Ch. 7: Compensation and Benefits

Learning outcomes

After this chapter you should be able to: describe a compensation philosophy; explain the goals of a compensation plan; describe the types of job evaluation systems and their uses; define the types of pay systems and the factors that decide which one is used; interpret the laws relating to compensation; describe the goals of employee benefits; discuss the types of benefits for employees; and describe pension plans, flexible benefits and employee assistance programs.

7.1 Developing a compensation package

Basic questions before a compensation philosophy is developed. HR first analyses what the organization's philosophy on pay is, using seven questions:

1. From the employee's perspective, what is a fair wage?
2. Are wages too high for the organization to stay financially healthy?
3. Do managers and employees know and buy into the compensation philosophy?
4. Does the pay scale reflect the importance of the various job titles?
5. Is compensation competitive enough to attract and retain employees?
6. Does the package comply with the law?
7. Does the philosophy keep up with changes in the labour market, the industry and the organization?

Possible compensation policies. Answering these questions may reveal "holes" in the package. The organization then makes policy choices such as:

1. Location: are salaries higher or lower depending on where the business is? Cost of living and a shortage of qualified people in an area both play a role.
2. Relative to the regional average: if pay is below average, what other benefits make up for it (for example flextime or free day care)?
3. Fixed pay scale or individual negotiation: without a set scale, how do you keep individual offers fair and nondiscriminatory?
4. Mix of salary and other rewards: some firms pay a lower salary but let employees earn more through bonuses and profit sharing.
5. Basis for raises: tenure, merit only, or a combination of both.

Compensation policy: market, market plus, market minus.

Market plus example (Cisco Systems). Cisco pays software engineers well above a market-paying competitor. Its compensation committee wants to attract, motivate and retain talented executives in a very competitive high-tech industry, based on financial targets, individual contribution, customer satisfaction and performance relative to competitors. Its three objectives: (1) a flexible total compensation program that takes into account the pay practices of identified peer companies competing for the same talent; (2) annual variable cash incentives based on corporate financial objectives, individual contribution and customer satisfaction; (3) aligning executives' financial interests with those of shareholders through long-term, equity-based incentives.

Market minus examples. Whole Foods caps executive pay at nineteen times the average store worker (or $608,000), far below the Fortune 500 average (343 times). The CEO argues that large pay gaps damage morale and make a workplace seem unfair and greedy. Southwest Airlines pays less (and asks more hours) but has only 1.4% turnover, attributed to culture and loyalty rather than pay.

Why choose one philosophy? Market minus can follow from core values (Whole Foods) or from jobs that need an unskilled workforce that is easier and cheaper to replace. Market plus fits cutting-edge industries that need the best and the brightest.

Four steps to a compensation management plan:

1. Guiding principles: decide how pay will be managed, aligned with mission, vision and values. The organization can lead (pay above market value), match (pay the same as companies with similar products and services) or lag (pay below market value). This is the organizational compensation philosophy, the same idea as market plus and market minus.
2. Job analysis assessment: job analysis (Chapter 4) produces job descriptions and specifications (tasks, skills, education, experience). HR compares jobs on internal and external equity.
3. Job value: jobs are priced much like products, using job evaluation approaches.
4. Pay matching: the data gathered in steps 1 to 3 are used to link each employee to a pay level, and pay levels and groupings are set up for every job.

7.2 Goals of a compensation package

Goals of a good compensation package:

• Attract the best people; a firm that pays less than its industry will likely not get the best candidates, which lowers company performance.
• Retain talent by being competitive enough that people want to stay.
• Improve morale, motivation and satisfaction; dissatisfaction leads to turnover and to poor work quality among those who stay.
• Increase loyalty.
• Comply with the law (federal, provincial, territorial): minimum wage, overtime pay, vacation pay.
• Reward individual or team performance and encourage peak performance.
• Indirect gains: better customer service by happier employees, a stronger bottom line, growth and expansion, fewer sick days taken when not really sick, and fewer disability claims.

