Assignment task:
Please cite textbook: Martocchio, J. (2020). Strategic Compensation: A Human Resource Management Approach (10th ed.) Pearson and 2 outside sources:
Question 1: What are the main differences between the minimum pay regulations in the United States (Chapter 2) and one other country's practices discussed in this chapter? How do these differences affect companies' ability to compete with other companies worldwide?
Question 2: Which component of compensation is most essential to motivate executives to lead companies toward competitive advantage? Discuss your rationale.
Textbook Reading Summary - Compensation and Labor-Management Relations
Collective bargaining agreements describe the terms of employment (e.g., pay and work hours) reached between management and the union. Compensation is a key topic. Unions have fought hard for general pay increases and regular COLAs to promote their members' standard of living. In Chapter 2, we will review the role of unions in compensation, and in Chapter 3, we indicate that unions have traditionally bargained for seniority pay systems in negotiations with management. More recently, unions have been willing to incorporate incentive pay systems. For example, unions appear to be receptive to behavioral encouragement plans because improving worker safety and minimizing absenteeism serve the best interests of both employees and employers.
Compensation and Legislation:
Employment laws establish the bounds of both acceptable employment practices and employee rights. Federal laws that apply to compensation practices are grouped according to four themes:
- Income continuity, safety, and work hours
- Pay discrimination
- Medical care and the accommodation of disabilities and family needs
- Prevailing wage laws
The federal government enacted income continuity, safety, and work hour laws (e.g., the Fair Labor Standards Act of 1938) to stabilize individuals' incomes when the individuals became unemployed because of poor business conditions or workplace injuries, as well as to set pay minimums and work-hour limits for children. The civil rights movement of the 1960s led to the passage of key legislation (e.g., the Equal Pay Act of 1963 and the Civil Rights Act of 1964) designed to protect designated classes of employees and to uphold their individual rights against discriminatory employment decisions, including matters of pay. Congress enacted legislation, namely, the Patient Protection and Affordable Care Act of 2010, the Pregnancy Discrimination Act of 1978, the Americans with Disabilities Act of 1990, and the Family and Medical Leave Act of 1993 to provide medical care and accommodate employees with disabilities and pressing family needs. Prevailing wage laws (e.g., the Davis-Bacon Act of 1931) set minimum wage rates for companies that provide paid services-such as building maintenance-to the U.S. government. We will review these laws in Chapter2.
How the Compensation Function Fits into HR Departments
Human resource practices do not operate in isolation. Every HR practice is related to others in different ways. For example, as an employer, U.S. federal government agencies publicly acknowledge the relationships between incentive compensation and other HR practices, including recruitment, relocation, and retention:
Recruitment: An agency may pay a recruitment incentive to a newly appointed career executive if the agency has determined that the position is likely to be difficult to fill in the absence of an incentive. A recruitment incentive may not exceed 25 percent of the executive's annual rate of basic pay in effect at the beginning of the service period multiplied by the number of years (including fractions of a year) in the service period (not to exceed 4 years).
Relocation: An agency may pay a relocation incentive to a current career executive who must relocate to accept a position in a different geographic area if the agency determines that the position is likely to be difficult to fill in the absence of an incentive. A relocation incentive may be paid only when the executive's rating of record under an official performance appraisal or evaluation system is at least "fully successful" or equivalent. A relocation incentive may not exceed 25 percent of the executive's annual rate of basic pay in effect at the beginning of the service period multiplied by the number of years (including fractions of a year) in the service period multiplied by the number of years (including fractions of a year) in the service period (not to exceed 4 years).
Retention: An agency may pay a retention incentive to a current career executive if (1) the agency determines that the unusually high or unique qualifications of the executive or a special need of the agency for the executive's services makes it essential to retain the executive, and that the executive would be likely to leave the Federal service in the absence of a retention incentive, or (2) the agency has a special need for the employee's services that makes it essential to retain the employee in his or her current position during a period of time before the closure or relocation of the employee's office, facility, activity, or organization and the employee would be likely to leave for a different position in the Federal service in the absence of a retention incentive. A retention incentive may be paid only when the executive's rating of record under an official performance appraisal or evaluation system is at least "fully successful" or equivalent. A retention incentive rate, expressed as a percentage of the executive's rate of basic pay, may not exceed 25 percent.
