17 – 1 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich
CHAPTER SEVENTEEN
GOVERNMENT AND LEGAL ISSUES IN
COMPENSATION
Overview
The last part of the total pay model is management. This means ensuring the right people get
the right pay for achieving the right objectives in the right way. While the text has touched on
issues of management, several issues remain. First, noted in Chapter 16, is the significant role
government plays in managing compensation. Legal issues in compensation in the U.S. are
covered in Chapter 17. Chapter 18 covers several aspects of managing compensation: costs
and added value, communication, and change.
Governments around the world play varying roles in the workplace. Legislation in any society
reflects people’s expectations about the role of government, with laws and regulations being
the most obvious government intervention. Beyond direct regulation, government affects
compensation in other ways. As a major employer, as a consumer of goods and services, and
through its fiscal and monetary policies, government affects the supply of and demand for
labor. The objective in this chapter is to help you become more familiar with the legal and
regulatory framework of compensation. Compliance will require legal advice.
Learning Objectives
Chapter Seventeen: Government and Legal Issues in Compensation 17 – 2
• Understand the role of government in the employment relationship.
• Distinguish between an employee and an independent contractor and discuss prevailing
Lecture Outline: Overview of Major Topics
I. Government as Part of the Employment Relationship
A. Overview
II. Fair Labor Standards Act of 1938
A. Minimum Wage
B. Overtime and Hours of Work
C. Child Labor
III. Living Wage
IV. Employee or Independent Contractor?
V. Prevailing Wage Laws
VI. Antitrust Issues
VII. Pay Discrimination: What Is It?
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Lecture Notes: Summary of Key Chapter Points
The presumption that people should be paid different wages based on “general sociological
factors” was still evident in the United States in the 1960s.
• The 1960s civil rights movement and subsequent legislation were intended to end such
practices.
In democratic societies, the legislative process begins when a problem is identified and
corrective legislation is proposed.
Once passed, laws are enforced by agencies through rulings, regulations, inspections, and
investigations.
In the United States, there are three branches of federal government and each plays a role in
the legal and regulatory framework in which employers work toward compliance objectives.
Over time, the legislative branch may change existing laws or pass new ones.
The regulatory environment is also a function of state and local laws, which often cover
Chapter Seventeen: Government and Legal Issues in Compensation 17 – 4
employers not covered by federal laws and/or include requirements that go beyond federal
laws.
To help motivate you to speak to an attorney should you encounter legal compliance risks,
consider Exhibit 17.1, which reports payments by employers to come into compliance with
regulatory actions brought by two U.S. government agencies, the Department of Labor’s Equal
Employment Opportunity Commission (EEOC) and its Wage and Hour Division (WHD).
I. Government as Part of the Employment Relationship
A. Overview
• People differ in their view of what role government should play in the
contemporary workplace.
• All countries throughout the world must address these issues.
o However, different countries and cultures have different perspectives.
• Governments’ usual interests in compensation decisions are whether:
• In addition to being a party to all employment relationships, government units
are also employers and purchasers.
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o Consequently, government decisions also affect conditions in the labor
market.
• In addition to government fiscal policy, the federal government influences
overall economic growth/demand and business activity through its monetary
policy.
• Government affects labor supply through legislation.
o Laws aimed at protecting specific groups also tend to restrict those
groups’ participation in the labor market.
• Exhibit 17.2 provides an overview of the regulatory framework, especially as
it applies to wages and salaries and other forms of direct pay.
II. Fair Labor Standards Act of 1938
• The Fair Labor Standards Act of 1938 (FLSA) covers all employees (with some
exceptions) of companies engaged in interstate commerce or in the production of
goods for interstate commerce. The FLSA’s major provisions are:
• An additional provision requires that records be kept of employees, their hours
worked, and their pay.
A. Minimum Wage
• Minimum-wage legislation is intended to provide an income floor for
workers in society’s least productive jobs.
• When first enacted in 1938, the minimum wage was 25 cents an hour.
Chapter Seventeen: Government and Legal Issues in Compensation 17 – 6
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Education.
o The decline of real purchasing power could be used to argue for indexing
the minimum wage to changes in the consumer price index.
• Estimates from the U.S. Bureau of Labor Statistics indicate that approximately
2.2 million U.S. workers are paid at or below the minimum wage.
o The majority (1.4 million) of those earning minimum wage or less are in
service occupations, mostly food service, where tips supplement hourly
6.4% of women).
