HR 202 Chapter 16

1. Compensation
Chapter 16
International Pay Systems
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Introduction
All around the world, competitive forces have changed the way
people work and how they get paid.
• Japanese companies are dismantling their seniority-based systems.
• European companies are shifting to variable pay and performance-
based appraisal.
• China’s system is unstable.
• The largest U.S. companies are adding overseas jobs.
Global acquisitions of former competitors change pay systems.
• The merged DaimlerChysler adopted a Chysler-like executive pay.
Changes in pay may directly tie to cataclysmic sociopolitical
change, as in China, Russia, and Eastern Europe.
• Too much change and experimentation can create social unrest.

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The Global Context
Understanding international compensation begins with
recognizing differences and similarities and how to manage them.
• Depends on variations in economic, institutional, organizational, and
employee characteristics.
Organizations must determine the degree each factor constrains
their compensation decisions and practices.
• Some constraints are regulatory and others are normative.
Organizations must decide the degree it uses compensation
practices similar to others and the degree it will be different.
Finally, they must weigh the home and local country context
differently for different jobs.

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Five Factors of International Compensation
Five contextual factors are especially relevant in international
compensation.
• Social contracts, including the legal framework and regulation.
• Cultures.
• Trade unions.
• Ownership and financial markets.
• Mangers’ autonomy.
These five factors overlap and interact with each other.

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The Social Contract
Viewed as part of the social contract, the employment
relationship is more than an individual and an employer.
Different countries hold differing beliefs about the role of
government, employees, unions, and employers.
• Understanding how to manage employee compensation in any
country requires an understanding of the country’s social contract.
• Changing employee compensation systems requires changing the
expectations of parties to the social contract.
The social contract evolves over time, sometimes quickly.
• The role has recently greatly expanded in the U.S. economy in:
• Automobiles and financial services.

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Centralized or Decentralized Pay-Setting
An example of the social contract’s effects on pay systems is the
degree of centralization of pay-setting among countries.
• The U.S., the U.K., and some central European countries use highly
decentralized approaches with little government involvement.
• In western and northern Europe, wage bargaining is likely to be
centralized, taking place at the industry or national level.
• Government involvement is typical.
Things continue to evolve.
• Even when centralized, there is bargaining at other levels.
• Companies may deviate from the centralized agreement.
• This allows some flexibility.
• Lower in centralized countries and higher in decentralized countries.

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Exhibit 16.2: The Social Contracts and Primary Bargaining Level
in Selected European Union Countries and the United States

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Regulation
Differences in wage flexibility also ties to regulatory restrictions.
• Maximum hours of work and hiring/firing of workers.
The legal framework affects employer flexibility with the role of
work councils and co-determination in countries like Germany.
• Work councils are employee formed and separate from the unions.
• The council has veto-rights and rights of consent.
• The co-determination law requires companies with 500-2000
employees have a third of supervisory board be employees.
In Europe, laws can vary within countries and also directives
apply across countries.
The social contract in Europe comes at a cost.
• Taxes are higher to protect workers from unemployment.

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Exhibit 16.6: Expenditures on Unemployment
Benefits as a Percent of Gross Domestic Product

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Culture
Culture is a shared mental programming, rooted in values, beliefs,
and assumptions, which influences how information is processed.
• National culture assumes a country’s people share a national character.
Hofstede’s national cultural attributes are:
• Power distance.
• Individualism – Collectivism.
• Uncertainty avoidance.
• Masculinity – Femininity.
• Long-term versus short-term orientation.
Collectivistic cultures should use egalitarian pay and individualistic
cultures should use individual- and performance-based pay.
• Such thinking can result in stereotyping

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In National Culture a Constraint on Compensation?
The authors believe “No” and the importance of national culture
has been overstated.
• The U.S. classifies as risk takers, ranking high on individualism.
• Slovenia is classified as collectivistic and security conscious.
• Yet, Slovenian managers take more risks and are more individualistic.
Re-analysis of Hofstede’s work shows the variance between
individuals within countries is larger than between countries.
How useful is the national culture in managing international pay?
• It is a starting point, thought of as the “average.”
Overreliance on the “average” can seriously mislead.
• The range of individuals within nations is more important.

