Description
Here are the 8 questions:
1. The four policy issues in the pay model are: (1) internal alignment; (2) external competitiveness; (3) employee contribution; and (4) management of the pay system.
What are the meanings of (1) internal alignment and (2) external competitiveness of the pay system?
Why is internal alignment an important policy in a strategic perspective of compensation? How does internal alignment influence employee behaviors?
2. List at least three basic objectives (e.g., efficiency) of a strategic pay system. What purposes do the objectives in the pay model serve?
3. What is a best-fit pay model? What are the essential differences between the best-fit and best-practices perspectives?
4. Job analysis has been considered the cornerstone of human resource management. Precisely how does it support managers making pay decisions?
– What does job analysis have to do with internal alignment of pay and the overall effectiveness of pay system?
5. What do pay surveys have to do with pay discrimination?
6. How is an earnings-at-risk plan different from an ordinary gain-sharing or profit sharing plan?
– How might earnings-at-risk plans affect attraction and retention of employees?
– How does whether the economy is growing or contracting affect the viability of earnings at risk plans?
7. A company is experiencing turnover in the range of 100 percent. Most of this occurs in the first 18 months of employment.
– How would you determine if this turnover rate is high?
– How would you justify to your boss that lower turnover is strategically important?
– What would you look at in both pay and other forms of rewards to identify ways of reducing turnover?
8. Select a familiar company or analyze the approach your college/company uses to pay employees. Infer its compensation strategy using the five dimensions (objectives, alignment, competitiveness, employee considerations, and management). What business strategy does it seem to “fit” (i.e., cost cutter, customer centered, innovator, or something else)?
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Compensation
(Chapter 14:
Compensation of Special Groups:
Executives and Others)
Jie (Jasmine) Feng, Ph.D.
Associate Professor in Human Resource Management
Rutgers | School of Management and Labor Relations
Special Groups: Overview
• Special treatment tends to focus on a few specific groups.
• Either in the form of add-on packages not received by other workers.
• Or In the form of compensation components unique in the organization.
• Special groups share two characteristics.
– They tend to be strategically important to their company.
– Their positions tend to have built-in conflict due to incompatible demands.
Examples:
• Supervisors.
• Top management.
• Boards of directors.
• Scientists and engineers.
• Sales personnel.
• Contingent workers.
2
Supervisors
• Conflict arises when upper management wants more worker output.
– And workers balk because their rewards do not increase.
• The major challenge in compensating supervisors centers on equity.
– Some incentive must be provided to entice nonexempt employees to
accept the challenges of being a supervisor.
• Organizations have devised several strategies to attract new
supervisors.
– The most popular method is to pay a base salary for supervisors (typically)
5 to 30% above the pay of the top-paid subordinate in the unit.
– Another method to maintain equitable differentials is to pay supervisors for
scheduled overtime.
– The biggest trend in supervisory compensation centers on increased use
of variable pay.
3
Corporate Directors
• A board of directors provides strategic advice on decision-making.
– Companies are trying to populate their boards with outside directors.
– What used to be a “rubber stamp” process is now a highly charged
analysis of, among other things, CEO compensation.
• There is considerable risk in these jobs.
– Stockholders can, and do, sue directors over CEO pay/performance.
• In exchange for assuming this risk, directors are well rewarded.
– A director, working 30 to 40 hours/month, is compensated $290,000.
– The mix of compensation is shifting from base pay to incentives.
4
Executives
Median annual pay for a CEO in the S&P 500 is over $12 million.
Executive
Company
Total Compensation
Elon Musk
Tesla, Inc.
$595 million
Tim Cook
Apple, Inc.
$134 million
Tom Rutledge
Charter
Communications, Inc.
$117 million
• Most people feel CEOs are overpaid, but CEOs say pay is
appropriate.
– There is no right or wrong answer to how much CEOs should get paid or
how much they should get paid relative to the average worker.
– There is a need to align CEO pay with company performance.
•
Source: Anders Melin and Cedric Sam. “Wall Street Gets the Flak, But Tech CEOs Get Paid All the Money.” Bloomberg.com, July 10, 2020.
5
How Aligned are Executive Pay and Performance?
• Research suggests that, on the whole, CEO pay and company
performance are strongly aligned.
