CHAPTER 9
DIRECT FINANCIAL COMPENSATION (MONETARY COMPENSATION)
CHAPTER OBJECTIVES
9.1 Summarize the usual components of a total compensation plan and the
environment of compensation practice
9.2 Explain the direct financial compensation practices
9.3 Discuss job structures and how they are established
9.4 Summarize competitive pay policies, pay level and pay mix
9.5 Explain what pay structures are and how they are created
9.6 Review exceptions to the rules: compensation for sales representatives, contingent
workers, and executives
KEY TERMS
Total compensation: Both the intrinsic and extrinsic rewards employees receive for
performing their jobs.
union representation.
Interindustry wage or compensation differentials: Pattern of pay and benefits
associated with characteristics of industries.
Exempt employees: Employees categorized as executive, administrative, professional, or
outside salespersons, and not required to be paid at an overtime rate for work beyond the
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Salary: One type of base pay. Employees earn salaries for performing their jobs,
regardless of the actual number of hours worked. Companies generally measure salary on
an annual basis.
Cost-of-living adjustment (COLA): Escalator clause in a labor agreement that
automatically increases wages as the U.S. Bureau of Labor Statistics’ cost-of-living index
rises.
General Schedule: Classification of federal government jobs into 15 classifications (GS-
1 through GS-15), based on such factors as skill, education, and experience levels. In
addition, jobs that require high levels of specialized education (e.g., a physicist),
significantly influence public policy (e.g., law judges), or require executive decision
making are classified in three additional categories: Senior Level (SL), Scientific &
Professional (SP) positions, and the Senior Executive Service (SES).
Profit sharing: Compensation plans that result in the distribution of a predetermined
percentage of the firm’s profits to employees.
Employee stock plans: The right to purchase shares of company stock.
Stock option: Incentive plan in which employees can buy a specified amount of stock in
their company in the future at or below the current market price.
Company stock: The total equity or worth of the company.
Job evaluation: Process that determines the relative value of one job in relation to
another.
Job evaluation ranking method: Job evaluation method in which the raters examine the
description of each job being evaluated and arrange the jobs in order according to their
value to the company.
Pay level compensation policies: Determine whether the company will be a pay leader
(market lead), a pay follower (market lag), or assume an average position (market match)
in the labor market.
Market lead policies: Pay policy that distinguishes companies from the competition by
compensating employees more highly than most competitors. Leading the market denotes
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Compensation survey: A means of obtaining data regarding what other firms are paying
for specific jobs or job classes within a given labor market.
Pay grade: Grouping of similar jobs to simplify pricing jobs.
Pay range: Minimum and maximum pay rate with enough variance between the two to
allow for a significant pay difference.
Wage curve: Fitting of plotted points on a curve to create a smooth progression between
Perquisites (perks): Special benefits provided by a firm to key executives to give the
executives something extra.
Golden parachute contract: Perquisite that protects executives in the event that another
company acquires their firm or if the executive is forced to leave the firm for other
reasons.
Say on pay: Provision that gives shareholders in all but the smallest companies an
advisory vote on executive pay.
LECTURE OUTLINE
TOTAL COMPENSATION AND THE ENVIRONMENT OF COMPENSATION
PRACTICE
● NONFINANCIAL COMPENSATION—Satisfaction that a person receives
from the job itself or from the psychological and/or physical environment in
which the job is performed.
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STRUCTURE OF DIRECT FINANCIAL COMPENSATION
CONTEXTUAL INFLUENCES
● LABOR MARKET—Potential employees located within the geographical area
from which employees are recruited.
● COST-OF-LIVING DIFFERENCES—Cost-of-living differences between
geographic locations may account for variations in compensation for similar jobs.
● Walsh-Healy Act of 1936: The act requires companies with federal
supply contracts exceeding $10,000 to pay prevailing wages. The act also
requires one and a half times the regular pay rate for hours over 8 per day,
or 40 per week.
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● Fair Labor Standards Act of 1938, as Amended: It establishes a
minimum wage, requires overtime pay, recordkeeping, and provides
standards for child labor. Exempt employees are categorized as executive,
administrative, professional, or outside salespersons. Non-exempt
employees are not categorized as executive, administrative, professional,
or outside salespersons, and required to receive overtime pay for work
beyond the completion of standard work hours.
● Equal Pay Act of 1963: Passed to remedy employment discrimination in
private industry. The Equal Pay Act of 1963 is based on the principle that
men and women should receive equal pay for performing equal work.
