CHAPTER 13 Compensating the Flexible Work Force: Contingent Employees and Flexible Work Schedules

Learning Objectives 1. List and define each of the four groups of contingent workers and the reasons for U.S. employers’ increased reliance on them.

2. Discuss at least one compensation issue and one employee benefits issue for each of the four groups of contingent workers.

3. List the four categories of flexible work schedules.

4. Summarize one pay and employee benefits issue for flexible work schedules, compressed workweeks, and telecommuting arrangements.

5. Describe at least three reactions unions have about the use of contingent work and flexible work schedule arrangements.

6. Identify two strategic issues and choices companies have regarding the use of contingent workers.

Outline I.

II.

III.

IV.

V.

The Contingent Workforce A. Overview B. Groups of Contingent Workers C. Reasons for U.S. Employers’ Increased Reliance on Contingent Workers Pay and Employee Benefits for Contingent Workers A. Legalities B. Part-time Employees C. Temporary Employees D. Leased Workers E. Independent Contractors, Freelancers, and Consultants Flexible Work Schedules: Flextime, Compressed Work Weeks, and Telecommuting A. Main Types B. Flextime Schedules C. Compressed Work Weeks D. Telecommuting E. Balancing the Demands of Work Life and Home Life Pay and Employee Benefits for Flexible Employees A. Pay B. Benefits Unions’ Reactions to Contingent Workers and Flexible Work Schedules 280 © Pearson Education Limited 2015

VI.

Strategic Issues and Choices in Using Contingent and Flexible Workers A. Lowest-Cost Strategies B. Differentiation Strategies VII. Discussion Questions and Suggested Answers VIII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses IX. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses

Looking Ahead: As the needs of workers are rapidly changing, many employers are now accommodating with flexible work schedules. Companies that choose to employ contingent workers have to be made aware of both the consequences and the benefits of hiring such workers, and seek to strike a balance between standard work schedules and flexible work schedules.

Lecture Outline I.

The Contingent Workforce A. Overview 1. Statistics a. 5.7 million contingent workers employed in February 2005 b. 27 million employees worked some form of a flexible schedule in May 2004 c. Contingent workers and those on a flexible schedule made up 27.5 percent of the civilian workforce 2. Many companies employ core and contingent workforces a. Core employees generally: i. Work at least 35 hours a week ii. Work eight hours a day, five days a week b. Contingent workers: i. They do not have an implicit or explicit contract for ongoing employment ii. Their duration of employment varies according to their convenience and employers’ business needs iii. They most commonly hold professional (e.g., accountants), clerical (e.g., secretary), or laborer (e.g., construction worker) positions iv. They perform jobs in service and retail trade industries c. More companies favor contingent employment to control: i. Staffing levels ii. Costs 281 © Pearson Education Limited 2015

B. Groups of Contingent Workers 1. Five main groups: a. Part-time employees b. Temporary and on-call employees c. Leased employee arrangements d. Independent contractors, freelancers, and consultants

Example: Number of Contingent Employees in February 2005 • Part-time 2,294,000 • On-call 2,500,000 • Temporary 1,200,000 • Leased 813,000

2. Part-time employees a. Two kinds: i. Voluntary—by choice ii. Involuntary—forced by circumstances b. Work fewer than 35 hours weekly c. Voluntary i. To supplement family income ii. To tend to family needs iii. To follow spouse’s career pursuits iv. As a lifestyle choice v. Many core workers negotiate for part-time schedules d. Involuntary i. Can’t find gainful employment ii. Most part-timers are involuntary iii. Many hold entry-level positions e. Advantages i. Flexibility ii. Cost savings on discretionary benefits

282 © Pearson Education Limited 2015

Example: Benefits Costs, December 2012 Benefit Full-time Paid leave $2.52 Supplemental pay 1.03 Insurance 2.92 Retirement and savings 1.31 Legally required benefits 2.62 Total hourly benefits costs $10.41

Part Time $0.42 0.19 0.76 0.25 1.65 $3.26

iii. Considerable savings in the areas of paid leave, insurance, and legally required benefits iv. Cost savings on overtime expenses v. FLSA requires companies pay nonexempt employees 1.5 times hourly pay rates for overtime pay vi. Retail businesses save by employing part-time sales associates during peak holiday shopping seasons f. Job sharing i. Two or more part-time employees perform a single full-time job ii. May meet regularly to coordinate efforts iii. Represents a compromise between employees’ needs or desire not to work full-time and employers’ needs to staff jobs on a full-time basis Example: Benefits of Job Sharing Benefits to Employers • Maintenance of productivity • Retention of skilled workers • Reduction or elimination of training costs • Greater flexibility • Minimization of hiring and training costs • Strengthening loyalty to company Benefits to Employees • Continued fringe benefits protection • Continued employment • Maintenance of family income • Continued participation in qualified retirement programs

3. Temporary and on-call employees a. Reasons for hiring temporary workers i. To fill in for core employees on approved leave ii. To have an extra set of hands during busy business activities 283 © Pearson Education Limited 2015

iii. Allows employers to determine need for more core employees iv. Allows employers to evaluate performance of workers for possible full-time employment, similar to a probationary period v. Allows temporary workers the chance to determine if the company is the right employer for them vi. Save on discretionary benefits costs b. Temporary agencies i. Most common source of temporary employees - about 1.2 million in 2005 (most current data available at time of publication) ii. Most agencies placed mainly clerical and administrative workers, now also auditors, computer systems analysts, and lawyers iii. Use based on reputation and fees iv. Placement fees are based on a percentage of their placements’ pay rates v. Are the legal employers of the workers vi. Select, train, and provide compensation for employees c. Direct hire arrangements i. Companies hire temporary workers directly ii. Temporary employees usually work less than a year iii. The hiring company is the legal employer and therefore responsible for all HR functions d. On-call arrangements i. Work sporadically throughout year as needed ii. HR functions are the responsibility of hiring company iii. Skilled trade union workers can be on-call when unable to find full-time employment 4. Leased employee arrangements a. Generally for long-term assignments b. Leasing company bills hiring company for costs including i. Payroll ii. Benefits iii. Payroll taxes c. Their placement fees that are either a percentage of the client’s payroll or a fixed fee per employee d. Employees usually work for the duration of the contract e. Types of arrangements i. Food service like ARAMARK

284 © Pearson Education Limited 2015

Example: Leasing Company • ARAMARK Food Services • Provides cafeteria services • Workers include: • Cooks • Food preparers • Checkout clerks • Workers are leasing company’s employees, not the client company’s ii. Security iii. Building maintenance iv. Administrative services f. Responsible for all HR functions g. Differ from temporary agencies in that their placements generally remain in effect for the duration of the contract with the host company 5. Independent contractors, freelancers, consultants a. Establish working relationships directly with host companies b. Typically possess specialized skills that are in short supply in the labor market c. Independent contractors hired to complete particular projects that generally last for a year or less d. Adjunct college professors are hired to cover i. For professors on sabbatical ii. Until a tenure-track professor is hired C. Reasons for U.S. Employers’ Increased Reliance on Contingent Workers 1. Five main reasons: a. Economic recessions b. International competition c. Shift from a manufacturing to a service economy d. Rise of women in workforce e. Runaway costs to provide employer-sponsored health insurance 2. Economic recessions a. Reduction in core employees to control costs b. Contingent workers used to restore staffing until economy stability and need for more core employees is determined c. Hiring contingent employees represents a form of risk control d. Contingent workers are easier to terminate 3. International competition a. Foreign businesses can manufacture goods more cheaply

285 © Pearson Education Limited 2015

b. Forces U.S. businesses to streamline operations by lowering labor costs 4. Shift from a manufacturing to a service economy a. Six broad divisions of service industries: i. Transportation ii. Communication iii. Public utilities iv. Wholesale trade v. Retail trade (finance, insurance, real estate) vi. Government b. By 2018 i. Jobs in manufacturing and mining sectors are expected to continue to decline ii. Service opportunities are expected to rise by fifteen million jobs c. Service jobs are more labor intensive than capital intensive jobs d. Expected trends i. More business-oriented services, like upgrading of software and intelligent machinery, and construction-related services ii. More consultants to improve business processes iii. More social services like daycare and residential care 5. Rise of women in the workforce a. Rise in single parent families b. Need to supplement family income c. Desire to follow husband’s career pursuits d. Allows mothers to balance work and family responsibilities e. Rise of single-parent households—single parents with low levels of education and limited job opportunities f. Dual career pressures 6. Runaway costs to provide employer-sponsored health insurance a. Approximately 86 percent of all full-time private sector employees had access to employer-sponsored health insurance programs in 2012 b. 39 percent of part-time employees had access to such plans c. Most companies choose not to offer health care benefits to part-time workers (and other contingent workers for that matter) because the cost of employers’ contributions to provide health insurance coverage is about the same for full- and part-time employees

286 © Pearson Education Limited 2015

Insurance Costs (including life, health, and disability) and Contingent Workers • Part-time employees work far fewer hours than full-time employees, in effect making the hourly cost of benefits substantially higher for part-time employees than for fulltime employees • For example, the average monthly health insurance premium in was $467 per employee • The employer’s hourly cost to provide health care insurance is approximately $2.92 for an employee who works 160 hours per month (i.e., 40 hours per week based on 4 weeks per month: $467/160) • For part-time employees, assuming 80 hours per month (that is, an assumed 20-hour work week based on 4 weeks per month) the hourly cost is $5.84 ($467/80) d. Substantially higher rate increases for medical services may be explained by several factors, including: i. Longer life expectancies ii. Aging baby boomers iii. Advances in medical research iv. The tendency to prolong life of terminally ill II.

Pay and Employee Benefits for Contingent Workers A. Legalities 1. All parties involved employing contingent workers possess liability under federal and state laws, including: a. Overtime and minimum wage guidelines under FLSA b. State workers’ compensation insurance premiums c. Nondiscriminatory compensation and employment practices under i. ERISA ii. NLRA iii. Civil Rights Act of 1964 iv. ADEA d. Temporary employment agencies and leasing companies are liable under these laws e. Client companies may also be liable B. Part-Time Employees 1. Challenges for employers a. Should companies pay part-time workers on an hourly basis or salary basis? b. Will equity problems arise between core employees and part-time employees? c. Should companies offer part-time workers benefits?

287 © Pearson Education Limited 2015

2. Pay a. Part-time workers generally earn less b. The following table shows average wages from March 2012 Average Hourly Wages in March 2012 Full Time Part Time Private Industry $23.22 $11.95 Management and Professional Workers 37.05 26.70 Production Workers 17.57 11.09 Service Employees 12.16 9.18 c. Salaried, full-time employees versus contingent workers i. Salaried employees’ effective hourly rate decreases with the increase in hours worked ii. Less-skilled contingent workers hourly pay may actually outpace salaried employees 3. Employee benefits a. Generally different dependent on: i. The size of the company ii. Whether the employer is private or public b. Employers are not required to offer protective insurance unless covered by COBRA c. Part-time employees may be eligible to participate in a company’s retirement plan if: i. They are age 21 or older ii. The work at least 1000 hours in 12 months (year of service) 4. Seasonal employees’ special considerations for retirement plan eligibility a. Generally do not meet annual service pension eligibility criterion b. Secretary of Labor defines 125 service days as the “year of service” c. Seasonal employees cannot be excluded from participation if they meet year of service criterion C. Temporary Employees 1. Temporary employment agencies are responsible for complying with all federal employment legislation, except worker’s compensation 2. Possible compensation challenges a. Do equity problems arise between core employees and temporary employees? b. How do FLSA overtime provisions affect temporary employees? c. Do companies offer temporary workers benefits?

288 © Pearson Education Limited 2015

d. Who is responsible for providing workers’ compensation protection: the temporary agency or the client company?