Shareholder Return
Shareholder Return in
$ (change in wealth)
CEO Return in $
(change in wealth)
25th percentile
−198 million
−0.7 million
Median
+163 million
+9.5 million
75th percentile
+553 million
+21.6 million
• Heavy use of bonuses and stock-based compensation may result in
executives taking too large of risks.
• One consequence was passage of the Dodd-Frank Act.
• What looks like a lack of alignment probably is not.
•
Source: Nyberg, A., Fulmer, I. S., Gerhart, B., and Carpenter, M. A. “Agency Theory Revisited: CEO Returns and Shareholder Interest Alignment,” Academy of Management Journal, vol. 53, 2010, 1029–1049.
6
Say on Pay (Shareholder Votes)
• The Dodd-Frank Act requires that shareholders vote to approve or
disapprove the compensation plan for its five highest paid executives.
– The vote is nonbinding.
– In 97-99% of company votes, shareholders approved executive pay.
• Even though the required vote is non-binding, most companies view a
no-vote as a public relations disaster.
• ISS recommends approval of the say on pay vote 90% of the time.
• It is also important to note that large shareholders can influence
executive pay.
7
Components of an Executive Compensation Package
• There are five basic elements of most executive compensation
packages.
– Base salary.
– Short-term (annual) incentives or bonuses.
– Long-term incentives (e.g., stock options and stock grants).
– Benefits.
– Perquisites (e.g., Automobile lease payments, Airline club memberships).
• The most recent figure on total CEO compensation was $12.7 million.
– Base salary accounted for just 8.7%.
– Long-term and short-term incentives account for the bulk of CEO pay.
– As the value of the S&P 500 increases or decreases, total CEO pay also
increases and decreases.
– CEO pay in large companies has grown faster than worker pay and thus
CEO pay/worker pay ratio has increased.
8
Components of an Executive Compensation Package
Base Salary and Annual Incentive Plan/Bonuses
• A compensation committee is
of particular importance when
determining executive base
pay.
– Composed usually of the
company’s board of directors
or a subset of the board.
• Most committees:
– Set CEO compensation at a
level between the highest
and lowest competitor.
– Pay may be higher if a
large company or if raiding
risk is high.
• Bonuses are designed to
motivate better short-term
performance.
– Nearly every executive in private
sector companies is covered by
a bonus plan.
– Three common measures are
profit, revenue, and cash flow.
– Non-financial measures can be
strategic, individual, or
discretionary.
– Bonuses have become a smaller
portion of executive pay.
– A balanced scorecard approach
is preferred.
9
EXHIBIT 14.7 Annual Incentive Plan for Top Five
Executives, Ford Motor Company
•
Although companies have many common performance measures in their
annual incentive plans, they typically tailor these to their own objectives and
strategies.
•
Source: Ford’s 2018 Proxy Statement. The plan is similar in later years, except that Ford Credit Profit before Tax is eliminated and weightings change (e.g., cash flow is weighted 50% in the
2021 Proxy Statement).
10
Components of an Executive Compensation Package
Long-Term Incentive
• Performance awards are the most used long-term incentive program
for executives – followed by restricted stock and stock options/SAR.
– With the change to fair value accounting practices, stock options must be
taken as an expense at the time they are granted.
– The most rigorous approach to computing the value of a stock option is to
use an options pricing model such as Black-Scholes.
• One concern with stock options is that they sometimes do not link as
closely as desired to performance of the executive.
– Another is the ability to “game the system.”
• Performance awards are now the most important long-term incentive
program.
– Long-term incentive plan grants must vest before they become property of
the recipient.
11
EXHIBIT 14.11 Effect of Volatility and Dividend Rate
on Option Value (as % of stock price)
• First, the higher the volatility, the better.
• Second, the lower the dividend rate, the greater the Black-Scholes
value of an option.
Dividend
Rate
Volatility for
10%
Volatility for
30%
Volatility for
50%
Volatility for
70%
0%
.45
.56
.69
.81
4%
.15
.29
.41
.51
8%
.02
.14
.24
.32
•
Source: Hall, B. J., “What You Need to Know about Stock Options,” Harvard Business Review 78, no. 2 (2000), pp. 121–129.
12
Components of an Executive Compensation Package
Executive Benefits and Perquisites
• Beyond the typical benefits,
many executives also receive:
– Additional life insurance.
– Exclusions from deductibles
for health-related costs.
– Supplementary pension
income exceeding maximum
permissible under ERISA.
