Fluent Essays

Use the first chapter of the Milkovich book as a source of information for addressing these questions. Be sure, however, to add your own thoughts and ideas as well. This first assignment is due on or before SUNDAY at 11:59 pm EST. Please attempt to keep your answers to a paragraph or two. Explain with examples the “total returns” people receive from work.Compensation for many people is an inherently personal and emotional issue. Express your opinion and give an example of how “taking compensation personally,” can play-out on the job. Explain the key elements of The Pay Model and how it can be used to develop an organization’s pay strategy.Can pay systems be effectively tailored to support differing business strategies? Explain your answer and give an example. chapter_1.docx evaluation_rubric_for_weekly_unit_assignments.docx Unformatted Attachment Preview COMPENSATION: DOES IT MATTER? (OR, “SO WHAT?”) Why should you care about compensation? Do you find that life goes more smoothly when there is at least as much money coming in as going out? (Refer, for example, to the lyrics for the Beatles’ song “Money.”)1 They say something like: it’s true money doesn’t buy everything, but if money can’t buy it, I can’t use it. OK, maybe something of an exaggeration, but.… Yes? Well, of course, it is the same for companies. It really does help to have as much money coming in (actually, more is better) as going out. Until recently, workers at Chrysler got total compensation (i.e., wages plus benefits) of about $76 per hour, whereas U.S. workers at Toyota received $48 per hour and the average total compensation per hour in U.S. manufacturing was $25 (and $16 in Korea, $3 in Mexico). It is one thing to pay more than your competitors if you get something more (e.g., higher productivity and/or quality) in return. But, Chrysler was not. So, the “strategy” was not sustainable. It ended up going through bankruptcy, being bought out by Fiat, and then reducing worker compensation costs as part of its strategy for return to competitiveness. Specifically, Chrysler took steps (as part of its bankruptcy plan) to bring its hourly labor costs down to about $49 more recently.2 General Motors (GM), like Chrysler, has, for decades, paid its workers well—too well perhaps for what it received in return. So what? Well, in 1970, GM had 150 U.S. plants and 395,000 hourly workers. In sharp contrast, GM now has 40 U.S. manufacturing plants and 51,000 U.S. hourly workers.3 In June 2009, GM, like Chrysler, had to file for bankruptcy (avoiding it for a while thanks to loans from the U.S. government—i.e., you, the taxpayer). Not all of GM’s problems were compensation related. Of course, building too many vehicles that consumers did not want was also a problem. But, having labor costs higher than the competition, without corresponding advantages in efficiency, quality, and customer service, does not seem to have served GM or its stakeholders well. Its stock price peaked at $93.62/share in April 2000. Its market value was about $60 billion in 2000. That shareholder wealth was wiped out in bankruptcy. Think of the billions of dollars the U.S. taxpayer had to put into GM. Think of all the jobs that have been lost over the years and the effects on communities that have lost those jobs. On the other hand, Nucor Steel pays its workers very well relative to what other companies inside and outside of the steel industry pay. But Nucor also has much higher productivity than is typical in the steel industry. The result: Both the company and its workers do well. Apple Computer is able to keep prices for its iPad and iPhone lower than otherwise by outsourcing manufacturing to China in facilities owned by the Hon Hai Precision Industry Co., Ltd (Foxconn), a Taiwanese company. (See Chapter 7.) As we will see later, doing so generates billions (yes, billions with a “b”) of dollars in cost savings per year. Google and Facebook are companies that are known for paying very well. So far, that seems to have worked in that their high pay allows them to be very selective in who they hire and who they keep and they would say that their talent rich strategy has helped them to foster growth and innovation. Wall Street financial services firms and banks used incentive plans that rewarded people for developing “innovative” new financial investment vehicles and for taking risks to earn themselves and their firms a lot of money.4 That is what happened—until several years ago. Then, the markets discovered that many such risks had gone bad. Blue Chip firms such as Lehman Brothers slid quickly into bankruptcy, whereas others like Bear Stearns and Merrill Lynch survived to varying degrees by finding other firms (J.P. Morgan and Bank of America, respectively) to buy them. The issue has not gone away. Recently, U.S. Federal Reserve officials have “made it clear that they believe bad behavior at banks goes deeper than a few bad apples and are advising firms to track warning signs of excessive