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CHAPTER 1
Strategic Compensation: A Component of Human Resource Systems
Learning Objectives
1.1. Define strategic compensation.
1.2. Summarize the role of compensation as a strategic business partner.
1.3. Explain strategic compensation decisions.
1.4. Identify and discuss the building blocks and structural elements of strategic compensation
systems.
1.5. Describe the fit of the compensation function in organizations.
1.6. Identify the stakeholders of the compensation function and summarize their stakes in the
work compensation professionals perform.
Outline
I. Overview
II. Defining Strategic Compensation
III. Compensation as a Strategic Business Partner
IV. Strategic Compensation Decisions
V. Building Blocks and Structure of Strategic Compensation Systems
VI. Fitting the Compensation Function in an Organization’s Structure
VII. Stakeholders of the Compensation System
VIII. Key Terms
IX. Discussion Questions and Suggested Answers
X. End of Chapter Case; Instructor Notes, and Questions and Suggested Student Responses
XI. Crunch the Numbers! Questions and Suggested Student Responses
XII. Assisted-Graded Questions
XIII. Additional Case from the MyManagementLab website; Instructor Notes and Questions
and Suggested Student Responses
Lecture Outline
I. Overview
A. Manpower planning
1. Predecessor to contemporary human resource management, 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. Competitive advantage
a. Since 1980’s recognition that employees can contribute to competitive
advantage
b. Competitive advantage describes a company’s success when the company
acquires or develops capabilities that facilitate outperforming the competition
c. HR becomes a strategic function
II. Defining Strategic Compensation
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. What is Strategic Compensation?
1. Competitive business strategy refers to the planned use of company resources
2. Human resource strategies specify the use of multiple HR practices to reinforce
competitive business strategy.
3. Strategic compensation refers to the design and implementation of compensation
systems to reinforce the objectives of both HR strategies and competitive business
strategies
III. Compensation as a Strategic Business Partner
A. HR and compensation professionals today need to think like the chief executive
officer (CEO) to become a strategic partner in achieving organizational plans and
results
B. Compensation professionals can give the CEO and CFO an understanding of the roles
employees play in the organizations to expand or shrink shareholder value
C. How HR functions serve as strategic business partner
1. Capital refers to factors that enable companies to generate income, raise stock
prices, bring economic value, strong brand identity, and reputation
2. Human capital, refers to sets of collective skills, knowledge, and abilities that
employees can apply to create value for their employers
3. Compensation professionals can leverage the value of human capital in a variety
of ways such as a well-designed merit pay program to reinforce performance
IV. Strategic Compensation Decisions
A. Environmental scanning
1. Used for strategy formulation
2. Main focus is discerning threats and opportunities
B. Competitive business strategy choices
1. Lowest-cost strategy or cost leadership focuses on gaining completive advantage
by being the lowest-cost producer of a product or service within the marketplace
2. Differentiation strategies develop products or services that are unique from those
of their competitors
C. Compensation decisions that support the firm’s strategy
1. Compensation professionals use two broad elements to support strategic
initiatives
a. Basic building blocks
b. Structural design elements
2. Employee roles associated with competitive strategies
a. Compensation professionals must design and implement compensation
practices that elicit strategy-consistent employee roles
V. Building Blocks and Structure of Strategic Compensation Systems
A. Building blocks: Core compensation and Employee Benefits
1. Core compensation
a. Base pay includes hourly pay or wage or salary
b. Is governed by Fair Labor Standards Act of 1938
c. Is set according to compensable factors such as level of skill, effort, and
responsibility required to perform the job and the severity of the working
conditions
i. Compensable factors are used to determine if jobs are equal under the
Equal Pay Act of 1963
d. Is adjusted periodically for cost-of-living increases, differences in an
employee’s job performance, and increases in an employee’s skill level
or job knowledge
e. Seniority pay systems reward employees with periodic additions to base
pay according to employees’ length of service in performing their jobs
i. 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
f. Merit pay is permanent base pay increases granted because of job
performance
g. Incentive pay or variable pay rewards employees for partially or
completely attaining a pre-determined work objective
h. Person-focused pay or competency-based pay rewards employee for
specifically learning new curricula
i. Pay-for-knowledge plans reward managerial, service, or professional
workers for successfully learning specific curricula
ii. Skill-based pay is used mostly for employees who perform physical
work and increases as workers master new skills
2. Employee Benefits