• ERISA requires that a plan:
– Cover 80% of employees.
– Provide determinable
benefits.
– Meet specific vesting and
nondiscrimination
requirements.
• Various tax and regulatory
agencies require companies to
place a value on “perks.”
– Personal use of corporate
aircraft.
– Financial/tax planning.
– Company car/car allowance.
– Executive physical.
– Supplemental insurance.
– Home security.
– Spousal travel.
– Club dues and allowances.
– Matching gifts/charity.
13
Why is Everyone So Interested in Executive
Compensation? And…Some Different Perspectives
• You wonder if anyone is worth $12 million per year.
– One issue has to do with income inequality.
• Why do executive pay committees recommend the amount and
manner of executive pay?
– The most basic reason is shareholder interests.
– There is strong evidence of a strong pay-for-performance link.
• One explanation for the high executive pay involves social
comparisons.
– A second approach focuses on explaining the level of executive wages.
– A different economic perspective looks at labor markets.
– Agency theory, incorporates the political motivations that are an inevitable
part of the corporate world.
14
Scientists and Engineers in High-Technology Industries
•
Scientists and engineers are
classified as professionals.
•
There is a close parallel
between pay increases and
knowledge obsolescence.
•
A second problem centers on
the question of equity.
•
Organizations rely heavily on
external market data in pricing
base pay, resulting in maturity
curves.
•
Some firms have tried to deal
with the plateau effect with the
dual-career ladder.
15
Sales Forces
• The sales staff spans the all-important boundary between the
organization and consumers.
– Sales can be outsourced.
– If kept in-house, a company may use inside and outside sales reps.
• Outside reps require individuals with high initiative, who work
unsupervised for extended periods of time.
– Standard compensation is not designed for this type of job.
– So, there is much more reliance on incentive payments tied to individual
performance.
– As the sales person’s ability becomes more important, the size of the
incentive component rises significantly.
16
Designing a Sales Compensation Plan
– The nature of the people dictates the primary focus of compensation
should be on direct financial rewards (base pay plus incentives).
– Organizational strategy – generally, there are two types of compensation
plans: unit rate plans and add-on plans.
– Market maturity – as sales patterns change, companies must adapt the
compensation accordingly.
– Competitor practices – external competitiveness is essential.
– The economic environment affects the structure of a pay package.
– The nature of the product or service to be sold may influence the design of
a compensation system.
• Figuring out what the sales target should be is a major challenge.
• The second biggest challenge is making the forecast of expected
sales as accurate as possible.
17
Contingent Workers and Workers under Alternative
Work Arrangements
• As employment status is temporary and employee benefits are less or
nonexistent, wages may be higher.
– Employers must be careful in the way they define contingent workers.
• Why the move to contingent workers?
– One answer may signal a permanent change in how business is done.
– Temp workers offer expansion and contraction of the workforce.
– Wages and benefits are lower and productivity is higher.
•
A major compensation challenge is identifying ways to deal with equity.
– One response is to view contingent workers as a pool of future hires.
– A second response is to champion the idea of boundary-less careers.
• There are also high-paid “gig” workers.
– 70% of gig workers likely prefer the arrangement, whereas the remaining
30% would choose traditional full-time jobs if available.
18
Compensation
(Chapter 11:
Performance Appraisals)
Jie (Jasmine) Feng, Ph.D.
Associate Professor in Human Resource Management
Rutgers | School of Management and Labor Relations
The Role of Performance Appraisals in Compensation
Decisions
• Performance reviews are used for a wide variety of decisions – only
one of which is to guide the allocation of merit increases.
– The link between performance ratings and these outcomes is not always
as strong as it could be.
– Performance ratings are influenced by a host of factors besides the
employee behaviors observed by raters.
• The biggest complaint from employees (and managers too) is that
appraisals are too subjective.
• Performance metrics is one of the hottest areas of study in both
academic and business organizations.
2
Performance Metrics
• Pay for performance programs evolve along multiple dimensions.
– First, is the measure (metric) results-oriented or behaviorally oriented?
– Second, does the measure focus on individual employees or teams or the whole
organization?
• Finding good results-oriented measures at the individual level, is very
difficult – due to subjectivity creating criterion-deficient data.
– Just because something is quantifiable does not mean it is an objective measure of
performance.
• Edward Deming contended that the work situation (not the individual)
is the major determinant of performance.