Compensation and Employment Termination
Employment termination takes place when an employee's agreement to perform work is terminated. Employment terminations are either involuntary or voluntary. The HR department plays a central role in managing involuntary employment terminations. Companies initiate involuntary terminations for a variety of reasons, including poor job performance, insubordination, violation of work rules, reduced business activity due to sluggish economic conditions, and plant closings. Discharge represents involuntary termination for poor job performance, insubordination, or gross violation of work rules. Involuntary layoff describes termination under sluggish economic conditions or because of plant closings. In the case of involuntary layoffs, HR professionals typically provide outplacement counseling to help employees find work elsewhere. Companies may choose to award severance pay, which usually amounts to several months' pay following involuntary termination and, in some cases, continued coverage under the employer's medical insurance plan. Employees often rely on severance pay to meet financial obligations while they search for employment. In the past, companies commonly offered a year or more of severance pay. Severance benefits today tend to be less generous. For example, as part of Delta Air Lines' closure of its Boston reservation center, the company offered only 6 weeks of severance pay regardless of seniority with the company.
Employees initiate voluntary terminations, most often to work for other companies or to retire. In the case of retirement, companies sponsor pension programs. Pension programs provide income to individuals throughout their retirement. Companies sometimes use early retirement programs to reduce workforce size and trim compensation expenditures. Early retirement programs contain incentives designed to encourage highly paid employees with substantial seniority to retire earlier than they had planned. These incentives expedite senior employees' retirement eligibility and increase their retirement income.
Compensation and Career Development
Most employees expect to experience career development within their present companies. Employees' careers develop in two different ways. First, some employees change the focus of their work-for example, from supervisor of payroll clerks to supervisor of inventory clerks. This change represents a lateral move across the company's hierarchy. Second, others maintain their focus and assume greater responsibilities. This change illustrates advancement upward through the company's hierarchy. Advancing from payroll clerk to manager of payroll administration is an example of moving upward through a company's hierarchy. Employees' compensation changes to reflect career development.
Geographic Pay Differentials
2-3 Summarize the reasons for the occurrence of geographic pay differentials.
Overall, there are relative pay differentials between geographic areas. Most typically, these are focused on comparisons between the nation and small geographic areas such as city or state. Based on the most recent comprehensive analysis published by the U.S. Bureau of Labor Statistics, all Los Angeles, California area employees were paid, on average, 20 percent more than the national average.25 In Lincoln, Nebraska, employees were paid 3 percent less than the national average. This is an example of relative pay differentials.
We can also consider pay rate differentials (expressed in dollars as hourly or annual pay) for occupations based on geographic regions (for instance, Massachusetts, and the city of Boston) and the United States, overall. On a day-to-day basis, compensation professionals focus on pay rates and pay rate differentials. It is important to note that pay rate differentials do not fully match relative pay differentials because relative pay differential measures control for the influence of various variables, and pay rate differentials do not, which we will discuss shortly. Nevertheless, we generally observe consistency in the direction of the relative pay and pay rate differentials. For instance, both statistics show that typical pay rates in the San Francisco area was 17 percent higher than in the UnitedStates, overall.26However, the pay rate difference was 33 percent.
These disparities are partly based on the calculation methods. Compared to relative rate differences, the relative pay differential calculation considers (controls for) other factors that can explain paydifferences within a defined area. The idea is to present a clearer picture of regional-based paydifferences. For example, as we have learned, interindustry wage differentials represent an important factor. Other control factors include the union status of the workforce, which we will discuss shortly, and whether employees work on a full- or part-time basis, which we will also discuss in Chapter12. Additional control factors include occupational type, work level, whether firms operate on a profit or not-for-profit basis, and skill-level differencesbetween employees who are performing the same job.28 Thus, it is important for compensation professionals to consider both types of statistics when evaluating geographic differences in compensation decisions.
Cost-of-living differencesbetween geographic locations also provide an additional explanation. Compensation professionals sometimes consider cost-of-living differencesbetween locations. For example, let's assume that a company was to offer starting pay to two equally qualified individuals who have been hired to perform the same job, but placed in different cities-Boston, Massachusetts and Fargo, North Dakota. If a differential was to be considered, it might be based on the cost of housing. Housing costs are among the largest financial obligations most individuals assume.
The median home price in Boston was $464,000, and only $214,000 in Fargo.29 The company may consider offering the Boston-based employee a higher salary to help offset some of the difference in cost-of-living. The idea is to help employees in similar jobs to maintain comparable standards of living, which will help with recruitment and retention of qualified employees. Other spending categories include food, utilities, transportation, and health care. Oftentimes, companies consider all the spending categories when setting pay rates. Cost-of-living comparison calculators (for example, one furnished by CNN) may be useful. Based on this calculator, a $50,000 salary in Fargo is equivalent to a $74,622 salary in Boston.
