Please click here to access the new HRM Failures case associated with this chapter. HRM
Failures features real-life situations in which an HR conflict ended up in court. Each case
includes a discussion questions and possible answers for easy use in the classroom. HRM
Failures are not included in the text so that you can provide your students with additional
real-life content that helps engrain chapter concepts.
1 Chapter Summary
This chapter discusses the nature of the pay structure and its component parts, the pay level, and
the job structure. Equity theory is discussed relative to internal and external comparisons that
employees make about their pay. Such comparisons may have consequences for employee
attitudes and retention. Such comparisons also play an important role in the controversy over
executive pay. Two administrative tools used in managing pay level and job structure
components of the pay structure are pay benchmarking surveys and job evaluation. A discussion
of globalization suggests why benchmarking is increasingly critical to meet the competition. A
theme that runs through this chapter is the need to consider how the organization’s strategy
matches the compensation plan. For example, skill-based pay is discussed in terms of the trend
toward reducing bureaucracy and communication of compensation being critical to reinforce
participation and commitment that is increasingly expected from employees.
2 Learning Objectives
After studying this chapter, the student should be able to:
1. List the major decision areas and concepts in employee compensation management.
2. Describe the major administrative tools used to manage employee compensation.
3. Explain the importance of competitive labor-market and product-market forces in
compensation decisions.
4. Discuss the significance of process issues such as communication in compensation
management.
5. Describe new developments in the design of pay structures.
6. Explain where the United States stands from an international perspective on pay issues.
7. Explain the reasons for the controversy over executive pay.
8. Describe the regulatory framework for employee compensation.
3 Extended Chapter Outline
Note: Key terms appear in boldface and are listed in the “Chapter Vocabulary” section.
Opening Vignette:
Deciding Where to Manufacture: The Role of Labor Costs
Mike McNamara is the CEO of Singapore-based Flextronics International. He claims that
justifying manufacturing electronic parts in the US is getting easier due to a trend of increasing
wages in low-cost countries like China and companies wanting to reduce transportation costs by
manufacturing parts closer to the customer. Being closer to the company provides the added
benefit of making it easier to assess and respond to changes in customer demand. This makes
locating production facilities either in the US or in Mexico (which offers proximity to customers
combined with labor costs that are slightly higher than countries like China but still lower than in
the US). Locating facilities in the US also provides a hedge against currency fluctuations.
Discussion Question
1. Explain what some of the implications of relocating production facilities are for HR
professionals in an organization.
There are human resource implications when a company decides to relocate its facilities.
Broadly speaking, these implications have to do with the decisions around what to do
with the workforce — in particular, the workforce that is directly affected by the decision
4 Introduction
From the employer’s point of view, pay is critical in attaining strategic goals.
1. Pay has a major impact on employee attitudes and behaviors.
2. Employee compensation is typically a significant organizational cost. (See
Table 11.1 for industry companies of Total Compensation as a Percentage
of Revenues.)
B. From the employees’ point of view, policies having to do with wages, salaries,
and other earnings affect their overall income and thus their standard of living.
Competing Through Sustainability
Working at Apple: Is Serving a ‘Higher Purpose” Enough?
This vignette provides an overview of an increasingly common issue for organizations today –
satisfying employees through pay and benefits verses creating a situation where the employee can
appreciate the notion of a protean career. The case discusses employees in Apples company stores
who earn around $11 per hour – substantially less than their counterparts at AT&T or Verizon
Wireless stores. Additionally, there appears to be little opportunity for advancement for these
employees. Apple has recognized the potential long-term impacts of not providing these
“specialists” with sustainable careers and career paths and has started to implement programs
intended to bolster long-term retention of employees.
Discussion Question
1. Can enthusiasm for an organization’s products and services make up for lower employee pay
over time?
Student responses may vary. However, economic realities today may outweigh an employee’s
2. Does it matter whether the organization is for-profit versus not-for-profit?
Again, since responses will be very personal, they will also vary. Depending on each student’s
C. Pay decisions can be broken into two major areas: Pay Structure and
Individual Pay.
1. Pay structure refers to the relative pay of different jobs (job structure)
2. Pay level is the average pay in organizations, including wages, salaries,
3. Job structure is the relative pay of jobs in organizations (i.e., the range of
4. Pay policies are attached to jobs, not individuals, in order to make the
5 Equity Theory and Fairness
A. Equity theory describes a process in which people evaluate the fairness of their
pay by comparing their pay to that of other people.
