Compensation: A Comprehensive Guide PDF

Compensation is perhaps the most visible element of the total rewards model and as such deserves a significant amount of attention and planning. Typically it is the first aspect of the employment agreement and calls for providing a monetary reward in exchange for the services and contributions the e...

Compensation is perhaps the most visible element of the total rewards model and as such deserves a significant amount of attention and planning. Typically it is the first aspect of the employment agreement and calls for providing a monetary reward in exchange for the services and contributions the employee provides to the organization. Compensation -- Pay provided by an employer to workers in exchange for services such as time, effort and talent. This includes both fixed and variable pay tied to overall contributions. Elements of Compensation Compensation can be categorized into the following two primary elements: Fixed pay, also known as base pay, is nondiscretionary compensation that does not vary according to performance or results achieved. The terms base pay and fixed pay are used interchangeably. The most common forms of fixed pay or base pay are hourly wages and salaries. Variable pay, also known as bonus, incentive, or pay at risk, is compensation that is contingent on discretion, performance or results achieved. Much of the innovation in compensation is occurring in the variable pay element Factors Influencing Compensation Compensation strategy and philosophy - Compensation philosophy -- A defined compensation philosophy is a statement of what the organization believes about how people should be paid. It should support the business strategy and be a good fit with the organization's culture. A key component is how the organization intends to pay relative to its competitors for people -- i.e., the desired market position. - Compensation strategy -- The compensation strategy includes the principles that guide the design, implementation and administration of a compensation program in an organization. It may also specify what programs will be used and how they will be administered. HR strategy - Compensation that considers the HR strategy leads to positive workforce experiences and ultimately organizational performance. This is done in conjunction with other total rewards programs, such as benefits or development, to make sure needed talent is available to the organization. Competitive environment - Competition for talent has a significant influence on the organization's compensation programs. This is particularly true when an organization is in a growth mode, experiencing heavy hiring, or competing for "hot jobs". - Organizations that are expanding their operations outside of their headquarters country need to determine the feasibility and the degree to which they want to replicate their base programs in other countries. Financial resources - Corporate budgets influence the resources available for the various components. The health of the economy and the general business influence the level of total rewards elements utilized to ensure the organization has the talent it needs. Regulatory and other requirements - Governmental and other organizations usually have requirements for compensation programs within their jurisdiction (e.g. minimum wage or pay equity, as well as acquired rights in some countries). - The existence of bargaining unit employees inside the organization must be considered when designing compensation programs for nonunion employee groups. The prevalence of union activity outside of the company, within the industry, creates challenges. - Compensation professionals should stay abreast of these regulations, which can be enacted at the federal level or only within certain states. For example, as of January 1st, 2024, there are eight states with active pay transparency laws, while more are set to take effect in 2025. Types of Pay-Related Laws Minimum rates of pay and overtime -- Requires minimum pay rates for covered employees and payment of overtime beyond a certain number of hours per week. - The Fair Labor Standards Act (FLSA) of 1938 in the U.S. established minimum wage, overtime pay, recordkeeping, and child labor standards affecting full-time and part-time workers in the private sector and in federal, state, and local governments. Covered, nonexempt workers are entitled to a minimum wage, but the FLSA does not require vacation pay, holiday pay or shift or weekend premium pay. Many U.S. cities and states have minimum wage requirements higher than the federal minimum. Pay equity and transparency -- Employees must be paid fairly and consistently, without discrimination based on gender, race or other protected categories. Pay may reflect job-related factors such as education, experience, and tenure. Some U.S. states have pay equity requirements as well as legislation surrounding pay transparency. States such as Colorado, California, and New York now have active pay transparency laws, which require employers to disclose certain compensation information. The push for pay transparency is expected to gain an even greater momentum with more states voting to adopt such