Identify the components of a compensation system.

11-1 Identify the components of a compensation system.
1. Base pay, either an hourly wage or salary. Base
pay is frequently a major decision factor for most
employees in deciding to accept the job.
2. Wage and salary add-ons. These include overtime
pay, shift differential, premium pay for working
weekends and holidays, and other add-ons.
3. Incentive pay for performance. Incentives give
workers strong reasons to perform above the
standard.
4. Benefits. This is indirect compensation that
provides something of value to the employee.
Benefits cost the company money even though
they aren’t direct compensation.
11-2 Briefly describe expectancy theory as it applies to
compensation.
Employees expect to put forth some form of effort
at work. This effort is expected to result in some
level of performance. The performance level is then
expected to result in some type of reward, and if it
432 PART IV: COMPENSATING
does, the employee expects to put out more effort.
The reward has to be significant to the individual,
and as long as it is, the employee will continue to
put out effort. So employees will either be motivated
by their outcomes, including compensation, or be
demotivated by them.
11-3 Briefly describe equity theory as it applies to
compensation.
According to equity theory, people compare their
inputs (the things they do in the organization) and
outcomes (the things that they receive from the organization)
to those of relevant others. But it’s their
and others’ perceived inputs and outcomes that
employees compare, not necessarily actual inputs
and outcomes. If employees believe that there is inequity,
they will change their work behavior to create
equity. Employees must perceive that they are being
treated fairly, relative to others. Compensation is
obviously a large part of the perceived outcomes.
11-4 Identify the seven basic issues that make up the
organizational philosophy on compensation.
1. Ability to pay. This is an honest assessment
of how much we can afford, or are willing to
afford, in order to compensate our employees.
2. Types of compensation. This refers to the mix of
the four basic components of compensation—
base pay, wage add-ons, incentives, and benefits—
that we employ. We must divide available
funds among the components.
3. Pay for performance or longevity. Will we pay
people based on organizational loyalty/tenure, or
will we pay based on performance in their jobs?
4. Skill or competency-based pay.
5. At, above, or below the market. What will our
general pay structure look like, and why?
6. Wage compression. This lowers the pay
differential between long-term and newly hired
employees.
7. Pay secrecy. Will we utilize pay secrecy clauses in
employment contracts? Pay secrecy may allow us
to hide actual wage inequities from employees,
but it has the potential to create dissatisfaction
and demotivation.
11-5 Discuss the three major provisions of the FLSA.
1. Minimum wage rates identify the lowest hourly
rate of pay generally allowed under the FLSA.
There are many exemptions, but if a person is
nonexempt, minimum wage will apply.
2. Overtime rates are also required for persons
who are nonexempt. However, there are different
exemptions for overtime than there are for
minimum wage, so HR managers must check the
law to determine who will have to be paid overtime.
3. Child labor requirements within the FLSA
identify the jobs and allowable working hours
for individuals between 14 and 18 years old.
Sixteen- and 17-year-olds can only be employed
in nonhazardous jobs, but their work hours are
unrestricted. However, 14- and 15-year-olds can
only work outside school hours, and the jobs
that they are allowed to do are limited to retail
and other service positions. They may not work
overtime.
11-6 Describe the penalties in the FLSA for
misclassification of nonexempt employees.
The employer can personally be criminally prosecuted
and fined up to $10,000 per infraction. There
is no maximum limit to the allowable fines, so fines
in the millions of dollars have been assessed in the
past. A second conviction can result in imprisonment.
Employers who willfully or repeatedly violate
the exemption rules may be assessed civil penalties
of up to $1,100 per violation. For child labor violations,
the civil penalty can be up to $11,000 per
worker for each violation and can go to as much as
$50,000 or even $100,000 if the violation causes the
serious injury or death of an employee less than 18
years old.
11-7 Briefly describe the concept of comparable worth
and how it compares with equal pay.
