Human Resources Chapter 2 Why The Bidding War Wealth Management Firms Make The Bulk Their Profits

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2 – 13 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich

Education.

• The premise of any strategic perspective is that if managers align pay decisions with

the organization’s strategy and values, are responsive to employees and union

relations, and are globally competitive, then the organization is more likely to achieve

competitive advantage.

• In contrast to the notion of strategic fit, some believe that (1) a set of best-pay

practices exists and (2) these practices can be applied universally across situations.

• The authors believe that adopting best-pay practices allows the employer to gain

preferential access to superior employees.

IX. Guidance from the Evidence

• There is consistent research evidence that the following practices do matter to the

organization’s objectives.

o Internal alignment: smaller internal pay differences and larger internal pay

differences can both be a “best” practice.

• Specific pay practices appear to be more beneficial in some contexts than in others.

• Thus, best practice versus best fit does not appear to be a useful way to frame the

question.

• A more useful question is, “What practices pay off best under what conditions?”

X. Virtuous and Vicious Circles

• One study reported that while pay levels (external competitiveness) differed among

companies, they were not related to a company’s subsequent financial performance.

• This study concluded that it is not only how much you pay but also how you pay that

matters.

Chapter Two: Strategy: The Totality of Decisions 2 – 14

• Exhibit 2.9 suggests that performance-based pay works best when there is success to

share.

o Performance-based pay that shares success with employees does improve

XI. Your Turn: Merrill Lynch

Summary of Case

The case profiles the financial crisis at Merrill Lynch at the end of the last decade, which was

acquired by Bank of America for $50 billion. B of A received government assistance during the

financial crisis from (and was covered by) TARP (the Troubled Asset Relief Program). One

initial consequence of TARP coverage was that some employees, including some high-level,

high-revenue generating employees, began to leave larger financial institutions like Merrill

Lynch/Bank of America to go to so-called “boutique” financial services firms, which had not

received TARP money and thus were not covered by TARP restrictions on compensation.

Another initial reaction was an increase in base pay levels and a decrease in bonus levels,

apparently in response to all of the negative publicity bonuses had received and as a way to get

2 – 15 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich

firms.

Learning Objective

Analyze the decision to provide higher base salaries instead of bonuses.

Discussion of Case Issues

At Merrill, there are some concerns among financial advisors. First, in the non-Merrill part of

Bank of America, brokers are under a discretionary bonus system rather than an (objective)

incentive system where pay is based on a formula. Merrill financial advisors fear that Bank of

America wants to extend that system to cover them. Second and likely related, non-Merrill

Teaching Guidelines

Use this case to stimulate a discussion assessing the compensation implications of providing

higher base salaries instead of bonuses.

Student answers may vary. Students can consider the following inputs in constructing their

answers.

1. What is the likely result of bidding wars of this type for top brokers? Will most firms

benefit? Who will be the winners and losers? What about the brokers?

• The bidding war is beneficial to top brokers, as most of the big firms are not retreating

from it. Since investors are still worried about making investments, big firms are

enthusiastic about appointing big brokers.

Chapter Two: Strategy: The Totality of Decisions 2 – 16

Education.

compared to trading and investing.

Source:

http://www.reuters.com/article/2012/04/10/us-bonusbubble-brokers-

idUSBRE8391EV20120410

2. Explain why there is such a strong relationship between pay and performance for

brokers. Why isn’t this true of many other jobs?

• The performance of brokers determines their pay. Big firms are ready to pay brokers high

bonuses as well as perks such as hiring of assistants, etc. The firms are spirited about

3. Should Bank of America change its compensation strategy to include more subjective

assessments of performance and a greater emphasis on cross-selling? What effect might

this have on its success in the bidding war for top brokers?

• A subjective assessment of performance refers to evaluation of intangible qualities of

employees and is based on subjective feedback from supervisors instead of objective,

measurable feedback. Cross-selling refers to the action of selling among clients with

Education.

assessment of performance is a good option.

Source:

http://smallbusiness.chron.com/subjective-performance-evaluation-20453.html

http://en.wikipedia.org/wiki/Cross-selling

4. In chapter 1, we talked about incentive and sorting effects of pay strategies. Describe

the incentive and sorting effects at Merrill Lynch and how changes to the compensation

strategy might affect them.

• Incentive effect refers to the degree to which pay influences individual and aggregate

motivation among the employees we have at any point in time. The incentive effect can

5. Have a look at the most recent changes to Merrill Lynch’s compensation plan for its

financial advisors. Why have these changes been made (what are the goals) and

how well do you expect them to work (and why)?

Answer: Merrill Lynch is in a business where human capital is the main cost, as well as

the key to revenue generation. Thus, it seeks to attract and retain high performing

brokers, who are key to generating revenue. Broker performance (revenue generated) is

Chapter Two: Strategy: The Totality of Decisions 2 – 18

Education.

revenue opportunities in other parts of the firm (including engaging in cross-selling). Not

all brokers are enthused about that system, which is not surprising given that most

brokers decided to join and remain with Merrell Lynch because of the compensation and

incentive system that was in place in the past when they joined. Finally, one might ask

the students to check recent stories on Merrell Lynch to see if any additional changes

have been made to broker compensation and how brokers are reacting.