FYI
Cost-of-living comparison calculators (for example, CNN's calculator) incorporate five categories as a basis for determining pay comparability between two locations:
- Groceries
- Housing
- Utilities
- Transportation
- Healthcare
Establishing Employee Benefits for U.S. Expatriates
Benefits represent an important component of expatriates' compensation packages. Companies design benefits programs to attract and retain the best expatriates. In addition, companies design these programs to promote a sense of security for expatriates and their families. Furthermore, well-designed programs should help expatriates and their families maintain regular contact with other family members and friends in the United States.
Benefits fall into three broad categories: protection programs, paid time off, and services. Protection programs provide family benefits, promote health, and guard against income loss caused by such catastrophic factors as unemployment, disability, or serious illnesses. Paid time off provides employees such paid time off, such as vacation. Service practices vary widely. Services provide such enhancements as tuition reimbursement and day care assistance to employees and their families.
Just like domestic employee benefits packages, international employee benefits plans include such protection programs as medical insurance and retirement programs. In most cases, U.S. citizens working overseas continue to receive medical insurance and participate in their retirement programs.
International and domestic plans are also similar in that they offer paid time off; however, international packages tend to incorporate more extensive benefits of this kind, which we will discuss later. Moreover, international employee benefits differ from domestic compensation regarding the types of allowances and reimbursements. For international assignees, these payments are designed to compensate for higher costs of living and housing, relocation allowances, and education allowances for expatriates' children.
Employers should take several considerations into account when designing international benefits programs, including:
- Total remuneration: What is included in the total employee pay structure (e.g., cash wages, benefits, mandated social programs, and other perquisites)? How much can the business afford?
- Benefit adequacy: To what extent must the employer enhance mandated programs to achieve desired staffing levels? Programs already in place and employees' utilization of them should be critically examined before determining what supplementary programs are needed and desirable.
- Tax effectiveness: What is the tax deductibility of these programs for the employer and employee in each country, and how does U.S. tax law treat expenditures in this area?
- Recognition of local customs and practices: Companies often provide benefits and services to employees based on those extended by other businesses in the locality, independent of their own attitude toward these same benefits and services.
International employee benefits packages contain the same components as domestic employee benefits packages and enhancements. U.S. expatriates receive many of the same standard benefits as their counterparts work
Undermining U.S. Companies' Ability to Compete
At present, there is no evidence showing that U.S. executive compensation pay practices have undermined U.S. companies' ability to compete with other companies in the global marketplace. Might executive compensation practices undermine U.S. companies' competitiveness in the future?
On one hand, it is reasonable to predict that CEO pay will not undermine U.S. companies' ability to compete because CEO pay increased as company profits increased. On the other hand, the current wave of widespread layoffs may hinder U.S. companies' competitiveness. The U.S. companies use layoffs to maintain profits and cut costs, heightening workers' job insecurities. The remaining workers may lose their faith in pay-for-performance systems and their trust in their employers as colleagues lose their jobs and CEOs continue to receive higher compensation. Workers may not feel that working hard will lead to higher pay or job security; therefore, they may choose not to work proficiently. As a result, reduced individual performance and destabilized workforces may make it difficult for U.S. companies to compete against foreign companies.
The SEC rules require the disclosure of executive compensation in U.S. companies; however, comparable rules do not exist in many foreign countries. As a result, it is difficult to make detailed comparisons between U.S. and foreign executive compensation. Nevertheless, recent research has studied the levels and composition of CEO compensation in the U.S. and in other countries where disclosure laws necessitate reporting of CEO pay. U.S. CEOs earned the most, approximately $11.6 million. CEO pay averaged slightly more than $10 million in the United Kingdom, approximately $8 million in Germany, nearly $3.0 million in France, $2.0 million in Japan, and $5.5 million in other countries.48Figure 11-3 lists average CEO pay in several OECD countries. Pay mix also differed substantially among CEOs in various countries. For instance, approximately one third of CEO pay in the United States and the U.K. was based on annual salary and bonus. The proportions were much higher elsewhere (73 percent in Germany, 75 percent in France, 89 percent in Japan, and 55 percent in other countries).
Components of Current Core Compensation
Executive current core compensation packages contain two components: annual base pay and bonuses.
Base Pay
Base pay is the fixed element of annual cash compensation. Companies that use formal salary structures may have specific pay grades and pay ranges (Chapter 8) for nonexempt employees and exempt employees, including supervisory, management, professional, and executive jobs, except for the CEO.