Comparable worth is similar pay for similar work,
which is different from equal pay for equal work. The
concept of comparable worth holds that if we can
compare your job with that of another person and
they are similar, we should pay you a similar wage,
which makes this concept much broader than equal
pay. The biggest problem with comparable worth
from a legal standpoint is how to legislate the value of
a job while taking supply and demand into account.
11-8 Identify the three types of job evaluation discussed
in the text and discuss whether they are more
objective or subjective in form.
1. The job ranking method is simply the process
of putting jobs in order from lowest to highest
or vice versa, in terms of value to the company.
However, it has limited usefulness because it is
subjective.
2. Point-factor methods, on the other hand,
attempt to be completely objective in form. They
break a job down into component skills or abilities,
known as factors, and then apply points to
each factor based on its difficulty.
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Chapter 11: Compensation Management 433
3. The factor comparison method combines the
ranking and point-factor methods to provide a
more thorough form of job evaluation. It identifies
benchmark jobs and then analyzes and
rank-orders them. We then compare all other
jobs in the organization to the benchmark jobs to
determine where each one fits in the rankings.
11-9 Briefly describe the concepts of job structure and
pay levels.
The job structure is what gives us a job hierarchy.
The job hierarchy is the stacking of the jobs in the
organization from the lowest (simplest) to the highest
(most complex) levels. A pay level (frequently
called a pay grade) will be made up of several different
jobs. Pay levels provide a framework for the minimum
and maximum pay for a particular group of
jobs in the organization. Pay levels are then laid out
one next to another in order to create the entire pay
structure for the company.
11-10 Discuss the concepts of product market competition
and labor market competition. What are they used
for?
Labor market competition sets the bottom of a pay
level. We have to compete with other companies to
attract labor, and if we don’t pay enough, we will
be unable to attract the workers we need. So we
compete in the labor market for available workers.
Product market competition sets the top of a pay
level. We can only pay someone as much as we can
recover from a customer when we sell our goods or
services. We can’t pay more than the value added to
the product or service by the labor. Together, product
market and labor market competition identify
the maximum and minimum rates of pay for a particular
group of jobs in a pay level.
11-11 Briefly describe the concept of a pay structure.
A pay structure is created by laying out our pay levels,
one next to the other. The entire group of pay
levels creates the pay structure. Benchmark jobs can
be plotted on the pay structure to get a market pay
line—a line that shows the average pay at different
levels in a particular industry. Once pay levels are
set, we can actually plot employee rates of pay on
the pay structure to see if any are plotted outside our
pay level ranges, either high or low. Individuals who
fall outside our pay range to the high side are paid
red-circle rates, and those who fall outside low are
paid green-circle rates. Each of these rates should be
reviewed and corrected if necessary.
11-12 Briefly discuss the value of broadbanding to the
organization.
Broadbanding lowers the number of pay levels that
a company administers by combining multiple pay
levels into one. Lowering the number of pay levels
makes the process simpler. It takes a long time to
create, maintain, and evaluate many pay levels, but
instead, we can have just a few broadbands. Because
pay bands are wider and taller under broadbanding,
the company also has more flexibility in pay rates for
individuals who are overperforming or underperforming.
Broadbanding may also cause most redand
green-circle rates to disappear. Lowering the
administrative burden of maintaining the compensation
system can significantly lower the person hours
required to manage it and thus lessen the overall cost
of the system.
11-13 Define the key terms found in the chapter margins
and listed following the Chapter Summary.
Complete the Key Terms Review to test your understanding
of this chapter’s key terms.
KEY TERMS
broadbanding
compensation
compensation system
delayering
equity theory
expectancy theory
job evaluation
minimum wage
overtime
pay structure
rate range
wage compression
KEY TERMS REVIEW
Complete each of the following statements using one of
this chapter’s key terms.
1. ________ is the total of an employee’s pay and
benefits.
2. ________ includes anything that an employee may
value and desire and that the employer is willing and
able to offer in exchange.
3. ________ proposes that employees are motivated
when they believe they can accomplish a task and the
rewards for doing so are worth the effort.