3. Core compensation—Pay a. In February 2005, they earned an average of $224 per week, it varies by: i. Occupation ii. Employee qualifications b. Many may work diligently to prove their worth for possible full-time employment c. Is affected if temporary employees move from one employer to another i. Some have no desire for full-time employment ii. A few are concerned with equity issues iii. Most don’t shop around and compare employers iv. Those who lost full-time positions due to sudden layoffs may not work as diligently d. Differences between temporary and seasonal employees i. For determining minimum wage and overtime pay eligibility under FLSA ii. Temporary workers can work any time throughout year, seasonal workers work during regular periods iii. Seasonal workers, like life guards and summer camp counselors, are exempt unless the employer operates over seven months a year 4. Employee benefits a. Companies generally do not provide discretionary benefits b. Temporary employees are eligible to participate in qualified pension benefits if they meet ERISA’s minimum service requirement of 125 days of work. c. Dual employer common law doctrine establishes temporary workers’ rights to receive workers’ compensation since they are employees of both the temporary agency and the hiring company D. Leased Workers 1. Who the legal employer is - is less clear than it is for a. Temporary employees b. Part-time employees 2. Pay a. In February 2005, they earned an average weekly wage of $204 for part-time and $756 for full-time b. Other compensation data is very limited

289 © Pearson Education Limited 2015

3. Benefits a. Leased employees are generally entitled to participation in the client companies’ qualified retirement programs b. Leasing companies become responsible for leased employees’ retirement benefits when the safe harbor rule requirements are met Safe Harbor Rules • The leased employee must be covered by the leasing company’s pension plan, which must • Be a money purchase plan with a nonintegrated employer contribution rate for each participant of at least 10% of compensation • Provide for full and immediate vesting • Allow each employee of the leasing organization to immediately participate in such a plan • Leased employees cannot constitute more than 20% of the recipient’s nonhighly compensated worker • Nonhighly compensated workforce means the total number of • Nonhighly compensated individuals who are employees of the recipient and who have performed services for the recipient for at least a year, or • Individuals who are leased employees of the recipient (determined without regard to the leasing rules)

c. Under COBRA, the IRC requires employers to provide leased workers continued coverage of: i. Group medical insurance ii. Group life insurance iii. Educational assistance programs E. Independent Contractors, Freelancers, and Consultants 1. Pay levels not monitored by the Bureau of Labor Statistics 2. Hiring companies not obligated to pay: a. Federal income tax withholding b. Overtime and minimum wages required under FLSA, however, employers are obligated to pay financially dependent workers overtime and minimum wages c. Insurance premiums required under state workers’ compensation laws, except where states explicitly require that companies maintain workers’ compensation coverage for all workers regardless of whether they are independent contractors d. Protection under i. ERISA 290 © Pearson Education Limited 2015

ii. FMLA iii. NLRA iv. ADA v. Title VII of the Civil Rights Act of 1964 e. Economic reality test i. Used to determine if employees are financially dependent ii. Concerns FLSA coverage Economic Reality Test Criteria • The extent the worker has the right to control the result of the work and the manner it is performed • The amount of control the employer has over the individual’s opportunity to realize a profit or sustain a loss • The extent to which the services are an integral part of the employer’s business operations • The amount of initiative or level of skill required for the worker to perform the job • The permanency, exclusivity, or duration of the relationship between the employer and the worker • The extent of the worker’s investment in equipment or materials required for the job

Example: Economic Reality Test • Nightclub dancers eligibility for minimum wages • Owners didn’t think they were eligible because • The dancers could perform whenever and wherever they wanted • The club had no control over the manner of performance • The dancers furnished their own costumes • Courts determined they were eligible because the club owners • Set hours in which the dancers could perform • Issued guidelines on dancers’ behavior at the club • Deducted 20 percent from the credit card tips of each dancer to cover administrative costs f. Right to control test i. IRC test ii. Used to determine whether an individual is an employee or an independent contractor 291 © Pearson Education Limited 2015

iii. Possessing the right to control work activities classifies individuals as employers rather than independent contractors

III.

Flexible Work Schedules: Flextime, Compressed Work Weeks, and Telecommuting A. Main Types 1. Flextime schedules 2. Compressed work weeks 3. Telecommuting B. Flextime 1. Along with compressed work schedules flextime is the most common 2. Applies to both core and contingent employees 3. Employee can set work hours within parameters 4. Total work hours not affected 5. May be required to be on-site during core business hours a. When business activity is high b. When important business activity is conducted 6. Possible employer benefits a. Lower tardiness and absenteeism b. Higher productivity c. Extended business hours and better service 7. Possible drawbacks a. Increased overhead costs b. Coordination problems C. Compressed Work Weeks 1. Same work hours in fewer days per week like: a. Four 10-hour days b. Three 12-hour days 2. Possible benefits a. Can promote recruitment and retention b. Can reduce commuting time c. Can allow more family time D. Telecommuting 1. Employees perform work away from business like: a. Home b. Remote locations 2. Work time generally split between business and off-site locations 292 © Pearson Education Limited 2015

Example: Alternative Telecommuting Arrangements • Satellite work centers - employees work from a remote extension of the employer’s office that includes a clerical staff and a full-time manager • Neighborhood work center - employees work from a satellite office shared by several employers • Nomadic executive office - executives who travel extensively maintain control over projects through use of telephone, fax, and e-mail • Some employees work entirely outside the office, while others might work offsite only once a month or two to three days a week • Telecommuters can be full- or part-time employees • Telecommuting arrangements can be temporary or permanent. A temporarily disabled employee may work at home until fully recovered. A permanently disabled employee may work at home exclusively

3. Appropriate for work that does not require regular direct contact with other employees like: a. Accounting b. Systems analysis c. Telephone sales 4. Employees stay in-touch with superiors and coworkers by: a. E-mail b. Faxes c. Telephone 5. Possible employer benefit a. Increased productivity b. Lower overhead costs c. Effective recruiting and retention practices 6. Possible employee benefits a. More family time b. Minimize commuting time c. Reduces commuting costs d. Separation from “office politics” e. Higher job performance 7. Possible disadvantages a. Fewer direct employee interactions b. Difficulty conducting accurate performance appraisals c. May disrupt personal life 293 © Pearson Education Limited 2015

E. Balancing the Demands of Work Life and Home Life 1. Flextime, compressed work weeks, and telecommuting should provide single parents or dual-career parents the opportunity to spend more time with their children 2. Flextime gives parents the opportunity to schedule work around special events at their children’s schools 3. Compressed work weeks enable parents on limited incomes to save on daycare costs by reducing the number of days at the office 4. Compressed work weeks and telecommuting reduce the time spouses have to spend away from each other IV.

Pay and Employee Benefits for Flexible Employees A. Pay a. Influence of FLSA’s overtime pay provision i. Was based on a five day 40-hour work week ii. Flexible employees weekly hours may vary, but average out over time iii. Led to Supreme Court ruling Walling v. A.H. Belo Corporation b. Walling v. A.H. Belo Corporation i. Supreme Court ruling concerning employers’ guarantee of fixed weekly pay for flexible employees when employer typically cannot determine the number of hours employees will work each week ii. The work week period fluctuates both above and below 40-hours per week c. Overtime for compressed work week schedules is difficult because: i. The Federal government bases regular hours as 40 per week ii. States vary on their determination of a “regular work week” B. Employee benefits issues a. Flexible work week schedules have the greatest impact on paid timeoff benefits like: i. Sick leave ii. Vacation time iii. Holidays b. Employers need to maintain equity among employees by offering comparable time-off if holidays fall on employees’ regular days off c. Working condition fringe benefits i. Provide telecommuters the necessary equipment to do work like computers, telex machines, copier, and sundry office supplies ii. The IRS treats equipment as taxable income when the use falls outside the established telecommuting relationship 294 © Pearson Education Limited 2015

iii. The IRS treats the equipment as a working condition fringe benefit if it is within the telecommuting relationship V.

Unions’ Reactions to Contingent and Flexible Workers 1. Most do not support the use of contingent workers and flexible work schedules a. They believe it might threaten job security b. They believe that it may lead to unfair, inequitable treatment 2. Common concerns a. Employers exploit contingent workers by paying them lower wages and benefits b. Employer’s efforts to get cheap labor will lead to a poorly trained and less skilled workforce that will hamper competitiveness c. Part-time employees are difficult to organize because their interests are centered on activities outside the workplace d. Part-time employment erodes labor standards: often denied fringe benefits, job security, and promotion opportunities e. Temporary employees generally have little concern for improving the productivity of a company f. The union’s bargaining power becomes weak when companies demonstrate their ability to perform effectively with temporaries g. The long days of compressed work weeks for flextime could endanger workers’ safety and health, even if the workers choose these long days h. Other issues include concerns about employee isolation, uncompensated overtime, and company monitoring in the home 3. Some unions are beginning to accept flexible work schedules, believing that doing so will strengthen their bargaining power

VI.

Strategic Issues and Choices in Using Contingent and Flexible Workers A. Cost Control Objectives 1. Contingent employment allows for lower discretionary benefit costs and provides less generous amounts of such benefits 2. Well-trained contingent workers can reduce training costs 3. Company-specific training a. Represents a significant cost to companies b. Training short-term contingent workers undermines strategy because of: i. The cost of training materials and instructors’ fees ii. “Downtime” pay for training time iii. Inefficiencies that may result until employees master new skills 295 © Pearson Education Limited 2015

4. Training may increase long-term employees’ productivity and flexibility, outweighing the short-term costs 5. Overall, contingent workers demonstrate less absenteeism B. Product and Service Innovation Objectives 1. Requires employees that are: a. Creative b. Open-minded c. Risk-takers 2. Requires companies to take a longer-term focus to attain their preestablished objectives 3. Contingent employment could: a. Bring in an influx of new employees with new ideas b. Minimize groupthink, where employees agree on mistaken solutions because they share the same mindset and view issues through the lens of conformity 4. Flexible work schedules may: a. Enable employees to work when they are at their peak physical and mental best b. Allow employees to work with fewer distractions and worries about personal matters

VII. Discussion Questions and Suggested Answers 13-1. Discuss some of the problems that companies are likely to face when both contingent workers and core employees work in the same location. Does it matter whether contingent workers and core employees are performing the same jobs? Explain your answer.

Possible problems that may arise when companies put contingent workers and core employees in the same location are mentality differences, attitude differences, and work reliance conflicts. Mentality issues generally emerge when one type of employee may feel that the other is inferior or hardly worth their time due to the temporary versus longterm contract. Attitude differences such as one employee treating the other with disregard due to the fact that one may not be there for much longer is also a potential problem.

Work reliance conflicts include situations in which a core employee becomes dependent on a contingent worker for substantial work or information and the contingent worker leaves forcing the core employee to put together the pieces.

296 © Pearson Education Limited 2015

13-2. Companies generally pay temporary employees lower wages and offer fewer benefits than they extend to their core counterparts. Nevertheless, what are some of the possible drawbacks for companies that employ temporary workers? Do you believe that these drawbacks outweigh the cost savings?

Explain your reasoning.

Other possible drawbacks for employing temporary workers include the constant retraining of employees, the funding that is necessary to train these new contingent employees and overall worker confidence or experience in the job related field. Having employees that have limited experience in the company’s line of work could lead to on the job mishaps and failures. Whenever an employee is hired they need to be trained in order to meet the expectations of the employer. In order to meet these expectations, companies must put their employees through extensive training. This training costs money, time, and overall potential customer satisfaction. Customers tend to like coming to the same store, for example, if they see the same friendly face every time.

13-3. What arguments can be made in favor of using compressed work week schedules for companies that pursue lowest-cost strategies? What are the arguments against using compressed work week schedules in such situations?

Compressed work week schedules are profitable for companies that pursue lowest-cost strategies because it reduces the number of times employees must commute between home and work as well as provides more time together for dual-career couples who live apart. However, compressed work week schedules may cause problems for employers as their employees are not necessarily there when they need them to be.

13-4. Based on your observation of the market practice in your country, describe some of the approaches adopted by employers in building a flexible workforce.

Answers will vary, but the approaches would include some of the following: telecommuting, part-time work arrangements, flexible work arrangements, and temporary workers.

13-5. Provide your reactions to the following statement: Contingent workers should be compensated on a pay-for-knowledge system.

It would certainly make sense to compensate workers on a pay-for-knowledge system, for when hiring contingent workers it is vital that they are capable of performing up to the standards of the company and that they contribute to the company as a whole. However, 297 © Pearson Education Limited 2015

pay-for-knowledge systems should not be used as a form of compensation when hiring a contingent worker as a sort of three month interview or as part of an internship in order to later become a full-time employee because of the simple fact that the worker is there to perform to the best of their ability and to learn so as to become a better employee for the future.

VIII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses Case Name: Telecommuting at MedEx Instructor Notes: Telecommuting creates a flexible work arrangement that allows employees to work from home, for at least part of the standard workweek. This option can be considered a valuable benefit to employees, particularly if they are challenged with balancing their work and home life. Telecommuting is most appropriate for positions where employees work independently and do not need frequent interactions with co-workers. The Specialists in this case work in positions that are most likely appropriate for telecommuting as they work independently on their own accounts.

Suggested Student Responses: 13-6. Would offering telecommuting as an option benefit MedEx? How? Offering the option for telecommuting could help improve employee satisfaction by giving employees more flexibility. The Specialists could save money on gas and parking and save time commuting. This extra time could help relieve some of the burden in trying to balance their lives. Improved employee satisfaction could lead to lower turnover rates. Offering telecommuting to employees could also offer some advantages in recruiting new employees if potential employees see the option as an attractive benefit.

Further, MedEx may be able to lower their overhead expenses and improve overall employee productivity.

13-7. How might telecommuting be implemented as an alternative work arrangement in your country?

Telecommuters open many opportunities because employees who work under such an arrangement generally spend part of their time working in the office and the other part 298 © Pearson Education Limited 2015

working at home. This alternative work arrangement is appropriate for work that does not require regular direct interpersonal interactions with other workers wherever they might be as accounting, systems analysis or and telephone sales. Telecommuters stay in touch with their colleagues and superiors through e-mail, telephone, and faxes.

