Chapter 9

Direct Financial
Compensation (Core
Compensation)

Copyright © 2016 Pearson Education, Ltd 9-1

 Learning Objectives
1. Describe direct financial compensation (core
compensation), indirect financial compensation
(employee benefits), and nonfinancial
compensation.
2. Identify and discuss the components of direct
financial compensation.
3. Review the determinants of direct financial
compensation.
4. Describe contextual influences on direct financial
compensation.

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 Learning Objectives (Cont.)
5. Discuss using job evaluation to build job structures.
6. Describe various competitive compensation
policies.
7. Explain the use of compensation surveys for job
pricing and determining market competitive pay
structures.
8. Discuss compensation for sales representatives.
9. Discuss compensation for contingent workers.
[Link] executive compensation and the various
features of executive compensation packages.
Copyright © 2016 Pearson Education, Ltd 9-3
LO 1
Compensation: An Overview
 Compensation: Total rewards provided to
employees in return for services
 Direct financial compensation (core):
Wages, salaries, bonuses, and commissions
 Indirect financial compensation (employee
benefits): All other financial rewards
 Nonfinancial compensation: Satisfaction
from job itself or from psychological and/or
physical environment in which employee works
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LO 1
Total Compensation Components

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LO 2
Direct Financial Compensation
 Base pay
 Cost-of-living adjustments
 Seniority pay
 Performance-based pay
 Person-focused pay

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LO 2
Base Pay
 Recurring pay for performing work
 Paid as hourly wage or annual salary
 The distinction is often associated with the
Fair Labor Standards Act for determining
eligibility for overtime pay

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LO 2
Cost-of-Living Adjustment
 Pay increase to compensate for rises in
the average cost of goods and services
 Protects standard of living by ensuring that
nominal pay (face value) does not fall
significantly below real pay (purchasing
power)

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LO 2
Seniority Pay
 Pay increases automatically as years of
service increase
 Human capital theory: Workers become
more proficient (build human capital) over
time
 The General Schedule is the federal
government’s comprehensive seniority-
based pay system
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LO 2
General Schedule (GS)

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LO 2
Performance-Based Pay
 Pay increases awarded based on level of
performance attainment
 Performance measures vary (e.g., employee
performance, company performance)
 Main types of pay-for-performance:
 Merit pay and merit bonuses
 Incentive pay (individual, group, company)

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LO 2
Merit Pay
 Pay-for-performance
 Pay increased based on supervisor’s
evaluation of past performance
 Pay increase is a permanent increment to
base pay
 Merit increases have averaged about 3
percent

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LO 2
Merit Bonuses and Spot Bonuses

 Merit bonuses reward individuals for past

performance. Unlike merit pay increases,
merit bonuses represent a one-time award
(not built into base pay)
 Spot bonuses are one-time rewards to
give timely recognition of good
performance

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LO 2
Permanent Pay Increase vs. Bonus

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LO 2
Incentive Pay
 Individual incentive plans (piecework,
management incentives, behavioral
encouragement plans, and referral plans)
 Group or team-based plans (design based
on purpose of team – work

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LO 2
Incentive Pay (Cont.)
Company-wide plans focus on rewarding
employees based on company-wide
performance such as profit and the value of
company stock

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LO 2
Types of Individual Incentive Plans

 Piecework plans: reward workers for

every item produced over a designated
production standard
 Management incentive plans: award
bonuses to managers when they meet or
exceed objectives based on sales, profit,
production, or other measures for their
division
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LO 2
Calculation of a Piecework Award
for a Garment Worker
Piecework standard: 15 stitched garments per hour
Hourly base rate awarded to employees when the standard is not met: $4.50 per hour
That is, workers receive $4.50 per hour worked regardless of whether they meet the
piecework standard of 15 stitched garments per hour.
Piecework incentive award: $0.75 per garment stitched per hour above the piecework
standard

Guaranteed Piecework Award (No. of Total Hourly

Hourly Base Garments Stitched Above the Earnings ($)
Pay ($) Piecework Standard x Piecework
Incentive Award)
First Hour 4.50 10 garments x $0.75/garment = 12.00
$7.50
Second 4.50 Fewer than 15 stitched garments, 4.50
Hour thus piecework award equals 0