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Unions and Ownership
Trade Unions and Employee
Involvement
Europe is highly unionized.
• Sweden – 67%.
• U.K. 24%.
• Italy – 34%.
Asia is less heavily unionized.
• Japan – 17%.
• South Korea – 10%.
In France, 90% work under
collective agreements.
• But fewer than 10% are union.
Germany has work councils.
Ownership and Financial
Markets
Ownership and financing affect
international pay.
Ownership and access to capital
is less concentrated in the U.S.
Bonuses linked to shareholder
value or stock options make no
sense in Japan or Korea.
Township enterprises are playing
a larger role in China.
Ownership differences influence
which type of pay makes sense.

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Managerial Autonomy
This factor refers to the degree of discretion managers have to
make total compensation a strategic tool.
• Inversely related to the degree of centralization and regulatory intensity.
• U.S. and U.K. companies have freedom to adopt pay practices and to
hire or downsize.
• Centralized pay found in the EU limits autonomy to align pay to strategy.
• Wage councils issue guidelines, adopted, by some degree, by everyone.
Corporate policies may limit managerial autonomy.
• Pay decisions made in the home office in one country may align with
corporate strategy but discounts local economic and social conditions.

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Comparing Costs
Even is wage rates appear the same, expenses for health care,
living costs, and allowances complicate the picture.
• Many nations offer national health care.
• Therefore, its value as part of compensation is diminished.
Accurate data is difficult to find when comparing a specific U.S
firm to a specific foreign competitor.
• Most data is from U.S. companies’ operations in global locations.
• Other data is often not available.
• International data may be biased to U.S. pay practices.

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Labor Costs and Productivity
Differences in labor costs exist.
• $3.91 hourly manufacturing
wage in Mexico.
• Compared to $39.03 in U.S.
• Lower productivity is offset by
lower labor costs.
Companies may move or grow
jobs if productivity is the same.
China is a low-wage country
but pay is higher than other
Asian countries.
• China has rapid pay rate
growth too.
Most companies analyze the
pros and cons of location.
• Some people in former Soviet
Bloc are unaware of
comparison shopping.
• Or have a credit/debit card.
• In manufacturing, it may be all
labor costs.
• Apple outsourcing to Foxconn.
Labor costs and quality of
available labor are important.
Taxes and the legal/regulatory
environment are important too.

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Cost of Living and Purchasing Power
Comparing living costs across boarders is very complex.
• Companies need such data to adjust pay for transferred employees.
• The objective is to maintain the same level of purchasing power.
A worker in Copenhagen has higher gross hourly pay than a
worker in NY City, but much lower purchasing power.
• To maintain the purchasing power of a New Yorker moving to
Copenhagen, additional compensation beyond pay would be needed.
• In contrast, a move to Kuala Lumpur at NYC pay levels would provide
an economic windfall.
One index of purchasing power is the number of working hours
needed to purchase an iPhone.
• 54 hours in New York City, 243 in Kuala Lumpur, 299 in Moscow, and
306 hours in Shanghai.

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The Total Pay Model: Strategic Choices
Pay systems differ around the globe.
The total pay model used in this book guides the following
discussion of pay systems in different countries.
The basic choices are:
• Objectives of pay systems.
• External competitiveness.
• Internal alignment.
• Employee contributions.
• Management.
While the choices may be universal, the results are not.

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Japanese Traditional National System
Traditional Japanese employment relationships were supported
by “three pillars.”
• Lifetime security within the company.
• Seniority-based pay and promotion systems.
• Enterprise unions – decentralized to a single company.
Japanese pay systems emphasize the person rather than the job.
• Seniority and skills rather than job or work performance.
• Promotions based on several factors rather than performance alone.
• Employment security based on performance of the organization and
the individual.
Japanese pay systems can be described in terms of base pay,
bonuses, and allowances / benefits.

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Exhibit 16.14: Salary Percentage Differentials by Job Level and
Rank/Skill Level within Job Level, Traditional Japanese Company
Jump to long image description.

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Japan – Base Pay
Base pay is based on career category, years of service, and skill
or performance level.
• Top Japanese careers – general administration, engineer/science,
secretary/office, technician/blue-collar, and contingent.
Seniority remains a major factor in determining base pay.
• Employees get annual increases until age 50, the amount of increase
varies according to skills and performance.
Each skill is defined by class and rank within the class.
• Employees advance in rank due to their supervisor’s evaluation of
effort, skills required for the work, and performance.
The seniority-based system has rising labor costs.
• Early retirement and “new jobs” with lower salaries control costs.