legislation. Anti-competitive price fixing -- Price fixing, wage fixing, or entering an agreement or establishing a mechanism to set wages and benefits is prohibited in many countries, including the U.S. Most organizations rely on third-party independent compensation survey providers to guarantee confidential data gathering Base Pay Base pay, or fixed pay, is the compensation paid to an employee for performing specific job responsibilities. An organization's hierarchy and job evaluation methods determine how it establishes pay. The definition of base pay can vary by country. For example: - India and South Africa use a Cost-to-Company approach to pay, and many countries include allowances in the calculation of base pay (e.g., housing, transportation, meals,) and may be considered part of base pay for benefits calculations. Base pay levels need to take into account variations in equivalent monthly salaries that vary by country -- While annual salary may be constant, pay delivery varies with many countries' pay practices, including smaller monthly salaries with a bonus paid out at certain times of the year. These differences may affect survey data. For example: - Some countries deliver base pay monthly but also include a 13th or 14th check during the year. - In some countries, base salary includes legally required bonuses, as well as other components. These differences may affect survey data. The bottom line fixed pay practices need to be based on market practice and competitive strategy for each country -- Factors affecting base pay: - Frequency of review due to: - Inflation - Government-imposed pay restraint - Cost-of-living adjustment (COLA) plus variable performance-related pay - Allowances - Government mandates (e.g., concept of acquired rights) Types of Base Pay Once base pay structures are built, the organization must determine how employees will be paid. Salary -- paid on a weekly, biweekly, semimonthly or monthly basis rather than by the hour, generally to higher level positions. In the U.S., exempt positions are typically paid a salary. Hourly wages -- paid by the hour for a job being performed. An individual's annual pay is dependent on the number of hours worked during the course of the year and the hourly rate of pay. In the U.S., nonexempt positions are typically paid an hourly wage. For example: \$20/hour with a schedule of 40 hours a week for 52 weeks = 2080 hours \$20 x 2080 = \$41,600 per year. Piece rate -- Payment is based on an individual employee's rate of production. A payment is received for each piece or unit of work produced. Piece rate payment can be either in place of, or in addition to, hourly payment. Although it seems like an incentive or commission plan, it is considered base pay and therefore must comply with minimum wage laws. Base Pay Structure Design There are several steps involved in building a base pay program. Job analysis -- a systematic, formal study of duties and responsibilities that comprise job content, provides key information about the nature and level of work performed. Many organizations include job analysis as part of the job documentation process, but job analysis must occur before jobs can be documented. Job documentation -- includes written information about job content or the functions of the job and required knowledge, skills and abilities (KSAs) and behaviors. The job description is the most common form of job documentation. Job evaluation -- a structured process to determine the value of an organization's jobs relative to each other. Job worth hierarchy -- to group or categorize jobs relative to other jobs (e.g., pay grades or job ladders). The job hierarchy is sometimes referred to as the job architecture. It is the final result of the job evaluation process. Base pay structure -- After the job hierarchy is established, a base pay structure can be created and utilized as a framework for pay decisions. Job analysis and job documentation provide the information needed to complete the job evaluation process. The job evaluation process and job worth hierarchy lay the foundation for a base pay structure. Purpose of Job Analysis Job analysis is the basis for job documentation, which is used for many HR programs and processes, including: - Creating job documentation, such as job descriptions - Determining where a job fits in a ladder or family - Supporting recruitment, training, performance management and other HR processes - Providing a basis for legal and regulatory compliance Types of Job Documentation Job documentation consists of written information about job content, typically resulting from a job analysis effort. There are several types of job documentation: Job profiles - Job profiles are typically shorter than job descriptions, and may only include a general one or two paragraph summary of the job, such as is often found in salary survey descriptions. Job descriptions - A job description is the most frequently used form of job documentation. It is a summary of the most important features of a job. A job description should describe and focus on the job itself and not on any specific individual who might fill the job. Important features included on a job description: The