• Changes to the federal minimum wage have direct effects (on workers having
a current wage between any state minimum wage and the federal minimum
wage).
o There are also indirect, spillover effects because as legislation forces pay
rates at the lowest end of the scale to move up, pay rates above the
minimum often increase in order to maintain differentials.
o This shift in pay structure does not affect all industries equally.
• Forty-five states plus the District of Columbia have their own minimum
wages to cover jobs omitted from federal legislation.
o If state and federal laws cover the same job, the higher rate prevails.
• Over half (29) the states have minimums higher than the federal rate, with the
highest being the District of Columbia at $12.50.
• Why would anyone be opposed to a mandated minimum wage or making
increases to it?
o The concern is that the resulting higher labor costs for affected firms may
lead them to decrease their demand for workers and/or their hours worked.
o Another consideration in evaluating minimum wage law effectiveness is
whether wage gains go primarily to workers from low income families
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rather than going to workers from families with higher incomes.
• Employers certainly have a stake in minimum wage public policy and thus
may seek to influence it over time.
• Exhibit 17.5 provides an example of how an employer can run afoul of
minimum wage, hours worked, and overtime provisions of the FLSA, as well
as the consequences.
B. Overtime and Hours of Work
• The overtime provision of the FLSA requires payment at one-and-a-half times
the standard for working more than 40 hours per week.
• However, the conditions that inspired the legislation have changed since the
law was passed. Contemporary employers face:
• These factors have lowered the break-even point at which it pays employers to
schedule longer hours and pay the overtime premium, rather than hire, train,
and pay benefits for more employees.
• Again, state laws sometimes go beyond the FLSA.
Exemptions
o The Wage and Hour Division of the Department of Labor, which is
charged with enforcement of the FLSA, provides strict criteria that must
be met in order for jobs to be exempt from minimum-wage and overtime
provisions. These are summarized in Exhibit 17.6.
Chapter Seventeen: Government and Legal Issues in Compensation 17 – 8
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Education.
$970 per week, which would greatly increase the number of U.S.
employees who are nonexempt.
▪ However, the Wage and Hour Division, under President Trump, has
made no change to the $455/week salary test.
▪ Instead, the Wage and Hour Division has published a Request for
Information (RFI), stating that “the RFI is an opportunity for the
public to provide information that will aid the Department in
formulating a proposal to revise these regulations.”
▪ The RFI requests input not only on the salary test, but also the duties
criteria shown in Exhibit 17.6.
▪ See the e-compensation box also.
o Unscrupulous employers sometimes try to get around the overtime
requirement by classifying employees as executives, even though the work
of these “executives” differs only slightly from that of their co-workers.
o Another challenge in compliance is that “in an evolving, always-on
workplace where employees routinely put in extra hours and shoot off e-
mails late at night from mobile devices, when the workday begins and
ends has become an issue for employers.”
o The impact of FLSA and other laws depends importantly on the degree to
which they are enforced.
o In Japan, unpaid overtime is a major issue.
▪ The Japanese Trade Union Confederation reports that two-thirds of
men work more than 20 hours of unpaid overtime each month.
What Time Is Covered?
o Occupational Safety and Health Administration legislation specifies the
number of breaks that must be provided in an 8-hour workday.
o The Portal-to-Portal Act provides that time spent on activities before
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beginning the “principal activity” is generally not compensable.
▪ The law is also relevant to “on–call employees” who must be available
to respond outside the usual workday.
What Income Is Covered?
o As more employees became eligible for bonuses, there was an argument
over whether bonus, gain-sharing, and stock option payments needed to be
included for calculating overtime pay.
Compensatory Time Off
o Federal legislation has been proposed (but not yet passed) that would give
employees and employers the option of trading overtime pay for time off.
▪ Rather than being paid overtime after 8 hours for a 10-hour workday,
C. Child Labor
• Generally, persons under 18 cannot work in hazardous jobs such as meat
Chapter Seventeen: Government and Legal Issues in Compensation 17 – 10
extent of the use of child labor outside the U.S. to produce goods destined for
U.S. consumers.
• Government guidelines help importers monitor the employment practices of
subcontractors producing goods for the U.S. market.
III. Living Wage
• Rather than push for changes in the FLSA, an alternative approach in recent years has
been to push for a “living wage” at local levels that provides a minimum wage
tailored to living costs in an area.
• Maryland became the first to adopt a statewide living wage ordinance, effective in
2009.
• Los Angeles’s law covers “contractors/subcontractors” who have agreements with the
city.
o The law mandates $12.73 an hour, including health care benefits. The required
wage rate is higher for airport workers.