13-8. What do you recommend MedEx do? Why? Students will most likely suggest that MedEx offers the telecommuting option. While it would take some effort to develop a thorough telecommuting policy, the company will most likely benefit from offering telecommuting.

MYLAB QUESTIONS 13-9. Explain leased employee arrangements. Discuss employee benefits for leased workers.

Answer: Lease companies employ qualified individuals and place them in client companies as a long-term basis. Lease companies provide both wages and benefits to their employees. Leased employees are generally entitled to participation in the client companies' qualified retirement programs; however, the leasing company becomes responsible for leased employees' retirement benefits when the safe harbor rule requirements are met. Client companies are responsible for providing group medical insurance, group life insurance, educational assistance programs, and continuation coverage requirements for group health plans under COBRA for leased employees.

13-10. Discuss flexible work schedules from the perspective of both unions and employees.

Answer: Flexible work schedules such as flextime schedules, compressed workweek schedules, and telecommuting help employees balance the demands of work life and home life. Flexible work schedules provide employees to spend more time with their children. For instance, telecommuting arrangements let parents be near their infants or preschool-age children. Compressed workweeks and telecommuting reduce commuting time and expense for employees. Moreover, compressed workweeks and telecommuting provide more time together for dual-career couples. On the other hand, unions generally do not support flexible work schedules. They are concerned about the workers' safety and health due to long hours of working under compressed workweeks or flextime. Besides, unions do not like their members to be telecommuters due to concerns about: employee isolation, uncompensated overtime, and company monitoring in the home.

IX.

Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses 299 © Pearson Education Limited 2015

Case Name: A New Leader at Stylings Instructor Notes: The CEO is responsible for implementing an organization’s competitive strategies and in many cases, has the greatest impact on organizational success. As such, an attractive compensation package is essential to attract the right talent to lead a company. However, the perception of the front line employees is an important consideration in determining compensation. Noted disparities in executive and front line compensation are clearly an issue in the retail industry where many employees are paid close to minimum wage. This disparity should be kept in mind while designing a package that still attracts the right talent and provides incentives for performance.

Suggested Student Responses: 13-11. What role does the compensation package play in attracting the right talent for the CEO position?

The CEO holds a significant responsibility in ensuring the success of an organization. A high level of risk comes with that responsibility. To attract a CEO willing to take on such risk, the compensation package must be attractive and provide the incentives to accomplish the goals of the organization.

13-12. What are some recommendations the consultant may provide to the Board for the compensation package?

As base pay is typically a smaller part of a CEO’s compensation package, the recommendations are likely to focus on other aspects of compensation. With the questionable future of the organization, a bonus structure that is contingent on performance is important with a focus on improving revenues. To ensure that the new executive is vested in the future of the company, stock options are an important part of the compensation package. As there is some risk of an acquisition, a golden parachute clause is also likely important. Perquisites should be limited as those are likely to spark the most negative response from employees who are facing budget cuts in the stores.

300 © Pearson Education Limited 2015

CHAPTER 14 Compensating Expatriates Learning Objectives 1. Summarize the four reasons international activities facilitate the attainment of competitive advantage.

2. Describe and explain the four preliminary considerations compensation professionals should take under advisement before designing international compensation programs.

3. List the three main components of international compensation programs, and provide a specific example of each one.

4. Explain the three approaches available to companies for setting expatriate employees’ base pay.

5. Summarize the three types of incentive payments that are commonly used in international compensation programs.

6. Give a description of two standard employee benefits and two illustrations of enhanced benefits for U.S. employees.

7. Describe the issue of repatriation.

Outline I.

II.

III. IV.

V.

Competitive Advantage and How International Activities Fit In A. Overview B. Lowest Cost Producers’ Relocations to Cheaper Production Areas C. Differentiation and the Search for New Global Markets D. How Globalization Is Affecting HR Departments E. Complexity of International Compensation Programs Preliminary Considerations A. Overview B. Host Country Nationals, Third Country Nationals, and Expatriates: Definitions and Relevance for Compensation Issues C. Term of International Assignment D. Staff Mobility E. Equity: Pay Referent Groups Components of International Compensation Programs Setting Base Pay for U.S. Expatriates A. Methods for Setting Base Pay B. Purchasing Power Incentive Compensation for U.S. Expatriates A. Overview 301 © Pearson Education Limited 2015

B. Foreign Source Premiums C. Hardship Allowances D. Mobility Premiums VI. Establishing Employee Benefits for U.S. Expatriates A. Overview B. Standard Benefits C. Enhanced Benefits VII. Balance Sheet Approach for U.S. Expatriates’ Compensation Packages A. Overview B. Housing and Utilities C. Goods and Services D. Discretionary Income E. Tax Considerations VIII. Repatriation Pay Issues IX. Discussion Questions and Suggested Answers X. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses XI. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses

Lecture Outline I.

Competitive Strategies and How International Activities Fit In A. Overview 1. Several factors have contributed to the expansion of the global market: a. Free trade agreements (such as NAFTA) b. Unification of the European markets c. Gradual weakening of the Communist influence in Easter Europe and Asia d. Greater opportunities for foreign companies to invest in the United States B. Lowest-Cost Producers’ Relocations to Cheaper Areas 1. Many U.S. businesses have established manufacturing and production facilities in Asian countries and in Mexico because labor is significantly less expensive than it is in the United States 2. Two key reasons for the cost difference: a. Labor unions generally do not have much bargaining power in developing Asian countries or in Mexico, where the governments possess extensive control over workplace affairs b. Asian governments historically have not valued individual employee rights as much as does the U.S. government 302 © Pearson Education Limited 2015

c. The National Labor Relations Act of 1935 requires management to bargain with labor unions over terms of employment such as wages and some employee benefits C. Differentiation and the Search for New Global Markets 1. Coca Cola and Pepsi products are well known worldwide because these companies aggressively introduced their soft drink products throughout numerous countries 2. However, Coke and Pepsi could distinguish themselves from competing companies by taking on new business initiatives that depart from “business as usual” and meet specific market needs Example: Differentiation and Search for New Global Markets • • •

• •

For Coke and Pepsi, “business as usual” means marketing soft drink products (i.e., carbonated water with artificial colors and flavors) Marketing bottled spring water would clearly be a departure from business as usual for them The People’s Republic of China (PRC) possesses a definite need for bottled spring water: the Chinese government is unable to provide its citizens and visitors with drinkable water because the country does not maintain adequate water purification plants Coke and Pepsi could distinguish themselves from other soft drink companies by marketing spring water along with their regular soft drink products Coke and Pepsi would be known as companies that serve necessary (bottled water) and recreational (soft drinks) beverage needs D. How Globalization Is Affecting HR Departments 1. Employee selection a. Culturally sensitive? b. Are families willing to adjust?

2. Training a. Cross-cultural b. In-house or outsourced 3. The use of international assignments is an important issue addressed by companies located in countries across the world 4. A multitude of large consulting firms conduct extensive research for client companies to ensure the most effective deployment of expatriates worldwide focusing on pay and benefits issues for expatriates, labor law, and useful information to help expatriates select and train local country nationals E. Complexity of International Compensation Programs 1. Globalization affects programs’: a. Development 303 © Pearson Education Limited 2015

b. Implementation 2. Four main challenges: a. How to further corporate interests abroad and encourage employees to take foreign assignments b. How to minimize financial risks to employees and make their (and their families) experiences as pleasant as possible c. How to promote a smooth transition back to life in the United States after completing assignment overseas (repatriation) d. How to promote their lowest-cost and differentiation strategies in foreign markets II.

Preliminary Considerations A. Overview 1. Distinguishing between employees a. Host country nationals (HCNs) b. Third country nationals (TCNs) c. Expatriates 2. Important compensation factors like: a. Terms of the assignment b. Staff mobility c. Pay equity B. Host Country Nationals, Third Country Nationals, and Expatriates: Definitions and Relevance for Compensation Issues 1. Three designations: a. Host country nationals (HCNs) b. Third country nationals (TCNs) c. Expatriates 2. HCNs a. Foreign national citizens who work in U.S. companies’ branch offices or manufacturing plants in their home country b. Example: a Japanese citizen working for GE in Japan 3. TCNs a. Foreign citizens who work in a U.S. company’s branch in a foreign country i. Other than the United States, or ii. Other than their home country b. Example: an Australian citizen working for GE in Japan 4. Expatriates a. U.S. citizens employed by a U.S. company in a foreign country 304 © Pearson Education Limited 2015

5.

6.

7.

8.

b. Example: a U.S. citizen working for GE in Japan HR professionals construct international compensation packages based on three main factors: a. Term of international assignment b. Staff mobility c. Equity: pay referent groups Term of international assignments a. Short term i. Less than one year ii. Do not require major changes in domestic compensation packages b. Extended (long) term i. Over one year ii. Necessitates changes to promote a sense of stability and comfort c. Compensation package changes may include: i. Housing allowances ii. Educational expenses for children iii. Adjustments to protect expatriates from paying “double” income taxes – to the United States and to the host country Staff mobility a. From the United States to host country and back b. From the United States to one host country and then to another host country c. May require financial incentives Equity: pay referent groups a. Domestic employees b. Host country employees c. Commensurate with performance or knowledge attainment

Example: Equity for Expatriates in Mexico • Mexican managers’ compensation packages include base pay and cash allowances • U.S. managers’ compensation packages include base pay and long term incentives • U.S. expatriates on long term assignments in Mexico may receive a compensation package similar to a Mexican manager working for a Mexican company

III.

Components of International Compensation Programs 1. Core compensation a. Base pay 305 © Pearson Education Limited 2015

2. Incentive compensation a. Foreign service premium b. Hardship allowance c. Mobility premium 3. Employee benefits 4. Standard benefits a. Protection programs b. Paid time off 5. Enhanced benefits a. Relocation assistance b. Educational reimbursement for expatriates’ children c. Home leave and travel reimbursement d. Rest and relaxation leave allowance IV.

Setting Base Pay for U.S. Expatriates A. Methods for Setting Base Pay 1. Three main methods a. Home country-based b. Host country-based c. Headquarters-based 2. Home country-based method a. Expatriates receive amount they would get in the United States b. Job evaluation, based on compensable factors, used to compare jobs c. Adjustments should reflect the additional skills needed d. Most appropriate for expatriates on short term assignments e. Equity pay problems not an issue in short term assignments 3. Host country-based method a. Pay based on what employees in the host country receive b. Factors include market pricing, job evaluation techniques, or jobholder’s past relevant work experience c. Most suitable when assignments are extended term 4. Headquarters-based method a. All pay is set according to scales used at company headquarters b. Not based on home or host country pay levels c. Most suitable for expatriates who go from one foreign assignment to another d. Administratively simpler, since pay not based on assignment location

306 © Pearson Education Limited 2015

B. Purchasing Power 1. Affects an employee’s standard of living 2. Diminished power undermines the strategic value of the compensation package to attract and maintain employees willing to work overseas 3. Two key factors: a. Stability of local currency b. Inflation 4. Many companies use the balance sheet approach to minimize risk factors such as stability of local currency and inflation 5. Currency stabilization a. Pay usually based on U.S. currency b. Many host countries do not accept U.S. currency as a legal tender c. Expatriates must exchange dollars for local currency based on current exchange rate d. Rate fluctuations affected by: i. Government policies ii. Market forces 6. Inflation a. Defined as the increase in prices for consumer goods and services b. Increases in inflation diminish purchasing power Example: Exchange Rates • Defined as the price at which one country’s currency can be swapped for another • Expressed in terms of foreign currency per U.S. dollars or in terms of U.S. dollars per unit of foreign currency • On April 5, 2013: $1 would exchange for 6.48 Swedish kronas • On April 5, 2013: $1 would exchange for 0.77 Euro

V.

Incentive Compensation for U.S. Expatriates A. Overview 1. Designed to: a. Promote higher job performance b. Minimize dysfunctional turnover 2. Three main incentives: a. Foreign services premiums b. Hardship premiums c. Mobility premiums

307 © Pearson Education Limited 2015

B. Foreign Service Premiums 1. Monetary payments above and beyond regular base pay 2. Designed to encourage employees to accept expatriate assignments 3. Generally apply to assignments over a year in length 4. Calculated: a. As a percentage of base pay b. As a percentage generally between 10 percent to 30 percent c. Percentage increases with assignment length or because of a shortage of available candidates 5. Are distributed over several installments to: a. Manage costs b. Remind expatriates of the premium throughout their assignments 6. Possible drawbacks a. Employees might believe the premium is a regular, permanent increase b. May not have incentive value if given in several small installments c. Employees may worry that their standard of living will decrease after repatriation when they lose the premium C. Hardship Allowances 1. Designed to recognize exceptionally hard living and working conditions at foreign locations 2. Are disbursed in small amounts throughout the duration of assignment 3. The greater the hardship, the larger the allowance a. Range from 5 percent to 35 percent 4. Over 150 countries considered hardship locations Example: Three criteria to identify hardship locations: • Extraordinarily difficult living conditions (e.g., inadequate housing, lack of recreational facilities, isolation, inadequate transportation facilities, and lack of food or consumer services) • Excessive physical hardship, including severe climates or high altitudes and the presence of dangerous conditions affecting physical and mental well-being • Notably unhealthy conditions (e.g., diseases and epidemics, lack of public sanitation, and inadequate health facilities) D. Mobility Premiums 1. Designed to encourage employees to move from one assignment to another a. From a domestic position 308 © Pearson Education Limited 2015

b. Between foreign assignments 2. Generally given in a one lump-sum payment VI.

