Seventh

Edition

STRATEGIC COMPENSATION
A HUMAN RESOURCE MANAGEMENT APPROACH

Joseph J. Martocchio
University of Illinois at Urbana-Champaign

PEARSON
Boston Columbus*f;Indianapolis New York San Francisco Upper Saddle River
Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto
Delhi Mexico City Sao Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo

CONTENTS
Preface xiii

Part I

Setting the Stage for Strategic Compensation

Chapter 1 STRATEGIC COMPENSATION 2

A Component of Human Resource Systems 2
Exploring and Defining the Compensation Context
What Is Compensation? 4
Core Compensation 5
Employee Benefits 6

A Historical Perspective on Compensation: The Road Toward

Strategic Compensation 9
Strategic Versus Tactical Decisions

11

Competitive Strategy Choices 13

Tactical Decisions that Support the Firm's Strategy 14
Compensation Professionals' Goals 15
How HR Professionals Fit into the Corporate Hierarchy 15
How the Compensation Function Fits into HR Departments
The Compensation Department's Main Goals 19
Stakeholders of the Compensation System 20

15

Employees 20
Line Managers 20
Executives 21
Unions 21
U.S. Government 21
COMPENSATION IN ACTION 21
Summary 22 Key Terms 22 Discussion Questions 22
CASE: Competitive Strategy at Sportsman Shoes 23
Endnotes 23

Chapter 2 CONTEXTUAL INFLUENCES ON COMPENSATION

PRACTICE 25
Employment Laws that Influence Compensation Tactics 26
Income Continuity, Safety, and Work Hours 27
Pay Discrimination 31
Civil Rights Act of 1964 33
Accommodating Disabilities and Family Needs 37
Prevailing Wage Laws 38
Laws that Guide Discretionary Employee Benefits
Internal Revenue Code 39

39

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Contents

Employee Retirement Income Security Act of

1974(ERISA) 40
Consolidated Omnibus Budget Reconciliation Act of 1985
(COBRA) 41
Continuation of Coverage under COBRA 42
Health Insurance Portability and Accountability Act of 1996
(HIPAA) 42
Pension Protection Act of 2006 42
Patient Protection and Affordable Care Act of 2010 43
Contextual Influences on the Federal Government as an Employer 44
Labor Unions as Contextual Influences 44
Market Influences 46
COMPENSATION IN ACTION 48
Summary 48 Key Terms 48 Discussion Questions 49
CASE: Exempt or Nonexempt? 49
Endnotes 50

Part II Bases for Pay

51

Chapter 3 TRADITIONAL BASES FOR PAY 52

Seniority and Merit 52
Seniority and Longevity Pay 53
Historical Overview 53
Who Participates? 54
Effectiveness of Seniority Pay Systems 54
Design of Seniority Pay and Longevity Pay Plans 55
Advantages of Seniority Pay 56
Fitting Seniority Pay with Competitive Strategies 57
Merit Pay 57
Who Participates? 57
Exploring the Elements of Merit Pay 58
Performance Appraisal 60
Types of Performance Appraisal Plans 60
Exploring the Performance Appraisal Process 65
Strengthening The Pay-For-Performance Link 69
Link Performance Appraisals to Business Goals 69
Analyze Jobs 69
Communicate 69
Establish Effective Appraisals 69
Empower Employees 69
Differentiate among Performers 70
Possible Limitations of Merit Pay Programs 71
Failure to Differentiate among Performers 71

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Poor Performance Measures 71

Supervisors' Biased Ratings of Employee Job Performance 71
Lack of Open Communication between Management and
Employees 71
Undesirable Social Structures 71
Factors Other than Merit 71
Undesirable Competition 72
Little Motivational Value 72
COMPENSATION IN ACTION 72
Summary 73 Key Terms 73 Discussion Questions
CASE: Appraising Performance at Precision 74
Endnotes 75

Chapter 4 INCENTIVE PAY

73

76

Exploring Incentive Pay 77

Contrasting Incentive Pay with Traditional Pay 77
Individual Incentives 80
Defining Individual Incentives 80
Types of Individual Incentive Plans 80
Advantages of Individual Incentive Pay Programs 83
Disadvantages of Individual Incentive Pay Programs 83
Group Incentives 83
Defining Group Incentives