● Wall Street Reform and Consumer Protection Act (Dodd-Frank Act):
Has provisions relating to executive compensation and corporate
governance that directly and significantly impact the executives, directors,
and shareholders of publicly traded companies and continue the increased
federal regulation of corporate governance and executive compensation
matters.
DIRECT FINANCIAL COMPENSATION COMPONENTS
There are five types of direct financial compensation, including base pay, cost-of-living
adjustments, seniority pay, pay-for-performance, and person-focused pay.
● SENIORITY PAY—Pay program in which pay increases are based on length of
service.
● PERFORMANCE–BASED PAY—Pay is governed by how well one does their
job.
● Merit pay: Pay increase added to employees’ base pay based on their
level of performance.
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● Incentive pay: Compensation, other than base wages or salaries, that
fluctuates according to employees’ attainment of some standard (e.g., a
pre-established formula, individual or group goals, or company earnings).
● Individual incentive plans:
● Group incentive plans: If a team is to function effectively, firms should
provide a reward based on the overall team performance as well.
● Gain sharing: Plans designed to bind employees to the firm’s
productivity and provide an incentive payment based on improved
company performance. The Scanlon plan is a gainsharing plan that
provides a financial reward to employees for savings in labor costs
resulting from their suggestions.
● Scanlon plan: Gainsharing plan that provides a financial reward to
employees for savings in labor costs resulting from their
suggestions.
● Company-wide incentive plans: Organizations normally base company-
wide plans on the firm’s productivity, cost savings, or profitability.
● PERSON–FOCUSED PAY—Job-based pay compensates employees for jobs
employees currently perform. Person-focused pay compensates employees
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developing the flexibility, knowledge, and skills to effectively perform a number
of jobs effectively. Skill-based pay is a system that compensates employees for
their job-related skills and knowledge, not for their job titles. Competency-based
pay is a compensation plan that rewards employees for the capabilities they
attain.
BUILDING JOB STRUCTURES A job structure is an ordered set of jobs that
represents the job structure or hierarchy. Job evaluation is a process that determines the
relative value of one job in relation to another.
ESTABLISHING COMPETITIVE COMPENSATION POLICIES
Compensation policies provide general guidelines for making compensation decisions.
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BUILDING PAY STRUCTURES
Pay structures represent pay rate differences for jobs on unequal worth and the
framework for recognizing differences in employee contributions. Compensation surveys
involve the collection and subsequent analysis of competitors’ compensation data.
assigned to pay grades, it may become obvious that some jobs are overpaid and
others underpaid.
● PAY COMPRESSION—Situation that occurs when less experienced employees
are paid as much or more than employees who have been with the organization a
long time due to a gradual increase in starting salaries and limited salary
adjustments for long-term employees.
EXCEPTIONS TO THE RULES: SALES PROFESSIONALS, CONTINGENT
WORKERS, AND EXECUTIVES
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● BASE SALARY—Factor in determining standard of living and also provides the
basis for other forms of compensation. The U.S. tax law does not allow
companies to deduct more than $1 million of an executive’s salary.
● SEVERANCE PACKAGES—The Securities and Exchange Commission has
adopted far-reaching executive compensation disclosure rules that apply to
publicly traded companies. The new rules require companies to list all the
agreements for each executive, to disclose the payment triggers, and, most
importantly, to give an estimated dollar value of potential payments and benefits
and the specific factors used to determine them. For the first time, investors will
see the estimated total dollar value of the exit packages.
● WALL STREET REFORM AND CONSUMER PROTECTION ACT
9-1. Define each of the following terms: a. compensation, b. direct financial
compensation, c. indirect financial compensation, and d. nonfinancial compensation.
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9-2. What are the contextual influences on direct financial compensation?
9-3. Discuss the determinants of direct financial compensation.
Factors relating to the organization, the labor market, the job, and the employee all have
an impact on job pricing and the ultimate determination of the individual’s financial
compensation.
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Employee: Factors related to the employee are also essential in determining an
individual’s compensation. These factors include job performance, skills/competencies,
seniority, experience, organization membership, potential, political influence, and luck.
Discuss the difference between pay-for-performance and person-focused pay.
Pay-for-performance compensation provides compensation based on employee
performance measures such as productivity. Person-focused pay compensates employees
for developing the flexibility, knowledge, and skills to effectively perform a number of
jobs effectively.
9-4. What are the differences between pay level and pay mix compensation policies?
9-5. How has government legislation affected compensation?
9-6. What is the difference between an exempt and a nonexempt employee?
