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Chapter 4

Chapter 4 compensation.docx

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Administrative Studies
ADMS 3490
Linda Love

Chapter 4: Components of Compensation Strategy The first strategic decision is about the relative proportions of base pay, performance pay, and indirect pay to include in the compensation mix. Three other choices follow what method(s) should be used for establishing base pay, what type(s) of performance pay(if any) should be provided, and which elements of indirect pay should be included. Compensation Mix choices: Base pay job evaluation, market pricing, and pay for knowledge Performance pays individual performance, group performance, and organization performance Indirect pay Mandatory benefits, pension plan, health and life insurance, pay for time not worked, employee services, and other benefits. Base pay: Base pay: is the portion of an individuals compensation that is based on time worked not on the output produced or results achieved. Base pay accounts for 75 to 80 percent of the compensation for a typical employee, performance pay about 5 to 10percent, and indirect pay about 15 percent of the total compensation. However these proportions vary across firms. Base pay is guaranteed by the employer if a person works for a certain amount of time; he or she is paid a prespecified amount of money. In some case, this amount is calculated on a hourly basis, in others daily, in others weekly, or monthly, or annually. When base pay is calculated on an hourly basis, base pay is known as wage When base pay is calculated on a weekly, monthly, or annual basis, it is known as a salary. Why use base pay? Advantages Base pay is sometimes preferable to out-put pay, even where out-put related pay is feasible Substitution of output related pay for time based pay is feasible only for jobs in which the output is : 1) easy to measure, 2) easy to price in terms of its value to the employer, 3) easy to attribute to individual employee, 4) controllable by the individual employee,4) relatively stable. Out-put pay is possible, but it is not desirable because it causes unwanted consequences. Jobs that combine some measurable outputs with immeasurable outputs are also not good candidates for a pay system based only on output, because employees tend to focus on the measured behaviours and neglect other behaviours. People prefer certainty in their rewards and thus prefer a large component of base pay in their compensation package. Base pay has been portrayed as something to be used simply because no another alternative is viable, and this is indeed the major motivation to use it. Base pay can also be used for more positive reasons: 1) flexibility: With time base pay, the employer is buying time from the employee. With certain limits, this time may be directed in many ways and redirected as need arises. Base pay doesnt confine employee attention to only one or two behaviours, as output tends to pay to do. 2) Base pay allows the employer to recognize and encourage important job behaviours that dont directly produce output, such as skill development. 3) Base pay can signal the relative importance of jobs within the organization. Generally, jobs of greater importance to the organization carry higher pay rates. 4) Base pay demonstrates commitment on the part of the employer to the employee, creating a greater likelihood of employee commitment to the employer. 5) Depending on the method used to set up a base pay strategy, it can support a particular managerial strategy. For example, a pay for knowledge base pay strategy supports a high involvement managerial strategy. 6) Base pay is used for simplicity- it is usually much simpler to implement and administer than an output related system. Base Pay Disadvantages 1) Base pay represents more of a fix employer commitment than performance pay, especially if salaries are used. Base pay is not linked to variability in an employers ability to pay in the way that performance pay can be. 2) While base pay does contribute to membership behaviour, it does not directly motivate task behaviour, nor does it signal key task behaviours. 3) Base pay does not relate to organizational success directly to individual success, it does not contribute to citizenship behaviour. 4) Base pay is not self correcting. In an output related system, employees who do not perform up to standard tend to voluntarily remove themselves from the organization because they are unable to earn enough money. But time base pay provides no such mechanism. Time base pay and output and performance pay are not mutually exclusive, but can combine. Performance Pay Performance pay can be defined as any type of financial reward given only when certain specified performance results occur. These results may be based on the performance of individual employees, a group or team of employees, or the entire organization. Performance pay is sometimes known as performance contingent pay, variable pay, or at risk pay. Pay for performance can be classified into three main categories depending on whether the performance relates to the individual employee, the group or work team or the entire organization. Individual performance pay plans include piece rates, commissions, merit and targeted incentives. Group performance pay plans include productivity gain sharing plans, goal sharing plans, and other type of team based pay. Organizational performance pay plan includes employee profit sharing plans, employee stock plans, and other organizational pay plans. Advantages of performance pay: 1) Properly designed, performance pay plans can signal key employee behaviours and motivate employees to achieve them 2) Performance pay can reduce the need for other types of mechanism for controlling employee behaviour. When employees know that their pay is dependent on performing particular behaviours, they won`t need a supervisor watching them to make sure they are working 3) Performance pay can raise an employees interest in performance and provide employees with information about their current performance levels 4) Different types of performance pay can be used to support specific managerial strategies. For example, individual performance pay can support a high involvement managerial strategy 5) Performance pay plans make more variable and therefore can help link compensation levels to the firm`s ability to pay. This linkage helps stabilize an organization`s employment levels,; lessening the need to lay off employees in difficult times only to rehire them when business improves. Disadvantage of performance pay: One general drawback is that employees generally prefer predictable and certain rewards to unpredictable and uncertain rewards. Employees will generally resist substitution of performance pay for base pay or indirect pay. In order to induce employees to accept this substitution, it may be necessary to offer higher total compensation than otherwise be necessary. Performance pay cause employees to focus only on aspects of behaviour that are being measured, ignoring other unmeasured but still important behaviours. Indirect pay Indirect pay was known as the fringe benefits as the extent costs increased they became known as only benefits Indirect pay can be anything that costs the employer money, addresses some type of employee need (thus conferring some type of benefit on the employee and is not included as part of the base or performance pay. Indirect pay systems vary in other ways. One key variation is choice: whether employees can choose what benefits they receive (a flexible benefits system) or whether they cannot (a fixed benefits system) another variation is responsibility for costs: whether the employer covers all costs, or whether employees are required to share in costs. 8 Motives to use Indirect Pay: 1) Competitive pressure. If competitors are offering benefits that are important to the people the firm wants to hire, then an employer may need to offer similar benefits to attract these employees. For instance, some employees would never dream of working for an employer who does not provide an adequate pension plan. 2) In order to satisfy the security needs of their members, unions have always bargained strongly for comprehensive employee benefits, and unionized firms have had to respond to these pressures. Non unionized firms may match the packages won by unions at other firms in order to remove one possible incentive for unionization; although they do not always do so. On average, employees in unionized firms get about 45 percent higher benefits than comparable non-union Canadian employees 3) Certain types of indirect pay get more favourable income tax treatment than direct pay. In this case, a firm may use indirect pay to provide a higher total amount of after tax compensation to employees than it would if the firm had paid out the same number of dollars in the form of direct pay. 4) Many benefits items- such as dental or medical coverage can be purchased for cheaply by the employer than the employee, due to certain employees, such as the ones with serious health problems, might not even b
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