84

Types of Group Incentive Plans 84

Advantages of Group Incentives 89
Disadvantages of Group Incentives 90
Companywide Incentives 90
Defining Companywide Incentives 91
Types of Companywide Incentive Plans 91
Designing Incentive Pay Programs 93
Group versus Individual Incentives 93
Level of Risk 94
Complementing or Replacing Base Pay 94
Performance Criteria 94
Time Horizon: Short Term versus Long Term 95
COMPENSATION IN ACTION 95
Summary 96 Key Terms 96 Discussion Questions
CASE: Individual or Team Reward? 97
Endnotes 98

Chapter 5 PERSON-FOCUSED PAY

99

Defining Person-Focused Pay: Competency-Based,

Pay-For-Knowledge, And Skill-Based Pay 100
What Is a "Competency"? 101

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Contents

Usage o f Person-Focused Pay Programs 102

Reasons t o Adopt Person-Focused Pay Programs 103
Technological Innovation 103
Increased Global Competition 104
Varieties of Person-Focused Pay Programs 104
Contrasting Person-Focused Pay W i t h Job-Based Pay 109
Advantages of Person-focused Pay Programs 110
Advantages t o Employees 110
Advantages t o Employers 111
Disadvantages of Person-focused Pay Programs 112
COMPENSATION IN ACTION 113
Summary 114 Key Terms 114 Discussion Questions 114
CASE: Person-focused Pay at Mitron Computers 114
Endnotes 115

Part III Designing Compensation Systems

117

Chapter 6 BUILDING INTERNALLY CONSISTENT COMPENSATION

SYSTEMS 118
Internal Consistency 119
Job Analysis 120
Steps in t h e Job Analysis Process 121
Legal Considerations f o r Job Analysis 125
Job Analysis Techniques 127
U.S. Department of Labor's Occupational Information Network
(O*NET) 127
Job Evaluation 132
Compensable Factors 132
The Job Evaluation Process 133
Job Evaluation Techniques 134
The Point Method 135
Alternative Job-Content Evaluation Approaches 138
Alternatives t o Job Evaluation 140
Internally Consistent Compensation Systems and Competitive
Strategy 140
COMPENSATION IN ACTION 141
Summary 142 Key Terms 142 Discussion Questions 142
CASE: Internal Consistency at Customers First 143
Endnotes 144

Chapter 7 BUILDING MARKET-COMPETITIVE COMPENSATION

SYSTEMS 145
Market-Competitive Pay Systems: The Basic Building Blocks 145
Compensation Surveys 146

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Preliminary Considerations 146

Using Published Compensation Survey Data 147
Compensation Surveys: Strategic Considerations 150
Compensation Survey Data 153
Updating the Survey Data

159

Integrating Internal Job Structures with External

Market Pay Rates 161
Compensation Policies and Strategic Mandates 163
COMPENSATION IN ACTION 164
Summary 165 Key Terms 165 Discussion Questions 165
CASE: Nutriment's New Hires 165
Endnotes 166

Chapter 8 BUILDING PAY STRUCTURES THAT RECOGNIZE

EMPLOYEE CONTRIBUTIONS 176
Constructing a Pay Structure 177
Step 1: Deciding on the Number of Pay Structures 177
Step 2: Determining a Market Pay Line 178
Step 3: Defining Pay Grades 178
Step 4: Calculating Pay Ranges for Each Pay Grade

178

Step 5: Evaluating the Results 184

Designing Merit Pay Systems 184
Merit Increase Amounts

185

Timing 186
Recurring versus Nonrecurring Merit Pay Increases 186
Present Level of Base Pay 186
Rewarding Performance: The Merit Pay Grid

186

Merit Pay Increase Budgets 188

Designing Sales Incentive Compensation Plans 190
Alternative Sales Compensation Plans 191
Sales Compensation Plans and Competitive Strategy 192
Determining Fixed Pay and the Compensation Mix 193
Designing Person-focused Programs 194
Establishing Skill Blocks 194
Transition Matters 195
Training and Certification 196
Pay Structure Variations 198
Broadbanding

