IV. Managing Pay to Support Strategy and Change
Alignment issues must be managed successfully to drive future revenues.
Compensation often plays a singular role when organizations restructure.
Strategic changes in the business strategy means the compensation strategy must be
realigned as well.
Pay is a powerful signal of change; changing people’s pay captures their attention.
Pay changes can play two roles in any restructuring.
oPay can be a leading catalyst for change, or
oA follower of change.
Whether pay is a leading catalyst for change or a follower of change,
compensation managers must learn how to implement and manage change.
oNot only must they know the strategic and technical aspects of compensation, they
also must know how to bargain, resolve disputes, empower employees, and develop
teams.
V. Communication: Managing the Message
Compensation communicates and signals what is important and what is not.
Employees must understand the pay system. Their understanding is shaped
indirectly through the paychecks they receive and directly via formal communication
about their pay, their performance, and the markets in which the organization competes.
oAn argument for employee involvement in the design of pay systems is that it
increases understanding. Two surveys are revealing.
A Watson Wyatt survey of 13,000 employees reported that about only 35
percent of them understood the link between their job performance and the pay
they receive.
WorldatWork did a second survey of 6,000 employees. Only about
one-third of them said they understood how pay ranges are determined or had a
reasonable idea of what their increase would be if they were promoted. Fewer
than half understood how their own pay increases are calculated.
oExhibit 18.10 provides further insight into employee (lack of) pay knowledge.
Two reasons are usually given for communicating pay information:
oThe first is that considerable resources have been devoted to designing a fair and
equitable system that is intended to attract and retain qualified people and motivate
performance. For managers and employees to gain an accurate view of the pay
system—one that perhaps influences their attitudes about it—they need to be
informed.
oThe second (and related) reason is that, according to some research, employees
seem to misperceive the pay system.
For example, they tend to overestimate the pay of those in lower-level jobs
and to underestimate the pay of those in higher-level jobs.
Further, there is some evidence to suggest that the goodwill engendered by
the act of being open about pay may also affect perceptions of pay equity.
Interestingly, the research also shows that employees in companies with
open pay communication policies are as inaccurate in estimating pay
differentials as those in companies in which pay secrecy prevails. However,
employers in companies with open pay policies tend to express higher
satisfaction with their pay and with the pay system.
Other research indicates that employee reactions to pay secrecy versus pay
openness depend on equity sensitivity, with those more sensitive to whether pay
is fair given inputs like performance being most likely to respond favorably to
pay openness.
To the degree that pay is based on performance, being more open with pay
could result in positive sorting effects over time to the extent that it is low
performers who are dissatisfied and they leave and are replaced by higher
performing employees.
oIn the case of benefits too, communication plays a potentially important role.
Employees greatly underestimate the value of their benefits, which is a major
concern given that benefits add roughly 40 cents on top of every dollar spent on
cash compensation.
WorldatWork recommends a six-stage process of communication, shown in
Exhibit 18.12.
oStep 1 is defining the objectives of the communication program. While specifying
objectives as a first step seems obvious, doing so is often overlooked in the rush to
design an attractive brochure, website, or CD.
oStep 2 is to collect information from executives, managers, and employees to assess
their current perceptions, attitudes, and understanding of the subject. Information
may be gathered through online opinion surveys and focus groups to identify
problems in understanding the compensation system.
oStep 3 is a communication program that will convey the information needed to
accomplish the original objectives. There is no standard approach on what to
communicate to individuals about their own pay or that of their colleagues.
Some organizations adopt a marketing approach. That includes consumer
attitude surveys about the product, snappy advertising about the pay policies,
and elaborate websites expounding policies and rationale. The objective is to
manage expectations and attitudes about pay.
In contrast, the communication approach tends to focus on explaining
practices, details, and the way pay is determined. The marketing approach
focuses on the strategy, values, and advantages of overall policies and may be
silent on specifics such as range maximums, increase guides, and the like.
oSteps 4 and 5 of the communication process are to determine the most effective
media, in light of the message and the audience, and to conduct the campaign.
Exhibit 18.13 recommends fine-tuning the message in terms of detail and emphasis,
depending on the audience.
Managers need to know how to use the development and motivation
aspects of the compensation program for the people they supervise.