• Some experts argue that rather than throwing out the entire appraisal
process, TQM principles should be applied to improve it.
3
Strategies for Better Understanding and Measuring Job
Performance – The Balanced Scorecard Approach
• A balanced scorecard approach is a way to look at what contributes
value in an organization.
– Focusing only on financials does not provide a way to fix problems from harming
those financials before it is too late.
• The definition of performance and its components is expanding.
– Identify the best appraisal format to improve quality of ratings.
– Identify groups of raters and examine if a given group provides more or less
accurate ratings.
– Identify how raters process information about job performance and translate it into
performance ratings.
– Raters can be trained to increase the accuracy of their ratings.
4
Strategy 1: Improve Appraisal Formats – Ranking
• Ranking formats require comparison of employees to determine the
relative ordering of the group on some performance measure.
• The straight ranking procedure is just that: employees are ranked
relative to each other.
• Alternation ranking recognizes that raters are better at ranking
people at extreme ends of distribution.
• The paired-comparison ranking method forces raters to make
ranking judgments about discrete pairs of people.
5
Strategy 1: Improve Appraisal Formats – Rating
Rating formats have two elements in common.
Rating formats require raters to evaluate employees on some absolute standard rather
than relative to other employees.
Each standard is measured on a scale whereby appraisers can check the point that
best represents an employee’s performance.
• Descriptors may be: adjectives, behaviors, or outcomes.
• When adjectives are used as anchors, the format is called a standard
rating scale.
• Behaviorally anchored rating scales (BARS) seem to be the most
common format using behaviors as descriptors.
• Outcomes also are used as a standard – the most common form is
management by objectives (MBO).
• In an essay format, supervisors answer open-ended questions, in
essay form, describing employee performance.
6
EXHIBIT 11.3 Rating Scale Using Absolute Standards
7
EXHIBIT 11.6 Example of MBO Objective for
Communications Skill
• Notice that emphasis is on outcomes achieved by employees.
1. Performance Objective
By July 1 of this year, Bill will complete
a report summarizing employee
reactions to the new performance
appraisal system. An oral presentation
will be prepared and delivered to all
nonexempt employees in groups of 1520. All oral presentations will be
completed by August 31, and reactions
of employees to this presentation will
average at least 3.0 on a 5-point scale.
2. Results
Written report completed by July 1. All
but one oral presentation completed by
August 31. Last report not completed
until September 15 because of
unavoidable conflicts in vacation
schedules. Average rating of
employees (reaction to oral
presentation) was 3.4, exceeding
minimum expectations.
8
Evaluating Performance Appraisal Formats
• A good performance appraisal
format scores well on five
dimensions.
• The choice of an appraisal format
is dependent on the types of
tasks being performed.
– Employee development
criterion.
– Administrative criterion.
– Personnel research criterion.
– Cost criterion.
– Validity criterion.
– When tasks are less routine, an
MBO strategy may be best.
– When tasks are highly uncertain
in nature, a standard rating
scales may be most appropriate.
9
Strategy 2: Select the Right Raters
• A second way to improve the accuracy of performance ratings is by
focusing on who conducts the ratings and which is more accurate.
✓ A method known as 360-degree feedback has grown popular.
✓ Some estimates indicate that more than 80% of the input for performance ratings
comes from supervisors.
✓ One of the major strengths of using peers as raters is that they work more closely
with the rate.
✓ Some organizations have experimented with self-ratings.
✓ The drive for quality means more companies are recognizing the importance of
customers.
✓ Historically, upward feedback was viewed as counterculture, but views are changing.
10
Strategy 3: Understand How Raters Process Information
•
•
Errors in the Rating Process.
Performance-irrelevant factors appear to influence ratings, and they can
cause errors in the evaluation process.
•
•
Common Errors in Appraising Performance: Criterion Contamination.
Criterion contamination, guilt, embarrassment, taking things for granted, not
noticing good/poor performance, the halo effect, dislike of confrontation, and too
little appraisal preparation.
•
•
Errors in Observation (Attention).
General appearance or change in performance may influence ratings.
•
•
Errors in Storage and Recall.
Raters tend to recall information in the form of trait categories and memory
decay may alter storage and recall process.
•
•
Errors in the Actual Evaluation.
The purpose of an evaluation affects the rating process.