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Japan – Bonuses
Bonuses provide additional pay equivalent to 1-5 months of
annual salary, depending on job level and organizational results.
• Bonuses are expected twice a year, even in bad financial times.
• A multiplier times monthly base pay determines bonus amount.
Bonuses are variable pay that helps control the employer’s cash
flow and labor cost – not necessarily as a motivator.
Japanese labor law encourages the use of bonuses by omitting
bonuses from calculations of many other benefit costs.
The timing of the bonuses is very important.
• Coincides with times of traditional gift giving.
The tradition of bonuses is deeply rooted in Japanese life and
considered an indispensable form of pay.

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Japan – Benefits and Allowances
Allowances come in a variety of forms.
• Family allowances.
• Commuting allowances.
• Housing and geographic differential allowances.
• Company housing – dormitories, or mortgage subsidies.
• Life-passage payments at marriage and death in the immediate family.
Legally mandated benefits in Japan include social security,
unemployment, and workers’ compensation.
• Employers also pay premiums for mandated health insurance,
preschool child support, and employment of the handicapped.

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German Traditional National System
Traditional German pay systems are embedded in a social
partnership between business, labor, and government.
• Creates vater staat, or “nanny state.”
• Vergutung is the most common German word for “compensation.”
• Pay decisions are highly regulated; over 90 different laws apply.
• Tariff agreements are negotiated for each industrial sector by the
major employers and unions.
• Methods for job evaluation and career progression are included in the
tariff agreements.
• Agreements do not apply to managerial jobs.
• Even small organizations not legally bound by tariffs use their
guidelines.

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Germany – Base Pay
Base pay accounts for 70-80% of total compensation.
• Based on job descriptions, job evaluations, and employee age.
• Tariff agreements for the German car company Adam Opel AG, sets the
following tariff groups.
• Wage earners – 8 levels.
• Salary earners – 6 administrative levels, 6 technical levels, 4 supervisory
levels.
Generally, a rate is negotiated for one of the levels and the other
levels in that group will be calculated as a percentage of that rate.

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Germany – Bonuses
There is a trend toward performance-based bonuses, but they
have not been part of a traditional German pay system.
Adam Opel AG’s tariff agreement stipulates that an average of
13% of the total base wages be paid as “efficiency allowances.”
• Systems for measuring this efficiency are negotiated with the works
council for each location.
• In reality, the efficiency allowances become expected annual bonuses.
Performance bonuses for managerial positions not included in
tariffs are based on company earnings and objectives.
Currently only about a third of top executives receive stock
options.

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Germany – Allowances and Benefits
Germany’s social contract includes generous social benefits.
Nationally mandated benefits, paid by taxes levied on employers
and employees, include:
• Liberal social security.
• Unemployment protection.
• Health care.
• Nursing care and other programs.
Additionally, companies commonly provide pension plans,
savings plans, building loans, and life insurance.
• Company cars are a popular status symbol.
• 30 vacation days and 13 national holidays annually.

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Strategic Comparisons: Japan, Germany, U.S.
Both the Japanese and German sociopolitical and cultural
systems constrain organizations’ use of pay as a strategic tool.
• German companies face constraints set by tariff agreements.
• Japanese companies also have similar pay structures across industries.
• U.S. managers have considerable flexibility to align pay systems with
business strategies.
Tariff agreements apply to German competitors’ labor costs too.
• Japanese organizations set long-term pay objectives.
• U.S. companies focus on the shorter term.
In Japan, person-based factors are used to set base pay.
• Job-based factors and seniority are used in Germany.

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Strategic Comparisons: Advantages/ Disadvantages
Each approach has advantages and disadvantages.
• The Japanese approach is consistent with:
• low turnover and high commitment and high security, greater acceptance of
change, and the need to be flexible.
• U.S. firms face higher turnover and skepticism about change.
• U.S. firms encourage innovation and recognize contributions of diversity.
• German systems are bureaucratic and rule-bound and inflexible but offer
stability.
• Both the Japanese and German systems face challenges from high costs
of an aging work force.
• Japan has taken limited advantage of women’s capabilities.
• U.S. challenges include increased employee uncertainty, the system’s
short-term focus, and employee’s skepticism about change.

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Evolution in Japanese and German Models
Slow economic growth and its seniority-based pay creates a
challenge for Japan in controlling its labor costs.
• Cheaper labor in China adds further pressure on controlling labor costs.
• Many companies are trying to maintain long-term employment rather
than lifetime employment and rewarding less senior employees.
• Companies are increasingly using performance-based pay.
Many of the changes in Germany are the result of global
competitive pressures and technological changes.
• German faces many challenges including an aging population and an
inflexible labor market.
• Companies are moving to other EU countries, China, and India.
• Companies are asking for greater autonomy in negotiating tariff
agreements.

