18 – 17 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich
• Commercial compensation software is available to analyze almost every
aspect of compensation information.
o Software can easily compare past estimates to what actually occurred.
III. Managing Revenues
• Although the cost of compensation is most easily measured, do not forget that
compensation is also central to driving future revenues.
• Some companies are beginning to analyze the value added of pay decisions and how
that influences revenues.
• Exhibit 18.9 illustrated the approach to assessing value gained in different ways,
which directly or indirectly influence revenues.
o The company in this exhibit has already done an analysis that suggests that the top
10% of employees improve returns by about 2-5% of their average salary.
o Now the company is considering two actions.
▪ Implement a bonus plan based on balanced scorecards for individual
managers.
▪ Increase the differentiation between top performers and average performers.
o Exhibit 18.9 shows the analysis of potential value added by these two options
• The practice of analyzing the returns from compensation decisions is in its early
stages.
o The promise is that it will direct thinking beyond treating compensation as only
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Education.
because other organizations will eventually find these “passive job seekers”.
IV. Managing Pay to Support Strategy and Change
• Alignment issues must be managed successfully to drive future revenues.
o Compensation often plays a singular role when organizations restructure.
o Strategic changes in the business strategy means the compensation strategy must
V. Communication: Managing the Message
• Compensation communicates and signals what is important and what is not.
• Employees must understand the pay system.
o Their understanding is shaped indirectly through the paychecks they receive and
directly via formal communication about their pay, their performance, and the
• Fewer than half understood how their own pay increases are calculated.
o Exhibit 18.10 provides further insight into employee (lack of) pay knowledge.
▪ Of note is that only 8 and 4%, respectively, of compensation professionals
18 – 19 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich
strongly agree that employees know their own pay range (e.g., the maximum
they can earn without getting promoted), or the pay rage above them (so, how
much they could earn if they were promoted).
• Two reasons are usually given for communicating pay information.
o The 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.
▪ From a motivational point of view, it would make sense to communicate and
demonstrate to employees that those with consistently high performance
receive higher compensation than others.
sector organizations may be illegal under the National Labor Relations Act if
it interferes with “concerted action” by employees, or Executive Order 13665
– Non-Retaliation for Disclosure of Compensation Information
o The second (and related) reason for communicating pay information is that,
according to some research, employees seem to misunderstand the pay system.
18 – 21 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich
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Education.
• 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.
o Step 6 of the communication process suggests that the program be evaluated.
▪ Did it accomplish its goals?
▪ Pay communication often has unintended consequences.
• For example, improving employees’ knowledge about pay may cause
some initial short-term concerns.
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.
• Some 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.
o Some also communicate the typical pay increases that can be expected for
• How people process information and make decisions, as shown in Exhibit
18.13, 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.
Chapter Eighteen: Management: Making It Work 18 – 22
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.
o Decentralized refers to a management strategy of giving separate business
units the responsibility of designing and administering their own systems.
o This contrasts with a centralized strategy, which locates the design and
administration responsibility at corporate headquarters.
o 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.
• Decentralizing certain aspects of pay design and administration has
considerable appeal.
o Pushing 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.
o For example, it may be difficult to transfer employees from one business
Flexibility within Corporatewide Principles
• The answers to the problems of decentralization can be found in developing a
set of corporate-wide principles or guidelines that all must meet.
18 – 23 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich
o The principles may differ for each major pay technique.
• The pay system is one of many management systems used in the organization.
o Consequently, it must be congruent with these other systems.
▪ For example, it may be appealing, on paper at least, to decentralize
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.
o For the compensation system, the basic question to ask is, “Does each
specific activity (technique) directly contribute to our objectives?”
• Outsourcing is a viable alternative as organizations struggle with activities
that do not directly contribute to objectives.
o These are often referred to as transactional activities, which are not unique
• Cost savings are the major potential advantage of outsourcing.
o 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.
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.
Chapter Eighteen: Management: Making It Work 18 – 24
o Some recommend reducing the controls and guidelines inherent in any pay
plan.
• Such approaches are consistent with the oft-heard plea that managers should
be free to manage pay.
o Yet, 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
Making Information Useful—Compensation Enterprise Systems
• Most managers find themselves overwhelmed with too much information.
o The challenge is to make the information useful.
• Compensation software transforms data into useful information and guides
decision making.
o Many software packages that serve a variety of purposes are available.
o Some of them support employee self-service, by which employees can
18 – 25 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich
some analysis, and creates reports at the click of the mouse.
• While 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.
• Computers inevitably bring up the issue of confidentiality.
o If personal compensation data are accessible to employees and
managers, privacy and security issues as well as ethical and legal
issues emerge.
o Regulations vary around the world.
B. Ethics: Managing or Manipulating?
• Compensation ethics is not an oxymoron.
o But absent a professional code of behaviors and values, it is a challenge
• Managing compensation ethically is increasingly complicated for several
reasons:
o Pay really matters; it is important to all of us.
o The 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?
Chapter Eighteen: Management: Making It Work 18 – 26
• The following reasons force employees to take a hard look at what employers
are doing:
o Misusing and even failing to understand survey statistics
• 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.”
VII. Your Turn: Communication by Copier
Summary of Case
The case is concerned with an employee discovering that a noted screw-up was making
$65,000 a year more than more competent colleagues, while some new hires were earning
almost $200,000 more than their counterparts with more experience. The employee is
dissatisfied and ponders over the inequity of having to work on weekends with the pay she was
getting. She quit three months later without having shared the information with her colleagues.
