Sixth Edition STRATEGIC COMPENSATION A HUMAN RESOURCE MANAGEMENT APPROACH Joseph J. Martocchio University of Illinois at Urbana-Champaign PEARSON Pearson Education International Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto Delhi Mexico City Sao PauloSydney Hong Kong Seoul Singapore Taipei Tokyo
CONTENTS Preface xxi Part I Setting the Stage for Strategic Compensation 1 Chapter 1 Strategic Compensation: A Component of Human Resource Systems 3 Chapter Outline 3 Exploring and Defining the Compensation Context 5 What Is Compensation? 5 Core Compensation 7 Employee Benefits 8 A Historical Perspective on Compensation: The Road toward Strategic Compensation 11 Strategic versus Tactical Decisions 13 Competitive Strategy Choices 16 Tactical Decisions That Support the Firm's Strategy 17 Compensation Professionals' Goals 17 How HR Professionals Fit into the Corporate Hierarchy 18 How the Compensation Function Fits into HR Departments 18 The Compensation Department's Main Goals 21 Stakeholders of the Compensation System 23 Employees 23 Line Managers 23 Executives 23 Compensation in Action 24 Unions 24,. U.S. Government 24 Summary 24 Key Terms 25 Discussion Questions 25 CASE: Competitive Strategy at Sportsman Shoes 25 Endnotes 26 Chapter 2 Contextual Influences on Compensation Practice 27 Chapter Outline 27 Compensation and the Social Good 28 Employees' Goals 29 Employers' Goals 29 Government's Goals 29 Employment Laws That Influence Compensation Tactics 29 Income Continuity, Safety, and Work Hours 30 Pay Discrimination 34 IX
Contents Civil Right Act of 1964 36 Accommodating Disabilities and Family Needs 40 Prevailing Wage Laws 41 Laws That Guide Discretionary Employee Benefits 42 Internal Revenue Code (IRC) 42 Employee Retirement Income Security Act of 1974 (ERISA) 43 Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) 44 Continuation of Coverage under COBRA 45 Health Insurance Portability and Accountability Act of 1996 (HIPAA) 46 Pension Protection Act of 2006 46 Contextual Influences on the Federal Government as an Employer 47 Labor Unions as Contextual Influences 47 Market Influences 49 Compensation in Action 50 Summary 51 Key Terms 51 Discussion Questions 52 CASE: Exempt or Nonexempt? 52 Endnotes 53 Part II Bases for Pay 55 Chapter 3 Traditional Bases for Pay: Seniority and Merit 57 Chapter Outline 57 Seniority and Longevity Pay 58 Historical Overview 58 Who Participates? 59 i Effectiveness of Seniority Pay Systems 59 Design of Seniority Pay and Longevity Pay Plans 60 Advantages of Seniority Pay 61 Fitting Seniority Pay with Competitive Strategies 62 Merit Pay 62 Who Participates? 62 Exploring the Elements of Merit Pay 62 Performance Appraisal 65 Types of Performance Appraisal Plans 65 Exploring the Performance Appraisal Process 70 Strengthening the Pay-for-Performance Link 74 Link Performance Appraisals to Business Goals 74 Analyze Jobs 74 Communicate 74 Establish Effective Appraisals 74
Contents xi Empower Employees 74 Differentiate among Performers 75 Possible Limitations of Merit Pay Programs 76 Failure to Differentiate among Performers 76 Poor Performance Measures 76 Supervisors' Biased Ratings of Employee Job Performance 76 Lack of Open Communication between Management and Employees 76 Undesirable Social Structures 76 Factors Other Than Merit 76 Undesirable Competition 77 Little Motivational Value 77 Compensation in Action 77 Summary 78 Key Terms 78 Discussion Questions 78 CASE: Appraising Performance at Precision 79 Endnotes 79 Chapter 4 Incentive Pay 81 Chapter Outline 81 Exploring Incentive Pay 82 Contrasting Incentive Pay with Traditional Pay 82 Individual Incentives 84 Defining Individual Incentives 85 Types of Individual