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and might have a title such as account executive or market researcher. A professional
employee performs work requiring advanced knowledge in a field of learning, normally
acquired through a prolonged course of specialized instruction.
Nonexempt employees: Those in jobs not conforming to the above definitions. However,
nonexempt employees, many of whom are paid salaries, must receive overtime pay.
9-7. Distinguish between the following job evaluation methods: (a) ranking; (b)
classification; (c) factor comparison; and (d) point method.
9-8. Define job pricing. What is the purpose of job pricing?
9-9. Define pay grades. State the basic procedure for determining pay grades.
A pay grade is the grouping of similar jobs to simplify pricing jobs. The grouping of
9-10. Define pay ranges. What is the purpose of establishing pay ranges?
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difference. Pay ranges are generally preferred because they allow employees to be paid
according to experience and performance levels.
9-11. Define broadbanding. What is the purpose of using broadbanding?
9-12. Distinguish between merit pay, bonus, spot bonuses, and piecework.
Merit pay: Pay increase added to employees’ base pay based on their level of
9-13. Discuss the main issues that are associated with compensating contingent
workers.
9-14. What are some company-wide pay plans? Briefly discuss each.
9-15. How is the compensation for sales representatives determined?
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9-16. Describe each of the following: (a) Say on pay; (b) Golden parachute contract;
9-17. What are the various types of executive compensation?
DISCUSSION OF CHAPTER 9 INCIDENTS
HRM Incident 1: The Pay Gap at Barker Enterprise
Roger Babbit is an administrative assistant at Barker Enterprise. For the past 12 years, he
has been working for Maria Mendoza, Director of Human Resources, and they have
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developed a good working rapport. Roger’s current annual salary of $75,000 places him
slightly higher than the midpoint of his salary range. His work has been consistently
exemplary, earning the highest performance appraisal score every year. In addition,
Roger regularly receives recognition rewards (a plaque and an Amazon.com gift
certificate) for his willingness to go the extra mile. In fact, Roger is known for his
trustworthiness, leading many coworkers to ask for career advice.
On a recent Monday morning, Maria introduced Roger to Bianca McCann, a newly hired
administrative assistant in the marketing department. Roger offered to meet Bianca for
lunch to share his positive experiences at Barker. During their conversation, Roger
learned that Bianca earned her associate degree in administrative science from his alma
mater where he earned the same degree 13 years ago. She graduated 2 years ago, and held
a job as an administrative assistant at Madigan Manufacturing prior to joining Barker
Enterprise. Bianca said that she enjoyed her work at Madigan, but was dissatisfied with
the pay because of substantial student loan debt. Barker’s pay scale is substantially higher
than Madigan’s, making it difficult to refuse a $70,000 salary offer.
QUESTIONS
9-26. Name and explain the issue underlying the pay gap between Roger and Bianca.
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9-27. What might be problems associated with withholding a pay adjustment for Roger
under these circumstances?
HRM Incident 2: The Controversial Job
David Rhine, compensation manager for Farrington Lingerie Company, was generally
relaxed and good-natured. Although he was a no-nonsense, competent executive, David
was one of the most popular managers in the company. This Friday morning, however,
David was not his usual self. As chairperson of the company’s job evaluation committee,
he had called a late morning meeting at which several jobs were to be considered for
reevaluation. The jobs had already been rated and assigned to pay grade 3. But the office
manager, Ben Butler, was upset that one was not rated higher. To press the issue, Ben had
taken his case to two executives who were also members of the job evaluation committee.
The two executives (production manager, Bill Nelson and general marketing manager,
Betty Anderson) then requested that the job ratings be reviewed. Bill and Betty supported
Ben’s side of the dispute, and David was not looking forward to the confrontation that
was almost certain to occur.
When David regained his composure, he quietly but firmly asserted, “Bill, we are not
here today to evaluate Marianne. Her supervisor does that at performance appraisal time.
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We’re meeting to evaluate jobs based on job content. In order to do this fairly, with
regard to other jobs in the company, we must leave personalities out of our evaluation.”
David then proceeded to pass out copies of the receptionist job description to Bill and
Betty, who were obviously very irritated.
QUESTIONS
9-28. Do you feel that David was justified in insisting that the job, not the person, be
evaluated? Discuss.
9-29. Do you believe that there is a maximum rate of pay for every job in an
organization, regardless of how well the job is being performed? Justify your
9-30. Assume that Marianne is earning the maximum of the range for her pay grade. In
what ways can she obtain a salary increase?