Compensation

MHR 3200 Dr. Larry Inks Department of Management and Human Resources Fisher College of Business The Ohio State University

Overview
Linkage to Earlier Class Topics
Compensation Terms Different Types of Compensation Approaches A Balanced Scorecard Approach to Compensation Compensation and YOU Summary Thoughts

Compensation and Performance Management

Human Resource Planning

Selection

Orientation/ Onboarding

Rewards (Merit increase, etc.) Performance Review Merit increase Bonus (variable comp) Profit sharing Equity (options) etc.

Setting Accountabilities

Developmental Review
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Linkage to Earlier Class Topics

Compensation Directly relates to an organizations ability to attract, select and hire the best possible employees/organization members Is strongly related to individual motivation, satisfaction, engagement and retention Can cause internal conflicts (e.g., team effectiveness) when equity is not perceived to be present Needs to be aligned with the goals and strategy of the organization - Different elements of compensation plan (merit vs. bonus, etc.) - Focus for compensation (individual vs. group vs. organization level) Can present difficulties in global organization management In the U.S., compensation is intensely personal and related to self-worth
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Compensation Terms/Concepts
Compensation The rewards, usually monetary in nature (either short- and/or long-term) that reinforce behavior, organizational membership, performance and retention. Important Terms/Concepts Intrinsic vs. extrinsic rewards Government regulations (Fair Labor Standards Act [exempt vs. hourly nonexempt that gets overtime], Equal Pay Act of 1963, etc.)

Different types of compensation (e.g., merit pay, incentive pay, etc.)

Determining wage structures: moving from thinner grades/levels to larger bands of pay where employees dont max out as easily Individual- vs. team- vs. organization-level incentives

Benchmarking: comparing w/ others to see if competitive in industry and for talent Total compensation (vs. total rewards: sum total of rewards, going well because of things besides money)
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Different Types of Employee Compensation

Merit pay

Incentive pay (variable pay as primary or secondary source of income)

Senior-level compensation (deferred compensation: anything past a certain level gets moved to a fund like a 401k) Ownership (aka equity) - Traditional stock option plans (usually at higher levels) - Employee Stock Ownership Plans (ESOPs) Profit sharing

Skill-based pay

Merit-Based Compensation
Merit pay programs link performance-appraisal ratings to annual pay increases.

A merit increase grid combines an employees performance rating with the employees position in a pay range (often called a compratio to determine the size and frequency of his or her pay increase.
Merit increase grids can also help bring about perceived pay equity. Some organizations provide guidelines regarding the percentage of employees who should fall into each performance category (e.g., a forced distribution). Criticisms of merit pay include emphasis on individual performance vs. teamwork, measurement problems, and (from Deming) that individuals dont have much impact on their own performance. Merit-based pay is an effective means of reinforcing performance!
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Incentive/Variable Compensation
Incentive pay (aka variable comp aka bonuses) are variable in nature Can be supplemental income (e.g., commissions in addition to base pay) or sole source of income (e.g., some realtor commissions) Typically are linked to some previously-set performance targets, accountabilities, etc. (but think carefully about these when setting them!) More objective when objective performance metrics (e.g., sales $) exist, but can be used for qualitative situations (e.g., accountabilities) Typically are focused on both individual and organizational performance but can be set up to reward team-level performance as well. Also includes bonus compensation for senior-level non-exempt When used as bonuses, typically have two key elements: - Funding: Organization targets need to be met to fund bonus pools - Distribution: Bonus pools distributed according to plan, targets, etc.

Need to ensure program is clearly communicated and understood

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A Sample, Generic Bonus Program*

Situation A Manager-level employee earns an annual base salary of $60,000 and is eligible for an annual bonus of 10% ($6,000). The bonus is contingent on the organization hitting its overall goals (revenue, profit, etc.) for funding, and the Managers bonus is a function of both organization performance (50%) and her own performance (50%). Organization hit its goals, so bonus program is fully funded. Manager accomplished 90% of her bonus objectives. Organization component: $6,000 (bonus target) x .5 (org. component) x 1.0 (org performance)=$3,000

Individual component: $6,000 (bonus target) x .5 (ind. component) x .90 (ind. performance)=$2,700
Total Managers bonus (before taxes!)=$5,700
* Tremendously oversimplified and one of many different types!!!
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Profit Sharing and Equity/Ownership