Incentive Plans 85 Advantages of Individual Incentive Pay Programs 87 Disadvantages of Individual Incentive Pay Programs 88 Group Incentives 88 Defining Group Incentives 89 Types of Gipup Incentive Plans 89 Advantages of Group Incentives 94 Disadvantages of Group Incentives 95 Companywide Incentives 95 Defining Companywide Incentives 95 Types of Companywide Incentive Plans 95 Profit Sharing Plan 95 Calculating Profit Sharing Awards 96 Advantages of Profit Sharing Plans 97 Disadvantages of Profit Sharing Plans 97 Employee Stock Option Plans 97 Designing Incentive Pay Programs 98 Group versus Individual Incentives 98 Level of Risk 98 Complementing or Replacing Base Pay 99
xii Contents Performance Criteria 99 Time Horizon: Short Term versus Long Term 99 Compensation in Action 100 Summary 100 Key Terms 101 Discussion Questions 101 CASE: Individual or Team Reward? 101 Endnotes 102 Chapter 5 Person-Focused Pay 103 Chapter Outline 103 Defining Competency-Based Pay, Pay-for-Knowledge, and Skill-Based Pay 104 What Is a "Competency"? 105 Usage of Pay-for-Knowledge Pay Programs 106 Reasons to Adopt Pay-for-Knowledge Pay Programs 106 Technological Innovation 106 Increased Global Competition 107 Varieties of Pay-for-Knowledge Pay Programs 108 Contrasting Person-Focused Pay with Job-Based Pay 112 Advantages of Pay-for-Knowledge Pay Programs 114 Advantages to Employees 114 Advantages to Employers 115 Disadvantages of Pay-for-Knowledge Pay Programs 115 Compensation in Action 116 Summary 117 Key Terms 117 Discussion Questions 118 CASE: Pay-for-Knowledge at Mitron Computers 118 Endnotes 119 Part III Designing Compensation Systems 121 Chapter 6 Building Internally Consistent Compensation Systems 123 \ Chapter Outline 123 Internal Consistency 124 Job Analysis 125 Steps in the Job Analysis Process 126 Legal Considerations for Job Analysis 130 Job Analysis Techniques 131 U.S. Department of Labor's Occupational Information Network (O*NET) 131 Job Evaluation 137 Compensable Factors 137 The Job Evaluation Process 139 Job Evaluation Techniques 140 The Point Method 141 Alternative Job-Content Evaluation Approaches 144 Alternatives to Job Evaluation 145
Contents xiii Internally Consistent Compensation Systems and Competitive Strategy 146 Compensation in Action 146 Summary 147 Key Terms 147 Discussion Questions 148 CASE: Internal Consistency at Customers First 148 Endnotes 149 Chapter 7 Building Market-Competitive Compensation Systems 150 Chapter Outline 150 Market-Competitive Pay Systems: The Basic Building Blocks 150 Compensation Surveys 151 Preliminary Considerations 151 Using Published Compensation Survey Data 153 Compensation Surveys: Strategic Considerations 156 Compensation Survey Data 159 Updating the Survey Data 165 Integrating Internal Job Structures with External Market Pay Rates 165 Compensation Policies and Strategic Mandates 169 Compensation in Action 169 Summary 170 Key Terms 170 Discussion Questions 171 CASE: Nutriment's New Hires 171 Endnotes 172 Appendix: U.S. 2009-2010 Salary Budget Survey 172 Chapter 8 Building Pay Structures That Recognize Employee Contributions. 181 Chapter Outline 181 Constructing a Pay Structure 182 Step 1: Deciding on the Number of Pay Structures 182 Step 2: Determining a Market Pay Line 183 Step 3: Defining Pay Grades 183 Step 4: Calculating Pay Ranges for Each Pay Grade 183 Step 5: Evaluating the Results 189 Designing Merit Pay Systems 189 Merit Increase Amounts 190 Timing 191 Recurring versus Nonrecurring Merit Pay Increases 191 Present Level of Base Pay 191 Rewarding Performance: The Merit Pay Grid 191 Merit Pay Increase Budgets 193 Designing Sales Incentive Compensation Plans 195 Alternative Sales Compensation Plans 196 Sales Compensation Plans and Competitive Strategy 197 Determining Fixed Pay and the Compensation Mix 198
