CHAPTER 9
Compensation and Benefits
Learning Objectives
After studying this chapter, the student should be able to:
1. Describe the basic issues involved in developing a compensation strategy.
2. Discuss how organizations develop a wage and salary structure.
Chapter Outline
Opening Case: Innovative Compensation at Nucor
Nucor is a pioneer in the steelmaking industry, one of the first to make new steel from scrap
metal. Nucor has the best labor relations of any domestic steelmaker. Nucor also has an
Employment at Nucor can be lucrative, but high pay is not guaranteed. If a bad batch of steel is
identified before leaving the factory, the workers get no bonus. If the bad steel gets to the
customer, they give up three times that amount. Bonuses are also dependent on the cyclical steel
Introduction
Compensation is the set of rewards that organizations provide to individuals in return for their
willingness to perform various jobs and tasks within the organization. Benefits are the various
rewards, incentives, and other items of value that an organization provides to its employees
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Chapter 9: Compensation and Benefits
I. Developing a Compensation Strategy
Compensation should never be a result of random decisions but instead the result of a careful and
systematic strategic process.
A. Basic Purposes of Compensation
Compensation has several fundamental purposes and objectives. First, the organization must
provide appropriate and equitable rewards to employees. Individuals who work for the
Internal equity in compensation refers to comparisons made by employees to other
employees within the same organization. In making these comparisons, the employee is
concerned that he is equitably paid for his contributions to the organization relative to the way
other employees are paid in the firm.
Other organizations also routinely conduct wage surveys. Business publications such as
Business Week, Fortune, and Nation’s Business routinely publish compensation levels for
various kinds of professional and executive position. In addition, the Bureau of National
Affairs and the Bureau of Labor Statistics also are important sources of government-
controlled wage and salary survey information. Figure 9.1presents a sample section from a
pay survey.
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Chapter 9: Compensation and Benefits
A survey such as this one is sent to other organizations in a given region. In this case, the
survey would go to organizations in various industries, but other surveys might be targeted to
a specific industry.
HR in the 21st Century: Waging War over Wages
The Fair Labor Standards Act (FLSA) of 1938 requires workers to be paid time-and-a-half for
any hours worked beyond 40 each week. Employers must judge whether an employee is
But when a female employee, for example, perceives internal inequity vis-à-vis a male
employee, this can also lead to a lawsuit. The Equal Pay Act of 1963 stipulates that men and
women who perform essentially the same job must be paid the same. If there are differences
in the compensation paid to men and women, then such differences may be defensible if they
are based on factors such as performance differentials.
B. Wages versus Salaries
Wages generally refer to hourly compensation paid to operating employees. Time is the basis
for wages—that is, the organization pays individuals for specific blocks of their time such as
payment by the hour. Most jobs that are paid on an hourly wage basis are lower-level or
C. Strategic Options for Compensation
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Chapter 9: Compensation and Benefits
Most organizations establish a formal compensation strategy that dictates how they will pay
individuals. Several decisions are embedded within such a strategy. The first relates to the
basis for pay. Traditionally, most organizations based pay on the functions performed on the
job, but more recently they have begun to rely on skill-based pay and pay-for-knowledge
programs.
In other organizations, differences in pay are based on differences in performance, regardless
of time on the job. These systems are generally seen as rewarding employees who are good
performers rather than those who simply remain longer with the organization. For such
systems to succeed, however, the organization has to be certain that it has an effective system
for measuring performance.
In addition to attracting high-quality employees, an above-market strategy has other benefits.
Above-market rates tend to minimize voluntary turnover among employees. Paying above-
market rates also might be beneficial by creating and fostering a culture of elitism and
competitive superiority.
The downside to above-market compensation levels, of course, is cost. The organization
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Chapter 9: Compensation and Benefits
Another strategic option is to pay below-market rates. The organization that adopts this
strategy is essentially deciding to pay workers less than the compensation levels offered by
other organizations competing for the same kinds of employees. Organizations most likely to
pursue a pay below-market rate are those in areas of high unemployment. Thus, the
organization may able to pay lower than the market-rate and still attract reasonable and
qualified employees.
An organization that adopts a market-rate strategy is likely to believe it can provide other
intangible or more subjective benefits to employees in return for their accepting a wage rate
that is perhaps lower than they might be paid elsewhere. Employees who perceive that they
are being offered an unusually high level of job security may therefore be willing to take a
somewhat lower wage rate and accept employment at a market rate.
D. Determinants of Compensation Strategy
Several different factors contribute to the compensation strategy that a firm develops. One
general set of factors has to do with the overall strategy of the organization itself. In addition
to these general strategic consideration, several other specific factors determine an
organization’s compensation strategy. The organization’s ability to pay above-market wages
and salaries.