198

Two-Tier Pay Structures 200

COMPENSATION IN ACTION 201
Summary 202 Key Terms 202 Discussion Questions 202
CASE: A New Sales Representative 202
Endnotes 203

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Part IV Employee Benefits 205

Chapter 9 DISCRETIONARY BENEFITS

206

An Overview of Discretionary Benefits 206

Components of Discretionary Benefits 208
Protection Programs 208
Paid Time Off 211
Services 213
The benefits and costs of Discretionary Benefits 215
COMPENSATION IN ACTION 216

Summary 217

Key Terms 217

Discussion Questions 217

CASE: Time off at Superior Software Services 218

Endnotes 219

Chapter 10 EMPLOYER-SPONSORED RETIREMENT PLANS

AND HEALTH INSURANCE PROGRAMS 220
Exploring Retirement Plans 221
Origins of Employer-Sponsored Retirement Benefits 221
Trends in Retirement Plan Coverage and Costs 222
Qualified Plans 222
Minimum Standards for Qualified Plans 223
Defined Benefit Plans 225
Minimum Funding Standards 226
Benefit Limits and Tax Deductions 226
Defined Contribution Plans 226
Individual Accounts 226
Investments of Contributions

226

Employee Participation in Investments 227

Minimum Funding Standards 227
Contribution Limits and Tax Deductions 227
Types of Defined Contribution Plans 227
Section 401 (k) Plans 227
Profit Sharing Plans 227
Stock Bonus Plans 228
Employee Stock Ownership Plans 228
Hybrid Plans: Cash Balance Plans 228
Defining and Exploring Health Insurance Programs 229
Origins of Health Insurance Benefits 229
Health Insurance Coverage and Costs 230
Fee-for-Service Plans 231
Features of Fee-for-Service Plans 232
Managed Care Plans 234
Health Maintenance Organizations 234

Contents
Features of Health Maintenance Organizations
Preferred Provider Organizations

Features of Preferred Provider Organizations

Deductibles

236

Coinsurance

236

Point-of-Service Plans

234

236
236

236

Specialized Insurance Benefits

Prescription Drug Plans

236

237

Mental Health and Substance Abuse

237

Features of Mental Health and Substance Abuse Plans

Consumer-Driven Health Care

237

238

COMPENSATION INACTION 239

Summary 240 Key Terms 240 Discussion Questions 241
CASE: A Health Savings Account at Frontline PR 241
Endnotes 242

Chapter 11 LEGALLY REQUIRED BENEFITS

243

A n Overview of Legally Required Benefits

244

Components of Legally Required Benefits

244

Social Security Act of 1935

244

State Compulsory Disability Laws (Workers'

Compensation) 251
Family and Medical Leave Act of 1993

254

The Benefits and Costs of Legally Required Benefits

Designing and Planning The Benefits Program
Determining W h o Receives Coverage
Financing

256

257

257

258

Employee Choice

258

Cost Containment
Communication

261
262

COMPENSATION IN ACTION 264

Summary 265 Key Terms 265

CASE: Benefits for Part-Time Workers 266

Part V

Discussion Questions 266

Endnotes 267

CONTEMPORARY STRATEGIC COMPENSATION

CHALLENGES 269

Chapter 12 COMPENSATING EXECUTIVES

270

Contrasting Executive Pay with Pay for Nonexecutive Employees 271

Principles of Executive Compensation: Implications for Competitive
Strategy 271
Defining Executive Status 272
Who Are Executives? 272

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Key Employees 272

Highly Compensated Employees 272
Executive Compensation Packages 273
Components of Current Core Compensation 274
Short-Term Incentives 275
Components of Deferred Core Compensation 276
Employee Benefits: Enhanced Protection Program Benefits and
Perquisites 279
Principles and Processes for Setting Executive Compensation 281
The Key Players in Setting Executive Compensation 281
Theoretical Explanations for Setting Executive
Compensation 283
Executive Compensation Disclosure Rules 285
Other Benefits 287
Say on Pay 288
Executive Compensation: Are U.S. Executives Paid Too Much? 288
Comparison between Executive Compensation and Compensation
for Other Worker Groups 288
Strategic Questions: Is Pay for Performance? 289
Ethical Considerations: Is Executive Compensation Fair? 290
International Competitiveness 290
COMPENSATION IN ACTION 291
Summary 292 Key Terms 292 Discussion Questions 293
CASE: CEO Pay in the News 293
Endnotes 294