a. Represent nonmonetary rewards
b. Discretionary benefits include three broad categories
i. Protection programs that provide family benefits, promote health, and
guard against income loss caused by factors such as unemployment,
disability, or serious illness
ii. Paid time off such as vacation
iii. Services provide such enhancements as tuition reimbursement and day
care assistance
c. Legally-required benefits are protection programs that attempt to promote
worker safety and health and maintain family income streams
i. Social Security Act of 1935
ii. Family and Medical Leave Act of 1993
iii. Patient Protection and Affordable Care Act of 2010
B. Fundamental Compensation System Design Elements
1. Internal consistency
a. Internally consistent compensation systems clearly define the relative value
of each job among all the jobs within a company
b. 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
c. Is achieved using job analysis and job evaluation
i. Job analysis is a systematic process for gathering, documenting, and
analyzing information in order to describe jobs
ii. Job evaluation is used to systematically recognize differences in the
relative worth among a set of jobs
2. Market competitiveness
a. Market-competitive pay systems are based on results of compensation
surveys
b. Compensation surveys collect and then analyze competitors
compensation data
3. Recognizing Individual Contributions
a. Pay structures recognize differences in employee contributions, such as
credentials, job knowledge, and job performance
b. Pay grades group jobs for pay policy application
c. Pay ranges include minimum, maximum, and midpoint pay rates
C. Alternative Pay Structure Configurations
1. Merit pay plans
2. Sales compensation plans
3. Broadband structures
4. Two-tier wage structures
5. Executive compensation
6. Contingent worker compensation
7. Expatriate compensation
8. Compensation structures in countries other than the United States
VI. Fitting the Compensation Function in an Organization’s Structure
A. How HR Professionals Fit into the Corporate Hierarchy
1. Line employees are workers who are directly involved in producing a
company’s goods or services
2. Staff employees are workers whose job it is to support the line functions-
human resource professionals are staff employees
3. 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
B. The Compensation Function
1. An executive is a top-level manager who reports directly to the corporation’s
CEO or to the head of a major division
2. A generalist, who may be an executive, performs tasks in a variety of
HR-related areas
3. A specialist may be an HR executive, manager, or non-manager who is
typically concerned with only one of the areas of compensation practice
C. How the Compensation Function Fits into HR Departments
1. Compensation, recruitment, and selection
a. Companies can spark interest by communicating the positive features of
the core compensation and employee benefits programs
b. Companies may offer inducements such as signing bonuses
2. Compensation and performance appraisal
a. Is key to effective merit pay programs
b. Employees must perceive a strong relationship between attaining
performance standards and receiving pay increases
3. Compensation and training
a. Successful pay-for-knowledge plans depend upon a company’s ability to
develop and implement systematic training programs
b. Companies implementing pay-for-knowledge plans typically increase the
amount of classroom and on-the-job training
4. Compensation and career development
a. Employees make lateral moves across a company’s hierarchy or vertical
moves up the hierarchy
b. Employees compensation changes reflect career development
5. Compensation and labor-management relations
a. Companies grant COLAs
b. Companies establish base pay on seniority pay
6. Compensation and employment termination
a. Employment terminations are either involuntary or voluntary
b. Some companies offer severance pay for involuntary terminations
c. Companies sponsor pension programs in the case of retirement
d. Companies sometimes use early retirement programs to reduce workforce
size
7. Compensation and legislation
a. Laws were enacted to establish acceptable employment practices and
protect employees’ rights
b. Are grouped 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. Patient Protection and Affordable Care Acto of 2010
v. Pregnancy Discrimination Act of 1978
vi. Americans with Disabilities Act of 1990 (amended in 2008)
vii. Family and Medical Leave Act of 1993
viii.Davis–Bacon Act of 1931
VII. Stakeholders of the Compensation System
A. The success of HR departments depends on how they will serve various stakeholders
including:
1. Employees
2. Line managers
3. Executives
4. Unions
5. U.S. government
B. Employees
1. Must educate employees on training options and connections between training and
their pay
2. Must determine which objectives of discretionary benefits are most important to
their particular workforce
C. Line managers
1. Use their knowledge of relevant laws to help them make sound compensation
judgments
2. Advise them on establishing pay rates
E. Executives
1. Develop and manage sound compensation systems
F. Unions
1. Abide by their collective bargaining agreements
G. U.S. Government
1. Keep updated and comply with all employment legislation
2. Demonstrate that alleged discriminatory pay practices are not discriminatory