11
Strategy 4: Training Raters to Rate More Accurately
• Rater training programs can be divided into three distinct categories.
• With rater-error training, the goal is to reduce errors (leniency,
severity, central tendency, halo), by familiarizing raters with them.
• Performance-dimension training exposes supervisors to the
performance dimensions to be used in rating.
• Performance-standard training provides raters with a standard of
comparison or frame of reference for making appraisals.
• Leniency errors are the most difficult form of error to eliminate.
• With everyone receiving relatively high ratings there is less distinction
between truly good and poor performers.
12
Strategy 5: Improving Rater Motivation and
Opportunity to Rate More Accurately
• A calibration session involves managers who meet to review draft
performance ratings and modify them as necessary to improve
consistency and accuracy/validity.
– Managers prepare preliminary performance appraisals, including
proposed appraisal ratings.
– Managers who supervise similar groups of employees meet and post
names and ratings for all to review.
– Participants review and discuss their proposed appraisal ratings for every
employee.
– Participants adjust ratings to assure accuracy and consistency.
– Final performance appraisals are prepared.
13
Putting It All Together:
The Performance Evaluation Process
– First, pay heed to the key elements in the total process that from day one
make for a good appraisal outcomes.
– Second, involve employees in every stage of developing performance
dimensions and building measuring scales.
– Third, raters should be trained and all employees should understand how the
system operates and what it will be used for.
– Fourth, raters should be motivated to rate accurately.
– Fifth, raters should maintain a diary of employee performance, both as
documentation and to jog memory.
– Sixth, conduct a performance diagnosis to determine if problems arise from
motivation, skill deficiency, or external environmental constraints.
– Finally, feedback to employees should be timely.
14
“New” Performance Appraisal
• New approaches are defined by three attributes: ratingless reviews,
ongoing feedback, and crowdsourced feedback.
– Emphasis is on providing ongoing, regular, constructive, detailed feedback “in
words” not as a number or rating.
– Crowdsourced feedback refers to the use of social media platforms to permit
peer feedback in a free-form manner.
– The “ratingless” term does not mean performance reviews have gone away –
there is actually more performance review.
15
A Checklist of Recommended Behaviors for Managers
and Employees
•
For managers.
–
–
–
–
–
Set clear expectations, priorities, success
criteria, and standards.
Revise expectations in real time, so
employees know what to do.
Provide informal feedback daily to praise,
coach, and course-correct employee
performance.
Check in regularly with employees to stay
in touch and provide guidance.
Coach employees and help them solve
problems to enable success.
•
For employees.
–
–
–
–
Clarify their performance expectations
to ensure they understand priorities
and standards; revisit expectations
when necessary.
Set expectations with peers about who
is doing what, and by when.
Ask for and accept feedback openly
and nondefensively.
Use feedback to course-correct and
continuously improve own
performance.
16
Equal Employment Opportunity and Performance
Evaluation
• Equal employment opportunity (EEO) and affirmative action have
influenced HR decision making for more than 40 years.
• The courts stress six issues.
– Specific written instructions on how to complete the
appraisal.
– The appraisal system should incorporate clear
criteria for evaluating performance.
– Adequately developed job descriptions.
– Required feedback about appraisal results.
– Review of ratings by a higher-level manager.
– Consistent treatment across raters.
• The focal question then becomes: Are similarly situated individuals
treated similarly?
• Documentation of performance only to discourage discrimination
claims causes poor employee relations.
17
Tying Pay to Subjectively Appraised Performance
(Merit Pay)
• The central issue involving merit pay is, “How do we get employees to
view raises as a reward for performance?”
• Companies who view raises as budget items have resulting pay
increase guidelines with little motivational impact.
• Pay increase guidelines with low-motivation potential provide equal
increases to all employees regardless of performance.
• General increases are typically found in unionized firms.
• Across-the-board increases are often linked to cost-of-living changes.
• Seniority increases tie pay increases to a preset progression pattern
based on seniority.
18
Competency: Customer Care
• Whether performance is measured on behaviors, competencies, or
traits, there must be agreement that higher levels of performance will
have positive impacts on corporate strategic objectives.
• Second, the company needs some continuum that describes different
levels from low to high on the performance measure.
• Third, the company needs to decide how much of a merit increase will
be given for different levels of performance.
• Decisions about these three requirements lead to some form of merit
pay guide.