XII. Still Your Turn: Mapping Compensation Strategies

Summary of Case

Using the concept of strategic mapping, students should describe the compensation strategy

for any organization of their choice and compare it with the compensation strategies of

Microsoft and SAS. Use Exhibit 2.8.

Learning Objective

Utilize the concept of strategic mapping to provide a picture of a company’s compensation

strategy (involves the five decisions contained in pay model).

Discussion of Case Questions

1. Summarize the key points of your company’s strategy.

2. What are the key differences compared to the strategies of Microsoft and SAS?

Alternatively, ask several managers in the same organization to map that organization’s

compensation strategy. You will probably need to assist them in completing the map. Then

compare the managers’ maps.

3. Summarize the key similarities and differences.

Teaching Guidelines

Use this case to analyze and understand the differences between the compensation strategies of

different companies using strategic mapping as a tool.

The best way to approach this case is to coordinate the discussion based on the dimensions and

concepts presented in Exhibit 2.8. The information provided in Exhibit 2.1 is also useful in

discussing this case. Then, spend some time comparing and contrasting the differences between

2 – 19 Compensation – Thirteenth Edition Gerhart │Newman │Milkovich

Microsoft and SAS with respect to the five dimensions: objectives, alignment, competitiveness,

employee contributions, and management.

Objectives: Prominence—how important is total compensation in the overall HR strategy? Is it a

catalyst, playing a lead role? Or is it less important, playing a more supporting role compared to

other HR programs. At Microsoft, compensation is rated highly prominent, while at SAS it is

more supportive.

Alignment: This is described in terms of flexibility, degree of internal hierarchy, and how well

compensation supports career growth. Both Microsoft and SAS use pay to support flexible work

design and promotions. Differences occur in the area of internal hierarchy—Microsoft is more

individual-oriented compared to SAS, whose focus is on teams and the philosophy of “everyone

is part of the SAS family.”

Chapter Two: Strategy: The Totality of Decisions 2 – 20

provide a framework for the responses to questions 1 and 2 under both potential assignments for

this case assignment. Once they understand the dimensions of strategic mapping, they should

apply this knowledge to the company selected in either assignment.

Answers to Review Questions

1. Select a familiar company or analyze the approach your college uses to pay teaching

assistants or faculty. Infer its compensation strategy using the five dimensions

(objectives, alignment, competitiveness, employee considerations, and management).

How does your company or school compare to Microsoft and Merrill Lynch? What

business strategy does it seem to “fit” (i.e., cost cutter, customer centered, innovator, or

something else)?

Student answers may vary.

The best way to organize the answer to this question is to construct a table similar to the one

in Exhibit 2.1. Then, spend some time comparing and contrasting the differences between

Microsoft and Merrill Lynch with respect to the five issues. While the objectives are similar,

2. Contrast the essential differences between the best-fit and best-practices perspectives.

The best-fit strategic approach proposes that pay programs, in combination with other HR

programs, should be based on the unique characteristics of the company, its employees, and

its external environment. Thus, if the pay system reflects the organization’s strategy and

3. Reread Exhibit 2.7. Discuss how those values might be reflected in a compensation

system. Are these values consistent with “Let the market decide”?

4. Three tests for any source of competitive advantage are align, differentiate, and add

value. Discuss whether these tests are difficult to pass. Can compensation really be a

source of competitive advantage?

Alignment of a pay strategy involves three aspects: (1) aligned with the business strategy; (2)

aligned externally with the economic and sociopolitical conditions; and (3) aligned internally

with the overall HR system. Alignment is probably the easiest test to pass.

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5. Set up a debate over the following proposition: Nonfinancial returns (great place to

work, opportunities to learn, job security, and flexible work schedules) are more

important (i.e., best practice) than pay.

Arguments against the topic:

• Money or pay is the fundamental motivator or work performance.

• The basic performance of the pay-for-performance and ESOPs systems were devised to

motivate employees using pay. The success of these systems shows that pay takes higher

Arguments in favor of the topic:

• Pay, when used as the only motivating factor, prompts employees to put in just the

minimum performance that is required to get the next raise or promotion.

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Education.

making and is supported by major companies around the world that strive to provide

necessary facilities that move beyond the scope of pay.

• Commitment towards one’s job, also supported by research evidence, seems to decrease

without elements of relational returns. Relational returns is a value-add that employees

look toward when pay-for-performance or other accepted forms of pay are on par with

industry standards.

• Essentially, the quality of work-life balance is stressed upon by employees seeking to

further their career in a fulfilling manner.

The conclusion to this debate would be a neutral stand where pay and nonfinancial returns

are equally important to motivate people to work, although in slightly different propositions

depending on the individual and the working conditions.

Research on motivating factors has revealed mixed results. However, employees are

motivated to work based on pay. But they put in extraordinary efforts only when they are

provided nonfinancial returns as well. In short, pay makes employees ‘work’ and

nonfinancial returns make them ‘perform.’