Chief executive officer jobs do not fall within formal pay structures for two reasons. First, the work done by CEOs is highly complex and unpredictable. It is not possible to specify discrete responsibilities and duties. The choice of competitive strategy by CEOs and other executives and the influence of external and internal market factors make it impossible to describe a CEO's job. Second, setting CEO compensation differs dramatically from the rational processes compensation professionals use to build market-competitive pay structures (Chapter 7). We will discuss agency theory, tournament theory, and social comparison theory later as explanations for setting CEO compensation.
In most cases, annual base pay represents a relatively small part of a CEO's total compensation for two reasons. First, it typically takes years before the fruits of a CEO's strategic initiatives are realized. Second, the IRS limits the amount of annual salary a company may exclude as a business expense. Only the first $1 million annually for an executive's pay may excluded from the company's income tax liability if the pay is not deemed to be pay-for-performance.7 Base pay would fall under this rule. This ruling was put into place to keep companies from boosting CEO annual pay to astronomical levels for the purposes of tax savings.
Bonuses
Bonuses represent single pay-for-performance payments companies use to reward employees for achievement of specific, exceptional goals. As discussed in previous chapters, compensation professionals design bonuses for merit pay programs (Chapter 3), gain-sharing plans and referral plans (Chapter 4), and sales incentive compensation programs (Chapter 8). Bonuses also represent a key component of executive compensation packages.
Companies' compensation committees recommend bonus awards to boards of directors for their approval (as we will discuss later in this chapter). Four types of bonuses are common in executive compensation:
- Discretionary
- Performance-contingent
- Predetermined allocation
- Target plan
As the term implies, boards of directors award discretionary bonuses to executives on an elective basis. They weigh four factors in determining the amount of a discretionary bonus: company profits, the financial condition of the company, business conditions, and prospects for the future. For example, boards of directors may award discretionary bonuses to executives when a company's position in the market is strong.
Executives receive performance-contingent bonuses based on the attainment of specific performance criteria. The performance appraisal system for determining bonus awards is often the same appraisal system used for determining merit increases or general performance reviews for salary (Chapter 3).
Unlike the previous executive bonuses, the total bonus pool for the predetermined allocation bonuses is based on a fixed formula. The central factor in determining the size of the total bonus pool and bonus amounts is company profits.
The target plan bonuses ties bonuses to executives' performance. The bonus amount increases commensurately with performance. Executives do not receive bonuses when their performance falls below minimally acceptable standards. The target plan bonus differs from the predetermined allocation bonus in an important way: Predetermined allocation bonus amounts are fixed, regardless of how well executives perform.
Employee Benefits: Enhanced Protection Program Benefits and Perquisites
Executives receive discretionary benefits like other employees; however, executives' discretionary benefits differ in two ways. First, protection programs include supplemental coverage that provides enhanced benefit levels. Second, the services component contains benefits exclusively for executives. These exclusive executive benefits are known as perquisites or perks.
Short-Term Incentives
Companies award short-term incentive compensation to executives to recognize their progress toward fulfilling competitive strategy goals. Executives may participate in current profit-sharing plans and gain sharing plans. Whereas short-term objectives reward nonexempt and lower-level management employees for achieving major milestone work objectives, short-term incentives applied to executives are designed to reward them for meeting intermediate performance criteria. The performance criteria relate to the performance of a company as dictated by competitive strategy. Change in the company's earnings per share over a 1-year period, growth in profits, and annual cost savings are criteria that may be used in executives' short-term incentive plans.
Short-term incentive compensation programs usually apply to a group of select executives within a company. The plan applies to more than one executive because the synergy that results from the efforts and expertise of top executives influences corporate performance. The board of directors distributes short-term incentive awards to each executive based on rank and compensation levels. Thus, the CEO will receive a larger performance award than will the executive vice president, whose position is lower in the company's structure than the CEO's position.
For example, let's assume that the CEO and executive vice president of a chain of general merchandise retail stores have agreed to lead the corporation as the lowest-cost chain of stores in the general merchandise retail industry. The CEO and executive vice president establish a five-year plan to meet this lowest-cost competitive strategy. The vice president of compensation recommends that the company adopt a gain sharing program to reward top executives for contributing to the cost reduction objective. After one year, the complementary decisions made by the CEO and executive vice president have enabled the corporation to save $10,000,000. The board of directors agrees that the executives' collaborative decisions led to noteworthy progress toward meeting the lowest-cost strategy and award the CEO 2 percent of the annual cost savings ($200,000) and the executive vice president 1 percent ($100,000).