4. ________ proposes that employees are motivated
when the ratio of their perceived outcomes to inputs is
at least roughly equal to that of other referent
individuals.
.
434 PART IV: COMPENSATING
5. ________ occurs when new employees require higher
starting pay than the historical norm, causing narrowing
of the pay gap between experienced and new
employees.
6. ________ is the lowest hourly rate of pay generally permissible
by federal law.
7. ________ is a higher than minimum, federally mandated
wage, required for nonexempt employees if they
work more than a certain number of hours in a week.
8. ________ is the process of determining the worth of
each position relative to the other positions within the
organization.
9. ________ is a hierarchy of jobs and their rates of pay
within the organization.
10. ________ provides the maximum, minimum, and midpoint
of pay for a certain group of jobs.
11. ________ is the process of changing the company
structure to get rid of some of the vertical hierarchy
(reporting levels) in an organization.
12. ________ is accomplished by combining multiple pay
levels into one.
COMMUNICATION SKILLS
The following critical-thinking questions can be used for
class discussion and/or for written assignments to develop
communication skills. Be sure to give complete explanations
for all answers.
1. Do you believe it is always necessary to provide
incentives as part of a pay structure? Why or why
not?
2. As the HR manager, would you pay more attention
to expectancy theory or equity theory in designing
your compensation system? Why?
3. If your company had promised an incentive program
right before the recession of 2007–2008, and if the
recession made it impossible for the company to pay
employees what they had been promised, then how
would you explain this to your workforce to keep
them motivated?
4. Would you rather have higher pay or better benefits?
Why?
5. Would you ever consider paying below the market
rate for employees if you had control of wages? Why
or why not?
6. Do you believe that pay secrecy can ever really work
in a business? Why or why not?
7. How would you approach a CEO or company president
who insisted on classifying nonexempt workers
as exempt? What would you say to get the CEO to
stop this practice?
8. Do you think that comparable worth should be made
federal law? Why or why not?
9. If you were the lead HR manager in your company,
would you ever consider setting pay levels by just
using external pay surveys and no internal analysis?
What are the advantages and disadvantages of this?
10. As the head of HR, would you rather change narrow
pay levels into broadbands? Can you think of any disadvantages
to doing so?
CASE 11-1 SELLING THE SALES FORCE ON COMMISSION COMPENSATION
Laughter could be heard from the back office as the sales
associate and his part-time assistant were jokingly discussing
the last sale. “Then the woman said to me, ‘Do
you absolutely guarantee that your product won’t scratch
my wood floors and won’t mark my kitchen linoleum?’
‘Guarantee,’ I repeated. ‘We not only guarantee that our
product won’t scuff or muff your wood or vinyl surfaces,
but the Oreck vacuum has been scientifically designed
with a floating head system that will adjust itself to any
surface.’ I then demonstrated how the vacuum easily
glides from our carpeted portion of the store to the
wooden area by the register. I immediately handed her the
vacuum and asked her to try it herself. She vacuumed half
the store just to test it out.
“She bought the best upright vacuum in the store including
extra bags and a room deodorizer. Let’s see if you can
do any better with your next customer!”
Sales Training
The local Oreck vacuum store was owned by Mr. Paulson,
who classified himself as a super salesman and took
great pains in training his sales force on how to close a
deal. The store was always staffed by two employees:
one full-timer with one part-timer to cover Paulson’s two
days off. The training consisted of On-the-Job Training
(usually watching Mr. Paulson go through several Oreck
vacuum presentations) coupled with take-home material
Chapter 11: Compensation Management 435
including a sales script and product information. Inventory
was computerized, and therefore it was easy for a
trainee to check his or her price knowledge using the computer.
After several observations of Mr. Paulson’s sales
techniques, the trainee was then allowed to make a sales
presentation on his or her own, with assistance provided
by Mr. Paulson as needed. The trainee was then debriefed
by Mr. Paulson and asked to make changes in the presentation
as needed in order to better close the customer. The
full-time employee worked six days, 48 hours per week
(including Saturdays and Sundays), with the part-time
employee working only on the weekend.