Employees may want to know the processes and policies as well as
specifics about how their pay is determined. The danger is overload—
information is so detailed that employees get snowed under sorting through it.
oStep 6 of the communication process suggests that the program be evaluated. Did it
accomplish its goals?
oPay communication often has unintended consequences.
For example, improving employees’ knowledge about pay may cause
some initial short-term concerns.
Over the years, employees may have rationalized a set of relationships
between their pay and the perceived pay and efforts of others. Receiving
accurate information may require that those perceptions be adjusted.
A. Say What? (Or, What to Say?)
If the pay system is not based on work-related or business-related logic,
then the wisest course is probably to avoid formal communication until the
system is put in order.
oEmployees are constantly getting intended and unintended messages
through the pay treatment they receive.
oSome employers communicate the range for an incumbent’s present job and
for all the jobs in a typical career path or progression to which employees
can logically aspire.
oSome also communicate the typical pay increases that can be expected for
poor, satisfactory, and top performance.
oThe rationale given is that employees exchange data (not always factual)
and/or guess at normal treatment and that the rumor mills are probably
incorrect. However, employee pay knowledge is often quite limited.
How people process information and make decisions, as shown in Exhibit
18.14, offers some new ideas when contemplating compensation
communications.
B. Opening the Books
There are some who advocate going beyond the sharing of pay
information to the sharing of all financial information with employees.
At the minimum, the most important information to be communicated is
the work-related and business-related rationales on which pay systems are
based.
VI. Structuring the Compensation Function and Its Roles
Compensation professionals seem to be constantly reevaluating where within the
organization the responsibility for the design and administration of pay systems should
be located. The organizational arrangements of the compensation function vary widely.
A. Centralization-Decentralization (and/or Outsourcing)
An important issue related to structuring the function revolves around the
degree of decentralization (or centralization) in the overall organization
structure.
Decentralized refers to a management strategy of giving separate business
units the responsibility of designing and administering their own systems.
This contrasts with a centralized strategy, which locates the design and
administration responsibility at corporate headquarters.
oA centralized compensation strategy and function is more likely to be found
in smaller and/or single line of business organizations.
oThis “one size fits all” approach is more likely to make sense when the
entire company mostly competes in a single product market.
However, in organizations that are larger and/or compete in different
product (or geographic) markets, human resource and compensation strategies
are more likely to need to be tailored to fit those different contexts.
oIn such cases, compensation professionals are increasingly likely to be
embedded in each business unit.
Decentralizing certain aspects of pay design and administration has
considerable appeal.
oPushing these responsibilities (and expenses) close to the units, managers,
and employees affected by them may help ensure that decisions are
business-related.
However, decentralization is not without dilemmas.
oFor example, it may be difficult to transfer employees from one business
unit to another.
oA pay system may support a sub-unit’s objectives but run counter to the
overall corporate objectives.
oAlso, decentralization, which by definition includes less direct control of
what managers do, can contribute to legal problems.
Flexibility within Corporatewide Principles
The answers to the problems of decentralization can be found in
developing a set of corporatewide principles or guidelines that all must meet.
The principles may differ for each major pay technique.
The pay system is one of many management systems used in the
organization. Consequently, it must be congruent with these other systems.
oFor example, it may be appealing, on paper at least, to decentralize some of
the compensation functions. However, if financial data and other
management systems are not also decentralized, the pay system may be at
odds with other systems.
Reengineering and Outsourcing
Value chain analysis and Six Sigma are processes used to improve quality
and ensure that value is added by each technique and at each stage in a process.
oFor the compensation system, the basic question to ask is, “Does each
specific activity (technique) directly contribute to our objectives?”
oIf some added value isn’t apparent, then the question is, “How should it be
redesigned? Or should it be dropped?”
oOf those activities that do add value, the next question is, “Who should do
it?” “Should the activity be done in-house, or can others do it more
effectively? That is, should it be outsourced?”
Outsourcing is a viable alternative as organizations struggle with activities
that do not directly contribute to objectives.
oThese are often referred to as transactional activities, which are not unique
to the organization and might be done cheaper (and perhaps also better) by
an outside provider.
oOn the other hand, more transformational or strategic activities (e.g., what
pay-for-performance strategy would best align with the business strategy)
are less likely to be outsourced.
Cost savings are the major potential advantage of outsourcing. Sometimes,
the quality of the service provided may also increase.