End of the Chapter
VIII. Key Terms
Competitive advantage: Describes a company’s success when the company acquires or
develops capabilities that facilitate outperforming the competition
Intrinsic compensation: Reflects employees’ psychological mind-sets that result from
performing their jobs
Extrinsic compensation: Includes both monetary and nonmonetary rewards
Core compensation: Monetary compensation
Employee benefits: Non-monetary compensation
Competitive business strategy: The planned use of company resources—financial capital,
equipment capital, and human capital— to promote and sustain competitive advantage
Human resources strategies: Specify the use of multiple HR practices to reinforce competitive
business strategy
Strategic compensation: Refers to the design and implementation of compensation systems to
reinforce the objectives of both HR strategies and competitive business strategies
Capital: Refers to the factors that enable companies to generate income, higher company stock
prices, economic value, strong positive brand identity, and reputation
Human capital: Refers to sets of collective skills, knowledge, and abilities that employees can
apply to create value for their employers
Cost leadership (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
Differentiation strategies: Companies adopt this strategy when they develop products or
services that are unique from those of their competitors
Base pay: Recurring money employees receive for doing their jobs
Hourly pay or wage: Base pay received for each hour worked
Salary: Base pay received for performing a job, regardless of the actual number of hours
worked
Compensable factors: Skill, effort, responsibility, and working condition factors
Cost-of-living adjustment: Represent periodic base pay increases that are founded on changes
in prices as recorded by the Consumer Price Index (CPI)
Seniority pay: A system to reward employees with periodic additions to base pay according to
employees’ length of service in performing their jobs
Human capital theory: Employees’ knowledge and skills (human capital) add value
Merit pay: Program that assumes that employees’ compensation over time should be
determined, at least in part, by differences in job performance as judged by supervisors or
managers
Incentive pay: Compensation (other than base wages or salaries) that fluctuates according to
employees’ attainment of some standard based on a preestablished formula, individual or group
goals, or company earnings
Variable pay: Compensation (other than base wages or salaries) that fluctuates according to
employees’ attainment of some standard based on a preestablished formula, individual or group
goals, or company earnings
Person-focused pay: Programs that reward employees for specifically learning new curricula
Competency-based pay: Programs that reward employees for specifically learning new
curricula
Pay-for-knowledge: Programs that reward managerial, service, or professional workers for
successfully learning specific curricula
Skill-based pay: Programs that increase workers’ pay as they master new skills
Discretionary benefits: Any variety of programs that provide paid time off, employee services,
and protection programs that are offered on a discretionary basis
Legally required benefits: Particular sets of benefits the U.S. government requires employers
to offer to employees
Paid time off: Provides employees with pay for time when they are not working (e.g., vacation)
Services: Provide such enhancements as tuition reimbursement and day care assistance to
employees and their families
Protection programs: Legally required benefits that attempt to promote worker safety and
health, maintain the influx of family income, and assist families in crisis
Internally consistent compensation systems: Clearly define the relative value of each job
among all jobs within a company
Job analysis: A a systematic process for gathering, documenting, and analyzing information in
order to describe jobs
Job evaluation: A process to recognize differences in the relative worth among a set of jobs and
to establish pay differentials accordingly
Market-competitive pay systems: Compensation professionals build market-competitive
compensation systems based on the results of compensation surveys
Compensation surveys: Collect and then analyze competitors’ compensation data
Pay structures: Represent pay rate differences for jobs of unequal worth and the framework for
recognizing differences in employee contributions
Pay grades: Group jobs for pay policy application
Pay ranges: Include minimum, maximum, and midpoint pay rates
Line employees: Employees that are directly involved in producing companies’ goods or
delivering their services
Staff employees: Employees that support the line functions
Severance pay: Companies may choose to award and amount, usually the equivalent of several
months’ pay following involuntary termination
Pension programs: Provide income to individuals throughout their retirement
Early retirement programs: Contain incentives designed to encourage highly paid employees
with substantial seniority to retire earlier than they had planned
Generalist: A human resource professional that may be an executive that performs tasks in a
variety of HR-related areas
Specialist An HR executive, manager, or non-manager who is typically concerned with only one
of the areas of compensation practice