Learning Objective
Analyze the importance of communicating the pay structure to employees within an
organization and understanding the reasons behind structuring pay in a particular manner for
individual employees.
Teaching Guideline
Use this case to highlight the issues regarding communication of pay information to
employees.
Discussion of Case Questions
1. How would you have reacted if you were Ms. Allen? Explain why.
Students’ answers will vary depending on their perceptions.
However it is important to remember that as an employee, it is natural to feel ill-used upon
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Education.
2. Put yourself in the place of the compensation director at Ms. Allen’s company. Based
on the pay model and what you now know about compensation, are there any
possible business- and work-related explanations for what Ms. Allen observed (i.e.,
the screw-up getting $65,000 more; new hires earning $200,000 more than more-
experienced employees; and Ms. Allen making less pay than others)?
As a compensation manager, it would be imperative to remember that pay is an important
factor that could influence a potential employees’ decision to join a company. It is also
understandable that a new hire, with a promise to added-value to the company will need to
3. As the compensation director, what would you do if Ms. Allen had brought you this
document, and asked for your help in understanding what was going on. (Firing the
person who left it on the copier is not an option. It may have been you.)
As a compensation manager, it is important to address employee grievances in a logical,
understanding manner. Ms. Allen needs to be heard out, and using the guidelines presented
VIII. Still Your Turn: Managing Compensation Costs, Headcount, and
Chapter Eighteen: Management: Making It Work 18 – 28
Participation/Communication Issues
Summary of Case
The case outlines how some companies, like Cisco Systems, Hewlett-Packard, American
Airlines, and General Motors, have cut employment or cut wages and/or benefits to reduce
Learning Objective
Analyze the importance of managing compensation costs, headcount, and
participation/communication issues.
Teaching Guideline
Use this case to discuss the importance of managing compensation costs, headcount, and
participation/communication issues.
Discussion of Case Issues
1. What is the difference between these two sets of companies? Is it simply that one set
of companies care more about its employees than the other set of companies? Or, is it
also the case that Southwest, Nucor, and Lincoln Electric have set up their
compensation strategies in a way that makes them more able (than Cisco, HP,
American, and GM) to cut labor costs when times are tough? (For more background,
go to google.com or another search engine and conduct a separate search for each
company using its name and the term “layoff.”) What about protecting investment in
employees and employee relations?
Students’ answers will vary for this question.
They could refer to the following links:
https://www.cnbc.com/2016/12/07/southwest-ceo-shares-the-secret-to-why-theyve-never-
18 – 29 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich
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Education.
https://www.pbs.org/newshour/nation/the-miracle-of-profit-sharing-year-65-and-still-no-
layoffs
http://online.wsj.com/article/SB10000872396390444025204577545362045100758.html
http://www.businessinsider.com/cisco-layoffs-three-percent-report-2012-7
http://www.cbsnews.com/8301-505123_162-57440354/hp-laying-off-27000-workers-in–
restructuring/
https://www.cnbc.com/2018/06/19/american-airlines-plans-for-layoffs-buyouts-due-to-us-
airways-merger.html
https://www.forbes.com/sites/stephaniedenning/2018/11/29/why-the-general-motors-
layoffs-were-strategic/#764a41725d5e
2. What can an employer do to make labor costs flexible so that profits do not take as
much of a beating during difficult economic times and so that fewer employees need
to be laid off?
Students’ answers to this question will vary.
However, it is important to note that the greater the ratio of variable pay to base pay, the
3. If you were in charge of designing a compensation system for a company that is fairly
new, but is now reaching a stage and size where it needs a formal compensation
system, how would you design the compensation system to have labor cost flexibility?
To what degree would you have others at the company participate in the design of the
new compensation system? Who would participate? Would you follow a policy of pay
openness in communicating your compensation system? Provide a rationale for your
decisions.
Students’ answers to this question will vary.
Many of them may say that they would go for a decentralized strategy because of the
Chapter Eighteen: Management: Making It Work 18 – 30
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Education.
internal consulting capability that human resource professionals in the business units, who
are often human resource generalists, can be drawn on to assist in the design of
compensation strategies.
Many of the students would follow a policy of pay openness in communicating the
compensation strategy because this will result in high commitment and an understanding
of how to maintain competitiveness. This will also improve attitudes and performance.
Answers to Review Questions
1. How can employers control labor costs?
The emphasis on managing and controlling compensation costs enables managers to
foresee the financial impact of pay expenditures on organization performance and to use
those expenditures where they will have a maximum effect on organization objectives. If
2. How does the management of the pay system affect pay objectives?
3. Why is the structure of the compensation function important?
A decentralized compensation function would push responsibilities and expenses closer to
the units and managers affected by them; this may help ensure that decisions are business-
related. However, decentralization may lead to problems of inconsistent treatment of
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Education.
4. Give some examples of how employers use inherent controls.
Some examples of how employers use inherent controls are given below:
• Range minimums and maximums establish the parameters of value that the employer
5. What activities in managing the pay system are likely candidates to be outsourced?
Why?
Benefits management is the prime candidate due to the complexity of regulations plus the
amount of clerical work involved. Other activities that can be outsourced include:
• Payroll management
6. Use Exhibit 18.13 to explain how the research on individual decision making can be
used in pay communication.