xiv Contents Designing Pay-for-Knowledge Programs 199 Establishing Skill Blocks 199 Transition Matters 200 Training and Certification 201 Pay Structure Variations 202 Broadbanding 205 Two-Tier Pay Structures 206 Compensation in Action 207 Summary 208 Key Terms 208 Discussion Questions 208 CASE: A New Sales Representative 208 Endnotes 209 Part IV Employee Benefits 211 Chapter 9 Discretionary Benefits 213 Chapter Outline 213 An Overview of Discretionary Benefits 213 Components of Discretionary Benefits 214 Protection Programs 216 Paid Time Off 218 Services 221 The Benefits and Costs of Discretionary Benefits 224 Compensation in Action 224 Summary 225 Key Terms 225 Discussion Questions 226 CASE: Time off at Superior Software Services 226 Endnotes 227 Chapter 10 Employer-Sponsored Retirement Plans and Health Insurance Programs 228 1 Chapter Outline 228 Exploring Retirement Plans 229 Origins of Employer-Sponsored Retirement Benefits 229 Trends in Retirement Plan Coverage and Costs 230 Qualified Plans 231 Minimum Standards for Qualified Plans 231 Defined Benefit Plans 233 Benefit Formulas 233 Minimum Funding Standards 234 Benefit Limits and Tax Deductions 234 Defined Contribution Plans 235 Individual Accounts 236 Investments of Contributions 236 Employee Participation in Investments 236 Accrual Rules 236
Contents XV Minimum Funding Standards 236 Contribution Limits and Tax Deductions 237 Types of Defined Contribution Plans 237 Section 401 (k) Plans 237 Profit-Sharing Plans 237 Stock Bonus Plans 238 Employee Stock Ownership Plans (ESOPs) 238 Hybrid Plans: Cash Balance Plans 239 Benefit Formulas 239 Controversy Surrounding Cash Balance Plans 240 Defining and Exploring Health Insurance Programs 242 Origins of Health Insurance Benefits 243 Health Insurance Coverage and Costs 244 Fee-for-Service Plans 245 Types of Medical Expense Benefits 246 Features of Fee-for-Service-Plans 246 Managed Care Plans 248 Health Maintenance Organizations 248 Features of Health Maintenance Organizations 248 Preferred Provider Organizations 250 Features of Preferred Provider Organizations 250 Deductibles 250 Coinsurance 250 Point-of-Service Plans' 250 Specialized Insurance Benefits 250 Prescription Drug Plans 251 Mental Health and Substance Abuse 252 Features oftmental Health and Substance Abuse Plans 252 Consumer-Driven Health Care 252 What's Next for Health Care in the United States? 254 Compensation in Action 255 Summary 256 Key Terms 256 Discussion Questions 257 CASE: A Health Savings Account at Frontline PR 257 Endnotes 258 Chapter 11 Legally Required Benefits 260 Chapter Outline 260 An Overview of Legally Required Benefits 261 Components of Legally Required Benefits 261 Social Security Act of 1935 261 State Compulsory Disability Laws (Workers' Compensation) 268 Family and Medical Leave Act of 1993 274
xvi Contents The Benefits and Costs of Legally Required Benefits 275 Designing and Planning the Benefits Program 276 Determining Who Receives Coverage 277 Financing 277 Employee Choice 278 Cost Containment 280 Communication 280 Compensation in Action 284 Summary 284 Key Terms 285 Discussion Questions 285 CASE: Benefits for Part-Time Workers 285 Endnotes 286 Part V Contemporary Strategic Compensation Challenges 287 Chapter 12 Compensating Executives 289 Chapter Outline 289 Contrasting Executive Pay with Pay for Nonexecutive Employees 290 Principles of Executive Compensation: Implications for Competitive Strategy 290 Defining Executive Status 290 Who Are Executives? 