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Chapter 9: Compensation and Benefits
II. Determining What to Pay
Once a compensation strategy has been chosen, it is necessary to determine exactly what
employees on a given job should be paid. The starting point in this effort has traditionally been
job evaluation.
A. Job-Evaluation Methods
Job evaluation is a method for determining the relative value or worth of a job to the
organization so that individuals who perform that job can be compensated adequately and
appropriately.
Classification System.
An organization that uses a classification system attempts to group sets of jobs together
into classifications, often called grades. After classifying is done, each set of jobs is then
A major advantage of the job-classification system is that it can be constructed relatively
simply and quickly. It is easy to understand and easy to communicate to employees. It also
provides specific standards for compensation and can easily accommodate changes in the
value of various individual jobs in the organization. On the other hand, the job
classification assumes that a constant and inflexible relationship exists between the job
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Chapter 9: Compensation and Benefits
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Point System
The most commonly used method of job evaluation method is the point system. The point
system requires managers to quantify, in objective terms, the value of the various elements
of specific jobs. Using job descriptions as a starting point, managers assign points to the
degree of various compensable factors that are required to perform each job—that is, any
Because the point system is used to evaluate jobs, most organizations also develop a point
manual. The point manual carefully and specifically defines the degrees of points from
first to fifth. These point manuals are then used for all subsequent job evaluation.
Factor-Comparison Method
A third method of job evaluation is the factor-comparison method. Like the point system,
the factor-comparison method allows the job evaluator to assess jobs on a factor-by-factor
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Chapter 9: Compensation and Benefits
relative importance of the job factor
• The two sets of ratings are prepared based on the ranking and the assigned wages to
determine the consistency demonstrated by the evaluators
• A job-comparison chart is developed to display the benchmark jobs and the monetary
values that each job receives for each factor
The factor-comparison system is a detailed and meticulous method for formally evaluating
B. Pay for Knowledge and Skill-Based Pay
Pay for knowledge involves compensating employees (usually managerial, service, or
professional employees) for learning specific material. Pay-for-knowledge systems reward
employees for mastering material that allows them to be more useful to the organization in the
Skill-based pay operated in much the same way as a pay-for-knowledge system, but these
plans are more likely to be associated with hourly workers. Instead of rewarding employees
III. Wage and Salary Administration
Most organizations call this process wage and salary administration or compensation
A. Pay Secrecy
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Chapter 9: Compensation and Benefits
Pay secrecy refers to the extent to which the compensation of any individual in an
organization is secret or the extent to which it is formally made available to other individuals.
On the other hand, advocates of pay secrecy maintain that what an individual is paid is his or
B. Pay Compression
Pay compression occurs when individuals with substantially different levels of experience or
performance abilities are being paid wages or salaries that are relatively equal. Pay
IV. The Nature of Benefits Programs
In addition to wages and salaries, most organizations provide their employees with an array of
other indirect compensations, or benefits. Although these benefits were once called fringe
A. The Costs of Benefits Programs
Data from the U.S. Chamber of Commerce provides some insights into the position of total
compensation paid to a typical employee in the United States. According to these figures, the
typical employee costs the company just over $50,000 a year in total compensation. Of this,
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B. Purposes of Benefits Programs
In general, benefit programs serve several purposes for the organization. First, many experts
believe that organizations willing to spend more money on total compensation are able to
attract better-qualified people and convince employees to work harder, saving the company
money. The general concept underlying this approach is known as efficiency wage theory.
V. Mandated Benefits
Specifically in the United States several laws have been passed that require organizations to offer
Unemployment insurance is intended to provide a basic subsistence payment to employees who
are between jobs—that is, for people who have stopped working for one organization but who
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Chapter 9: Compensation and Benefits
A. Social Security
A second mandated benefit created by the same law is Social Security itself. What most
people think of as Social Security is officially the Old Age Survivors and Disability
B. Workers’ Compensation
Workers’ compensation is insurance that covers individuals who suffer a job-related illness
C. Mandated Health Care
The Patient Protection and Affordable Health Care Act (or the Affordable Care Act) was
signed into law on March 23, 2010. The basic aim of the Act is to increase the quality and
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Chapter 9: Compensation and Benefits
VI. Nonmandated Benefits
A. Private Pension Plans
In addition to the pension benefits guaranteed under the Social Security Act, many companies
elect to establish private pension plans for their employees. These prearranged plans are
administered by the organization that provides income to the employee at her or his
B. Paid Time Off
No U.S. laws mandate this type of benefit, but most employees now expect it. Most full-time
employees receive about ten paid holidays per year. In addition, religious holidays (in
addition to Christmas) are also often given. Organizations have to be careful with this