Chapter 13 COMPENSATING THE FLEXIBLE WORKFORCE

295

Contingent Employees and Flexible Work Schedules 295

The Contingent Workforce 296
Groups of Contingent Workers 296
Reasons for U.S. Employers' Increased Reliance on Contingent
Workers 301
Pay and Employee Benefits for Contingent Workers 303
Part-Time Employees 304
Temporary Employees 305
Leased Workers 306
Independent Contractors, Freelancers, and Consultants 307
Flexible Work Schedules: Flextime, Compressed Workweeks,
and Telecommuting 309
Flextime Schedules 309
Compressed Workweek Schedules 309
Telecommuting 310
Flexible Work Schedules: Balancing the Demands of Work Life and
Home Life 310

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Pay and Employee Benefits for Flexible Employees 311

Pay 311
Employee Benefits 311
Unions' Reactions to Contingent Workers and Flexible
Work Schedules 313
Strategic Issues and Choices in Using Contingent and Flexible
Workers 313
COMPENSATION INACTION 314
Summary 315 Key Terms 315 Discussion Questions 316
CASE: Telecommuting at MedEx 316
Endnotes 317

Part VI Compensation Issues a r o u n d t h e W o r l d

319

Chapter 14 COMPENSATING EXPATRIATES 320

Competitive Advantage and How International Activities
Fit In 321
Lowest-Cost Producers' Relocations t o Cheaper Production
Areas 321
Differentiation and the Search for New Global Markets 321
How Globalization Is Affecting HR Departments 322
Complexity of International Compensation Programs 322
Preliminary Considerations 323
Host Country Nationals, Third Country Nationals,
and Expatriates: Definitions and Relevance for
Compensation Issues 323
Term of International Assignment 323
Staff Mobility 324
Equity: Pay Referent Groups 324
Components of International Compensation Programs 324
Setting Base Pay For U.S. Expatriates 325
Methods for Setting Base Pay 325
Purchasing Power 326
Incentive Compensation for U.S. Expatriates 327
Foreign Service Premiums 327
Hardship Allowances 327
Mobility Premiums 328
Establishing Employee Benefits for U.S. Expatriates 328
Standard Benefits for U.S. Expatriates 329
Enhanced Benefits for U.S. Expatriates 330
Balance Sheet Approach for U.S. Expatriates' Compensation
Packages 331
Housing and Utilities 332
Goods and Services 332

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Contents

Discretionary Income 333

Tax Considerations 333
Repatriation Pay Issues

334

COMPENSATION IN ACTION 335

Summary 336 Key Terms 336
CASE: Jenkins Goes Abroad 336
Endnotes 337

Discussion Questions 336

Chapter 15 PAY AND BENEFITS OUTSIDE THE

UNITED STATES 338
North America 339
Canada 342
Mexico 343
South America 345
Brazil 345
Europe 346
Germany 346
Asia 348
India 348
People's Republic of China 349
COMPENSATION IN ACTION 351
Summary 352 Discussion Questions 352
CASE: North American Expansion for Threads Apparel 352
Endnotes 353

Epilogue
Chapter 16 CHALLENGES FACING COMPENSATION
PROFESSIONALS

356

Fallout from the "Great Recession" 357

What is an Economic Recession? 357
Underemployment: Implications for Compensation

358

The Compensation-Productivity Gap 360

Rising Wages in China 362
Challenges in Health Care Reform 362
Key Considerations for Employers 363
Challenges to the Legality of PPACA 363
Workforce Demographic Shifts 364
Labor Force Diversity 364
Relevance for Employee Benefits 365
Considerations for Employee Motivation

Glossary 368
Author Index 384
Subject Index 386

Summary 366
Endnotes 366

Key Terms 366

366
Discussion Questions 366