INTRODUCTION TO COMPENSATION AND BENEFITS

1. McGraw-Hill/IrwinMcGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Milkovich/Newman: Compensation, Ninth EditionMilkovich/Newman: Compensation, Ninth Edition
Chapter 1Chapter 1
Introduction toIntroduction to
compensationcompensation
and benefitsand benefits

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Compensation refers to all
forms of financial returns
and tangible services and
benefits employees
receive as part of an
employment relationship
What Is Compensation?What Is Compensation?

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Contrasting Perspectives ofContrasting Perspectives of
CompensationCompensation
Society’s
Views
Stockholders’
Views
Employees’
Views
Managers’
Views

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Compensation: DefinitionCompensation: Definition
 EmployeesEmployees
– Major source of financial securityMajor source of financial security
– Return in an exchangeReturn in an exchange between employer and themselvesbetween employer and themselves
– EntitlementEntitlement for being an employee of the companyfor being an employee of the company
– RewardReward for a job well donefor a job well done

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Compensation: Definition (cont.)Compensation: Definition (cont.)
 SocietySociety
– Pay as a measure of justicePay as a measure of justice
 Gender pay gap in U.S., after adjusting for differences inGender pay gap in U.S., after adjusting for differences in
education, experience, occupation, has narrowed from 36education, experience, occupation, has narrowed from 36
percent in 1980 to 13 percent in 2006percent in 1980 to 13 percent in 2006
– Benefits as a reflection of justice in societyBenefits as a reflection of justice in society
 ~46m Americans do not have health insurance (16% of~46m Americans do not have health insurance (16% of
population)population)
 Proportion of Americans w/ private insurance 67.5% in 2007Proportion of Americans w/ private insurance 67.5% in 2007
– Job losses (or gains) attributed to differences inJob losses (or gains) attributed to differences in
compensation (see Ex. 1.1)compensation (see Ex. 1.1)
– Belief that pay increases lead to price increasesBelief that pay increases lead to price increases

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Compensation: Definition (cont.)Compensation: Definition (cont.)
 StockholdersStockholders
– Linking executive pay to company performance theoreticallyLinking executive pay to company performance theoretically
increases stockholders' returns (see Ex. 1.2)increases stockholders' returns (see Ex. 1.2)
 ManagersManagers
– A major expense (labor expense can account for 50+% ofA major expense (labor expense can account for 50+% of
total costs)total costs)
– Used to influence employee behaviors and to improve theUsed to influence employee behaviors and to improve the
organization's performance (see Ex. 1.3)organization's performance (see Ex. 1.3)
 Grocery store clerk pay (2005):Grocery store clerk pay (2005):
– Industry average: $12.28/hrIndustry average: $12.28/hr
– Costco:Costco: $16$16
– Whole FoodsWhole Foods $12.50$12.50
– Sam’s ClubSam’s Club $12$12
– Wal-MartWal-Mart $9.68$9.68
 Labor costs as % of total costs for grocery stores historically 15-18%;Labor costs as % of total costs for grocery stores historically 15-18%;
today norm is 9-12%; warehouse stores 4-6%; Whole Foods 25%today norm is 9-12%; warehouse stores 4-6%; Whole Foods 25%

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Exhibit 1.4: Total Returns forExhibit 1.4: Total Returns for
WorkWork

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Forms Of PayForms Of Pay
 Relational returns
– Psychological in nature
 Total compensationTotal compensation
– Cash Compensation/ transactionalCash Compensation/ transactional
 Base wagesBase wages
– Difference between wage and salaryDifference between wage and salary
 Merit pay/cost-of-living adjustmentsMerit pay/cost-of-living adjustments
– Merit increases – given in recognition of past work behavior –Merit increases – given in recognition of past work behavior –
adjustments to baseadjustments to base
– Cost-of-living adjustments –same increases to everyone,Cost-of-living adjustments –same increases to everyone,
regardless of performanceregardless of performance

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Forms Of Pay (cont.)Forms Of Pay (cont.)
– Cash Compensation/ transactional (cont.)Cash Compensation/ transactional (cont.)
 Incentives/ Variable pay – tie pay increases directly to
performance
– Does not increase base wage; must be reearned each pay periodDoes not increase base wage; must be reearned each pay period
– Potential size generally known beforehandPotential size generally known beforehand
– Long-term (stock options), and short-termLong-term (stock options), and short-term
– BenefitsBenefits
 Income protection (some are legally required)Income protection (some are legally required)
 Work/life balance (includes pay for time not worked)Work/life balance (includes pay for time not worked)
 Allowances (e.g., expatriates)Allowances (e.g., expatriates)