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LO 2
Types of Individual Incentive Plans
(Cont.)
 Behavior encouragement plans:
employees receive payments for specific
behavioral accomplishments
 Referral plans: employees receive
bonuses for recruitment of highly qualified
employees

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LO 2
Group Incentives: Gainsharing
 Binds employees to firm’s productivity and
provides incentive payment based on
improved company performance
 Scanlon, Multicost Scanlon, Rucker, and
Improshare plans are most popular
 Helps align an organization’s people
strategy with its business strategy

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LO 2
Scanlon Plan

 Reward to employees for savings in

labor costs resulting from employees’
suggestions
 Employee-management committees
evaluate these suggestions
 Systems for participative management

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LO 2
Company-Wide Incentive Plans
 Profit sharing
 Employee stock option plans

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LO 2
Profit Sharing
 Distribution of predetermined percentage
of firm’s profits to employees
 Kinds of plans:
Current profit sharing
Deferred profit sharing
Combination plans
 Vesting: Determines amount of profit
employee owns
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LO 2
Employee Stock Option Plans
Companies grant employees right to
purchase share of company
Company stock (a unit of company equity)
Company stock shares (shares of
company equity)
Stock options (right to purchase stock)

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LO 2
Person-Focused Pay
 Rewards employees for acquiring new
skills, competencies, and knowledge
necessary to perform work
 Stands in comparison to job-focused pay,
which we discussed
 On the other hand, job-based pay rewards
employees for performance on the job
being currently performed
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LO 2
Sample Person-Focused
Pay Structure

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LO 2
Person-Focused Pay (Cont.)
Common types of person-focused pay:
Skill-based pay
Competency-based pay

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LO 3
Determinants of
Direct Financial Compensation
 Job structures
 Competitive compensation policies
 Pay structures

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LO 3
Determinants of
Direct Financial Compensation (Cont.)

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LO 4
Contextual Influences on Direct
Financial Compensation
 Labor market
 Labor unions
 Economy
 Inter-industry wage differentials
 Legislation

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LO 4
Legislation
 Davis-Bacon Act of 1931
 Walsh-Healy Act of 1936
 Fair Labor Standards Act of 1938
 Equal Pay Act of 1963
 Wall Street Reform and Consumer
Protection Act of 2010 (Dodd-Frank Act)

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LO 5
Build Job Structures Using
Job Evaluation
 Job structure: An ordered set of jobs
represents the job structure or hierarchy. That is,
jobs that require higher qualifications, more
responsibilities, and more complex job duties
should be paid more
 Job evaluation: Systematically recognizes
differences in the relative worth among a set of
jobs and to establish pay differentials
accordingly

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LO 5
Job Evaluation Methods
 Ranking method
 Classification method
 Factor comparison method
 Point method

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LO 6
Competitive Compensation Policies

 Compensation policy: Choices that

compensation professionals make to
promote competitive advantage
 Pay level policies
Market lead policies
Market match policies
Market lag policies
 Pay mix policies
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LO 6
Pay Level Policies
 Market lead: Pay higher wages and salaries
to attract high-quality, productive employees
and thus achieve lower per-unit labor costs
 Market match, or going rate: Pay what
most employers pay for same job
 Market lag: Pay below market rate because
of firm’s poor financial condition or belief that
it does not require highly capable employees

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LO 6
Wage Curve
 Fitting of plotted points to create smooth
progression between pay grades
 Creates a smooth progression
 Often uses statistical methods

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LO 6
Pay Level Policy

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LO 6
Pay Mix Policies

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LO 7
Market-Competitive Pay Structures

 Pay structures represent pay rate

differences for jobs of unequal worth and
the framework for recognizing differences
in employee contributions. These structures
result from an analysis based on
compensation survey work.
 Compensation surveys involve the
collection and subsequent analysis of
competitors’ compensation data.
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LO 7
Market-Competitive Pay Structures
(Cont.)
 Pay grades
 Pay ranges
Points along the pay range
Topping out (pay range max.)
Pay range span

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LO 7
Pay Grades
 Grouping of similar jobs to simplify pricing
jobs
 Similar to a university’s practice of
grouping grades
Grades of 90–100 are an “A”
Grades of 80–89 are a “B,” etc.
 Plotting jobs on a scatter diagram

Copyright © 2016 Pearson Education, Ltd 9-41

LO 7
Pay Ranges
 Minimum and maximum pay rate with
enough variance between to allow for
significant pay difference
 Generally preferred over single pay rates
 Need to develop a method to advance
individuals through the range