general nature of the work - Duties - Responsibilities The level of the work to be performed - Skill, effort, responsibility, working conditions and where the job fits in the hierarchy Job specifications - Employee characteristics required for competent performance of the job Job ladders - Information on multiple levels within the same job family. The may include a general summary of the family, and then specific level descriptors within the family (e.g., entry, intermediate, senior). Content-Based Job Evaluation Approach Nonquantitative methods, or whole-job methods of job evaluation, view the job globally in terms of its importance to the company. - Ranking is the simplest form of job evaluation. The process involves a whole-job, job-to-job comparison, resulting in an ordering of jobs from highest to lowest in relative worth to the organization. Ranking only gives an indication of order. It does not reveal anything about the relative degree of distance between jobs. - The classification method also compares jobs on a whole-job basis. Predefined class descriptions are established, and then the job is placed in whichever classification best describes it. This is sometimes called "job slotting." - Examples of classes might be Professional 1, 2, or 3, or Manager 1 and 2. Quantitative methods, or factor methods of job evaluation, examine the importance of jobs in terms of compensable factors. - The point factor method of job evaluation uses defined factors and degrees to establish job value. The corresponding points for that level are then awarded to the job and combined for all factors to derive a total score. - The job component approach develops a job worth hierarchy by using statistical analysis. This analysis identifies the factors and factor weights that best explain the relative market pay levels of benchmark jobs. Nonbenchmark jobs can then be evaluated using the model produced from the statistical analysis. Market-Based Job Evaluation Approach Market pricing - In today's competitive market place, it is common to see pay structures designed using a market pricing technique. Market pricing requires collection and interpretation of market data external to the organization as well as identification of the prevailing rate for a job. In emerging markets, availability of data may be scarce. Why collect market data? - Analyze pay competitiveness by collecting information on the prevailing rate for benchmark jobs. - Identify pay trends by watching movement of salaries in the labor market. - Identify competitive pay practices by gathering information on practices, programs, policies and procedures. What is a benchmark job? - A standard job used to make pay comparisons - The jobs selected should be easily defined and found in other organizations. - At least 50% of jobs should be benchmarked when using market pricing to build a base pay structure. - If 70% or more of the job content is similar, the data may be used for benchmarking purposes. Why use caution when comparing data? -- The same statistics must be used in order to ensure that the data will be valid and reliable for comparison. - It is important to ensure that reported salaries are in the same form (weekly salary, monthly salary). - Local surveys may use different methodologies. - Some vendors report figures as medians (middle number), others report means (averages). In order to have a valid comparison, the statistics must be reported in the same form. Job Hierarchy Once the job evaluation is completed, a job hierarchy can be established. What is it? - A job hierarchy helps to establish a relationship between jobs by grouping similar jobs as established in the job evaluation process. Why is it important? - By establishing a job hierarchy, compensation professionals can indicate how various jobs can be categorized within the organization. - It can then be used to form the foundation of the base pay system. Why is it used? - A job hierarchy is used to determine and ensure internal and/or external equity both among positions and groups of positions. Job grades/pay structures are then based upon that internal and/or external equity. - What does it look like? The dotted lines represent grade breaks. Base Pay Structure Definition -- The pay structure of an organization is a management tool that reflects the collection and organization of internal and external compensation data to support job values. A pay structure consists of a series of pay ranges that represent jobs of similar internal and/or external worth. Objectives - Create alignment between work and rewards - Help to achieve organizational objectives; effective compensation tools for supporting the organization - Reflect the company's desired position with respect to competitive pay at a certain point in time (compensation philosophy) Components of a Base Pay Structure When building a base pay structure, the following must be determined: Number of pay grades/bands -- The purpose of pay grades/bands is to identify a compensation range within which multiple jobs are grouped that have similar value based on internal comparisons and external market data. - The number of pay structures or bands may be affected by: - Diversity