19
EXHIBIT 11.12 Merit Increase Grid (or Matrix)
• A merit increase grid ties pay not only to performance but also to
position in the pay range.
Position in
Range
Performance
Rating of Not
Satisfactory
Performance
Rating of
Needs
Improvement
Performance
Rating of
Competent
Performance
Rating of
Commendable
Performance
Rating of
Superior
Fourth quartile
0%
0%
2%
3%
4%
Third quartile
0
0
3
4
5
Second
quartile
0
0
4
5
6
First quartile
0
1
5
6
7
Below
minimum of
range
0
2
6
7
8
20
Designing Merit Guidelines
• First, what should the poorest performer be paid as an increase?
• Most organizations give no increases to very poor performers.
• Second, how much should average performers be paid as an
increase?
• Most organizations try to ensure that average performers are kept
whole relative to cost of living.
• Third, how much should the top performers be paid?
• In part, budgetary considerations answer this question.
• Finally, matrixes can differ in the size of the differential between
different levels of performance.
• A larger jump between levels would signal a stronger commitment to
recognizing performance with higher pay increases.
21
Compensation
(Chapter 12: The Benefit Determination Process)
Jie (Jasmine) Feng, Ph.D.
Associate Professor in Human Resource Management
Rutgers | School of Management and Labor Relations
Overview
• Controlling labor costs is not possible without controlling benefits
costs.
– Employers seek to make benefit costs move in line with revenues and
profits – rather than a fixed cost.
• Benefits seem to influence whether employees come to work for a
company, whether they stay, when they retire – maybe how they
perform.
– However, different employees look for different types of benefits.
• Benefits can be used to differentiate an employer from competitors.
– They may also do it cheaper, giving them an edge on rivals.
• Though it makes sense to think of benefits as part of total
compensation, benefits are unique in some important aspects.
– Benefits are unique is their complexity.
• The pandemic helped us see that benefits and benefits flexibility are
critical in dealing with a crisis.
2
Why the Growth in Employee Benefits?
• Employee benefits are that part of the total compensation package,
other than pay for time worked, provided to employees in whole or in
part by employer payments (for example, life insurance, pension,
workers’ compensation, vacation).
✓ The cost of employer benefits has risen over time.
✓ Pension costs are a major challenge with many underfunded plans.
3
EXHIBIT 12.1 Total Hourly Compensation and Benefits Costs, U.S.
Private Industry Workers, by Establishment Size
• Employee benefits can no longer realistically be called “fringe
benefits.”
Establishment
Size for All
Establishment
Size for 1-99
Employees
Establishment
Size for 500 Or
More Employees
Total Compensation
$36.23
$29.99
$53.83
Wages and Salaries
$25.48
$22.21
$34.94
Benefits
$10.74
$7.78
$18.88
Benefits/Total
Compensation
30%
26%
35%
Benefits/Wages and
Salaries
42%
35%
54%
•
Source: Bureau of Labor Statistics, U.S. Department of Labor. Employer Costs for Employee Compensation—December 2020. USDL-20-0437. March 18, 2021. www.bls.gov.
4
Exhibit 12.2 Benefits as a Percentage of Wages/Salaries and Total
Compensation
• Benefits costs have grown over time and now represent 31.7 percent
of total compensation.
•
Source: Data through 1990, U.S. Chamber of Commerce Research Center, Employee Benefits 1990, Employee Benefits 1997, Employee Benefits 2000, Washington, DC: U.S. Chamber of
Commerce, 1991, 1997, and 2000. Data from 1995 onward: Bureau of Labor Statistics, U.S. Department of Labor. “Employer Costs for Employee Compensation.”
5
Why the Growth in Employee Benefits? Wage and Price Controls
and Unions
• During both World War II and the
Korean War, the federal
government instituted strict wage
and price controls.
• Both unions and employers
sought new benefits to satisfy
worker demands.
• This was the catalyst for
pensions, health care coverage,
time off and more.
• This was a perfect opportunity
for unions to exercise these
rights acquired under the
Wagner Act of 1935.
– Largely through the efforts of
unions, several common
benefits arose.
– Pension plans.
– Supplementary
unemployment.
– Extended vacation days.
– Guaranteed annual wages.
6
Why the Growth in Employee Benefits? Employer
Impetus
• Many benefits in existence today were provided at employer initiative.
– This can be traced to pragmatic concerns about employee
satisfaction and productivity.