Establishing Employee Benefits for U.S. Expatriates A. Overview 1. Companies design benefits programs to attract and retain the best expatriates 2. International employee benefits plans include such protection programs as medical insurance and retirement programs 3. U.S. citizens working overseas continue to receive medical insurance and participate in their retirement programs 4. International and domestic plans are also similar in that they offer paid time off; however, international packages tend to incorporate more extensive benefits of this kind 5. Employers should take several considerations into account when designing international benefits programs, including: a. Total remuneration: What is included in the total employee pay structure (e.g., cash wages, benefits, mandated social programs, and other perquisites)? How much can the business afford? b. Benefit adequacy: To what extent must the employer enhance mandated programs to achieve desired staffing levels? Programs already in place and employees’ utilization of them should be critically examined before determining what supplementary programs are needed and desirable. c. Tax effectiveness: What is the tax deductibility of these programs for the employer and employee in each country, and how does U.S. tax law treat expenditures in this area? d. Recognition of local customs and practices: Companies often provide benefits and services to employees based on those extended by other businesses in the locality, independent of their own attitude toward these same benefits and services.

B. Standard Benefits for U.S. Expatriates 1. Protection programs a. Two main types: i. Legally-required benefits ii. Discretionary benefits b. Laws that affect legally-required benefits i. Social Security Act of 1935 ii. Family and Medical Leave Act of 1993 iii. States’ workers’ compensation laws generally do not apply c. Discretionary benefits 309 © Pearson Education Limited 2015

i. As a strategic response to workforce diversity ii. To retain the best-performing employees 2. Paid time off a. Benefits include: i. Annual vacations ii. Holidays iii. Emergency leave b. Expatriates typically receive the same annual vacation benefits as do their domestic counterparts c. U.S. companies must comply with foreign laws that govern the amount of vacation d. Leave for personal or family emergencies i. Paid ii. Travel expenses usually included C. Enhanced Benefits for U.S. Expatriates 1. Four main types: a. Relocation assistance b. Education reimbursements for expatriates’ children c. Home-leave benefits and travel reimbursements d. Rest and relaxation leave and allowance 2. Relocation assistance a. To and from the overseas assignment b. Payments based on three main factors: i. Distance ii. Length of assignment iii. Rank in the company Example: Relocation Assistance Payments The relocation allowance or reimbursement provides employees with money for: • Temporary quarters prior to departure because the expatriate’s house has been sold or rented • Transportation to the foreign post for employees and their families • Reasonable expenses incurred by the family during travel • Temporary quarters while waiting for delivery of household goods or while looking for suitable housing • Moving household goods to the foreign post • Storing household goods in the United States

310 © Pearson Education Limited 2015

3. Education reimbursements for expatriates’ children a. Generally for private, English-speaking schools b. Done for two reasons: i. Some foreign schools are not comparable to U.S. public schools ii. Most U.S. children do not speak a foreign language fluently c. Tuition is generally higher than in U.S. private schools 4. Home-leave benefits and travel reimbursements a. To manage the adjustment to the foreign culture b. To maintain direct personal contact with family and friends at home c. Vary company to company d. Reimbursements for the expatriate and family members typically include: i. Cost of round-trip airfare ii. Ground transportation iii. Accommodations while traveling e. Generally, expatriates have to be on the assignment at least six months 5. Rest and relaxation leave and allowances a. Provided by employers who realize that employees on assignments in hardship locations may need extra time off to “recharge their batteries” b. Companies can designate where the time can be spent c. Allowance to cover travel expenses between the foreign post and retreat locations, based on: i. Cost of transportation ii. Food iii. Lodging d. U.S. State Department publishes per diem schedules i. For various cities ii. Amounts set by location and family size Example: Time-off designated area • Expatriates in China’s Special Economic Zone • Can go to Hong Kong • Hong Kong offers: • Diverse ethnic restaurants • Western-style entertainment

311 © Pearson Education Limited 2015

VII.

Balance Sheet Approach for U.S. Expatriates’ Compensation Packages A. Overview 1. Protects expatriates’ standard of living 2. Enables companies to control costs because it relies on objective indexes that measure cost differences between the United States and foreign countries 3. Most appropriate when: a. The home country is an appropriate reference point for economic comparisons b. Employees are likely to maintain psychological and cultural ties with the home or base country c. Employees prefer not to assimilate into the foreign culture d. The assignment is of limited duration e. The assignment following the international assignment will be in the home country f. The company promises employees that they will not lose financially while on foreign assignment 4. Major expenditures a. Housing and utilities b. Goods and services c. Discretionary income d. Taxes 5. Allowances a. Are given when the costs are more in the foreign assignment b. Vary according to the customary lifestyle of expatriate 6. Determining costs in foreign countries a. Through interviews with returning expatriates b. From private consulting or research companies c. U.S. State Department Indexes of Living Costs Abroad, Quarters Allowances, and Hardship Differentials i. Published quarterly ii. Most cost-effective iii. Available • At no charge in libraries with government depositories • On the World Wide Web at (http://www.state.gov) B. Housing and Utilities 1. Housing and utilities costs 2. Three main sections: 312 © Pearson Education Limited 2015

3.

4.

5.

6.

a. Survey data b. Exchange rates c. Annual allowance for family status and salary range Survey data is from the month when the Office of Allowances received housing expenditure reports Exchange rates contain three pieces of information: a. Effective date b. Foreign unit c. Number per U.S. dollar The exchange rate is used to compute the Quarters Allowance Quarters Allowances table a. Contains information on family status and salary ranges b. Family status i. Single ii. Family c. Family i. Refers to a two-or-more-person group ii. Larger families receive supplements iii. Families of two or three receive a 10 percent supplement iv. Families of four or five receive a 20 percent supplement v. Families of six or more receive a 30 percent supplement

Example: Quarter Allowances • $65,600 for single expatriates making over $93,177 in Beijing, China • $23,100 for single expatriates making over $93,177 in Tapei, Taiwan • $79,690 for a family of six earning over $93,177 in Beijing, China C. Goods and Services 1. Base on indexes of living costs abroad 2. Indexes compare the costs of representative goods and services purchased at the foreign location to comparable goods and services purchased in the Washington D.C. area 3. Indexes are place-to-place cost comparisons at specific: a. Times b. Currency exchange rates 4. State Department’s Indexes of Living Costs Abroad a. Three pertinent sections: i. The survey data ii. Exchange rates 313 © Pearson Education Limited 2015

iii. Local index b. Survey data represents the month the Department of State received the cost data c. The local index is a measure of the cost of living at foreign posts relative to Washington D.C. Example: Indexes of Living Costs Abroad • Index for Washington is 100 • Index for Muscat, Oman is 131—costs are 31 percent higher than in Washington D.C. • Index for Tegucigalpa, Honduras is 99—costs are 1 percent lower than in Washington D.C. • Allowances not needed for Tegucigalpa, because the cost of living there is lower than in the United States

D. Discretionary Income 1. Covers a variety of financial obligations in the United States for which expatriates remain responsible while away 2. Expenditures a.

Pension contributions b.

Savings and investments c.

Insurance payments d.

Equity portion of mortgage payments e.

Alimony support f.

Child support g.

Student loan payments h.

Car payments E. Tax Considerations 1. Expatriates subject to a. FUTA b. Social Security c. Income taxes i. United States ii. Foreign country (where applicable) iii. Paying both is a form of double taxation 2. IRS includes regulations that address taxation issues 3. Employer considerations a. Under the balance sheet approach, companies choose between two approaches to help address concerns about double taxation: 314 © Pearson Education Limited 2015

i. Tax protection ii. Tax equalization 4. Hypothetical tax method a. Calculated as the U.S. income tax based on the same salary level, excluding all foreign allowances b. A key element of both tax protection and equalization 5. Tax protection a. Employers reimburse expatriates for the difference between i. The actual income tax amount and ii. The hypothetical tax when the actual tax amount is greater b. Expatriates i. Pay the entire tax bill when the taxes are less than or equal to the hypothetical tax ii. Realize a tax benefit whenever actual taxes are less than the hypothetical tax, because they will have paid lower income taxes on their overseas assignments 6. Tax equalization a. Employers i. Take the responsibility for paying income taxes to the United States and foreign governments on behalf of the expatriates ii. Deduct income from the expatriates’ paychecks that totals the hypothetical tax amounts at year’s end iii. Reimburse expatriates for the difference between the hypothetical tax and the actual income tax whenever the actual income tax amount is less b. Employees reimburse the company when the actual tax is greater than the hypothetical tax c. Offers two advantages over tax protection i. Expatriates receive equitable treatment regardless of their locations ii. Employers save money by not allowing expatriates to keep tax windfalls VIII. Repatriation Pay Issues 1. Returning expatriates might initially view domestic assignments as a punishment because they lose their supplemental income and benefits 2. Some returning expatriates perceive their value to the company heightens because of their overseas assignments, more so than the company does 3. Returning expatriates may find it difficult to work collaboratively with colleagues, undermining differentiation objectives

315 © Pearson Education Limited 2015

4. Strong resentments may lead returning expatriates to find employment with competitors 5. Companies should invest in former expatriates’ career development a. To signal company’s commitment to the employee b. Investment may be seen as a form of compensation 6. Companies should capitalize on expatriates’ experiences to gain a better understanding of foreign business environments 7. Former expatriates can contribute to the quality of international assignments by conveying what did and did not work well during their assignments IX.

Discussion Questions and Suggested Answers

14-1. Discuss the strengths and weaknesses of the following methods for establishing base pay in international contexts: home country-based pay, headquarters-based pay, and host country-based pay.

The home country-based pay method is often most appropriate for expatriates. Equity problems are not very likely to arise because expatriates’ assignments are too short to establish local national employees as pay referents. Instead, expatriates will base pay comparisons on their home country standards. In general, the home country-based pay method is most suitable when expatriate assignments are short in duration and local nationals performing comparable jobs receive substantially higher pay. Expatriates may rely on local cultural norms over extended periods as the standard for judging the equitableness of their compensation. The host country-based method compensates expatriates based on the host countries’ pay scales. Companies use various standards for determining base pay, including market pricing, job evaluation techniques, and jobholders’ past relevant work experience. Other countries use different standards. For instance, the Japanese emphasize seniority. Expatriates’ base pay will be competitive with other employees’ base pay in the host countries. The host country-based method is most suitable when assignments are of long duration. The headquarters-based method compensates all employees according to the pay scales used at the headquarters. This method makes the most sense for expatriates who move from one foreign assignment to another and rarely, if ever, work in their home countries. This system is administratively simple because it applies the pay standard of one country to all employees regardless of the location of their foreign assignment or their country of citizenship.

14-2. For a country of your choice, conduct research into the cultural characteristics that you believe should be important considerations in establishing a core compensation program for a U.S. company that plans to locate there. Discuss these characteristics. Discuss as well whether you feel that pay-for-performance programs are compatible. If compatible in any way, what course of action would you take to promote this compatibility?

316 © Pearson Education Limited 2015

If a U.S. company were to decide to locate in Japan, certain cultural norms may need to be used by employees in order to safely establish a strong relationship with the people.

For instance, in most food consumption areas it is polite to burp, take off ones shoes before entering, and sit down on the floor when eating. Pay-for-knowledge and pay-forperformance compensation plans may be best as the company is first starting out so as to pay their employees based upon how well they cope with the cultural differences and/or their knowledge of the customs. In order to promote this compatibility it may be best to hire an expert in the cultural norms and acceptances of the Japanese people.

14-3. What are some of the challenges that a multinational company would need to anticipate if it wants to relocate one of its HCNs and their family to work in your country?

Some of the challenges would include (1) providing cultural training so that the HCN’s family can adjust and adapt to the host county’s culture, language and customs; (2) providing proper housing, spousal assistance, and children’s education; (3), providing leave for a trip home at least once a year for the HCN’s family to catch-up and establish connections and bonds with their families, friends and social network in the home country; and (4) preparing the HCS’s family to repatriate at the end of the assignment.

14-4. Allowances and reimbursements for international assignments are costly.

Should companies avoid international business activities? Explain your answer. If you answer no, what can companies to do minimize cost?