1. A person will compare his or her ratio of perceived outcomes (e.g., pay,
benefits, etc.) to perceived inputs (e.g., education, effort, experience) to
the ratio of a comparison other.
2. If the person’s ratio is higher, research suggests that rationalization will
occur to account for the perceived overpayment. If the comparison other’s
ratio is higher, the person may attempt to restore equity by reducing one’s
inputs (e.g., working less), increasing one’s outcomes (e.g., asking for a
raise, theft), or leaving the company.
3. Two types of employee social comparisons of pay are especially relevant
in making pay-level and job structure decisions. (See Table 11.2)
a. External equity pay comparisons focus on what other organizations
pay for roughly the same job. These comparisons influence
decisions to join and remain in the organization. A market-pay
survey is used by organizations to examine the level of other
organizations’ pay.
b. Internal equity pay comparisons focus on what employees within
the same organization, but in different jobs, are paid. In addition,
employees make internal equity pay comparisons with others
performing the same job.
III. Developing Pay Levels
A. An organization faces two important competitive market pressures in deciding
what to pay its employees:
1. Product-market competition – the challenge to sell goods and services at a
quantity and price that will bring a return on investment. An organization
that has higher labor costs than its competitors will have to charge higher
prices for products of similar quality. This will likely lead to a loss of sales
to the competition. Product-market competition places an upper bound on
labor costs and compensation, although productivity differences are also
important. Labor costs are the average cost per employee (direct pay and
indirect compensation, such as benefits) and staffing level (number of
employees). Financially troubled organizations tend to focus cuts on one
or both of these.
Competing Through Globalization:
How Much to Produce in China: Labor Costs, Productivity, and Managing Risks
This case highlights some other issues other than strictly cost factors that companies are using in
their decisions concerning where to locate their production facilities. One such issue is too much
dependence on one country for production. Changes in the labor force desires, demographics
and other issues are forcing firms to spread their production facilities around to avoid
dependence on one country.
Discussion Question 1
1. Why are some companies moving production from China to other countries? (See
also the opening to the chapter.)
As discussed in the chapter opener, rising costs in China is certainly one factor,
2. How large of a manufacturing presence will China have going forward?
Based on the evidence presented in the case, China will be a decreasing presence
2. Labor-market competition – the amount an organization must pay to
compete against other organizations that hire similar employees. Usually
B. Employees as a Resource
1. This is a philosophy that considers employees to be an investment
that will yield valuable returns. Controlling costs through
noncompetitive pay can result in low employee productivity and
quality.
2. Pay policies and programs are one of the most important human
resource tools for encouraging desired employee behaviors and
discouraging undesired behaviors.
C. Deciding what to Pay
1. Deciding pay is discretionary, with a broad range. The organization has to
decide whether to pay at, below, or above the market average.
2. Efficiency wage theory states that wages influence worker productivity.
The benefits of higher wages may outweigh higher costs when the
organization’s technology or structure depends on highly skilled
employees or when the organization has difficulty observing and
monitoring employee performance.
D. Market Pay Surveys
1. Benchmarking is a procedure by which an organization compares its own
practices against those of the competition. Benchmarking in this situation
is done by pay surveys that provide information on the going rates of pay
of the competition.
2. Benchmarking is typically accomplished through use of pay surveys,
which provide information on going rates of pay among competing
organizations. The following issues must be determined before pay
surveys are used:
a. Which employers should be included in the survey?
b. Which jobs are included in the survey?
c. If multiple surveys are used, how are all the rates of pay weighted
and combined?
3. Product-market comparisons will be more important when:
a. Labor costs represent a large share of total costs.
b. Product demand is elastic.
c. The supply of labor is inelastic.
d. Employee skills are specific to the product market.
4. Labor-market comparisons will be more important when:
a. Attracting and retaining employees is difficult.
b. The costs of recruiting are high.
5. As well as knowing what other organizations are paying, it is necessary to
know what those organizations are getting in return for their investment in
employees. Ratios such as revenues to employees or revenues to labor cost
could be used.