Sites such as Glassdoor and Indeed give easy access to salary information. Compensation should be approached strategically: understand the role of pay in the bottom line before designing the package.

7.3 Job evaluation and pay systems

1. Job ranking system. Among the easiest methods, applied by small firms or inside departments. Job titles are written down and put in order of how important they are to the organization. One version is the paired comparison: every job is set against each of the other jobs and given a score, and the totals order the jobs from most to least valuable. Scores: 0 = less important than the job it is compared with, 1 = roughly equal, 2 = more important.

So the sales director should earn more than the project administrative assistant, and the receptionist less. The person ranking must know the duties of all jobs. Advantage: simple, reasonably good results. Disadvantage: it does not show the size of differences between jobs, including jobs that received the same rank.

2. Job classification system. Every job is classified and grouped by the knowledge and skills required, years of experience and amount of authority. Each classification includes the basic function, characteristics, typical work and pay range data.

3. Point factor system. The value of a job is the total of points assigned to it. The factors that earn points are called compensable factors (from leadership ability to specific responsibilities and skills). Each factor gets a weight according to its importance to the organization; each factor has a narrative explaining how points are distributed. Points are multiplied by the weight to get a score per factor; the total score places the job (and employee) on a pay level. Example compensable factors:

1. Knowledge
2. Autonomy
3. Supervision
4. Psychological demands
5. Interpersonal skills
6. Internal and external contacts

Hay profile method. A proprietary job evaluation method built on three factors: know-how, problem solving and accountability. Each factor contains specific statements (such as "procedural proficiency") with a point value. Job descriptions are matched to the statements that fit best and the points are added up, giving a quantitative basis for evaluation and pay. Advantage: quantitative. Disadvantage: expensive and elaborate.

Pay systems. Job evaluation is followed by pay grading, which fixes the pay scale for particular jobs or kinds of jobs.

• Pay grade levels: develop a set of pay grades and assign each job to one. Raises stay within the range of the grade until a promotion moves the employee to a higher grade. Advantage: fairness; everyone doing the same job is in the same range, leaving little room for pay discrimination. Disadvantages: rigid, may hinder hiring the best people; can reduce motivation to work harder (extra tasks do not change the grade), creating a stagnant environment; can create too many hierarchical levels. Organizations in several cities may add a geographic percentage (e.g. 10% more in Toronto than in rural Ontario).
• Delayering and banding: cutting down the number of pay levels (e.g. from thirty to five or six) with wider salary ranges per level. General Electric did this because employees avoided useful reassignments at a lower grade. It gives more flexibility, lets the firm reward performance better while keeping a basic model for hiring managers; it also happens during downsizing.
• Going rate model: pay is based on analysis of the going rate for a job at that time. Works well when market or labour supply-and-demand pressures strongly affect the business; e.g. if good project managers are scarce and most companies pay $75,000, you will have to pay the same or more.

7.4 Compensation strategies and pay theories

Compensation strategies (in addition to the pay level models):

Pay theories help in choosing a pay system.

HR must look at external pay equity (what people in similar organizations earn for a similar job) and internal pay equity (comparison within the organization, looking at higher and lower level jobs and years of service). Example: the Walmart CEO earned about $35 million while employees earned around minimum wage; Walmart defends this by pointing to the specialized skills a Fortune 500 CEO needs. For a pay strategy to work, perceived inputs (work) and outputs (pay) must match fairly.

Wall Street illustrates reinforcement: bonuses (on average $128,530 in 2010) and commissions form a large part of pay. This raises ethical questions about commission and bonus plans. A bonus should reward performance, not be a guaranteed part of pay, and should drive and reward the desired behaviour. The book also notes that money is not always a motivator.

Variable pay. Total pay has three categories: pay (the hourly, weekly or monthly salary), incentives (pay-for-performance for meeting standards such as sales targets; they link company goals to employee goals) and other compensation. Desirable traits of incentive plans:

• Clearly communicated
• Attainable but challenging
• Easily understandable
• Tied to company goals

Variable pay leads to better behaviour at work, helps the firm stay competitive and supports attracting and keeping staff. It depends on performance, is normally earned each year and leaves the base pay unchanged.