Profit Sharing - Payments are based on a measure of organization performance (profits), and payments do not become a part of base pay. - It may encourage employees to think more like owners. - Can enhance feelings of procedural and distributive justice - Drawback is that employees may not see strong link between their performance and organization performance - Can also be seen as an expected element of compensation Equity/Ownership - Encourages employees to focus on the success of the organization as a whole entity - Stock options give employees the opportunity to buy company stock at a fixed price (the strike price) set each option cycle. - Employee stock ownership plans (ESOPs) are employee ownership plans that give employers certain tax and financial advantages when stock is granted to employees. Use of stock options deserves a closer look as it is widespread
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Stock Options
Typically used at higher levels of an organization (e.g., Manager+) Gives an employee the option to purchase stock at a later date, at a price (the strike price) that is set at a given point (the strike date). Some amount of options or dollars at work used as indicator of number of options, and this will usually vary across organization levels. Typically seen as a long-term incentive, and therefore linked to an individuals future potential vs. current performance Typically have a vesting period until they can actually be exercised (e.g., 3-5 years, either partial-vesting or cliff-vesting). Can help employees focus on overall organization performance and success Option-eligible so can purchase stocks at old price, and then have ~3-year vesting period before getting money back: cashless exercise Underwater: when options not doing well

But there are some definite problematic issues with option programs
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Concerns with Stock Option Programs

Same challenges exist as with merit and incentive pay regarding the need to be equitable and use options as a means of sending a message. Need to keep in mind that they should be used to reward value, both current and future; be careful not to focus too much on high-potential employees at the expense of known high-value employees. The more an organization uses options as part of their total compensation package, the more vulnerable they are re: stock price. As with bonuses (incentive pay), these can become seen as an established and expected aspect of compensationwhen it doesnt deliver can cause significant problems (e.g., turnover, etc.). Biggest recent change is that organizations now need to expense these options. Per FASB, need to start expensing options as formal part of P&L starting first fiscal year after June 15, 2005 Focus on options seems to be declining given recent events
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A Balanced Scorecard Approach

A balanced scorecard approach to compensation uses a combination of different types of compensation strategies (e.g., merit pay, incentive pay, stock options, etc.). When carefully thought through and developed, can provide a balanced focus on individual, team, and organization-level performance. Because it is more complex, it requires more thoughtful development, ongoing maintenance, and very clear communication to employees. Typically will provide a focus on a variety of different important elements of organization success (e.g, customers, organization growth, internal operating efficiency, people development). Need to review it each year to ensure it is competitive, is driving correct behaviors and results, is clearly understood, etc. So what could a balanced scorecard approach look like?
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A Sample Balanced Scorecard Approach*

Organization Level Entry/ Individual Contributor Manager Director Vice President Senior Vice President+ Base Target Bonus Equity/Options Compensation ESOP (% of Base) (% of Base) $35-$75K Yes n/a (typically) n/a (typically)

$55-$95K $85-$135K $125-$250K

Yes Yes Yes

10%-15% 20%-30% 35%-50%

50% 100% 200%

$195K+

Yes

50%-80%+

300%

* Tremendously oversimplified!!!
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Compensation and YOU

Differentiate total compensation from total rewardsbut both are important and relevant for you Understand that when youre looking at a new role, the target range is different from your current compensationwhich theyll ask for. Try to come in as high in the range (comp-ratio) as possible; otherwise one can stay near the bottom of each range as they progress. Understand the total compensation package, both current as well as potential future (if you advance within the company). Do some research re: how bonuses have paid out, stock performance, etc. Have patience and keep your expectations in check As soon as possible, start your long-term wealth creationdont wait!

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Summary Thoughts About Compensation

Clear communication of program(s), targets, guidelines, etc. is absolutely critical to perceived equity, justice, and related engagement. Programs should be carefully thought through to ensure a proper focus on organizational objectives and that the right behavior is rewarded. Programs can be structured to reward individual and/or team and/or organization-level performance, but requires some good thought. Compensation programs need to be used to a) reward people for their performance and b) provide messages as to how that performance (and the individual) is seen. Benchmarking (both for program development and ongoing pay competitiveness) is important for best possible programs. Best approach is to use a combination of different approaches to provide a good balance between short-term and long-term incentives (balanced scorecard).
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Review
Linkage to Earlier Class Topics
Compensation Terms Different Types of Compensation Approaches A Balanced Scorecard Approach to Compensation Compensation and YOU Summary Thoughts

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What Questions Do You Have?