17 – 11 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich
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Education.
o New hires tended to be better qualified, with higher levels of education and
training than those hired before the law was passed.
• Living wage laws are increasingly popular. Coalitions of union members and church
groups often support them.
• Because they are so narrowly tailored, there is some speculation that their real
intention is to reduce any cost savings a municipality might receive from outsourcing.
IV. Employee or Independent Contractor?
• U.S. employers are legally obligated to pay Social Security, unemployment
compensation, and workers compensation taxes on wages and salaries on behalf of
their employees.
• The decision of whether to classify a worker as an employee or independent
contractor requires careful attention to compliance issues.
• Both tax law—enforced by the Internal Revenue Service (IRS)—and the Employee
Retirement Income Security Act (ERISA)—enforced by the Department of Labor—
are relevant.
• The most widely used classification criteria are provided by the IRS and shown in
V. Prevailing Wage Laws
• Prevailing wage laws set pay for work done to produce goods and services
contracted by the federal government.
• A government-defined prevailing wage is the minimum wage that must be paid for
work done on covered government projects or purchases.
• Prevailing-wage laws prevent contractors from using their size to drive down wages.
Chapter Seventeen: Government and Legal Issues in Compensation 17 – 12
camping near the job site.
• To comply with the law, contractors must determine the “going rate” for construction
labor in an area.
o As a practical matter, the “union rate” for labor becomes the going rate. That rate
then becomes the mandated minimum wage on the government-financed project.
• One effect is to distort market wages and drive up the cost of government-financed
projects.
• The main prevailing-wage laws include the:
• A spate of new laws extends prevailing-wage coverage to new immigrants to the U.S.
and to non-citizens who are working in the United States under special provisions.
o For example, the Nursing Relief for Disadvantaged Areas Act of 1999 allows
qualified hospitals to employ temporary foreign workers as registered nurses for
up to three years under a special visa program.
• Much of the legislation discussed so far was originally passed in the 1930s and 1940s
in response to social issues of that time.
VI. Antitrust Issues
• Chapter 8 included information on the need to avoid antitrust concerns.
o A lawsuit representing 64,000 former software engineers and programmers at
Apple Inc., Google, Inc., Intel Corp., and Adobe Systems alleged these companies
entered into an agreement between 2005 and 2009 that they would not poach, or
try to recruit away, each other’s employees.
VII. Pay Discrimination: What Is It?
• The federal pay discrimination laws are summarized in Exhibit 17.8.
• The law recognizes two types of discrimination:
o Access discrimination—the charges of discrimination and reverse discrimination
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that most often make the news involve access discrimination: the denial of
particular jobs, promotions, or training opportunities to qualified women or
minorities.
o Valuation discrimination—looks at the pay women and minorities receive for
the jobs they perform.
o Many believe that this definition of valuation discrimination does not go far
enough. They believe that valuation discrimination can also occur when men and
women hold entirely different jobs.
▪ Is it illegal to pay employees in one job group less than employees in the other
if the two job groups contain work that is not equal in content or results but is,
VIII. The Equal Pay Act
• The Equal Pay Act (EPA) of 1963 (which is part of the FLSA) forbids wage
discrimination on the basis of gender if employees perform equal work in the same
establishment.
o Jobs are considered equal if they require equal skill, effort, and responsibility and
are performed under similar working conditions.
• Differences in pay between men and women doing equal work are legal if these
differences are based on any one of four criteria, called an affirmative defenses:
A. Definition of Equal
• The Supreme Court first established guidelines to define equal work in the
Schultz v. Wheaton Glass case back in 1970.
o Wheaton Glass Company maintained two job classifications for selector-
Chapter Seventeen: Government and Legal Issues in Compensation 17 – 14
packers in its production department: male and female.
o The female job class carried a pay rate 10% below that of the male job
class.
• Additionally, in several cases where the duties employees actually performed
were different from those in the job descriptions, the courts held that the
actual work performed must be used to decide whether jobs are substantially
equal.
B. Definitions of Skill, Effort, Responsibility, Working Conditions
• The Department of Labor provides these definitions of the four factors
o Skill: Experience, training, education, and ability as measured by the
performance requirements of a particular job.
• Guidelines to clarify these definitions have evolved through court decisions.
For an employer to support a claim of unequal work, the following conditions
must be met:
o The effort/skill/responsibility must be substantially greater in one of the
jobs compared.
• Time of day (e.g., working a night shift) does not constitute dissimilar
working conditions. However, if a differential for working at night is paid, it
must be separated from the base wage for the job.