– Rest breaks often were implemented in the belief that fatigue
increased accidents and lowered productivity.
– Savings and profit-sharing plans were implemented to improve
performance and provide increased security for worker retirement.
– Benefits were designed to create a climate in which employees
thought of management as genuinely concerned for their welfare.
– Benefits slowly became a costly entitlement of the U.S. work force.
7
Why the Growth in Employee Benefits?
Cost (Including Tax) Effectiveness of Benefits
• Another impetus for the growth of employee benefits is their cost
effectiveness in two situations.
• The first cost advantage is that most employee benefits are not
taxable.
– An extra dollar paid in cash is not an extra dollar received in the paycheck.
• A second cost advantage is that group-based benefits can often be
obtained at a lower rate than could be obtained by individual
employees.
– Group insurance also has relatively easy qualification standards.
– Giving security to a set of employees who might not otherwise qualify.
8
EXHIBIT 12.3 Example of Marginal Tax Rates for an
Employee Salary of $80,000
(Marginal) Tax Rate
•
Federal
25.00%
State (New York)
6.09%
City (New York)
3.82%
Social Security
6.20%
Medicare
1.45%
Total tax rate
43%
Note: Local taxes (state, city, and property taxes) up of to $10,000 total are deductible on the federal return, if
itemizing deductions. In this case, the effective marginal tax rate would be 40% (rather than 43%).
9
Why the Growth in Employee Benefits? Government
Impetus
• Three employee benefits are mandated by either the state or federal
government.
• Workers’ compensation (state).
• Unemployment insurance (federal).
• Social security (federal).
• In addition, most other employee benefits are affected by such laws as
the Employee Retirement Income Security Act (ERISA).
• Which affects pension administration, and various sections of the
Internal Revenue Code.
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The Value of Employee Benefits
• Medical benefits continue to be ranked tops in importance for most
employee groups.
• A firm with 10,000 employees spends roughly $119 million on health
insurance alone.
• A major concern is evidence that employees frequently undervalue the
benefits provided by their organization, or are even unaware of them.
• One possible way to improve employer return on investment in
benefits is to provide employees with greater choice in the benefits
they receive.
– The perceived value of benefits rises when employers introduce choice
through a flexible benefit package.
– Some experts speculate that a key element in reward attractiveness (and
benefits) may be their visibility.
– Not only do employers have to plan and design an effective benefit
program, they also need to communicate their value to employees.
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Benefits Planning and Design Issues
• Employers need to decide the role of benefits in their overall
compensation package.
– The planning process also should include strategies for ensuring external
competitiveness and adequacy of benefits.
• Ensuring that benefits are adequate is a somewhat more difficult task.
– There is no magic formula for defining benefit adequacy.
• The answer may lie in the relationship between benefit adequacy and
the third plan objective: cost of effectiveness.
– Organizations need to consider whether employee benefits are cost
justified.
– Employers are shifting increased benefit costs to employees through
higher deductibles and co-pays, for example.
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Benefit Administration Issues
• Who should be protected or benefited?
– A whole set of questions need to be answered with policy decisions.
• How much choice should employees have among an array of
benefits?
– The level will depend on advantages and disadvantages.
– Another way to increase awareness is to offer market-based, or
customer-driven health care.
• How should benefits be financed?
– Noncontributory, contributory, or employee financed.
• Are the benefits legally defensible?
– Benefit administrators should develop a compliance checklist and conduct
regular audits of benefits.
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EXHIBIT 12.6 Advantages and Disadvantages of
Flexible Benefit Programs
• Advantages
1. Employees choose packages that best satisfy their unique needs.
2. Flexible benefits help firms meet the changing needs of a changing workforce.
3. Increased involvement of employees and families improves understanding of benefits.
4. Flexible plans make introduction of new benefits less costly. Any new option is added
merely as one among a wide variety of elements from which to choose.
5. Cost containment: Organization sets dollar maximum; employee chooses within that
constraint.
• Disadvantages
1. Employees make bad choices and find themselves not covered for predictable
emergencies.
2. Administrative burdens and expenses increase.
3. Adverse selection: Employees pick only benefits they will use; the subsequent highbenefit utilization increases its cost.
4. Flexible benefit plans are subject to nondiscrimination requirements in Section 125 of
the Internal Revenue Code.
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Components of a Benefit Plan
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Comp
