978-0134320540 Chapter 13 Lecture Notes

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CHAPTER 13

Compensating Expatriates

Learning Objectives

13-1. Discuss competitive advantage and how international activities fit in.

13-2. Describe and explain preliminary considerations compensation professionals

should take under advisement before designing international compensation

programs.

13-3. List the main components of international compensation programs.

13-4. Discuss the balance sheet approach for U.S. expatriates’ compensation

packages.

13-5. Describe repatriation issues.

Outline

I. Competitive Strategies and How International Activities Fit In

II. Preliminary Considerations

III. Components of International Compensation Programs

IV. Incentive Compensation for U.S. Expatriates

V. Establishing Employee Benefits for U.S. Expatriates

VI. Balance Sheet Approach for U.S. Expatriates’ Compensation Packages

VII. Repatriation Pay Issues

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 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

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

D. How Globalization Is Affecting HR Departments

1. Employee selection

a. Culturally sensitive?

b. Are families willing to adjust?

2. Training

a. Cross-cultural values

3. The use of international assignments is an important issue addressed by

companies located in countries across the world

E. Complexity of International Compensation Programs

1. 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 are foreign national citizens who work in U.S. companies’ branch offices

or manufacturing plants in their home country

3. TCNs are foreign citizens who work in a U.S. company’s branch in a foreign

country other than the U.S. or their home country

4. Expatriates are U.S. citizens employed by a U.S. company in a foreign country

5. HR professionals construct international compensation packages based on three

main factors:

a. Term of international assignment

b. Staff mobility

c. Equity: pay referent groups

6. Term of international assignments

a. Short term (less than one year) generally do not require major changes in

domestic compensation packages

b. Extended (long) term assignments necessitate 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

7. 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 to make moves as comfortable as possible

8. Equity: pay referent groups

a. Expatirates are likely to evaluate compensation , in part, according to equity

considerations

b. Referrent groups

i. Domestic employees

ii. Host country employees

III. Components of International Compensation Programs

A. Setting Base Pay for U.S. Expatriates

1. U.S. companies must determine method

2. Purchasing power important consideration influenced by:

i. Stability of local currency

ii. Inflation

B. 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. Most appropriate for expatriates

d. Equity pay problems not an issue because expatriates are typically 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

C. 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. 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 which is the price at which one country’s currency can be

swapped for another

d. Rate fluctuations affected by:

i. Government policies

ii. Market forces

4. Inflation

a. Defined as the increase in prices for consumer goods and services

b. Increases in inflation diminish purchasing power

IV. Incentive Compensation for U.S. Expatriates

A. Overview

1. International compensation plans to encourage expatriates to accept and remin on

international assignments

2. Also compensates for willingness to tolerate less desirable living and working

conditions

a. Promote higher job performance

b. Minimize dysfunctional turnover

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

5. 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

D. Mobility Premiums

1. Designed to encourage employees to move from one assignment to another

a. From a domestic position

b. Between foreign assignments

2. Generally given in a one lump-sum payment

V. Establishing Employee Benefits for U.S. Expatriates

A. Overview

1. Companies design benefits programs to attract and retain the best expatriates

2. Also promote a sense of security for expatriates and their families and help

maintain contact with friends and family in the U.S.

3. 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 provide family benefits, promote health, and guard

against income loss caused by such catastrophic fctors as unemplment,

disability, or serious illness

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. Expatriates generally receive paid time off for foreign national or local

holidays

e. Leave for personal or family emergencies

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. Covers expatriates’ expenses to relocate to foreign posts

b. Payments based on three main factors:

i. Distance

ii. Length of assignment

iii. Rank in the company

3. Education reimbursements for expatriates’ children

a. Generally for private, English-speaking schools

b. Tuition is generally higher than in U.S. private schools

c. 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

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. Length and frequency depends on expected duration of assignment

e. Generally, expatriates have to be on the assignment for a specific period (6-12

months)

5. Rest and relaxation leave and allowances

a. Provided for expatriates who work in designated hardship foreign locations

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

VI. Balance Sheet Approach for U.S. Expatriates’ Compensation Packages

A. Overview

1. Provides expatriates the standard of living they normally enjoy in the United

States

2. Strategic value for two reasons

a. Protects expatriates’ standards of living

b. 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

B. Housing and Utilities

1. Eployers provide to cover the difference between housing and utilites costs in the

U.S. and in foreign posts

a. U.S. Departement of state uses the term quarters allowance

2. Quarters allowance table contains three main sections:

a. Survey date is the month when the Office of Allowances received housing

expenditure reports

b. Exchange rate section includes effective date, foreign unit, and number per

U.S. dollar

c. Annual allowance for family status and salary range includes

i. Family status: Single or Family

ii. Family refers to a two-or-more-person group, larger families receive

supplements

C. Goods and Services

1. Expatriates receive when the ost of living is higher in that country than it is in the

U.S.

