Remuneration: Lifting the curtain on HR’s dark art (part 2)

Regular reading of The HR Coffee Pot will recall from Sheshaya Surtani her previous contribution ‘Making rewards rewarding’ part one of this four part post, this time Sheshaya has delivered the second part of her four part article on remuneration. More of Sheshaya’s writing can be found here.

This post focuses on base pay rates as a means by which firms compensate their employees. In setting base pay, an HR manager has to consider many things such as the form of pay (wages vs. salary) and the basis upon which pay is based ( i.e. skills/knowledge, task, seniority, status, credentials, and/or job worth).

  • Pay by salary or wages?
    What is the distinction between wages and salaries?
  • Wages –expressed as an hourly rate, and employees whose time on the job is closely monitored.
  • Salaries- expressed per month/year. It is paid to employees who manage their own time.
  • Basis upon which base pay is determined:Key Question:

    What factors would an HR manager have to take into consideration when designing a base pay structure?What is base pay?

ü  Fixed part of the compensation package

ü  Guaranteed and contractual

ü  Represents the minimum compensation expected for carrying out a particular job.

ü  Generally ignores differences attributable to individual employees.

ü  Can be:

  • Hourly basic pay rate (often expressed as a weekly wage)
  • Annual salary

The main factors to take into account: The individual, the organisation, the external environment

  1. 1.      The individual
  • Education
    • Match between an employees’ education and what is required for the job
    • Quality of education. For instance the average starting salary for an LSE graduate in 2009 was £29,707 six months after graduation, which was significantly above the UK average of £27000.
    • Level of skills
      A worker entering employment is given a base pay that will be increased gradually as the worker demonstrates the ability to carry out certain tasks. For instance teachers and other professionals experience a pay increase if they acquire off-the-job study training programmes.

      • Industries such as aerospace, pharmaceuticals, high technology, and others where specialized expertise is a competitive necessity, pay more.
      • Professionals who took IT or business-related training over the past year earned an average of nearly $3,400 more than those who did not. In particular, professionals who had earned an IT or project management certification during the past five years earned an average of $2,720 more than their counterparts (2011 IT Skills and Salary Report – Global Knowledge & TechRepublic)

Why promote this pay rationale? High commitment HR firms are strong advocates of skills or knowledge based pay, because they want to give employees the incentive to be able to do more, thus be more flexible and understand the workings of the firm better.
àPromote employee retention, providing them with an opportunity to grow on the job
àEmployees motivated to obtain additional skills and knowledge
àEmployees and more flexible and trainable
àConfer status on being more skilled and knowledgeable.
àAcquisition of new skills and knowledge is a source of intrinsic motivation.

Empirical evidence:
Murray and Gerhart conducted research on an assembly facility within a large American manufacturing company that adopted a skills based pay plan. The found that after adoption of the skills based pay system, the facility experienced significantly higher productivity. i.e. lower labour costs per unit, superior quality outcomes, etc. However, issues were also noted: workers can “top out” fairly quickly. This meant that after a few years in the organisation, all the skills have been learnt and the motivation and excitement that come with progressing is gone. Workers tend to get distracted by the money that comes with the acquisition and use of new competencies, which can be a source of substantial intrinsic motivation (yet it is objectified where the object is money).In order to deal with this issue, employers increase the list of competencies for which it is willing to pay, by adding capabilities that will (sometimes) be seldom used by the worker, leading to an overqualified and overpaid workforce.

  • · Status (age, knowledge)
    There are some jobs e.g. professional athletes and surgery there it is viewed as legitimate to pay a nominal subordinate more than his or her nominal supervisor. No one quibbles with paying a top athlete more than his coach or a star surgeon more than the director of the hospital. (This legitimacy is market based/market excused). However with exceptions noted above, superiors are generally paid more than their subordinates. This promotes status consistency. 

    • Seniority and cultural values:
      Firms pay more to workers with higher experience based on their seniority, either in terms of chronological age or tenure in the job. For instance, in East Asia, age confers status. A powerful body in this arena are trade unions, who through collective bargaining favour rewarding the most politically powerful members. There is a general perception that with seniority, those who are older possess greater levels of skills and experience and are generally more stable workers (thereby conferring lower absenteeism and turnover rates).By virtue of seniority perceptions and higher wage patterns for the older, more experienced staff, this implies that those highly mobile are less likely to apply for jobs where rewards are receiver only after a long tenure. Thus organisations with these pay policies will attract an inherently more stable workforce.

Empirical evidence: In both educational institutions and industry, the possession of 30 or more years of experience, was associated with a net salary advantage of 58% over persons just beginning of a professional career (Emanuel Melichar,1968).

Nonetheless key issues still remain:

  • Outsourcing nature of work patterns.
  • The worker faces uncertainty about his or her tenure in the job. E.g. if the worker’s spouse gets a good job in another location, this makes the employee uncertain with respect to his or her compensation. Consequently this may be suboptimal in terms of risk.  Since rewards are delayed and somewhat congruent on the employer’s good will, this places employees in a very low bargaining position against their employers. Employees who appreciate either of these effects will demand higher average wages, averaged over the life of their employment to compensate.
  •  Is it really necessary to retain employees under long contracts?
  •  Skills and knowledge become obsolete quickly in some jobs. – is makes sense to promote low turnover among more senior workers, or confer status on those who are increasingly “out of it”- in such cases, giving rewards on the basis of “here-and-now for work performed here-and-now” makes more sense.
  1. 2.      The organisation
  • Profitability and performance of the company
    • Employees working for a highly profitable business have a greater chance of receiving higher pay than those working for a less profitable enterprise.
    • Job Characteristics
      • Degree of decision-making responsibility
      • Contribution to the organisation
      • Level in the organisational hierarchy
      • Complexity of the job.
      • Shift Differentials
        • Less favourable shift times are typically paid a premium due to the higher social and physical costs involved in working outside “normal work hours.”
        • Hazardous Working Conditions
          • Dangerous working conditions can be defined to include anything from handling dangerous chemicals in a research facility to coal mining.
          • Jobs that fall into this category are usually regulated by outside authorities, including labour unions and the government.
          • Compensation Philosophy
          • o order to attract and retain the very best pool of skilled workers available
          • o Decisions to lag the market/meet the market/lead the market(c.f. page 6)
  1. 3.      The external environment
  • Supply and Demand of Labour
  • Geographic Location
    • Certain areas where the cost of living is high have historically paid higher wages. For example, if you earned a salary of $40,000 in Texarkana, you would have to earn $87,885 in Honolulu to maintain the same standard of living-that represents a 120% difference in pay!
    • The consumer price index (CPI) is an example of a cost-of-living index used to measures changes in the price level of consumer goods and services purchased by households.
    • Government Policy
      • Fair compensation for work is an integral component of decent work as defined by the ILO.
      • Minimum wage rates
      • All things considered, what does the evidence say about Base pay?

Studies have found that companies with narrow “pay differentials” are often viewed by customers as having significantly improved product quality relative to competitors, particularly in sectors such as manufacturing. However, it is critical to note that on the downside, compressing wage distributions can often lead to overpaying the worst and underpaying the best performers, who may quit and join rival firms instead.

Interested in learning more? Read on to the next post based on payment by performance (PRP), as an alternative measure of how firms compensate their employees.

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