Scope—The Compensation Discipline deals with the various forms of direct compensation—that is, employees’ pay—that employers use to attract, recognize and retain workers. It includes designing and administering compensation systems including base pay, differential and incentive pay, and overtime. It also includes matters that focus on compensation-related careers, communications, legal and regulatory issues, technology, metrics and outsourcing, as well as effective compensation practices and global compensation issues. It does not include the various forms of indirect employee compensation—commonly referred to as “benefits."
Overview
Compensation refers to wages and salary paid by employers to employees in exchange for work. Compensation also includes variable pay in the form of short- and long-term incentives, such as cash bonuses and company stock awards, as well as promotions and pay increases. The Total Rewards Program typically is comprised of compensation, benefits and personal growth opportunities, although some organizations include work/life balance as a fourth element.
Compensation refers to wages and salary paid by employers to employees in exchange for work. Compensation also includes variable pay in the form of short- and long-term incentives, such as cash bonuses and company stock awards, as well as promotions and pay increases. The Total Rewards Program typically is comprised of compensation, benefits and personal growth opportunities, although some organizations include work/life balance as a fourth element.
Wages and Salary
Wages and salary are commonly known as base pay. Base pay is the foundation of total compensation, because it establishes the standard of living for employees. It also serves as the primary indication of the value the organization places on the role an employee plays and on the contributions the employee makes. For base pay rates to be effective, both the organization and employees must view them as being internally equitable, externally competitive, affordable and cost effective, legal and defensible, understandable, and appropriate for the organization and for the workforce.
Wages and salary are commonly known as base pay. Base pay is the foundation of total compensation, because it establishes the standard of living for employees. It also serves as the primary indication of the value the organization places on the role an employee plays and on the contributions the employee makes. For base pay rates to be effective, both the organization and employees must view them as being internally equitable, externally competitive, affordable and cost effective, legal and defensible, understandable, and appropriate for the organization and for the workforce.
Variable Pay
Variable pay is a significant element of the direct compensation package in a growing number of organizations. The trend is toward more use of variable pay, expanded eligibility and increasing prominence of variable pay in the total direct compensation package. Variable pay can be in the form of short-term (one year or less) or long-term (two years or more) incentives or bonuses and employee ownership programs.
Variable pay is a significant element of the direct compensation package in a growing number of organizations. The trend is toward more use of variable pay, expanded eligibility and increasing prominence of variable pay in the total direct compensation package. Variable pay can be in the form of short-term (one year or less) or long-term (two years or more) incentives or bonuses and employee ownership programs.
Short-term incentive plans include:
In most short-term variable pay plans, participants have a target—typically a percentage of base pay—that is paid out when the individual, team, business unit or organization meets a goal or combination of goals. Over-target pay-outs may occur when objectives are exceeded.
One of the objectives of long-term incentive plans is to retain key employees by vesting a percentage of the plan award over a number of years. In addition to cash plans, there are a variety of stock-based plans to choose from, including stock option, restricted stock and performance-based stock plans. Many companies have transitioned from stock option plans in favor of full value share plans due to a change in how stock options are expensed.
One of the objectives of long-term incentive plans is to retain key employees by vesting a percentage of the plan award over a number of years. In addition to cash plans, there are a variety of stock-based plans to choose from, including stock option, restricted stock and performance-based stock plans. Many companies have transitioned from stock option plans in favor of full value share plans due to a change in how stock options are expensed.
Other Pay
There are a variety of other situations where employees are paid a premium over their regular wages and incentives. Organizations often pay a differential to employees when they are required to work under non-standard working conditions such as evening or night shifts or in unusually cold, warm or dangerous environments. Additional pay also may be offered to employees who perform the lead function or to employees who are on-call after regular working hours for emergency or highly specialized situations.
There are a variety of other situations where employees are paid a premium over their regular wages and incentives. Organizations often pay a differential to employees when they are required to work under non-standard working conditions such as evening or night shifts or in unusually cold, warm or dangerous environments. Additional pay also may be offered to employees who perform the lead function or to employees who are on-call after regular working hours for emergency or highly specialized situations.
