Chapter 11: Total Rewards and Compensation
Chapter 11
Total Rewards and Compensation
Learning Objectives
After students read this chapter, they should be able to:
• Identify the three general components of total rewards and give examples of each.
• Explain the major laws governing employee compensation.
Chapter Overview
Total rewards including compensation systems in organizations must be linked to
organizational strategies. Compensation remunerates employees for their knowledge,
skills, and abilities through:
• Base pay
• Variable pay
• Benefits
The chapter opens with a discussion of the nature of total rewards and compensation
regarding the three basic types of compensation, compensation philosophies, and
compensation responsibilities.
Chapter 11: Total Rewards and Compensation
metrics and compensation. Then, compensation system design issues are explored
including motivation theories and compensation, compensation fairness and equity
(external equity, internal equity, and pay secrecy), market competitive compensation, (lag-
the-market, lead-the-market, and match-the-market strategy), competency-based pay,
individual versus team reward.
The importance of combining data from pay surveys and job evaluations to develop pay
structures is then detailed. The establishment of pay grades, pay ranges, and individual pay
issues (red-circled employees, green-circled employees, and pay compression) are
Chapter Outline
Chapter 11: Total Rewards and Compensation
Companies address pay and benefits with a total rewards philosophy. The total rewards
package includes all forms of compensation; the monetary and nonmonetary rewards
provided by a company to attract, motivate, and retain employees (Figure 11-1).
I. Nature of Total Rewards and Compensation
Several strategic decisions guide the design of compensation practices:
• Legal compliance with all applicable laws and regulations
• Cost-effectiveness for the organization
HR Headline: No Poaching Rules Leave High-Tech Employees Out in the Cold
Most Americans have voluntarily placed their names on a “Do Not Call” list to prevent
unsolicited telemarketing calls. But a conspiracy among high-tech employers in Silicon
These secret agreements were widely instituted to prohibit “bidding wars” among the
companies. Employees receiving job offers from a rival tech firm could use that as
leverage to request a pay increase with the current employer.
Decisions on the lawsuits have not been handed down. But, companies are forewarned
that limiting employee mobility, pay, and opportunity to freely move in the job market
can be a dangerous and costly way to retain talented workers.
Chapter 11: Total Rewards and Compensation
Figure 11-2 identifies elements of three primary components of the total rewards package.
Developing a viable total rewards program that includes an appropriate mix of the three
primary elements means that companies should evaluate compensation policies on a
regular basis. The organizational culture and pay policy should be complementary and
consistent.
A. Components of Compensation
Tangible rewards can be measured and it is possible to calculate the value of each
reward. Intangible rewards, on the other hand, cannot be easily measured or
Base Pay
The basic compensation that an employee receives, usually as an hourly wage or
salary, is called base pay. Many organizations use two base pay categories, hourly
and salaried. Employees paid by the hour receive wages, payments calculated on the
basis of the time worked. In contrast, employees paid a salary receive the same
payment each period regardless of the number of hours worked.
Variable Pay
Benefits
A benefit is a reward—for instance, health insurance, vacation pay, or a retirement
Chapter 11: Total Rewards and Compensation
II. Laws Governing Compensation
Pay practices are regulated by several key laws that address issues such as overtime pay,
minimum wage standards, hours of work, and pay equity.
A. Fair Labor Standards Act (FLSA)
The primary federal law affecting compensation is the Fair Labor Standards Act
(FLSA), which was passed in 1938. Compliance with FLSA provisions is enforced by
Minimum Wage
The FLSA sets a minimum wage to be paid to a broad spectrum of covered
employees. A lower minimum wage is set for “tipped” employees, such as restaurant
servers, but their compensation must equal or exceed the minimum wage when
average tips are included. The current minimum wage of $7.25 an hour was set as
part of the Fair Minimum Wage Act of 2007.
Child Labor Provisions
Exempt and Non-exempt Statuses
Under the FLSA, employees are classified as exempt or nonexempt. Exempt
Chapter 11: Total Rewards and Compensation
Overtime
The FLSA established overtime pay requirements at one and one-half times the
regular pay rate for all hours worked over 40 in a week, except for exempt
employees. The workweek is defined as a consecutive period of 168 hours (24 hours
× 7 days), which does not have to be a calendar week. Hospitals and nursing homes
are allowed a special definition for the workweek to accommodate their 24/7
scheduling demands. No daily number of hours requiring overtime is set, except for
special provisions relating to hospitals and other specially designated organizations.