Pay decision considerations:

• Size and expected growth: a ten-person company likely uses a going rate or management fit model; as it grows a more formal pay structure becomes wise.
• International operations: a centralized compensation system (one pay system for everyone regardless of location) can be unfair because cost of living differs by country. The currency of pay also matters: most US firms pay overseas staff in dollars, and exchange rate fluctuations create challenges.
• Communication and participation: how HR communicates the pay system strongly affects motivation; involving employees, e.g. through pay attitude surveys, makes the process transparent and leads to higher performance.
• Market pay surveys: review wages constantly to stay within expected industry ranges.

7.5 Laws relating to pay

People may not be discriminated against in pay systems. Comparable worth states that people performing the same type of job should get similar pay. In practice women earn less than men in many industries (on average 75 cents for every $1.00 a man earns, per the Pay Equity Office, 2023). Gender is a protected ground in the Canadian Human Rights Act, so it may not play a role in pay (see Pay Equity in Chapter 3).

7.6 Goals of employee benefits

Pay plus benefits together form Total Rewards. Benefits include insurance, income security, time off, educational support, financial rewards and employee assistance, and help attract and retain top talent. Benefits serve three sets of goals:

7.7 Mandatory and voluntary benefits

Voluntary benefits are at the discretion of the employer. Common ones:

7.8 Flexible benefits

In a competitive labour market, employers use flexible benefits: employees choose their own benefits from a "menu of choices" that fits their individual and family needs. Some receive credits to buy their package, others have benefit accounts into which employee and employer contribute. The employee has full control, can prioritize by lifestyle, and receives the price and coverage details of each benefit. Credit-based accounts under an extended health plan (a popular form, described in the book under Employee Assistance Programs) can pay for vision and dental care, optional life insurance, massage and physiotherapy.

Challenges for HR: flexible benefits are complex, time consuming and costly; databases and technology help handle the many individual requests. Communicating all the choices is difficult: employees must take responsibility for learning about the options, while HR must provide information readily and in simple language and know all the products well enough to explain them.

A final note on compensation and benefits strategy. Besides recruiting and retaining, consider your workforce's needs. Step one is to ask employees what they care about (some prefer more pay and fewer benefits, or better benefits with fewer days off); surveys help. The plan may change as the business changes. Communicate the plan (HR blog, e-mail, face to face) and make employees aware of the cost to the company, e.g. that the employer pays 80% of medical premiums, so they see their value to the organization.

Key terms at a glance

• Lead / match / lag: pay above, equal to, or below market value.
• Paired comparison: each job compared with every other job and scored to rank jobs.
• Pay grading: fixing the pay scale for particular jobs or kinds of jobs.
• Delayering and banding: reducing the number of pay levels.
• Going rate model: pay based on the current market rate for a job.
• Incentive: pay-for-performance for meeting standards.
• Mandatory vs voluntary benefits: required by law vs at the employer's discretion.
• Financial services / social services: company discounts and paid expenses / employee assistance programs.

Summary

HR builds compensation packages that fit the organization's goals, starting from a compensation philosophy (market, market plus or market minus; lead, match or lag) shaped by internal and external factors. Job evaluation (ranking, classification, point factor, Hay) sets the relative worth of jobs, followed by pay grading or alternatives such as delayering, the going rate model, skill-based pay, competency-based pay, broadbanding and variable pay. Equity, expectancy and reinforcement theory explain how pay affects motivation. Canadian law forbids pay discrimination and requires pay equity and compliance with Employment Standards and collective agreements. Benefits serve society, the organization and employees, and are mandatory (CPP/QPP, EI, workers' compensation, statutory leave) or voluntary (insurance, pensions, RRSP, TFSA, time off, assistance plans), and increasingly flexible.