Human Resources – Chapter 8: Pay Structure Decisions
Pay decisions can be broken into two areas:
1. Pay structure – the relative pay of different jobs (job structure_ and how much they are
paid (pay level).
• Pay level – The average pay, including wages, salaries, and bonuses, of jobs in an
• Job structure - The relative pay of jobs within an organization.
2. Individual Pay
Pay level and job structure are characteristics of and reflect organizations, rather than individual
Equity Theory and Fairness
Equity theory suggests that people evaluate the fairness of their situations by comparing them
with those of other people.
Aperson (P) compares her own ratio of perceived outcomes (O) (pay, benefits, working
conditions) to perceived inputs (I) (effort, ability, experience) to the ratio of a comparison other
OP / IP , or = Oo/Io?
If P’s ratio (Op/Ip) is smaller than the comparison other’s ratio (Oo/Io), under0reward inequity
results. If P’s ratio is larger, over-reward inequity results, although evidence suggests that this
type of inequity is less likely to occur and less likely to be sustained because P may rationalize
the situation by re-evaluating her outcomes less favorably or inputs (self-worth) more favorably.
Two types of employee social comparisons of pay are especially relevant in making pay level
and job structure decisions.
1. External equity pay comparisons focus on what employees in other organizations are paid
for doing the same general job.
Amarket pay survey is the primary administrative tool organizations use in choosing a
pay level. Focuses on pay level.
2. Internal equity pay comparisons focus on what employees within the same organization,
but in different jobs, are paid.
Focuses on job structure, through job evaluation.
Developing Pay Levels
Any organization faces two important competitive market challenges in deciding what to pay its
employees: product market competition and labor market competition.
Product Market Competition
Organizations must be able to sell their goods and services at a quantity and price that will bring
a sufficient return on their investment. Companies that have the same labor costs in comparison
to their revenue, but one company’s labor costs are higher in general, means that company must
be charging more for their product. Thus, product market competition places an upper bound on labor costs and compensation. This
upper bound is more constrictive when labor costs are a larger share of total costs and when
demand for the product is affected by the changes in price (elastic.)
Labor Market Competition
It is the amount an organization must pay to compete against other companies that hire similar
employees. Labor market competition places a lower bound on pay levels.
Employees as a Resource
Pay Levels – Deciding What to Pay
Under efficiency wage theory, the benefits of higher pay outweigh the higher costs.
The efficiency wage theory states that wages influence worker productivity.
Market Pay Surveys
Benchmarking – Comparing an organization’s practices against those of the competition.
In compensation management, benchmarking against product and labor market competitors is
typically accomplished through the use of one or more pay surveys.
Product market comparisons that focus on labor costs are likely to deserve greater weight when
1) labor costs represent a large share of total costs, 2) product demand is elastic (it changes in
response to price), 3) the supply of labor is inelastic, 4) employee skills are specific to the
Labor market comparisons may be more important when 1) attracting and retaining qualified
employees is difficult and 2) the costs of recruiting replacements are high.
Once a market rate has been chosen, it is incorporated into the pay structure. Typically, especially
for white-collar jobs – it is used for setting the midpoint of pay ranges for either jobs or pay
The use of rate ranges permits a company to recognize differences in employee performance,
seniority, training, etc. Rate ranges – different employees in the same job may have different
For some blue-collar jobs, there may be a single rate of pay for all employees within the job.
Benchmark Jobs and Nonbenchmark Jobs
Benchmark jobs are key jobs, nonbenchmark jobs are non-key jobs.
Benchmark jobs – key jobs used in pay surveys, that have relatively stable content and are
common to many organizations.
Nonbenchmark jobs – jobs that are unique to organizations and that cannot be directly valued
or compared through the use of market surveys.
Developing a Job Structure
One typical way of measuring internal job worth is to use an administrative procedure called job
evaluation – an administrative procedure used to measure internal job worth. 3 most common
types of job evaluation: ranking, classification/grade description and the point method. Ranking and classification are qualitative. The point method is quantitative. Compensable
factors – the characteristics of jobs that an organization values and chooses to pay for.All 3
methods result in a hierarchical job structure. Job evaluation in not a one-time process. The point
method stands up to the scrutiny of pay equity legislation.
This is the simplest and cheapest form of job evaluation. Often chosen by a small firm or startup
firm. Sometimes called “whole job ranking.” Alteration ranking – evaluators begin examining all
jobs in the organization; they decide what job is most valuable and least valuable, continue going
back and forth. Paired comparison works better when there are many more jobs to be considered
– each individual job is methodically compared to each other job in the organization one by one
on a matric.
Classification (Grade Description) Method
Many large public-sector organizations use the classification method of job evaluation. This uses
generic organization-wide descriptions to classify jobs into groups with other similar jobs that fit
the same generalized description. Process: creating general classes of jobs, then a series of grade
descriptions for each class is written to further differentiate the level of skill, experience,
complexity and responsibility required for jobs placed in each grade, then salary maximums and
minimums are set for each classification and grade and adjusted annually. Once in place this
method provides a universal and easy approach for coping with tons of jobs, and is defensible.
The Point Method
This is based on breaking an individual job down into the key characteristics of jobs that an
organization values or its compensable factors. Compensable factors are derived from the
organization’s job analysis and resulting job descriptions, plus the weight assigned to each