of jobs in the organization - Functional area (nursing, engineering, marketing) - Job level (administrative, professional, technical, executive, etc.) Pay range - Grades typically have a maximum, midpoint, and minimum. The midpoint of the pay range typically reflects market rate for the positions in that pay range. Some organizations may choose to set midpoints above or below market rates. - Pay grades/bands usually overlap. Minimums and maximums usually fall within adjoining grades. - Pay grades/bands should distinguish between skill or responsibility, and supervisor/ subordinate relationships. - Pay grades/bands should allow for career progression. Midpoint-to-midpoint differential -- the difference in rates paid at midpoint of two adjacent grades. A midpoint represents the middle of a given salary range or pay grade. 10-15% differentials are common. Types of Pay Adjustments Beyond the initial pay rate offered to a new employee, pay increases may be granted for a variety of reasons. Merit increase-- Organizations may provide employees an annual increase in the form of a merit increase tied to individual performance and prevailing merit budget practices. - Increases can be stated as an overall pool of money by department -- such as 4% of current salary budget to be distributed based on individual performance -- or there may be specific guidelines by performance level. Cost-of-living adjustments (COLAs) -- usually made to keep up with the rate of inflation. They may be treated as a separate payment, in addition to the regular base pay. Equity adjustments - reflect internal compression issues (for example, between supervisor and subordinate, or between peers with dissimilar lengths of service or performance levels). General increases -- often given to all or a significant percentage of employees when an organization finds its compensation program is behind competitive market rates. A set monetary amount or a percentage increase may be given. Skill-based or pay-for-knowledge approach -- Individuals are paid for the skills they possess rather than their job responsibilities. Pay increases are given based upon increased knowledge, skill or ability. The employee may or may not use the skill. Lump-sum payment -- often are provided in place of an annual increase to the base salary as a means of controlling annual fixed-cost increases. For example, a lump-sum payment may be made to an employee at the top of his/her salary grade maximum to keep the salary from going over the maximum. Differential Pay In addition to base pay, some employers pay differentials. - Shift differential -- paid to an individual to accommodate specific working conditions. It is most often called a shift differential when the individual is working hours other than the traditional 8 a.m. to 5 p.m. - Weekend or holiday differential -- paid in addition to the normal hourly rate to pay for working a holiday or weekend. It may take the form of an additional hourly rate or a flat monetary amount. - On-Call Pay -- paid for being available to work upon notice - Hazard Pay -- pay for working in hazardous conditions - Expatriate differential -- paid for the difference in costs between an individual's home country and the assignment location (e.g., housing, goods and services, hazardous duty allowance) - Geographic differential -- pay differences established for the same job based on variations in costs of living or costs of labor among two or more geographical areas - Language differential -- paid to an individual fluent in more than one language who uses these skills in the work setting to meet organizational needs - Skill-Based Pay -- pay to an individual for possessing a particular skill Variable Pay The popularity and utilization of variable pay is not uniform throughout the world. The concept is popular in North America and has been adopted in some countries. In certain countries and regions (e.g., China, Central Europe and Eastern Europe), the concept of variable pay is not fully accepted. Variable pay rewards for accomplishments and results - Organizational, group or individual results -- aligns and focuses organizations, business units, teams and individuals on the accomplishment of key goals and objectives, assesses their performance, and rewards those who accomplish them - Typically paid monthly, quarterly or annually-- depends on common market practice, the availability of performance measures, and the goals of the plan. - Not guaranteed -- Variable pay is popular, in part, due to its ability to reward employees for performance without becoming a permanent part of their base pay. It can be increased, decreased or eliminated based on the performance of the organization and its ability to pay. Variable pay is Performance-based compensation -- serves as a pay differentiator between those who achieve results and those who do not. Variable pay has become more popular, in part, due to its ability to reward employees for performance without becoming a permanent part of their base pay. It can be increased, decreased or eliminated based on the performance of the organization and its ability to pay. Most Common Types of Short-Term Variable Pay Plans Short-term incentive (STI) plans consist of plans for which desired results will be achieved in one year or less. There are several primary categories of short-term variable pay: bonuses, incentives, commissions. Within each of these categories there are specific types of variable pay plans. Commission Plans Commissions are a type of short-term incentive plan specifically for sales employees. Commissions are cash payments, based on a predetermined performance and reward schedule that typically make up the larger portion of an individual's total compensation. They are typically based on sales or profit margin on those sales. - Commissions are typically paid as a percentage of sales - Employees on commission typically receive a large portion of their total pay in the form of - commissions - Commissions are typically considered part of sales compensation, which is a specialized area of compensation design Compensation programs must match the mix of compensation to the skill set required of the job. The skill set required usually falls into one of three categories: - Customer identification -- analyze market, contact prospects, qualify leads - Customer service -- expedite orders, handle service problems, coordinate service efforts - Customer persuasion (rain maker) -- These employees select accounts to call on, identify buyers, make presentations, overcome objections and make sales. The more persuasion required, the higher the targeted at-risk percentage - Bonuses are less formula-driven and more discretionary than incentive plans. - A bonus award might, for example, be based on an employee's overall performance rating or other type of holistic measure. - A bonus might be discretionary based on total company performance or management judgement. Bonus Plans Bonus plans typically refer to rewards given for the completion of a specific task or objective. Hiring (sign-on) bonus - Payment to a prospective employee to induce acceptance of an employment offer - It also can be used to buy out any compensation the employee will be walking away from in order to make a change in employment. Referral bonus - Payment for recommending an applicant who is subsequently hired. - Amounts are often based on the level of the person to be hired. - Some plans will pay a portion upon hire and a portion at some milestone, such as completing training, passing a probation period or at a set period of time (e.g., 6 months or 12 months). Retention (stay) bonus - Payment to certain critical employees in exchange for agreement to continue employment until a specified date or for a specified period of time - Often used in mergers, acquisitions, bankruptcies, closing/ceasing operations - The objective is to provide continuity when there is uncertainty. - May be awarded to provide additional compensation to key or high performing employees Incentive Plans Elements of an Incentive Plan Criteria determined in advance -- The criteria and objectives for performance and the reward schedule are determined in advance and communicated to participants. Incentives must be re-earned each year or performance period. Performance measures -- Typically based on specific performance measures Weighting -- Performance measures can be weighted between individual, team, and total organizational performance Payouts -- Amount of payment can vary with level of performance - Monetary or non-monetary -- Rewards are typically monetary (cash or equity) but may be non-monetary (merchandise, travel, etc.). - Self-funded or budgeted -- The plan is self-funded (generates its own savings) or budgeted. Long-Term Incentive (LTI) Plans Long-term incentive (LTI) plans include those for which desired results will be achieved in more than one year. The period of measurement is most often from three to five years. Types of LTI plans include: Equity-based - Company stock is used to create an equity interest in the company and foster identification with shareholder interests. - The value of the award is based on the performance of the organization's stock. - Actual awards may be in the form of stock or cash. Cash-based - Long-term incentive plans in which the award is based in cash and not based on stock or equity. - These may be used in addition to stock-based plans or in organizations that do not have stock. Equity compensation programs typically are used as long-term incentives utilizing stock/ share or a stock/share equivalent for payments. Equity may be used to foster employee ownership in the organization. Time period -- Long-term incentives are paid out based on performance extending past a 12-month period. Types -- Equity incentives may include the following: - Stock/share options -- the right to purchase company stock/shares at a specified price over a specified time period after time requirements of continued employment are met - Stock/share grants -- stock/shares provided to employees at no cost to them - Restricted stock/shares or units -- stock/shares awarded to employees with prohibitions on sale or transfer until restrictions lapse - Performance shares/Performance Cash -- Units having a monetary value are awarded to employees based on the attainment of certain internal or external performance measures.