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C. Factors Other Than Sex
• Of the four affirmative defenses for unequal pay for equal work, “a factor
other than sex” has prompted the most court cases.
• Factors other than sex include:
o Shift differentials
• Factors other than sex have been interpreted as a broad exception that may
include business reasons advanced by an employer.
o No legal clarification of a “factor other than sex” has ever been provided.
D. “Reverse” Discrimination
• Several court cases deal with discrimination against men when pay for women
is adjusted.
o The University of Nebraska created a model to calculate salaries based on
estimated values for a faculty member’s education, field of specialization,
• Viewed collectively, the courts have provided reasonably clear directions to
interpret the Equal Pay Act.
o The design of pay systems must incorporate a policy of equal pay for
substantially equal work.
Chapter Seventeen: Government and Legal Issues in Compensation 17 – 16
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Education.
differently if the pay system is designed to recognize differences in
performance, seniority, quality and quantity of results, or certain factors
other than sex in a nondiscriminatory manner.
o Further, if a new pay system is designed, it must be equally applied to all
employees.
• What does this tell about discrimination on jobs that are not substantially
equal—dissimilar jobs?
IX. Title VII of the Civil Rights Act of 1964 and Related Laws
• The Civil Rights Act is a far-reaching law that grew out of the civil rights movement
of the 1950s and 1960s.
• Title VII of the act prohibits discrimination on the basis of sex, race, color, religion,
or national origin in any employment condition, including hiring, firing, promotion,
transfer, compensation, and admission to training programs.
o The EEOC is responsible for Title VII enforcement.
• In addition to Title VII, the 1967 Age Discrimination in Employment Act (ADEA)
and the 1990 Americans with Disabilities Act (ADA) also prohibit discrimination
based on age and disability, respectively.
• Title VII cases of pay discrimination typically focus on differences in pay,
promotions, pay raises, and performance reviews.
• Settlements in these types of cases are the result of class action lawsuits.
o A class action lawsuit is “any civil case in which parties indicated their intent to
o A key issue in class actions is the definition of the class.
▪ One requirement for forming a class is a commonality of interests.
▪ A 2011 Supreme Court decision in Walmart Stores, Inc. v. Dukes, et. al. made
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employers to not only require employees to agree to resolve their individual
employment discrimination complaints via arbitration, but to also require them to
agree to give up their rights to pursue a class action lawsuit.
▪ The National Labor Relations Board has ruled that workers cannot be required
• The passage in 2009 of the Lilly Ledbetter Fair Pay Act is expected to further
increase the compliance challenge for employers.
o The statute of limitations for filing a claim of discrimination is within 180 days
(300 days in states with their own equal employment opportunity agencies) of the
date of the alleged discriminatory employment practice.
o Lilly Ledbetter’s claim was made after she left her job as a supervisor in a tire
plant and were based on the lasting effects of compensation decisions she alleged
• Court cases have established two theories of discrimination behavior under Title VII:
A. Disparate Treatment
• Disparate or unequal treatment applies different standards to different
employees. For example, asking women but not men if they plan to have
children.
B. Disparate Impact
• Practices that have a differential effect on members of protected groups are
illegal, unless the differences are work-related.
• The major case that established this interpretation of Title VII is Griggs v.
Chapter Seventeen: Government and Legal Issues in Compensation 17 – 18
Duke Power Co., which struck down employment tests and educational
requirements that screened out a higher proportion of blacks than whites.
• Under disparate impact, whether or not the employer intended to discriminate
is irrelevant.
• The two standards of discrimination—disparate treatment versus disparate
impact—remain difficult to apply to pay issues, since pay differences are legal
for dissimilar work.
X. Executive Order 11246
• Enforced by the Office of Federal Contracts Compliance Programs (OFCCP),
Department of Labor, Executive Order 11246 (E.O. 11246) prohibits discrimination
on the basis of race, color, religion, sex, or national origin.
• It requires covered government contractors to file affirmative action plans, which
have three parts.
o Utilization analysis compares the contractor’s workforce to the available external
• The text focuses specifically on the steps in the OFCCP’s compliance review process
as it applies to compensation.
o It begins with a selection of contractors based, in part, on a mathematical model,
called the Federal Contractor Selection System (FCSS), which is intended to
o If selected, the first step is a desk audit.
▪ The OFCCP will notify the employer that it is conducting an audit and will
instruct the employer to provide complete information on its Affirmative
Action Program and all supporting personnel activity (such as hiring,
promotion decisions) and compensation data within 30 days.