Companies should not avoid international business activities because in turn they can be extremely profitable. In order to minimize the cost of such international business activities, companies can invest in a former expatriate’s career development and capitalize on expatriates’ experiences to gain a better understanding of foreign business environments. Companies must determine the method for setting expatriates’ base pay.

Final determination should come only after companies carefully weigh the strengths and limitations of alternative methods. In addition, the purchasing power of base pay is an important consideration. Purchasing power affects the standard of living.

14-5. Of the many reimbursements and allowances that U.S. companies make for employees who take foreign assignments, which one is the most essential?

Discuss your reasons.

The most essential reimbursement and allowance that U.S. companies make for employees who take foreign assignments is home-leave benefits and travel reimbursements. Under this allowance, companies offer home-leave benefits to help expatriates manage the adjustments to foreign cultures and to maintain direct personal contact with family and friends. As the name implies, home-leave benefits enable 317 © Pearson Education Limited 2015

expatriates to take paid time-off in the United States. Most companies reimburse expatriates for expenses associated with travel between the foreign post and the United States. These reimbursements apply to expatriates and to reimburse the cost of round-trip airfare, ground transportation, and accommodations while traveling to and from the foreign post.

X.

End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses

Case Name: Jenkins Goes Abroad Instructor Notes: Many Human Resources practitioners face the new challenge of expanding operations globally. Even if a company is sending just a few employees abroad, if the duration is longer than a year, possible adjustments must be made to the individual’s compensation.

Companies must consider not only the need to maintain employee’s standard of living as they move into a different economy, but also the need to encourage the acceptance of an international assignment.

Suggested Student Responses: 14-6. How should Dale approach the determination of the consultant’s salaries as expatriates?

Initially, Dale should consider the fact that the assignment is relatively long term. The consultants will be in the U.K. for a period of more than a year, and therefore, an adjustment to their pay is most likely appropriate. As the U.S. dollar is currently weak against the Pound, Dale should also consider the purchasing power of the consultants in the U.K. and the fact that the consultants’ current U.S. salary will likely lead to a lower standard of living. However, the assignment is not permanent and therefore the employees will need to eventually transition back into the U.S. culture. Therefore, maintaining purchasing power is a priority. Because of this, Jenkins should most likely take a balance sheet approach to determining the pay of the expatriates.

14-7. Should Jenkins offer any incentive compensation or additional benefits to the expatriates? Why or why not?

Based on Dale’s initial discussions with the consultants, it seems they may be hesitant to take the assignment because of their concerns with their long-term career growth.

Therefore, an incentive such as a foreign service premium may be appropriate. Because the consultants will eventually transition back to the United States, Jenkins may also want 318 © Pearson Education Limited 2015

to consider offering home leave benefits in order to help the consultants maintain contact with friends and colleagues.

319 © Pearson Education Limited 2015

MYLAB QUESTIONS 14-8.

Describe the four challenges that companies face in the development and the implementation of international compensation programs. How can a company prevent problems that are driven by repatriation?

Answer: Challenges: 1) encourage employees to take foreign assignments, 2) minimize financial risk to employees, 3) promote a smooth transition back to life in the United States (i.e., repatriation), 4) promote U.S. businesses' lowest cost and differentiation strategies in foreign markets. Repatriation which is the third challenged described above can be resolved by the following: 1) Companies should invest in former expatriates' career developments, 2) companies should use expatriates' experiences to better understand foreign business environments.

14-9.

Explain headquarters-based method to calculate expatriates based pay.

Which incentive might work better for this method?

Answer: In headquarters-based method, employees are paid based on headquarters pay scale. This method is more useful for expatriates who move from one assignment to another. Among the main incentives for expatriates, mobility premiums would be more suitable for headquarters-based method. This incentive rewards employees for moving from one assignment to another.

XI.

Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses

Case Name: Independent Contractor or Part-time Employee?

Instructor Notes: Uncertainty and the need for flexibility lead many employers to engage contingent workers as part of their workforce. Independent contractors are often hired for their specialized skills to complete specific projects or perform a job for a designated amount of time. Often a company will prefer to hire someone as an independent contractor in order to have more flexibility and also to contain benefit costs as the company does not provide benefits to an independent contractor. However, as an employer does not have certain obligations to an independent contractor, it is important that they are properly classified under state and federal employment laws.

320 © Pearson Education Limited 2015

Suggested Student Responses: 14-10. Why would EcoSafe prefer to engage Laney as an independent contractor?

EcoSafe would have fewer obligations to Laney as an independent contractor. They would not be obligated to pay Federal income tax withholding, overtime pay, insurance premiums for worker’s compensation, or provide protection under several employment laws. Further, Laney would not be eligible to participate in company sponsored benefit programs such as paid time off and health plan insurance. Finally, should EcoSafe at some point no longer need Laney’s services, it is easier to end the relationship.

14-11. Based on the information provided, do you think Laney should be engaged as an independent contractor?

Because of the legal implications of the classification as an independent contractor, it is important to properly classify an employee. Under the IRS’s 20-factor test to determine if a person is an employee or an independent contractor, there are several considerations for Laney’s case. Most indicate that Laney cannot be classified as an independent contractor. For example, EcoSafe intends to have control over when and how she will work. She will be integrated into the firm with an office, equipment and the use of the administrative staff. They have implied an ongoing relationship including discussions about eventually transitioning into a full-time position. Finally, Laney intends to cease her work with other clients, making EcoSafe her only relationship. All of these factors suggest that Laney must be hired as an employee.

321 © Pearson Education Limited 2015

CHAPTER 15 Pay and Benefits Outside the United States Learning Objectives 1. Explain the differences between pay and benefits in the United States and in countries around the world (included in this chapter).

2. State the total costs of hourly compensation in manufacturing settings around the world.

3. List the countries that impose minimum wage rates.

4. Summarize the paid time off benefits in at least two countries.

5. Briefly summarize the protection benefits such as retirement, health care, and social security in at least two countries.

Outline Introduction North America A. Overview B. Canada C. Mexico III. South America A. Overview B. Brazil IV. Europe A. Overview B. Germany V. Asia A. Overview B. India C. People’s Republic of China VI. Discussion Questions and Suggested Answers VII. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses VIII. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses I. II.

321 © Pearson Education Limited 2015

Lecture Outline I.

Introduction 1. Globalization has resulted in a high level of interconnections between the economies of various parts of the world 2. U.S. employers will increasingly conduct business with entities in a variety of other countries as former underdeveloped parts of the world experience tremendous economic, trade, and standard of living growth 3. In addition, the move from traditional manufacturing to knowledge- and service-based employment also means that jobs as well as markets are more likely to be dispersed geographically 4. HR management professionals are going to have increased opportunities to develop compensation and benefits programs for U.S. employees in foreign assignments, as well as for indigenous employees in foreign offices of the parent company 5. Many other governments do not regularly assess pay levels in their economies, which stands in stark contrast to the wealth of data provided regularly on U.S. markets 6. The U.S. Bureau of Labor Statistics, however, regularly compares the hourly compensation costs in several countries 7. The gross domestic product (GDP) describes the size of a country’s economy, where size is expressed as the market value of all final goods and services produced within the country over a specified period 8. GDP per capita generally indicates the standard of living within a country, the larger the per capita GDP, presumably the better is the standard of living

II.

North America A. Overview 1. Mexico, Canada, and the United States are part of a trade bloc known as NAFTA—the North Atlantic Free Trade Agreement 2. NAFTA called for the elimination of duties and the phasing out of tariffs over a period of 14 years 3. Trade restrictions were removed under NAFTA from such industries as motor vehicles and automotive parts, computers, textiles, and agriculture 4. The labor side of NAFTA is the North American Agreement on Labor Cooperation (NAALC) 5. Created to promote cooperation between trade unions and social organizations in order to champion improved labor conditions B. Canada 1. Constitutional monarchy that is also a parliamentary democracy and a federation consisting of ten provinces and three territories 2. Per capita GDP—$41,500 3. Labor force—18.85 million 4. The market-based Canadian economy is very similar to that of the United States’ 322 © Pearson Education Limited 2015

5. Canadian law holds that labor and employment law fall within the exclusive jurisdiction of the provinces 6. Federal legislation cannot override provincial laws, even when the industry or employer primarily conducts business overseas (except in the cases where the industries are expressly assigned to federal jurisdiction) 7. English Statute of Labourers of 1562 established working hours and wages 8. Eventually repealed in the early nineteenth century—became part of the English common law and later became part of the common law governing all the provinces other than Quebec 9. Quebec has the Civil Code of Quebec which came into effect in 1866; a modernized version of the Civil Code came into effect on January 1, 1994 10. Wage and Salary a. Canada does possess a statutory minimum wage law b. At the federal level, there is an obligation placed upon provincial governments to establish minimum rates of pay by or under an Act of the legislature c. In 2012, Alberta has the lowest minimum wage rate in Canada (i.e., $9.95) d. The highest rate (i.e., $11.00) can be found in Nunavut 11. Paid time off benefits a. Canadian employment law holds that employees are entitled to between eight and nine annual paid holidays as well as two weeks paid vacation time along with a sum of money as vacation pay (increasing to three weeks after six years of employment) b. The amount of vacation pay is equal to two percent of the employee’s pay for the preceding year per week of vacation c. Employees are eligible for a total of 17 weeks of benefits during pregnancy and after childbirth 12. Protection benefits a. Pensions and retirement benefits i. Canada has two state pension plans ii. One for Quebec residents only and one for the rest of Canada iii. Both funded by matching contributions from employers and employees and fully portable upon employment changes, much like 401(k) plans in the United States b. Health and disability benefits i. Medical and basic hospital care in Canada is paid for by provincial medical insurance plans with compulsory coverage for all residents and funding revenue derived from both general federal taxation and from provincial taxes ii. Even though public health plans normally do not provide employed persons with prescription drugs except while they are hospitalized, additional benefits are provided by private supplementary insurance by employers, including dental and vision care

323 © Pearson Education Limited 2015

C.

iii. Employers also provide long- and short-term disability benefits for sickness or injury as part of a benefits package Mexico 1. The “Labor and Social Security” article of the constitution is still in effect 2. Employment relationships in Mexico fall under the Federal Labor Law which was last revised in January of 1997 and clearly defines the terms worker and employer for the purpose of individual employment 3. Per capita GDP—$15,300 4. Labor force—19 million 5. Wage and salary a. The Mexican government requires that two minimum wage rates be applied: i. The first, general minimum wage, applies to all workers and the amount depends upon the region of the country ii. The second is the occupational minimum wages that are higher than the general minimum wages b. Occupations that require greater skill, knowledge, and experience are compensated at higher rates 6. Paid time off benefits a. Workers are entitled to paid time off during public holidays and workers required to work during a mandatory holiday are entitled to double pay b. Female employees are entitled to maternity leave—six weeks prior to giving birth and six weeks after birth on full salary c. Employees are entitled to six vacation days after being employed for one year and to two more days for each subsequent year, up to a maximum of twelve days 7. Protection benefits a. Social security i. Social security programs in Mexico are administered by the Mexican Social Security Institute ii. Protect employees in the matters of occupational accidents and illnesses, maternity, sicknesses, incapacitation, old age, retirement, and survivor pensions, daycare for children of insured workers, and social services iii. The system is financed by contributions from workers, employers, and the government, with contributions based on salary levels, and with workers earning minimum salary exempt from making contributions, whereas employers bear the bulk of the contributions to the different insurance funds iv. Workers with at least 52 weeks worth of payments into the system who withdraw are entitled to continue making voluntary payments v. Cash benefits take the form of transfer payments in the early stages of illness or incapacitation, depending on the medical condition and its effects on work and pensions

324 © Pearson Education Limited 2015

vi. In-kind benefits take the form of medical attention, including surgery and medicines, hospitalization services, and so forth b. Pension and retirement benefits i. Effective July 1, 1997, all workers must join the mandatory individual account system, which is slowly replacing the former social insurance system ii. At retirement, employees covered by the social insurance system before 1997 can choose to receive benefits from either the social insurance system or from the mandatory individual account system c. Health benefits i. Medical services are normally provided directly to patients (including old-age pensioners covered by the 1997 law) through the health facilities of the Mexican Social Security Institute ii. Benefits include general and specialist care, surgery, maternity care, hospitalization or care in a convalescent home, medicines, laboratory services, dental care, and appliances, and are payable for 52 weeks, but may in some cases be extended to 104 weeks iii. In addition, the wife of an insured man also receives postnatal benefits in kind, and medical services are provided for dependent children up to age 16 (age 25 if a student, no limit if disabled) d. Other benefits i. A national system of worker housing exists paid for by employer contributions in the form of payroll tax fixed at five percent and helps workers obtain sufficient credit for the acquisition of housing ii. Workers not employed after age 50 are entitled to receive the full balance of contributions made in their name to the housing fund III. South America A. Overview 1. The biggest trade bloc in South America used to be Mercosur, or the Southern Common Market, comprised of Argentina, Brazil, Paraguay, Uruguay, and Venezuela as the main members and Bolivia, Chile, Colombia, Ecuador, and Peru as associate states 2. The second-biggest trade bloc was the Andean Community of Nations made up of Bolivia, Colombia, Ecuador, Peru, Venezuela, and Chile 3. These two trade blocs merged as of a declaration signed on December 8, 2004 at the Third South American Summit and formed one large trade bloc known as the South American Community of Nations that plans to model itself on the European Union B. Brazil 1. The Consolidation of Labor Laws (Consolidacao das Leis do Trabalho) accords many employee benefits the status of fundamental constitutional rights and in general the employment relationship in Brazil is highly regulated by statute