Compensation Infrastructure
To manage compensation efficiently and cost effectively, a compensation infrastructure is developed. At a minimum, the compensation infrastructure consists of:
To manage compensation efficiently and cost effectively, a compensation infrastructure is developed. At a minimum, the compensation infrastructure consists of:
- A compensation philosophy;
- A set of jobs covering the roles in the organization;
- A set of pay ranges to guide managers in making hiring offers and in promotional, merit and other pay increases.
Compensation philosophy
Development of the compensation philosophy—a statement about how the organization manages compensation—is an important first step in creating the compensation infrastructure. A typical compensation philosophy might state that the organization sets target pay rates at the 50th percentile of the competitive market, provides incentives for meeting stretch goals that results in pay delivery at the 75th percentile, and provides long-term incentives in the form of full value stock options to senior professionals and managers to align objectives with those of shareholders. The compensation philosophy provides important guidance to compensation professionals in the initial set-up and ongoing maintenance of the compensation infrastructure.
Job analysis
Maintaining jobs and associated pay grades is a key role for the Compensation Analyst in many organizations. Creating an efficient set of jobs with associated pay grades starts with job analysis. Job analysis is the systematic study of jobs to determine what activities and responsibilities they include, their relative importance in comparison with other jobs, the personal qualifications necessary for performance of the jobs and the conditions under which the work is performed. Job analysis focuses on the job, not the person doing the job (even though some job analysis data may be collected from incumbents).
The most effective job analysis technique, if feasible, is to collect information directly from the most qualified job incumbent(s) via an open-ended or highly structured questionnaire. Other methods include observation, interview, or work diary or log.
Job analysis data can be used to identify the knowledge, skills and expertise required to effectively perform job assignments, establish criteria for selection and promotions, design objectives for training and development programs, develop the standards for the measurement of performance, and assist with the determination of pay classification levels. An important output from the job analysis process is information that can be used to develop job descriptions and job specifications.
Job evaluation
After the job analysis is complete, an important decision regarding job pricing must be made. If the organization is most concerned with being competitive regarding pay with external companies, the next step would be market pricing. On the other hand, if the organization is most concerned with internal equity, the next step would be job evaluation.
The job evaluation process determines the relative worth of each job by establishing a hierarchy of jobs within an organization and is the key to establishing a fair and equitable pay structure.
Job evaluation methods can be quantitative, qualitative or some combination of both.
Non-quantitative job evaluation methods attempt to establish a relative order to jobs, while quantitative methods attempt to establish how much more one job is worth compared with another job by using a scaling system. There are thousands of different job evaluation systems now in use. Each uses one of about a dozen technical approaches such as the factor comparison, point-factor, job component, definition, ranking or slotting methods to determine the value of each job in the organization.
Non-quantitative job evaluation methods attempt to establish a relative order to jobs, while quantitative methods attempt to establish how much more one job is worth compared with another job by using a scaling system. There are thousands of different job evaluation systems now in use. Each uses one of about a dozen technical approaches such as the factor comparison, point-factor, job component, definition, ranking or slotting methods to determine the value of each job in the organization.
Market pricing
Market pricing is the process of setting pay structures almost exclusively by collecting, analyzing and matching job salary survey data to determine rates paid in the external market. Organizations may elect to use this method across the board or just for certain professions that are market-driven (e.g., information systems, engineering).
A salary survey collects information on base pay (salary), recent or projected pay adjustments, bonuses or bonus eligibility and/or other forms of compensation on selected jobs across or within occupational fields for a labor market defined by its geographical reach (local, regional, national or international), industrial scope and other characteristics. Surveys range from short questionnaires on a few issues or jobs across a limited number of employers conducted by in-house staff to large-scale, comprehensive samples of many employers or workers across industries conducted by outside parties.
HR professionals (typically compensation specialists) use survey data to help develop pay structures, price jobs, advise on salary offers, forecast wage movement, formulate performance pay matrices, prepare salary budgets, support labor contract negotiations and perform other work requiring sound information on competitive compensation.