2. Based on State Department’s Indexes of Living Costs Abroad

a. Place-to-place cost comparisons at specific times and currency exchange rates

D. Discretionary Income

1. Covers a variety of financial obligations in the United States for which expatriates

remain responsible while away

2. Usually long-term in nature

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. Employer considerations: Tax protection and tax equalization

a. Under the balance sheet approach, companies choose between two approaches

to help address concerns about double taxation:

i. Tax protection

ii. Tax equalization

b. Hypothetical tax method is a key element of both tax protection and

equalization

i. Calculated as the U.S. income tax based on the same salary level,

excluding all foreign allowances

c. Under tax protection employers reimburse expatriates for the difference

between the actual income tax amount and and the hypothetical tax when the

actual tax amount is greater

d. Under tax equalization employers take the responsibility for paying income

taxes to the United States and foreign governments on behalf of the

expatriates

i. Deduct income from the expatriates’ paychecks that totals the hypothetical

tax amounts at year’s end

ii. Reimburse expatriates for the difference between the hypothetical tax and

the actual income tax whenever the actual income tax amount is less

VII. Repatriation Pay Issues

A. Overview

1. Returning expatriates might initially view domestic assignments as a punishment

because their total compensation decreases when they lose special pay incentives

and leave allowances

2. Some returning expatriates perceive their value to the company heightens because

of their overseas assignments, more so than the company does

3. Companies can prevent many of these problems by following two measures:

a. Investing in career development programs to signa that the company values

returnees

b. Companies should capitalize on expatriates’ experiences to gain a better

understanding of foreign business environments

End of Chapter

VIII. Key Terms

North American Free Trade Agreement (NAFTA): Free trade agreement between the U.S.,

Canada, and Mexico

Repatriation: The process of making the transition from an international assignment and living

abroad to a domestic assignment and living in the home country

Host country nationals (HCN): Foreign national citizens who work in U.S. companies’ branch

offices or manufacturing plants in their home countries

Third country nationals (TCN): Foreign national citizens who work in U.S. companies’

branch offices or manufacturing plants in foreign countries—excluding the United States and

their own home countries

Expatriates: U.S. citizens employed in U.S. companies with work assignments outside the

United States

Home country-based pay method: Compensates expatriates the amount they would receive if

they were performing similar work in the United States

Host country-based method: Compensates expatriates based on the host countries’ pay scales

Headquarters-based method: Compensates all employees according to the pay scales used at

the headquarters

Exchange rate: The price at which one country’s currency can be swapped for another

Inflation: Is the increase in prices for consumer goods and services

Foreign service premiums: Monetary payments above and beyond regular base pay

Hardship allowance: Compensates expatriates for their sacrifices while on assignment

Mobility premiums: Reward employees for moving from one assignment to another

Relocation assistance payments: Cover expatriates’ expenses to relocate to foreign posts

Home leave benefits: Enable expatriates to take paid time off in the United States

Balance sheet approach: Provides expatriates the standard of living they normally enjoy in the

United States

Housing and utilities allowances: Cover the difference between housing and utilities costs in

the United States and in the foreign post

Quarters allowances: Term used in the U.S. to refer to housing and utilities allowances

Goods and services allowances: Offered when the cost of living is higher in that

country than it is in the United States

Indexes of living costs abroad: Compare the costs (U.S. dollars) of representative goods and

services (excluding education) expatriates purchase at the foreign location with the cost of

comparable goods and services purchased in the Washington, DC, area

Discretionary income: Covers a variety of financial obligations in the United States for which

expatriates remain responsible

Hypothetical tax: Employer calculation of the U.S. income tax based on the same salary level,

excluding all foreign allowances

Tax protection: Employers reimburse expatriates for the difference between the actual income

tax amount and the hypothetical tax when the actual income tax amount—based on tax returns

filed with the IRS—is greater

Tax equalization: Employers take the responsibility for paying income taxes to the U.S. and

foreign governments on behalf of the expatriates