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LO 7
Scatter Diagram of Evaluated Jobs Illustrating
Wage Curve, Pay Grades, and Pay Ranges

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LO 7
Broadbanding
 Technique that collapses many pay grades
(salary grades) into a few wide bands to
improve organizational effectiveness
 Lateral employee development
 Develops employee skills and encourages
team focus

Copyright © 2016 Pearson Education, Ltd 9-44

LO 7
Broadbanding and Its Relationship to
Traditional Pay Grades and Ranges
Average Hourly Pay

Grade 6

Grade 5
Grade 4
Grade 3 Band III

Grade 2
Band II
Grade 1

Band I

Low High
Job Worth
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LO 7
Two-Tiered Pay

 New employees paid less

 Temporary or permanent rewards
 Mainly in unionized companies
 May hinder recruiting
 Can lower employees’ morale

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LO 7
Adjusting Pay Rates
 Overpaid and underpaid jobs
 Bring underpaid jobs up to minimum of
pay range
 Promote person who is overpaid or freeze
rate until across-the-board pay increases
bring job into line
 Bad idea to cut pay

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LO 7
Salary Compression
Salary compression: Occurs when less
experienced employees are paid as much
as or more than employees who have been
with the organization a long time due to a
gradual increase in starting salaries and
limited salary adjustment for long-term
employees

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LO 8
Sales Representative
Compensation
 Salary
 Commission
 Part-Salary, Part-Commission

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LO 9
Contingent Worker Compensation

 In most cases, contingent workers earn

less pay than permanent counterparts
 Far less likely to receive health or
retirement benefits

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LO 10

Executive Compensation

Remember the skills possessed by

company executives largely
determine whether firm will prosper,
survive, or fail
Compensation programs need to be
developed that motivate these
executives to strive to achieve long-
term success for firm
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LO 10

Types of Executive Compensation

 Base salary
 Bonuses and performance-based pay
 Stock option plans
 Perquisites (perks)
 Severance packages

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LO 10

Base Salary
 Factor in determining executive’s
standard of living
 Salary provides basis for other forms of
compensation; may determine amount
of bonuses and certain benefits
 U.S. tax law does not allow companies
to deduct more than $1 million of
executive’s salary
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LO 10
Bonuses and
Performance-Based Pay
 Trend toward more performance-based
compensation packages for executives
 Payment of bonuses reflects managerial
belief in their incentive value

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LO 10

Stock Option Plans

 Options for managers to buy specified
amount of stock in future at or below
current market price
 Some boards of directors require their top
executives to hold some of firm’s stock
 Financial Accounting Standards Boards
require companies to expense stock
options, thereby making them less
attractive
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LO 10

Perquisites (Perks)
 Special benefits provided by firm to
small group of key executives
 Designed to give executives
something extra
 Securities and Exchange
Commission lowered threshold for
disclosure of executive perks from
$50,000 to $10,000
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LO 10

Severance Packages

 Not set up after CEO has quit or been fired

 SEC requires companies to list all
agreements for each executive
 Investors will see estimated total dollar value
of exit packages

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LO 10
Executive Compensation
Issues in the U.S.
 Say on Pay
 Golden parachute contract
 Clawback contract provision

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LO 10

Say on Pay
 Gives shareholders in all but smallest
companies an advisory vote on
executive pay
 Some expect vote will cause greater
accountability on executive pay
 Votes at least every 3 years

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LO 10
Golden Parachute Contract
 Perquisite protecting executives in event
another company acquires firm or
executive is forced to leave firm for other
reasons
 At times has been abused
 Dodd-Frank Act has disclosure
requirements
 Requires shareholder advisory vote on
certain arrangements
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LO 10

Clawback Contract Provision

 Provision allows company to recover
compensation if subsequent review
indicates payments were not calculated
accurately or performance goals were not
met
 Dodd-Frank Act requires companies to
develop Clawback policies to recover
compensation later deemed excessive

Copyright © 2016 Pearson Education, Ltd 9-61

LO 10
Executive Compensation
in the Global Environment
 Whereas people in United States derive
great status from high pay, nations in large
parts of Europe and Asia shun
conspicuous wealth
 Governance of executive pay varies from
country to country
 Investors in some countries can cast
binding vote on executive pay
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