290 Key Employees 292 Highly Compensated Employees 292 Executive Compensation Packages 292 Components of Current Core Compensation 292 Short-Term Incentives 294 Components of Deferred Core Compensation 295, Employee Benefits: Enhanced Protection Program Benefits and I 1 Perquisites 298 Principles and Processes for Setting Executive Compensation 300 The Key Players in Setting Executive Compensation 300 Theoretical Explanations for Setting Executive Compensation 302 Executive Compensation Disclosure Rules 303 Other Benefits 306 Executive Compensation: Are U.S. Executives Paid Too Much? 307 Comparison between Executive Compensation and Compensation for Other Worker Groups 307 Strategic Questions: Is Pay for Performance? 307 Ethical Considerations: Is Executive Compensation Fair? 308 International Competitiveness 309 Compensation in Action 309 Summary 310 Key Terms 310 Discussion Questions 311 CASE: CEO Pay in the News 311 Endnotes 312
Contents xvii Chapter 13 Compensating the Flexible Workforce: Contingent Employees and Flexible Work Schedules 313 Chapter Outline 313 The Contingent Workforce 314 Groups of Contingent Workers 314 Reasons for U.S. Employers' Increased Reliance on Contingent Workers 318 Pay and Employee Benefits for Contingent Workers 320 Part-Time Employees 321 Temporary Employees 322 Leased Workers 323 Independent Contractors, Freelancers, and Consultants 324 Flexible Work Schedules: Flextime, Compressed Workweeks, and Telecommuting 326 Flextime Schedules 326 Compressed Workweek Schedules 326 Telecommuting 326 Flexible Work Schedules: Balancing the Demands of Work Life and Home Life 327 Pay and Employee Benefits for Flexible Employees 328 Pay 328 Employee Benefits 329 Unions' Reactions to Contingent Workers and Flexible Work Schedules 329 Strategic Issues and Choices in Using Contingent and Flexible Workers 330 Compensation in Action 331 Summary 331 Key Terms 332 Discussion Questions 332 CASE: Telecommuting at MedEx 332 Endnotes 333 Part VI Compensation Issues Around the World 335 Chapter 14 Compensating Expatriates 337 Chapter Outline 337 Competitive Advantage and How International Activities Fit In 338 Lowest-Cost Producers' Relocations to Cheaper Production Areas 338 Differentiation and the Search for New Global Markets 338 How Globalization Is Affecting HR Departments 339 Complexity of International Compensation Programs 339 Preliminary Considerations 339
xviii Contents Host Country Nationals, Third Country Nationals, and Expatriates: Definitions and Relevance for Compensation Issues 340 Term of International Assignment 340 Staff Mobility 340 Equity: Pay Referent Groups 341 Components of International Compensation Programs 341 Setting Base Pay for U.S. Expatriates 341 Methods for Setting Base Pay 342 Purchasing Power 342 Incentive Compensation for U.S. Expatriates 343 Foreign Service Premiums 344 Hardship Allowances 344 Mobility Premiums 344 Establishing Employee Benefits for U.S. Expatriates 345 Standard Benefits for U.S. Expatriates 346 Enhanced Benefits for U.S. Expatriates 347 Balance Sheet Approach for U.S. Expatriates' Compensation Packages 348 Housing and Utilities 349 Goods and Services 349 Discretionary Income 351 Tax Considerations 351 Repatriation Pay Issues 352 Compensation in Action 353 / Summary 354 Key Terms 354 Discussion Questions 354 CASE: Jenkins Goes Abroad 354 Endnotes 355 Chapter 15 Pay and Benefits outside the United States 356 I Chapter Outline 356 North America 357 Canada 359 Mexico 362 South America 363 Brazil 364 Argentina 365 Europe 366 France 366 Germany 368 Italy 369 Russia 370
Contents xix Asia 371 India 372 People's Republic of China 373 South Korea 375 Compensation in Action 376 Summary 376 CASE: North American Expansion for Threads 377 Endnotes 377 Glossary 380 Author Index 394 Subject Index 396