325 © Pearson Education Limited 2015

2. Brazilian law states that any/all benefits habitually granted by the employer, whether expressly or tacitly, are considered part of the employee’s salary for all legal purposes and cannot be abolished 3. In practice, employers discharge employees arbitrarily because there is a substantial supply of readily available workers who are willing to accept lower pay 3. Per capita GDP—$12,000 4. Labor force—107.10 million 5. Wage and salary a. Minimum wage imposed b. In accordance with the Federal Constitution, the minimum wage rate is nationally uniform and set by law c. The minimum wage is fixed by a Provisional Measure, namely an Act of the Executive having the force of law, in accordance with Article 62 of the Federal Constitution and placed before Congress for conversion into law d. In 2011, this wage was 545 R$ (Reais) 6. Protection benefits a. Social security i. The social security system that went into effect in 1991 details various benefits for workers in Brazil ii. Comprehensive social security benefits are provided by law to all workers regarding retirement for illness, old age, or length of service; death benefit pensions; assistance during imprisonment of worker; savings fund; social services; professional rehabilitation assistance; work accident payments; maternity leave payments; family salary support; accident insurance; and sick leave benefits b. Pensions i. Social insurance is provided to employed persons in industry, commerce, and agriculture, domestic servants, some categories of casual workers, elected civil servants, and the self-employed ii. The monthly benefit is equal to 70 percent of average earnings plus 1 percent of average earnings for each year of contributions, up to a maximum of 100 percent iii. Employees contribute 8.5 percent of gross earnings, and voluntary contributors and members of cooperatives contribute 20 percent of declared earnings iv. Employers are required to contribute 20 percent of payroll (22.5 percent of payroll for employers in the financial sector), 15 percent of earnings for work cooperatives, 12 percent of payroll on behalf of domestic workers, and 2.7 percent of earnings for rural employers c. Health benefits i. Medical services are provided directly to patients in rural and urban areas through the Unified Health System and include such benefits as general, specialist, maternity, and dental care; 326 © Pearson Education Limited 2015

hospitalization; medicines (some cost sharing is required); and necessary transportation IV. Europe A. Overview 1. The European Union (EU) is a unique international organization that aims at becoming an economic superpower while still retaining quintessential European practices such as high levels of employment, social welfare protection, and strong trade unions 2. Under the laws of all Member States, employers must provide employees with a written document about the terms of the employment contract 3. The concept of “employment at will” does not exist in the EU as in the United States 4. The EU makes use of Directives and Community Legislations to ensure that some minimum standards are adopted by member states 5. All member states either have specific legislation or unfair dismissal or general civil code provisions that apply to termination of employment contracts 6. The EU Website reports that community labor law was designed with the aim of ensuring that the creation of the Single Market did not result in a lowering of labor standards or distortions in competition 7. On the basis of article 137 of the treaty, the Community shall support and complement the activities of the Member States in the area of social policy, particularly minimum requirements at the EU level in the fields of working and employment conditions, and with regard to the information and consultation of workers B. Germany 1. Germany’s employment laws provide considerable voice to labor and job security to employees and the German Civil Code provides numerous statutes that deal with individual employment as well as collective agreements 2. There have been increasing concerns about the aging workforce and high unemployment bankrupting the social security system but for now Germany has managed to bring the deficit to within the EU debt limit 3. Per capita GDP—$39,100 4. Labor force—44.01 million 5. Wage and salary a. Minimum wage in Germany is not mandated by the government, and is established through the collective bargaining process b. Two types of collective agreements: i. Association agreements are made between trade unions and employers’ associations ii. Company agreements are made between trade unions and individual employers

327 © Pearson Education Limited 2015

6.

7.

V.

c. An extension of either type of agreement to other sectors or employers may be granted upon the request of at least one party to the collective agreement Paid time off benefits a. The statutory minimum vacation has been set at 24 working days (or four weeks since Saturdays are counted) b. Younger workers have a right to a vacation of 25 to 30 working days; disabled workers have an additional five days of vacation c. Under the terms of the Maternity Leave Law, time away from work as a result of maternity leave or other limits on work by pregnant women and mothers must be counted as time worked for the purpose of determining entitlement to vacation time Protection benefits a. Pensions i. Germany has a statutory pension system analogous to the Social Security system in the United States ii. Employers offer the company pension plan and a tax-favored investment plan iii. Employees have three different sources for their pension benefits: statutory pension insurance, company pension plans, and private life insurance b. Health insurance i. German laws stipulate guidelines for the minimal health welfare of workers ii. For blue collar workers (and some white collar workers) mandatory state health insurance premiums are shared equally by the insured and by the employer iii. Employees whose income exceeds a certain amount can opt out of the state plan and purchase private health insurance

Asia A. Overview 1. Asia has several trade blocs including the Asia-Pacific Economic Cooperation, the Asia-Europe Economic Meeting, the Association of Southeast Asian Nations, and the South Asian Association for Regional Cooperation 2. Given the wide variation and diversity in the world’s largest and most populous continent, however, there is no unifying economic body like the EU or NAFTA that represents all the countries of Asia B. India 1. The Directive Principle of State Policy has statutes that affect various aspects of the employment relationship such as working conditions and participation in management 2. There are wide variations between the public and private sectors, with the Ministry of Labour and labor laws governing employment relationships in the public sector and more employer discretion allowed in the private sector 328 © Pearson Education Limited 2015

3. Per capita GDP—$3,900 4. Labor force—498.4 million 5. Wage and salary a. Minimum wage is fixed by an authority dual system b. Minimum wage rates are determined by the government for certain sectors, and a collective agreement determines others c. Minimum wage rates for occupations that are largely nonunionized or have little bargaining power may be set in accordance with the Minimum Wages Act, 1948 d. The central government sets minimum wages for 45 different occupations, including agricultural workers, construction and road maintenance workers, workers in mines, railway workers, and stone breaking or crushing workers e. In addition, states have set minimum wages for 1,232 different occupations in their respective regions f. Minimum wage rates apply only to those scheduled occupations that have more than 1,000 employees working in the applicable state g. E.g., in Delhi the minimum wage rate ranged between 279 and 339 rupees per day in 2013 h. Wage rate varies by the level of job skill and industry 6. Paid time off benefits a. Leave is usually calculated for each year based on the number of days worked in the previous year and if worker does not take all of the accumulated leave it is allowed to roll over to the succeeding calendar year up to a maximum of 30 days b. There is no statutory provision of paternity leave but maternity leave is allowed in the form of paid time off and possible medical bonus 7. Protection benefits a. Pensions i. First and current laws regarding pensions were passed in 1952 (employees’ provident funds), with amendments in 1972 (payment of gratuity), 1976 (employees’ deposit-linked insurance), 1995 (employees’ pension scheme), and 1995 (national social assistance program) ii. In 2004, a voluntary old-age, disability, and survivors’ benefits scheme was enacted iii. Voluntary coverage exists for employees of covered establishments with monthly earnings of more than 6,500 rupees, with the agreement of the employer and for establishments with less than 20 employees if the employer and a majority of the employees agree to contribute iv. Provident fund contributions include 12 percent of basic wages (10 percent of basic wages in five specified categories of industry) in covered establishments with less than 20 employees and some other specific cases

329 © Pearson Education Limited 2015

C.

v. The maximum monthly earnings for contribution purposes are 6,500 rupees (1 USD = 50.8 rupees) b.

Health Benefits i. State governments arrange for the provision of medical care on behalf of the Employees’ State Insurance Corporation ii. Services are provided in different states through social insurance dispensaries and hospitals, state government services, or private doctors under contract People’s Republic of China 1. The PRC Labor Law was established in 1995, resulting in a break from the traditional “iron rice bowl” system of employment, with a shift from stateowned enterprises to private ones, a move which has given rise to new employment relationship issues 2. Under the older welfare system the workforce was considered the property of the State and many benefits such as housing, medical, and retirement schemes were payable directly by the state-owned enterprises to the employees 3. Since the introduction of the PRC Labor Law the employment relationship is now defined by individual contracts 4. Per capita GDP—$9,100 5. Labor force—795.4 million 6. Wage and salary a. According to China’s Labour Act, 1994, the State possesses the responsibility to implement a system of guaranteed minimum wages b. There is no national minimum wage rate in China; instead, minimum wage rates are set by region c. Separate standards are stipulated by provincial, regional, and municipal peoples’ governments for their respective regions and reported to the State Council for consent d. The provisions concerning minimum wages apply to enterprises, private non-enterprise entities, individual industrial and commercial households with employees (the employing entities), and the laborers who have formed a labor relationship with them e. The minimum wage rate varies by region - in 2011, the monthly minimum wage was 1,300 yuan in Gaunghzho (the highest in China) and 1,120 yuan in Shanghai with the lowest amount in Anhui Province and Jiangxi Province at 500 yuan 7. Paid time off benefits a. Employees who have worked for one or more years are entitled to be paid annual leave but there are no binding laws about this; national policy guidelines recommend 5 to 15 days b. Employees who have worked for more than one year are entitled to “home leave” if they do not live in the same place as their spouse or parents c. Women are entitled to no less than 90 days of maternity leave starting 15 days prior to birth 330 © Pearson Education Limited 2015

8. Protection benefits a. Pensions i. There has been a new law to decouple the employment relationship from the social insurance system, setting up a unified basic pension system ii. The system now has social insurance and mandatory individual accounts iii. Coverage includes employees in urban enterprises and urban institutions managed as enterprises and the urban self-employed iv. Employees of government and communist party organizations and of cultural, educational, and scientific institutions (except for institutions financed off-budget) are covered under a governmentfunded, employer-administered system v. An employee contribution to mandatory individual accounts is 8 percent of gross insured earnings vi. The minimum earnings for employee contribution and benefit purposes are equal to 60 percent of the local average wage for the previous year vii. The maximum earnings for employee contribution and benefit purposes vary, but they may be as much as 300 percent of the local average wage for the previous year viii. Employer contribution to mandatory individual accounts is as high as 20 percent of insured payroll based on local regulations b. Health insurance i. A unified medical insurance system exists with all employers and workers participating in this system; employers contribute six percent of payroll employees contribute two percent of their salary. ii. Health insurance is based on Basic Medical Insurance Fund consisting of a Pooled Fund and Personal Accounts iii. Employees’ contributions go directly to their Personal Accounts and 30 percent of employer contributions are paid into this account iv. The social insurance fund reimburses the cost of the medical benefit from 10 percent up to 400 percent of the local average annual wage

Health care note: With rising health care costs, the ability of citizens to receive adequate care is of heightened concern in all countries.

331 © Pearson Education Limited 2015

VI.

Discussion Questions and Suggested Answers

15-1. Discuss the main differences between the minimum pay regulations in the United States (Chapter 2) and one other country’s practices discussed in this chapter. How do these differences affect companies’ ability to compete with other companies worldwide?

The answer may vary depending on the country chosen by students. In 2007, U.S. Congress passed an increase in the federal minimum wage from $5.15 in increments to $7.25 in 2009. Currently, approximately 24 states have minimum wage laws that specify higher minimum wage rates than federal level specified in the FLSA. Specific FLSA exemptions permit employers to pay some workers less than the minimum wage such as students employed in retail or service businesses, on farms, and etc. (with the consent of the DOL). In some countries governments establish nationally uniform minimum wage rates, while in other countries minimum wage rates are established depending on regions or occupations. For instance, in Brazil, the minimum wage rate is nationally uniform (545 RS in 2010). In Canada, the jurisdiction defined by province determines the minimum hourly rate. For instance, the minimum wage rate in Alberta is $9.95 and in Nunavut (the highest rate) it is $11.00. In China, there is no national minimum wage rate. Instead, it varies by region. In 2011, the monthly minimum wage was 1,300 yuan in Guangzhou (the highest in China) and 1,120 yuan in Shanghai with the lowest amount in Anhui Province and Jiangxi Province at 500 yuan. Mexico has two minimum wage rates: 1) general minimum wage applies to all workers and the amount depends on the region of the country (In 2011, minimum wage in Geographic area C was 56.70 pesos per day and 59.80 pesos per day in Geographic area A) and 2) occupational minimum wages. In India, minimum wage rates are determined by the government for certain sectors, and collective agreement determines others. In Germany, minimum wage rate is set by a collective bargaining process. German government does not mandate a minimum wage except for construction workers, electrical workers, janitors, roofers, painters, and letter carries.