Due to antitrust regulations, it should be noted that organizations should avoid direct comparisons of pay and salary data with competitors (i.e., they should not contact other companies directly to ask what they pay for a particular job). Third-party salary surveys through professional associations, professional societies or consulting groups are recommended to avoid any implication of conflict in this regard.
Pay ranges
The result of pricing is a target pay rate for each job within the organization. Once this is accomplished, the next step is to develop pay ranges to provide managers with a range of pay for each job. Ideally, managers use the pay range to manage pay relative to performance and experience in the job.
The result of pricing is a target pay rate for each job within the organization. Once this is accomplished, the next step is to develop pay ranges to provide managers with a range of pay for each job. Ideally, managers use the pay range to manage pay relative to performance and experience in the job.
A company may choose traditional pay structures, or broadbanding to organize the pay bands related to jobs. Traditional pay structures tie a range of pay to a cluster of jobs with the midpoint of the range corresponding to the theoretical market competitive rate. In broadbanding, companies have fewer ranges but they are wider, accommodating more jobs and encouraging lateral moves within the organization.
A useful tool for managers to assess internal equity or appropriateness of an individual’s pay relative to performance and experience is the compa-ratio. A compa-ratio is a measure that expresses current pay rates as a percentage of range midpoints. For an individual at the midpoint of the range the compa-ratio is 1.0, while someone at the minimum might have a compa-ratio of 0.8 and someone at maximum a compa-ratio of 1.2.
Pay Actions
A key area of responsibility within the compensation discipline involves proposing the annual pay increase budget. The overall merit pay budget for the year is planned using market data and company performance. Once the budget is set, managers must make decisions about how to allocate the budget across the organization. A salary management guide is helpful for this purpose. Such a guide reflects the relationship between employee performance, their current position within the pay range and the budget for merit increases.
A key area of responsibility within the compensation discipline involves proposing the annual pay increase budget. The overall merit pay budget for the year is planned using market data and company performance. Once the budget is set, managers must make decisions about how to allocate the budget across the organization. A salary management guide is helpful for this purpose. Such a guide reflects the relationship between employee performance, their current position within the pay range and the budget for merit increases.
Pay actions provide for adjustments to the pay of employees on an annual basis to preserve competitiveness. Pay actions most often occur either on a single (focal) date or throughout the year. In a focal point review system, all employees receive performance and merit increase reviews on a common date. Anniversary date increases are usually on the anniversary date of employment or promotion.
When organizations use individual pay increases to motivate employees, the pay system is performance based. Regardless of whether a focal point or anniversary schedule is utilized, it is important that the timing of the performance appraisal and the salary action are coordinated. If an employee is to believe pay is tied to performance there must be a visible connection, and long periods of time between the performance review and the salary action diminish the connection.
In a person-based pay system, pay is based on what the employee brings to the organization in the form of knowledge, skills, abilities and behaviors. There are three approaches to tying base pay to what people have in the way of qualifications:
In a person-based pay system, pay is based on what the employee brings to the organization in the form of knowledge, skills, abilities and behaviors. There are three approaches to tying base pay to what people have in the way of qualifications:
- Skill-based.
- Knowledge-based.
- Credential-based.
Skill-based pay makes the base rate contingent on how many job-related skills the employee has learned, the level of skill mastery or a combination of both. Knowledge-based pay typically centers on career ladders, which identify expertise levels within the same occupation or discipline. A third person-based approach, credential-based pay, recognizes formal credentials such as licenses, professional certifications, admission to the Bar and other such formal designations as a basis for determining pay.
Specialized Compensation Categories
Some types of compensation require specialized planning and design. These include:
- Executive compensation.
- Global compensation.
- Sales compensation.
- Executive compensation
Executive Compensation typically applies to the top 2-5 percent of an organization’s workforce. In addition to base pay and short- and long-term incentive pay, executives are often eligible for other compensation elements such as deferred compensation and perquisites. Perquisites might include a reserved parking place, a comprehensive annual physical exam, tax planning, first class airfare or use of a company car. Executive pay in public companies is undergoing much more scrutiny as a result of Sarbanes-Oxley legislation.
Francis Jeyaraj
Specialist - Compensation & Benefits
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