Common Overtime Issues
For individuals who are nonexempt, employers must consider the following issues:
• Compensatory time off—“comp” hours are earned by public-sector nonexempt
employees in lieu of payment for extra time worked at the rate of one and one–
• Training time—time spent in training must be counted as time worked by
nonexempt employees unless it is voluntary or not directly job-related.
• Travel time—travel time must be counted as work time if it occurs during
normal work hours for the benefit of the employer. Travel to and from work is
not considered compensable travel time.
Chapter 11: Total Rewards and Compensation
B. Pay Equity Laws
Title VII of the Civil Rights Act of 1964 prohibits discrimination on the basis of race,
color, sex, religion, or national origin. However, prior to its passage, pay discrimination
on the basis of sex was outlawed under the Equal Pay Act of 1963.
Equal Pay Act of 1963
The act prohibits companies from using different wage scales for men and women
performing substantially the same jobs. Pay differences can be justified on the basis
Lilly Ledbetter Fair Pay Act
This law was enacted in 2008 in response to a Supreme Court decision restricting the
statute of limitations allowed under the Equal Pay Act for claiming pay
C. Independent Contractor Regulations
The growing use of contingent workers by many organizations has drawn the attention
of several enforcement agencies such as the Internal Revenue Service (IRS), DOL, U.S.
Treasury Department, and state taxing authorities. When workers are improperly
Chapter 11: Total Rewards and Compensation
Additional Laws Affecting Compensation
Several compensation-related laws apply to firms that have contracts with the U.S.
government. These laws require that federal contractors pay a prevailing wage,
which is determined by a formula that considers the rate paid for a job by a majority
of the employers in the appropriate geographic area. The Davis-Bacon Act of 1931,
III. Strategic Compensation Decisions
A. Compensation Philosophies
There are two basic compensation philosophies which should be seen as opposite ends
of a continuum (Figure 11-5). At one end of the continuum is the entitlement
philosophy; at the other end is the performance philosophy. Most compensation systems
fall somewhere in between these two extremes.
Entitlement Philosophy
The entitlement philosophy assumes that individuals who have worked another year
are entitled to pay increases with little regard for performance differences. When
Performance Philosophy
Chapter 11: Total Rewards and Compensation
A pay-for-performance philosophy assumes that compensation decisions reflect
performance differences. Organizations using this philosophy do not guarantee
B. Communicating Pay Philosophy
Sharing the organizational pay philosophy helps employees to recognize the value of
the total reward package provided as well as how their job performance might affect
C. Compensation Responsibilities
HR specialists and line managers work together to administer compensation
expenditures. HR specialists develop and administer the organizational compensation
Payroll Administration
Calculating pay and ensuring timely, accurate payroll processing is particularly
important to assure compliance with compensation laws and to maintain positive
employee relations. Payroll staff may report to the company’s HR function or the
accounting function.
Human Resource Metrics and Compensation
Employers spend a substantial amount of money on employee compensation. Just like
any other area of cost, compensation expenditures should be evaluated to determine
Chapter 11: Total Rewards and Compensation
The raw data needed to calculate various measures may be found in a number of
functions in the company. Wage rates, total payroll costs, and overtime information can
be obtained from the payroll staff or vendor. Productivity numbers may be tracked by
the operations department. Tenure and compensation range information may be tracked
IV. Compensation System Design Issues
Depending on the compensation philosophies, strategies, and approaches identified for an
organization, many decisions are made that affect the design of the compensation system.
Employee satisfaction with the compensation system can be influenced by how the
organization manages these issues.
HR Perspective: Using Predictive Analytics to Determine Pay
For many years, companies have collected information about compensation practices in
their industry and geographic locations. This information helps to ensure that the firm is
paying competitively to attract and retain high-quality workers. In recent years,
companies have started to use more sophisticated analytics to study employee turnover
trends and to determine how compensation might affect retention.
Chapter 11: Total Rewards and Compensation
A. Motivation Theories and Compensation
Two theories of motivation influence the design of compensation systems. Expectancy
theory and equity theory are especially relevant to the perceptions employees have of
the total rewards provided by the organization.