Companies’ ability to compete globally would be affected by the minimum pay regulations of the country where they operate. Companies operating in countries or regions with lower minimum wage rate may benefit from lower labor costs.

15-2. Discuss the main differences between retirement systems in the United States (taking into account legally required and discretionary programs) and one other country discussed in this chapter. Does it appear that the costs of retirement programs are creating burdens for competitive advantage?

In the United States, individuals may receive retirement benefits from three sources: 1) employer-sponsored retirement plans provide employees with income after they have met a minimum retirement age and have left the company, 2) OASDI program provides government-mandated retirement income to employees who have made sufficient contributions through payroll taxes, 3) individuals may use their initiative to take 332 © Pearson Education Limited 2015

advantage of tax regulations that have created such retirement programs as individual retirement accounts (IRAs) and Roth IRAs. Canada has two different state pension plans: 1) for Quebec residents and 2) for the rest of the country. Both of the plans are similar to 401(k) plans in the US. Mexico’s former social insurance system has been transforming into mandatory individual account system. In addition to social insurance, in Brazil, there is also voluntary coverage for housewives, students, the unemployed and other categories.

Also, they have a special system for public-sector employees and military personnel. In China, there has been a new law to decouple the employment relationship from the social insurance system, setting up a unified basic pension system. The new system has social insurance and mandatory individual accounts. Countries have differences and similarities in terms of retirement systems. The cost of retirement programs may create burdens for competitive advantage for companies operating in countries where government contributions are lower and mandated employer/employee contributions are higher.

VII.

End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses

Case: North American Expansion for Threads Apparel Instructor Notes: Organizations that expand their operations internationally must understand the basic legal requirements as well as norms for pay and benefit in the country where they are doing business. The North American Free Trade Agreement (NAFTA) has increased trade between the United States, Canada, and Mexico and as a result, more organizations are doing business in one or both of these countries. However, employment practices in Canada and Mexico still differ from the United States and a company entering into one of these countries must understand the labor environment.

Suggested Student Responses: 15-3. What are some labor-related factors that Threads should consider when comparing Mexico and Canada?

Beyond the availability of the right talent, an important consideration is related to costs and employment practices. A company must consider local pay rates, and costs of healthcare and retirement benefits. A company should also consider the presence or absence of organized labor.

15-4. What are some labor-related factors that would favor Canada as the location of the new facility? Mexico?

The employment environment in Canada is more similar to the United States than Mexico. As such, Thread’s management may find it easier to transition into the Canadian work environment. With higher paid workers, Threads could potentially more easily 333 © Pearson Education Limited 2015

maintain the high quality standards that they have based their reputation on. Canada also has a public healthcare system, which reduces the burden placed on employers. Threads may choose to provide additional healthcare benefits, but costs will likely be lower than they pay for U.S. workers. Mexico is more attractive from a cost management standpoint.

Labor costs are far below those in Canada, which are more in line with U.S. norms.

Mexico has lower pay rates, and the government provides most healthcare and retirement benefits.

MYLAB QUESTIONS 15-5. Why is it important for HR and compensation professionals to learn about compensation practices in other parts of the world? Discuss.

Answer: Answer should include the following points: The current state of globalization has resulted in a high level of interconnections between the economies of various parts of the world. U.S. employers will increasingly conduct business with entities in a variety of other countries as former underdeveloped parts of the world experience tremendous economic, trade, and standard of living growth.

In addition, the move from traditional manufacturing to knowledge- and service-based employment also means that jobs as well as markets are more likely to be dispersed geographically.

As the need for employers to interact globally increases, HR management professionals are going to have increased opportunities to develop compensation and benefits programs for U.S. employees in foreign assignments, as well as for indigenous employees in foreign offices of the parent company.

It is essential that compensation professionals know the basic legal employment context and the minimum employment statutory employment standards of the country where they propose to do business. After that, compensation professionals may consider the norms for competitive pay and benefits needed to attract the desired talent.

15-6. Briefly compare minimum wage rates and paid time off policies in Canada and Mexico.

Answer: Answer should include the following main points about each country: Canada (wage rates) In Canada, there is a statutory minimum wage law. Provincial governments must set minimum rates of pay. In 2011, British Columbia and Canada had the lowest minimum wage rate ($8.75). The highest minimum wage rate is in Nunavut ($11.00).

334 © Pearson Education Limited 2015

Mexico (wage rates) Workers are entitled to paid time-off during public holidays and workers required to work during a mandatory holiday are entitled to double pay. Female employees are entitled to maternity leave—6 weeks leave prior to giving birth and 6 weeks leave after birth on full salary. Employees are entitled to 6 vacation days after being employed for 1 year and to 2 more days for each subsequent year, up to a maximum of 12 days.

Canada (paid time off) Canadian employment law holds that employees are entitled to between 8 and 9 annual paid holidays as well as 2 weeks paid vacation time along with a sum of money as vacation pay (increasing to 3 weeks after 6 years of employment). The amount of vacation pay is equal to 2% of employee's pay for the preceding year per week of vacation. Employees are eligible for a total of 17 weeks' benefits during pregnancy and after childbirth.

Mexico (paid time off) There are two minimum wage rate applications in Mexico. General minimum wage applies to all workers and the amount changes depending on the region of the country. In 2011, minimum wage was 56.70 pesos per day in Geographic area C, 59.80 pesos per day in Geographic area A. Occupational minimum wage is the second type and it is higher than the general minimum wage.

VIII. Additional Cases from the MyManagementLab Website; Instructor Notes, and Questions and Suggested Student Responses Case: Expatriate Problems at Global Appliance Instructor Notes There are many human resource management practices that affect the success of international assignments including the selection and training of expatriates. The design of the compensation package also has a significant effect on the success of international assignments. There must be incentives for employees to take international assignments and also financial risk to the employee should be minimized. In ensuring the success of expatriates, careful attention should be paid to the pay and benefits given to those asked to work in an international assignment. In this case, the Human Resources Director most likely needs to speak with more employees and current expatriates to understand their concerns, but initially examining their compensation program is a good first step.

335 © Pearson Education Limited 2015

Suggested Student Responses: 15-7. How can compensation practices affect the willingness of executives at Global Appliance to take international assignments?

Easing financial concerns helps make an international assignment more attractive. Often, an employee may respond positively to incentives, but at a minimum does not want an international assignment to affect him or her negatively from a financial aspect.

Employers must also consider the effects on the employee’s family while on an international assignment. As Global’s expatriate compensation program has changed over the years, it is reasonable to suspect that those changes may have impacted satisfaction with international assignments.

15-8. What are some aspects of Global’s compensation practices that Jackson should examine?

Jackson should first examine the base pay of the expatriates and ensure that their process for setting base pay at least allows the expatriates to maintain their same purchasing power. He should also examine incentives in place. If they do not currently offer a foreign service premium, they may want to consider doing so. He should also examine benefits such as rest and relaxation leave allowances and benefits to support the education of children. Further, Jackson should examine some of the unique incentives offered to some individuals over the years to ensure that such incentives are determined for appropriate business reasons and that they are fairly distributed. Finally, since some employees are indicating that it “isn’t worth it” to take on the assignments, Jackson should look at the repatriation practices of the company.

336 © Pearson Education Limited 2015

CHAPTER 16 Challenges Facing Compensation Professionals

Learning Objectives 1. Explain the impact of economic recession and underemployment on compensation practice.

2. Point to the reasons for rising wages in China.

3. Describe the challenges associated with executive compensation.

4. Summarize the challenges associated with health care reform.

5. Describe the influence of changing workforce demographics on employee benefits practice.

6. Summarize the issue of marriage between same-sex individuals and the U.S. Supreme Court ruling on the Defense of Marriage Act.

Outline I. II.

Overview Fallout from the “Great Recession” A. What Is an Economic Recession?

III. Underemployment: Implications for Compensation A. The Compensation-Productivity Gap IV. Executive Compensation V. Rising Wages in China VI. Challenges in Healthcare Reform VII. Workforce Demographics Shifts A. Labor Force Diversity B. Relevance for Employee Benefits C. Considerations for Employee Motivation VIII. Marriage Between Same-Sex Individuals and the U.S. Supreme Court Ruling on the Defense of Marriage Act IX. Discussion Questions and Suggested Answers

Lecture Outline I.

Overview 1. Four key issues that will shape the work of compensation professionals: a. Fallout from the “Great Recession” b. Rising wages in China 337 © Pearson Education Limited 2015

c. Challenges in health care reform d. Workforce demographic shifts II.

Fallout from the “Great Recession” A. The U.S. Economy Experienced an Economic Recession 1. Between December 2007 and June 2009, lasting 19 months 2. The term “Great Recession” is widely used to describe the significance of it 3. Was the longest recession since World War II B. What Is an Economic Recession?

1. Economic recession refers to a general slowdown in economic activity 2. Evidence of economic recessions include: a. Reduced gross domestic product (GDP) b. Increased unemployment rates 3. Reduced consumer spending is one of the primary causes of economic recessions 4. Consumers’ demand for products and services declines

Example: Lower consumer demand • General Motors and Chrysler respond to lower consumer demand for their products by cutting production levels in order to avoid excess inventory 5. Significant layoffs of employees occur due to lower demand Example: Layoff activity • The number of layoffs, separations, and initial claimants a. rose dramatically during the recession b. began decreasing following the recession c. numbers following the recession remain substantially higher than prior to the recession Period 2005 2006 2007 2008 2009 2011 2012

Layoff Events 4,881 4,885 5,363 8,259 11,824 6,596 6,051

Separations 884,661 935,969 965,935 1,516,978 2,108,202 1,112,710 1,152,258

Initial Claimants 834,533 951,155 978,712 1,670,042 2,442,000 1,289,273 1,777,143

6. Reduced production adversely affects other companies’ operations 7. Reduced demand for products and services across industries contributes to the recession 338 © Pearson Education Limited 2015

Example: Reduced demand for products and services • The Federal Reserve Bank: a. 86 percent of industries have cut back production since the beginning of the Great Recession b. the reduction is the most widespread since 1969 (the Federal Reserve Bank began tracking this information in 1969) 8.

GDP a. Declined each quarter during the Great Recession b. Began rising following the end of the recession c. Will take some time to get back to pre-recession levels

III. Underemployment: Implications for Compensation A. Underemployment: Implications for Compensation 1. Underemployment refers to employees who wish to work full-time but are forced to work part time for economic reasons such as: a. Poor business conditions b. Inability to find a job Example: Underemployment in the U.S. • The number of underemployed individuals rose dramatically since recession Period October–November 2007 October–November 2008 October–November 2009 October–November 2010 October–November 2011 October–November 2012

Number Underemployed 4,201,000 7,217,333 8,907,333 8,902,666 8,443,333 8,114,000

Absolute Change, 2007–2012 Percent Change, 2007–2012

3,913,000 93

2. The mean hourly earnings of the underemployed were below those of fulltime workers, both: a. Overall b. In each educational group

339 © Pearson Education Limited 2015

Example: Underemployed v. Full-time Workers Education Group Underemployed Full-time workers Difference All workers $12.80 $20.96 $8.16 High school students 7.07 8.20 1.13 College students 13.04 12.67 0.37 High school dropouts 11.23 12.11 -0.88 High graduates 11.78 16.67 4.89 1-3 years of college 13.83 18.96 5.13 Bachelor’s degree 14.35 26.17 11.82 Master’s or higher 21.46 32.07 10.61 degree • The mean hourly earnings for full-time workers were higher than underemployed workers by 64 percent • The difference between the mean hourly earnings of the underemployed and those of full-time workers ranged between $0.88 and $11.82 in each of the five education groups whose members were not enrolled in school 3. Malemployment occurs when job holders possess greater education, skills, or knowledge than is required to perform their jobs Example: malemployment • Person holding a bachelor’s degree in psychology • Works as a part-time grocery store clerk • Both underemployed and malemployed

B.