Major potential disadvantages include less responsiveness to unique
employee-manager problems, less control over decisions that are often critical
to all employees (i.e., their pay), information leaks to rivals and competitors.
oIn addition, as with any contract, while an agreement may be signed stating
that an outsourcing firm will provide a certain set of services and at a certain
level, either side may subsequently find that their vision of the agreement
and their experience of what is actually delivered may end up being
different.
Balancing Flexibility and Control
One of the major attacks on traditional compensation plans is that they
often degenerate into bureaucratic nightmares that hinder the organization’s
ability to respond to competitive pressures.
oSome recommend reducing the controls and guidelines inherent in any pay
plan. Hence, banding eliminates or at least reduces the impact of range
maximums and minimums.
oReplacing merit grids with bonuses eliminates the link between the pay
increase and the employees’ salary position in the range and performance
rating.
oReplacing job evaluation with skill- or competency-based plans permits
assigning employees to a variety of work, regardless of their pay.
Such approaches are consistent with the oft-heard plea that managers
should be free to manage pay.
oYet, permitting managers to be free to pay employees as they judge best
rests on a basic premise: Managers will use pay to achieve the organization’s
objectives—efficiency, fairness, and compliance with regulations—rather
than their own objectives.
Clearly, some balance between hidebound controls and chaos is required
to ensure that pay decisions are directed at the organization’s goals yet permit
sufficient flexibility to respond to unique situations.
A final issue related to pay design and administration is the skills and
competencies required in compensation managers. The grandest strategy and
structure may seem well designed, well thought out in the abstract, but could be
a disaster if people qualified to carry it out are not part of the staff.
Making Information Useful—Compensation Enterprise Systems
Most managers find themselves overwhelmed with too much information.
The challenge is to make the information useful.
Compensation software transforms data into useful information and guides
decision making.
Many software packages that serve a variety of purposes are available.
oSome of them support employee self-service, by which employees can
access their personal information, make choices about which health care
coverage they prefer, allocate savings between growth or value investment
funds, access vacation schedules, or check out a list of child or elder care
service providers.
oManager self-service helps managers pay their employees appropriately.
oCommunication portals, designed for employees or managers, explain
compensation policies and practices, answer frequently asked questions, and
explain how these systems affect their pay.
oOther software processes transactions. It standardizes forms, performs some
analysis, and creates reports at the click of the mouse.
oWhile compensation software is proliferating, what remains a scarcer
resource is the intellectual capital: the compensation knowledge and
judgment required to understand which information, analyses, and reports
are useful.
Part of this intellectual capital includes analytical (“statistical and
math”) skills.
Another part is knowledge of the business. A shortage of this
knowledge among compensation managers not only limits the usefulness
of compensation software but also limits the contribution of
compensation management.
oComputers inevitably bring up the issue of confidentiality. If personal
compensation data are accessible to employees and managers, privacy and
security issues as well as ethical and legal issues emerge.
Regulations vary around the world.
The European Union has issued the Data Privacy Directive, which is
significantly stronger than U.S. regulations.
Unauthorized users, both inside and outside the corporation, remain
a threat.
B. Ethics: Managing or Manipulating?
Compensation ethics is not an oxymoron. But absent a professional code
of behaviors and values, it is a challenge for compensation managers to ensure
that their actions are ethical.
oPublic discussion of ethics in compensation topics such as executive pay or
backdating option grants benefits from the voices of informed compensation
practitioners.
Managing compensation ethically is increasingly complicated for several
reasons:
oPay really matters; it is important to all of us.
oThe fierce pressure to achieve results.
The increased use of pay for performance, which is based on
results achieved and exceeding targets, can contribute to these pressures.
However, assessing results sometimes has a “smoke and mirrors”
feel to it.
Measures of financial performance do not provide an immutable
gold standard. They can be “managed.”
Where is the Compensation Professional?
Performance-based pay is not the only area that presents ethical dilemmas.
The following reasons force employers to take a hard look at what
employers are doing:
oMisusing and even failing to understand survey statistics
oManipulating job evaluations
oPeer-company competitive data
oMasking overtime and pay discrimination violations
oFailure to understand that correlation does not mean causation
oRecommending pay programs without addressing their expected costs and
returns
A starting point to judge the ethics of our behavior may be our
compensation model, presented with the advice: “Strive to achieve both
efficiency and fairness.”