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Strategic Market Mind-Set
The three general worldwide compensation strategies are:
• The localizer, the exporter, and the globalizer.
A localizer may have a different pay system for each country and
operate independent of corporate headquarters.
Exporters are the opposite with one system they “export” for
worldwide implementation at all locations.
Globalizers seek a common system that can be used as part of
the “glue” to support consistency across all global locations.
• Headquarters and the operating units are networked to share ideas
and knowledge.
• Some believe this is the business model for the 21st century.
• Focus is first on global strategy and then adapted to local conditions.

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Expatriate Pay
Employees temporarily working and living in a foreign country
are called expatriates (or “expats”).
• Parent-country nationals (PCNs) are citizens of the employer’s home
country and living and working in another country.
• Third-country nationals (TCNs) are citizens of neither the employer’s
home country nor the foreign country where they live and work.
• Local country nationals (LCNs) are citizens of a foreign country where
the parent employer operates. Hiring LCNs has advantages.
• They know the local conditions and no relocation expenses.
• Avoids the need to “adapt” to the local culture.
• Satisfies nationalistic demands for hiring locals.
• TCNs or expats may be brought in for experience, to protect
information, or for a needed skill set.
Designating expatriate pay systems is a challenge.

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Elements of Expatriate Compensation
Salary.
• Base plus incentives are determined by evaluation or “job leveling.”
Taxes.
• The U.S. is the only country to tax income earned in a foreign location.
• Most employers pay the tax via tax equalization.
Housing.
• Expatriate colonies often collection from many companies.
Allowances and premiums.
• There are many allowances and premiums due to the expat working
with less supervision, living and working in strange surroundings, and
representing the employer in the host country.

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The Balance Sheet Approach
Most global firms pay in a balance sheet approach – expats
should have the same spending power as those at home.
• Ensures cost-effective mobility of people to global assignments.
• Ensures that expats neither gain nor lose financially.
• Minimizes adjustments required of expats and their dependents.
Equalizing pay may not motivate an employee to move to a
foreign country – so employers offer financial incentives.
If international experience is a future required competency, then
the bonuses should be reduced.
• Experience increases likelihood of future promotions.
• Yet, U.S. expatriates feel their organizations do not value the expertise.

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Exhibit 16.20: Balance Sheet Approach
Jump to long image description.

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Alternatives to Balance Sheet Approach
Employers continue to explore alternatives, due to the cost.
Employers and employees negotiate for an agreeable package.
Another alternative, localization, or local plus, ties salary to the
host country’s salary scales and provides allowances.
The modified balance sheet ties salary to a region and may
decrease allowances over time.
The lump-sum/cafeteria approach offers expats more choices.
• Offers lump-sums to offset differences in standards of living.
Companies may use less expats and more LCNs and TCNs

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Expatriate Systems – Objectives? Quel dommage!
The complexities of international compensation are clear.
• What you do not hear is how the expatriate pay system affects
competitive advantage, customer satisfaction, or quality.
Expatriate pay systems emphasize maintaining purchasing power
and minimizing disruptions and inequalities.
• The lack of alignment with organizational objectives is glaring.
• The only major innovation in expat pay is to re-label them and TCNs as
“international assignees.”
Expatriate pay must be sufficient to encourage the employee to
take the assignment,
• yet not so attractive the local nationals feel unfairly treated or that
expats refuse future reassignments.

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Employee Preferences
An additional consideration is employees’ preferences for
international assignments.
For many Europeans, it is just part of a career.
For many U.S. employees, it means leaving the action.
Employees differ in their preferences and they vary over time.
• 68% of expats do not know what their jobs will be when they return
home.
• 54% return to lower-level jobs, only 11% are promoted.
• 5% believe their company values overseas experience.
• 77% have less disposable income when they return home.
• Only 13% of expats are women, yet 49% of U.S. managers and
professionals.

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Borderless World – Borderless Pay? Globalists
Globalists are managers who operate anywhere in the world in a
borderless manner.
• Some companies are designing borderless pay systems.
• One testing ground is the European Union.
• One difficulty is that base pay levels and other components depend
too much on differences in each nation’s laws and customs.
Focusing on expat pay may blind companies to the issue of
appropriate pay for employees seeking global opportunities.
• There is a focus on local operations, the home country pay, and less
attention to integrating operations in global firms.
• Commitment to a long-term global strategy is difficult is local
managers have little input and receive limited benefits.

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End of Chapter 16.