Competing Through Technology:
When Does Paying More Pay Off: Using Big Data
This vignette overviews the fact than many employers (95% according to Mercer and
WorldatWork) collect benchmark data on pay, yet less than half use analytics and predictive
modeling in setting pay levels. This may be changing. For example, one large regional bank
collected turnover data to create a statistical model that would help them predict an employee’s
probability of turnover. The results might be surprising to some – pay was not the biggest factor
in determining turnover, but rather increased responsibility was. That was very different from
what Ceasar’s Entertainment in Las Vegas learned – their model revealed that changes in salary
did impact turnover, but only to a certain salary level.
Discussion Question
1. Why do companies benchmark?
Students should recognize the variety of reasons a company benchmarks. This case
2. How can data and technology be used to improve benchmarking and make better
decisions about pay?
The answer to this question was spelled out pretty clearly in the vignette – just increasing
E. Rate Ranges
1. Use of rate ranges permit a company to recognize differences in
employee performance. Different employees in the same job may have
different pay rates.
F. Key jobs and nonkey jobs
1. Key jobs are benchmark jobs that have relatively stable content and are
common to many organizations so that market-pay survey data can be
obtained.
2. Nonkey jobs are unique to organizations and cannot be directly valued or
compared through the use of market surveys.
Example: Typical key jobs would include administrative assistant,
department manager, controls engineer, and so on.
IV. Developing a Job Structure
A. A job structure refers to the relative worth of various jobs in the organization,
based on internal comparisons.
B. Job evaluation is an administrative procedure that measures a job’s internal worth
to the organization.
1. The evaluation process is composed of compensable factors, which are
the characteristics of jobs that an organization values and chooses to pay
for.
C. The Point – Factor System – Job evaluators often apply a weighting scheme to
account for the differing importance of the compensable factors to the
organization. Either a priority weight can be assigned using expert judgment
about the importance of each factor, or weights can be derived statistically by how
important each factor seems to be in determining labor-market pay. (Table 11.3
indicates an example of a three-factor job evaluation system).
Example: One of the most popular commercial point-factor systems on the market
is The Hay Plan, which includes three compensable factors: know-how, problem
solving, and accountability.
D. Developing a Pay Structure
1. Includes examining and balancing both internal and external comparisons.
There are significant differences in employers in terms of whether they
place priority on internal or external comparisons (Table 11.4 indicates an
example of both types of data for 15 jobs).
2. Three pay-setting approaches include:
a. Market survey approach – This approach has the greatest emphasis
on external comparisons. It bases pay on market surveys that
cover as many key jobs as possible (for an example, see Table
11.5).
– A pay-policy line is a mathematical expression that describes the
relationship between a job’s pay and its job evaluation points.
(Figure 11.1).
b. Pay policy line – The second pay-setting approach combines
information from internal and external comparisons to derive pay
rates for both key and nonkey jobs. However, actual market rates
are not used for key jobs.
c. Pay grades – Group jobs into a smaller number of pay grades.
(Table 1.6 and the last column of Table 11.5 demonstrate a
five-grade structure).
– A pay grade is grouping jobs of similar worth or content
together for pay administration purposes. (Figure 11.2 provides
an example of a sample pay grade structure).
– The range spread is the distance between the minimum and
maximum amounts in a pay grade
– Disadvantages of using grades are that some jobs may be
underpaid while others may be overpaid.
E. Conflicts Between Market Pay Surveys and Job Evaluation
1. The relative worth of jobs is quite similar overall, whether based on job
evaluation or pay survey data. However, some inconsistencies do arise.
2. In resolving the conflict, emphasizing the internal data would create a
situation of overpaying jobs that are paid less in the market, which drives
up labor costs (and creates product–market problems).
3. If external market data are emphasized and a job is paid lower internally,
the comparisons that employees make internally would result in
dissatisfaction.
4. There are no right answers. An organization should consider its strategy
and what jobs and/or functions will be critical for success.
F. Monitoring Compensation Costs
1. The pay structure represents policy, but practice may not always coincide.
2. One way to examine the difference between policy and practice is to
compute a compa-ratio, which is the actual average pay for
grade/midpoint pay for grade (Table 11.7).
G. Globalization, Geographic Region, and Pay Structures
1. Pay structures can differ substantially across countries both in terms of
their level and in terms of the relative worth of jobs (See Figure 11.3).
2. Typically, expatriate pay and benefits continue to be linked more closely
to the home country. However, this link appears to be slowly weakening
and now depends more on the nature and length of the assignment.