Sales and Service Revenues
There were two distinct revenue streams: sales, which
accounted for 90% of the revenues (predominantly of
vacuum cleaners), and repair work. In terms of sales,
by far the best moving item was the Oreck XL followed
by vacuum bags (which were carried for all makes and
models) and cleaning accessories. The markup on vacuums
and other cleaning equipment was 100% while the
markup on cleaning products and ancillary items was
200%. Repair work was priced at 200% over parts costs
plus a $29.95 flat labor fee.
Price Flexibility
Unlike most other retail operations, Mr. Paulson allowed
his employees some price flexibility on big-ticket items
including the Oreck XL. These items did not have prices
listed on them, and the sales personnel were instructed
not to divulge the price until their sales presentations were
completed. Sales personnel were given the option of either
dropping the price (e.g., a $499 machine could be lowered
to $449) or offering the customer an additional incentive
for purchasing the machine (e.g., extra bags, upgrade in the
vacuum cleaner). Customers could also receive a trade-in
allowance (e.g., $25 for a machine in any condition) at the
time of the sale. Mr. Paulson preferred that his sales force
drop the price rather than let a customer walk out of the
store empty-handed, although he always cautioned his
sales force not to drop the price too early in the sale.
Employee Compensation
The average wage earned by employees at the store was
considered fairly low for the region. Full-time employees
received a straight salary of $500 a week plus benefits
(complete medical and dental coverage, two weeks’
paid vacation, no sick or personal days, unpaid holidays
when available) and earned a commission of 2.5% of
gross store sales over $7,000 a week. Part-time employees
received $65 a day plus a commission of 2.5% of gross
store sales over $1,000 per day they worked, and they
received no benefits. Store revenue generally ran about
$6,500 for the week with a 20% net profit margin.
Third-party exit interviews with several of the exemployees
indicated that the owner put inordinate
pressure on them to sell products and services to the
customers. “I felt like I always had to sell the customer
something whether they needed it or not. Paulson felt
that you could always find a way to overcome customers’
objections, even if it meant using pressure sales tactics.
I wanted to build up customer loyalty for the store
over the long run, but you can’t do that by browbeating
consumers into sales just to try to make commission. A
straight weekly salary would have remedied that problem.”
Other complaints included tying the commission
into total store sales (rather than individual sales), working
weekends without a pay differential, working six days
a week, and the fact that the commission base was set
higher than the store weekly average sales.
The owner indicated that many of the employees who
left the job just did not seem to have the selling instinct
needed for his sales force, and high turnover was therefore
not only expected but desired in order to get the
best salespeople. When questioned about the compensation
package, Paulson replied, “This scheme is used
to motivate my sales force. I want hungry employees
who want to sell. If they do a good job in selling, they
get rewarded—if they don’t sell, they have a base salary
to get by on. Many of my employees leave because
they cannot sell enough to earn a commission. I know
that it’s hard to live on $500 a week, but I do not want
to have employees who just sit around and collect a
paycheck.”
Questions
1. What is the compensation package for the fulltime
sales force at the store? Classify by kind of
compensation.
2. Explain Paulson’s rationale for the current compensation
system using expectancy theory. Why might his
ex-employees have disagreed with his rationale?
3. Using equity theory, explain why Paulson’s compensation
system may be deemed inequitable by his former
employees.
4. Describe Paulson’s current compensation philosophy.
5. Do you think this compensation philosophy is an effective
one?
6. Construct a new compensation system for Paulson’s
full-time employees. Make sure to address all four basic
kinds of compensation.