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POLICIESPOLICIES TECHNIQUESTECHNIQUES OBJECTIVESOBJECTIVES
EFFICIENCYEFFICIENCY
• PerformancePerformance
• QualityQuality
• CustomersCustomers
• StockholdersStockholders
• CostsCosts
FAIRNESSFAIRNESS
COMPLIANCECOMPLIANCE
COMPETITIVENESSCOMPETITIVENESS
Market Surveys Policy PAYMarket Surveys Policy PAY
definitions lines STRUCTUREdefinitions lines STRUCTURE
CONTRIBUTORSCONTRIBUTORS
Seniority Performance Merit INCENTIVESeniority Performance Merit INCENTIVE
based based guidelines PROGRAMSbased based guidelines PROGRAMS
MANAGEMENTMANAGEMENT Costs Communication Change EVALUATIONCosts Communication Change EVALUATION
Exhibit 1.5: THE PAY MODELExhibit 1.5: THE PAY MODEL
ALIGNMENTALIGNMENT
Work Descriptions Evaluation/Work Descriptions Evaluation/
analysis certificationanalysis certification
INTERNALINTERNAL
STRUCTURESTRUCTURE

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Compensation ObjectivesCompensation Objectives
EfficiencyEfficiency
FairnessFairness
ComplianceCompliance

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Pay System Objectives atPay System Objectives at
Medtronic and Whole FoodsMedtronic and Whole Foods
MedtronicMedtronic
 Support Medtronic mission andSupport Medtronic mission and
increased complexity ofincreased complexity of
businessbusiness
 Minimize increases in fixedMinimize increases in fixed
costscosts
 Attract and engage top talentAttract and engage top talent
 Emphasize personal, team andEmphasize personal, team and
Medtronic performanceMedtronic performance
 Recognize personal and familyRecognize personal and family
total well-beingtotal well-being
 Ensure fair treatmentEnsure fair treatment
Whole FoodsWhole Foods
 We are committed to increasing long-We are committed to increasing long-
term shareholder valueterm shareholder value
 Profits are earned every day throughProfits are earned every day through
voluntary exchange with our customersvoluntary exchange with our customers
 Profits are essential to create capital forProfits are essential to create capital for
growth, prosperity, opportunity, jobgrowth, prosperity, opportunity, job
satisfaction and job securitysatisfaction and job security
 Support team member happiness andSupport team member happiness and
excellenceexcellence
 We share together in our collective fateWe share together in our collective fate

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Internal alignmentInternal alignment
– FocusFocus - Comparisons among jobs or skill levels inside- Comparisons among jobs or skill levels inside
a single organizationa single organization
– Pay relationships within an organization affectPay relationships within an organization affect
employee decisions to:employee decisions to:
 Stay with the organizationStay with the organization
 Become more flexible by investing in additional trainingBecome more flexible by investing in additional training
 Seek greater responsibilitySeek greater responsibility
External competitivenessExternal competitiveness
– FocusFocus - Compensation relationships external to the- Compensation relationships external to the
organization: comparison with competitorsorganization: comparison with competitors
– Pay is ‘market driven’Pay is ‘market driven’
Four Policy ChoicesFour Policy Choices

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Four Policy Choices (cont.)Four Policy Choices (cont.)
 External competitiveness (cont.)External competitiveness (cont.)
– Effects of decisions regarding how much and what forms:Effects of decisions regarding how much and what forms:
 To ensure that pay is sufficient to attract and retain employeesTo ensure that pay is sufficient to attract and retain employees
 To control labor costs to ensure competitive pricing of products/To control labor costs to ensure competitive pricing of products/
servicesservices
 Employee contributionsEmployee contributions
– FocusFocus - Relative emphasis placed on employee performance- Relative emphasis placed on employee performance
 Performance based pay affects fairnessPerformance based pay affects fairness
 ManagementManagement
– FocusFocus - Policies ensuring the right people get the right pay- Policies ensuring the right people get the right pay
for achieving the right objectives in the right wayfor achieving the right objectives in the right way

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ConclusionConclusion
 the model presented in this chapter provides a structure forthe model presented in this chapter provides a structure for
understanding compensation systemsunderstanding compensation systems
 the three main components of the model include:the three main components of the model include:
– the objectives of the pay systemthe objectives of the pay system
– the policy decisions that provide the system’s foundationthe policy decisions that provide the system’s foundation
– the techniques that link policies and objectivesthe techniques that link policies and objectives
 two key questions should constantly be asked:two key questions should constantly be asked:
– first, why do it this way? ->there is rarely one correct wayfirst, why do it this way? ->there is rarely one correct way
to design a system or pay an individualto design a system or pay an individual
– second, so what? ->what does this technique do for us?second, so what? ->what does this technique do for us?
->how does it help achieve organizational goals?->how does it help achieve organizational goals?