4. Longer term implications of underemployment a. Underemployed workers are likely to have lower future earnings i. Employers provide less or no training b. Underemployment may slowdown the economic recovery from recession i. Lower current pay and anticipated lower future earnings will likely reduce the consumption of goods and services ii. Holds back increases in spending, business production, and employment levels The compensation-productivity gap 1. The gap between real hourly compensation and labor productivity shows whether workers’ pay is keeping up with productivity 2. Real hourly compensation measures the purchasing power of a dollar 3. Nominal hourly compensation is the face value of a dollar 4. Increases in the costs of goods and services cause nominal pay to be less than real pay

340 © Pearson Education Limited 2015

Example: Let’s assume, • An employee accepted a job at $10 per hour a. nominal pay: $10 b. real pay: $10 • A year later the price of goods and services increased on average five percent a. nominal pay: $10 b. real pay: $9.50 • Hourly real pay declined by 5 percent or $0.50

5. Productivity growth promotes rising living standards 6. Increases in productivity growth indicate companies’ investments in a. Capital equipment i. New manufacturing facilities ii. Research and development labs iii. Sales distribution centers b. Information technology through structured databases i. Example: physicians may access databases to help them diagnose health conditions based on patients’ symptoms and health histories ii. Example: companies can identify customers for new products and services based on variety of factors such as household income and purchasing history 7. The gap between real hourly compensation and labor productivity widened a. 1947-1973 i. The annual change in productivity averaged 2.8 percent ii. Real hourly compensation growth averaged 2.6 percent b. 1973-1979 i. The annual change in productivity averaged 1.1 percent ii. Real hourly compensation growth averaged 0.9 percent c. 1979-1990 i. The annual change in productivity averaged 1.4 percent ii. Real hourly compensation growth averaged 0.5 percent d. 1990-2000 i. The annual change in productivity averaged 2.1percent ii. Real hourly compensation growth averaged 1.5 percent e. 2000-2011 i. The average annual growth in productivity is 2.3 percent ii. The average annual growth in real compensation is 0.9 percent 8. Reasons for the compensation-productivity gap a. High unemployment following recessions leave employees with relatively lower power to bargain for higher pay i. The supply of individuals seeking work is greater than company demand for new workers 341 © Pearson Education Limited 2015

b. Most companies lose profit during economic recessions, and generally increase their profits following recessions i. Companies promote profits, in part, by holding down employees’ pay IV. Executive Compensation 1.

Executive compensation practices under scrutiny of many from the public, labor unions, federal government, and some boards of directors 2.

Company boards of directors set executive pay 3.

The Dodd-Frank Act requires transparency in setting executive compensation and shareholder advisory vote about their support or lack thereof (“say-on-pay”) 4.

In Europe, four countries instituted laws that provide shareholders with the right to cast a binding vote to approve or disapprove proposed executive compensation packages 5.

Many unanswered questions remain about U.S. executive compensation practices: a. Do shareholders have sufficient knowledge about the qualifications of the executive and whether the proposed compensation package is fitting? b. Should all shareholders have an equal say on pay? That is, would it be appropriate to count votes in proportion to the number of shares? c. Should we assume that individuals will factor in executive compensation practices as part of their decision to invest in a company or to divest from it?

V.

Rising Wages in China 1. Many U.S. companies relocated manufacturing facilities from the United States to other countries such as China due to lower their labor costs 2. The cost of labor in China has been increasing rapidly 3. Rising costs are reducing the competitive advantage gained from relocating manufacturing facilities to China 4. Among developing Asian countries, China’s average pay rate is highest 5. Minimum wage rose rates an average of 24 percent 6. Average monthly income for migrant workers increased 13 percent 7. Chinese policy makers are supportive of increased wages a. Encouraging higher wages promotes domestic consumption b. Increased domestic consumption will decrease the country’s reliance on exports to sustain growth c. Reduced reliance on exports is necessary as labor costs within China increase rapidly 8. Labor shortages contributed to wage increases in China a. One-child policy i. Rapidly aging Chinese population ii. Reduced number of young workforce entrants

342 © Pearson Education Limited 2015

iii. The largest segment of the Chinese population is in the 35-44 age range VI. Challenges in Healthcare Reform A. Overview 1. The Patient Protection and Affordable Care Act (PPACA) was signed by President Barack Obama on March 23, 2010 2. PPACA was amended by the passage of the Health Care and Education Reconciliation Act of 2010 3. These laws provide the basis for health care reform in the United States 4. The goal of the health care reform is to reduce the number of uninsured U.S. residents by 32 million in 2016 5. The estimated cost of the health care reform through the year 2019 is $971 billion 6. The Health Care and Education Reconciliation Act adds several requirements a. There are a multitude of revisions to PPACA such as: i. Limiting the penalty to companies that choose not to offer health insurance b. Adding a variety of provisions that will enable more students and families to qualify for financial aid i. Loans will be administered directly by the U.S. Department of Education B. Key Considerations for Employers 1. The new legislation will require most employers to provide health care insurance to employees 2. Beginning 2014, employers with 50 or more full-time employees that do not offer health insurance coverage must pay a $2000 penalty per employee 3. There are higher fines for employers that offer unaffordable health insurance 4. It is expected that the cost of health care insurance will become more expensive to employers due to the new requirements a. Elimination of the lifetime benefits cap b. Limits waiting periods before new employees may receive health care coverage to a maximum of 90 days VII. Workforce Demographic Shifts A. Labor Force Diversity 1. Labor force diversity will continue to increase based on age, gender, race, and ethnicity due to: a. Changes in the composition of the population b. Labor force participation rates across demographic groups 2. The projected growth of the labor force will be affected by the aging of baby-boom generation a. Born between 1946 and 1964 343 © Pearson Education Limited 2015

B.

b. Will be 54 to 72 years old in 2018 c. The number of workers in this age group is expected to increase significantly between 2008 and 2018 3. Labor Force Participation Rate During the Period 2008-2018 a. Age i. For younger workers: expected to decline from 58.8 percent to 54.5 percent ii. For older workers: expected to rise from 39.4 percent to 43.5 percent b. Gender i. For women: all age groups are projected to increase slightly ii. Projected growth for women is 9 percent iii. Projected growth for men is 7.5 percent iv. Women’s share is expected to increase by less than 1 percent (from 46.5 percent in 2006 to 46.9 percent by 2018) v. Men’s share is expected to decline by less than 1 percent (from 53.5 percent in 2008 to 53.1 percent by 2018) c. Ethnicity i. Hispanic labor force is expected to reach 30 million ii. White non-Hispanics will far outnumber the Hispanics (approximately 107 million versus approximately 30 million) Relevance for employee benefits 1. An employer-sponsored benefits program is most effective when the needs and preferences of the workforce are similar 2. Differences in employee preferences and needs necessitates flexible benefit offerings

344 © Pearson Education Limited 2015

Example: Likely Preferred Benefits Demographics Unmarried male and female employees (uncoupled employees) Employees with dependent elderly parents or relatives Married male and female employees Employees with children, male or female, coupled or uncoupled

Older workers (nearing retirement)

C.

Life Events Benefits Physical fitness programs Generous vacation allowances Elder care benefits Flexible work schedules Flexible work schedules Day care assistance Life insurance Health insurance with dependent coverage Education benefits for children Retirement plans with accelerated benefits accumulation Insurance with prescription drug benefits Generous sick-leave allowances Disability insurance Retiree health care benefits

3. Benefits professionals may use surveys to gather information about employee a. Demographics b. Needs c. Preferences d. Recent or anticipated life changes e. Preference on benefits 4. Current offerings can be compared with the survey results Considerations for employee motivation 1. It is expected that employee benefits will motivate employees to perform better 2. However, it might not be applicable in many settings due to the changing demographics of the U.S. workforce 3. Variation across generational and regional norms regarding: a. Appropriate age of marriage b. Age at which an employee gets concerned with life insurance

VIII. Marriage Between Same-sex Individuals and the U.S. Supreme Court Ruling on the Defense of Marriage Act 1.

In recent decades, more companies have chosen to offer the same employee benefits to domestic partners of employees, sometimes, the partner’s dependent children 2.

Some states have established legislation that grants domestic partners the same rights to receive the same benefits as married spouses 345 © Pearson Education Limited 2015

3.

4.

5.

6.

7.

IX.

Definitions of domestic partners vary. For example, one definition includes unmarried partners in either heterosexual or same-sex relationships. In other cases, domestic partnership is recognized for individuals in a same-sex relationship The Defense of Marriage Act of 1996 prohibits recognition of marriage between same-sex individuals. However, more than a dozen states since that time have instituted laws that legalize same sex marriage, including Iowa, Massachusetts, Rhode Island, and New York Legalized same-sex marriages provided equal protection under state laws, but not federal laws In fact, until June 2012, the Defense of Marriage Act prohibited samesex spouses from being recognized as beneficiaries for federal benefits such as Social Security or leave under the Family and Medical Leave Act. Subsequently, challenges to this prohibition took place in the courts In June 2013, the U.S. Supreme Court ruled that Section 3 of the Defense of Marriage Act is unconstitutional. Specifically, the Court’s ruling applies to the part of the law, which had previously denied federal benefits to gay and lesbian couples in states where such unions are permitted. The ruling means that same-sex couples lawfully married in their state can receive the same federal benefits as heterosexual couples, such as possible tax advantages by filing jointly, benefits for veterans’ spouses and inheritance-tax exemptions.

Discussion Questions and Suggested Answers

16-1. This chapter discusses four important issues that will shape compensation professionals’ work for years to come. Which of these stands to create the greatest uncertainty for compensation professionals? Explain your answer.

This is a subjective question and answers greatly depend on the student’s position and point of view. One can argue that challenges in health care reform create the greatest uncertainty for compensation professionals’ work as there exist some challenges to the legality of PPACA. Several groups of people have already filed lawsuits challenging its legality. They mainly claim that either proving coverage to employers will be very costly to businesses or that PPACA violates the constitutional rights of people. The next steps in these legal challenges entail appeals in various U.S. Courts of Appeals. Ultimately, the issue will likely be decided by the U.S. Supreme Court. In the meanwhile, the landscape for health care reform holds a significant uncertainty for employers and therefore for compensation professionals.

16-2. Describe the most recent developments in health care reform. How do these developments compare to what is discussed in this chapter? To help answer this question, conduct a search on the internet using terms such as ‘health care reform’ or ‘Patient Protection and Affordable Care Act’.

346 © Pearson Education Limited 2015

One of the recent developments in health care reform is that the U.S. Supreme Court agreed to hear a challenge to the PPACA on November 14, 2011. This development set the stage for oral arguments by March 2012 and a decision in late June 2012. Besides, as of October 2011, the constitutionality of PPACA has been upheld by three out of four federal appellate courts. The fourth one declared only the law’s individual mandate alone as unconstitutional. These developments show that health care reform continues to bring complexity for compensation professionals, but after the decision of the higher courts, the uncertainty around the health care reform probably will diminish.

16-3. Explain the factors that contributed to the rising wage in China.

China may have increased its wages because many U.S. companies have relocated their manufacturing facilities from the United States. As such, labor cost rose in China and have been increasing rapidly. Moreover, rising costs are reducing the competitive advantage gained from relocating manufacturing facilities to China. Furthermore, among developing Asian countries, China’s average pay rate is highest: the minimum wage rates rose by an average of 24 percent whereas the average monthly income for migrant workers increased 13 percent. In addition, Chinese policy makers are supportive of increased wages. They have encouraged higher wages to promote domestic consumption knowing that it will decrease the country’s reliance on exports to sustain growth; reduced reliance on exports is necessary as labor costs within China increase rapidly. Additional factors that may have contributed to the labor shortages (and by extension, the wage increases in China) are the one-child policy and the rapidly aging Chinese population.

MYLAB QUESTIONS 16-4.

List the four challenges for compensation professionals. Among these, describe the challenges brought by wage issues in China.

Answer: The four challenges: 1) impact of economic recession on compensation practice, 2) rising wages in China, 3) uncertainty and challenges associated with health care reform, 4) the influence of changing workforce demographics on employee benefits practice. Many U.S. manufacturers relocated their facilities to China to reduce labor cost.

However, labor cost has been increasing in China rapidly. This is negatively affecting the companies that relocated their manufacturing facilities to China. These companies' competitive advantage that is gained by relocation is diminishing. Policy makers of China support the increased wages because higher wages increase domestic consumption, which in return decrease the reliance on exports to sustain country's growth. Labor shortage (due to one child policy) is another factor for wage increases.

16-5. Briefly discuss the uncertainties brought by health care reform and changing workforce demographics.

347 © Pearson Education Limited 2015

Answer: The basis for the health care reform was brought by the Patient Protection and Affordable Care Act (PPACA) and its amendment (Health Care and Education Reconciliation Act of 2010). Before PPACA, companies chose whether to offer health care insurance to employees. With the reform, companies will pay significant penalties if they do not provide health insurance to their employees. There are higher fines for companies that offer unaffordable health insurance. Moreover, the lifetime benefits cap will be eliminated. There will be a limit for waiting periods before new employees may receive health care coverage. Therefore, cost of health insurance will be higher for companies with the health care reform. There have been lawsuits against the new laws and currently there is high uncertainty for employers regarding the health care reform.

Benefit programs that is provide by the employer is most effective when the employees are relatively similar in terms of needs and preferences. Labor force diversity necessitates more flexible benefit offerings. The labor force diversity will continue to rise in terms of age, gender, race, and ethnicity as stated by the U.S. Bureau of Labor Statistics. For younger workers, labor force participation rate is expected to decline and for older workers labor force participation rate is expected to rise. Hispanic labor force is expected to be 30 million in 2018. While women's share of labor force participation is expected to increase by less than 1%, men's share is expected to decrease by less than 1%. The diverse labor force is a challenge for compensation professionals to design benefit plans that will accommodate the needs of their employees.

348 © Pearson Education Limited 2015