Expectancy Theory
Expectancy theory says that an employee’s motivation is based on several linked
concepts. Figure 11-7 shows the important relationships in expectancy theory. This
Equity Theory
The equity theory states that individuals judge fairness (equity) in compensation by
comparing their inputs and outcomes against the inputs and outcomes of referent
The comparisons are personal and are based on individual perceptions, not
necessarily facts. An individual who feels that he or she is not being rewarded fairly
can restore equity in two ways:
• Reduce inputs
B. Compensation Fairness and Equity
Most people work for monetary rewards. Whether they receive base pay or variable pay,
the extent to which employees perceive their compensation to be fair often affects their
performance and how they view their jobs and their employers.
External Equity
Chapter 11: Total Rewards and Compensation
If an employer’s rewards are not viewed as equitable compared to other
Internal Equity
Internal equity means that employees are compensated fairly with regard to the
knowledge, skills, and abilities (KSAs) they use in their jobs, as well as their
responsibilities, accomplishments, and job performance. Two key issues are
particularly important to internal equity:
• Procedural justice—it is the perceived fairness of the process and procedures
used to make decisions about employees, including their pay. As it applies to
Pay secrecy
Another equity issue concerns the degree of secrecy organizations have regarding
their pay systems. Pay information that may be kept secret in “closed” systems
Chapter 11: Total Rewards and Compensation
of pay. If an organization has implemented competitive pay practices and has a fair
and reasonable pay structure, employee concerns about inequity can be reduced by
sharing this information.
C. Market Competitive Compensation
Whether an organization’s total reward practices are competitive has a significant
impact on employees’ views of compensation fairness. Providing competitive
compensation to employees is a concern for all employers. Organizations face the
HR Skills and Applications: Quantitative Techniques Facilitate Compensation
Management
To effectively manage employee compensation, it is often necessary to conduct
quantitative assessments of reward data. This can be challenging because many HR
professionals have not been given the training required to assess compensation data.
Despite this reality, an understanding of some basic statistical concepts can help
organizations to offer more competitive, cost-effective pay structures that attract talent,
increase job satisfaction, and reduce turnover.
Chapter 11: Total Rewards and Compensation
Lag-the-Market Strategy
An employer using a first-quartile strategy chooses to “lag the market” by paying
below market levels for several reasons. If the employer is experiencing financial
difficulties it may be unable to pay more. Also, when an abundance of workers is
Lead-the-Market Strategy
A third-quartile strategy uses an aggressive approach to “lead the market.” This
strategy generally enables a company to attract and retain sufficient workers with the
required capabilities and to be more selective when hiring.
Match-the-Market Strategy
Most employers position themselves in the second quartile (median), the middle of
Selecting a Quartile
Pay structures and levels can affect organizational performance and staffing quality.
D. Competency-Based Pay
Most compensation programs are designed to reward employees for carrying out their
tasks, duties, and responsibilities. The job requirements determine which employees
Chapter 11: Total Rewards and Compensation
Competency-based pay rewards individuals for the capabilities they demonstrate and
acquire. In knowledge-based pay (KBP) or skill-based pay (SBP) systems, employees
E. Individual versus Team Rewards
Determining how to compensate individuals whose performance may be a result of
team efforts and achievements is complicated. For base pay, employers may
V. Global Compensation Issues
Organizations with employees working throughout the world face some special
compensation issues. Variations in laws, living costs, tax policies, and other factors must
be considered in designing the compensation for local employees and managers, as well as
managers and professionals on international assignment. Fluctuations in the values of
various currencies must be tracked and adjustments made as exchange rates rise or fall.
A. International Assignees
Multinational companies may staff their operations with a mixture of employees from
around the world. Figure 11-11 shows the three primary types of international
assignees.
Chapter 11: Total Rewards and Compensation
Expatriate employees may have unique needs and preferences in terms of how the
compensation package is structured. Therefore, involving the expatriate in structuring
the reward package may improve retention and job performance.
The two primary approaches to international compensation for expatriates are:
• Home-country based approach—it is the most commonly used method. The
overall objective is to maintain the expatriate’s standard of living in the home
country.
o Housing, taxes, and discretionary spending expenses are calculated based on
those items in the home country. The company then pays the expatriate the
VI. Developing a Base Pay System
Figure 11-12 shows how a base compensation system is developed using the compensation
philosophy and job analysis. The process incorporates information gathered while valuing
jobs and analyzing pay surveys—activities designed to ensure that the pay system is both
Employers want their employees to perceive that their pay levels are appropriate in relation
to pay for jobs performed by others within the organization. The two general approaches
for valuing jobs are job evaluation and market pricing. Job evaluation looks at pay levels