Case created by Herbert Sherman, PhD, and Theodore
Vallas, Department of Management Sciences, School of
Business Brooklyn Campus, Long Island University
436 PART IV: COMPENSATING
CASE 11-2 EMPLOYEE RED-LINING AT CVS: THE HAVE AND THE HAVE NOT
CVS Caremark is the second-largest drugstore chain in
the United States (just behind Wal-Mart). It employs
286,000 people in 45 states under the CVS logo, and it
operates more than 7,600 drugstores. In 2013, CVS’s
sales exceeded $126 billion, but its net income was only
around $4.6 billion, for about a 3.6% profit—about the
median profit for the industry.94
As would any other public corporation, CVS wanted to
increase its profitability for stockholders and regain its
position as the industry leader. One method of increasing
profits is cutting operational costs, and CVS decided
to do just that. It adjusted employee annual pay raises by
placing an earnings ceiling on salaries, and any employees
earning the highest hourly wage in their job classification
became ineligible for a raise.
Besides the obvious cost savings, why put a “red line”
on wages? The main goal was to adjust the highest-paid
employees’ compensation to the job market average and,
with these savings, provide raises to the employees who
were paid below that average. The philosophy was that as
a CVS employee, one should expect lower raises (or none
at all) if one is earning much more than one’s colleagues.
So once an employee reached the red line, that person
received no additional compensation.
CVS executives knew that the new compensation policy
would negatively impact some of their most loyal
employees, yet the executives felt that they needed to
draw a line on salaries in order to make the most of
limited compensation dollars. What they did not figure
was that the policy mostly hurt the employees who
had been working there the longest. Worse, these same
employees feared retaliation if they publicly criticized
the new policy. How would it look to the other lower-
paid employees (and worse, the public at large) if the
highest-paid employees complained about their lack of
raises?
Nationwide, the minimum wage is set at $7.25 per
hour, but the wage management guidelines of CVS are
different in most regions depending on the minimum
wage in each state. Lowest-ranked employees with
exceptional skills would receive a 4.75% raise on an
annual basis if they were making minimum wage. However,
if an employee with exceptional skills in the same
position was already earning $12.50 an hour, that person
would not receive a raise, having already crossed
the red line.95 With employment at will, the possibility
of being laid off, and a tough job market, where would
these employees get such high-paying jobs in the retail
and service industries? It was better for them to keep
quiet about their pay and stay in a company that they
were comfortable with.96
Wage rates depend on employees’ rank, and it is no
secret that the CEO is going to be paid much more than
the company’s average worker. This is because the CEO
job requires a more demanding set of skills compared
to the average store job, and the workload of a CEO is
much more demanding. But if the range of compensation
is so great, it may discourage employees who are
paid less.97
Some ethical and legal concerns arose when these same
red-lined employees found out that this new compensation
policy did not seem to apply to the top-level executives.
The CEO of CVS was paid a total of $23 million
in 2013, including bonuses and additional perks. He
earned a 26% raise from the previous year, and that was
almost 800 times more than the median income of a CVS
employee. The red-lined employees saw an inequitable
pay situation, with the rich getting richer because they
were allowed a raise while the in-store employees had a
cap on their income. The CEO’s salary package was tied
to the company’s performance, and according to CVS
spokesperson Carolyn Castel, “Last year, CVS Caremark
had an outstanding year and continued to deliver strong
financial results and enhanced returns to shareholders in a
challenging economic environment, performing favorably
against our peer group in several key areas.”98
Questions
1. Describe the pay structure and compensation system
for a CVS store employee. How might this pay structure
be different from that of the CEO of the firm?
2. Define the rate range of CVS employees. How would
you change the pay structure to encourage performance,
especially for red-lined employees?
3. In terms of expectancy and equity theories, describe
how the red-line policy will affect the motivation of
employees.
4. In light of the red-line policy, what was CVS’s philosophy
toward employee performance, compensation,
and longevity?
5. If you were CVS’s CEO, knowing that you have to
reduce costs and balance employee wages, what other
measures would you take besides freezing raises for the
highest-paid employees?
6. Why would the firm implement an HR policy that it
knew would negatively affect its highest-paid employees?
Did it perhaps have a hidden agenda?
Case created by Herbert Sherman, PhD, and Theodore
Vallas, Department of Management Sciences, School of
Business Brooklyn Campus, Long Island University

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