risk taking and other cultural breakdowns.” In the words of one Fed official, “Risk takers are drawn to finance like they are to Formula One racing.” An important driver of risk taking among traders and others is the incentive system that encourages them to be “confident and aggressive” and that often results in those who thrive under this incentive rising to top leadership positions at the banks.5 Does greater expertise in the design and execution of compensation plans play a role in controlling excessive risk taking and other problematic behaviors and encouraging a more positive culture? Congress and the president seemed to think so, because in hopes of avoiding a similar financial crisis in the future they put into place legislation, the Troubled Asset Relief Program (TARP), which included restrictions on executive pay designed to discourage executives from taking “unnecessary and excessive risks.” Another commentator agreed. In an opinion piece in The Wall Street Journal, entitled “How Business Schools Have Failed Business,” the former director of corporate finance policy at the United States Treasury argued that misaligned incentives were a major cause of the global financial crisis (see above) and he wondered how many of the business schools that educated top executives and directors included a course on how to design compensation systems. His answer: not many. Our book, we hope, can play a role in helping to better educate you, the reader, about the design of compensation systems, both for managers and for workers. How people are paid affects their behaviors at work, which affect an organization’s success.7 For most employers, compensation is a major part of total cost, and often it is the single largest part of operating cost. These two facts together mean that well-designed compensation systems can help an organization achieve and sustain competitive advantage. On the other hand, as we have recently seen, poorly designed compensation systems can likewise play a major role in undermining organization success. COMPENSATION: DEFINITION, PLEASE How people view compensation affects how they behave. It does not mean the same thing to everyone. Your view probably differs, depending on whether you look at compensation from the perspective of a member of society, a stockholder, a manager, or an employee. Thus, we begin by recognizing different perspectives. Society Some people see pay as a measure of justice. For example, a comparison of earnings between men and women highlights what many consider inequities in pay decisions. In 2013, among full-time workers in the United States, U.S. Bureau of Labor Statistics data indicate that women earned 82 percent of what men earned, up from 62 percent in 1979.8 If women had the same education, experience, and union coverage as men and also worked in the same industries and occupations, the ratio would increase, but most evidence suggests that no more than one-half of the gap would disappear. Thus, under even a best case scenario, such adjustments would increase the women/men earnings ratio to as high as about 90 percent, still leaving a sizable gap.9 Society has taken an interest in such earnings differentials. One indicator of this interest is the introduction of laws and regulation aimed at eliminating the role of discrimination in causing them.10 (See Chapter 17.) Benefits given as part of a total compensation package may also be seen as a reflection of equity or justice in society. Employers spend about 44 cents for benefits on top of every dollar paid for wages and salaries.11 Individuals and businesses in the United States spend $2.9 trillion per year, or 17.4 percent of its economic output (gross domestic product) on health care.12 Nevertheless, roughly 41 million people in the United States (14 percent of the population) have no health insurance.13 (The Affordable Care Act of 2010 is aimed at increasing coverage and one projection is the number of uninsured will decrease to 23 million by 2023.)14 A major reason is that the great majority of people (who are under the age of 65 and not below the poverty line) obtain health insurance through their employers, but small employers, which account for a substantial share of employment, are much less likely than larger employers to offer health insurance to their employees. As a result, 8 in 10 of the uninsured in the United States are from working families.15 Given that those who do have insurance typically have it through an employer, it also follows then that as the unemployment rate increases, health care coverage declines further. Some users of online dating services provide information on their employer-provided health care insurance. Dating service “shoppers” say they view health insurance coverage as a sign of how well a prospect is doing in a career. Job losses (or gains) in a country over time are partly a function of relative labor costs (and productivity) across countries. People in the United States worry about losing manufacturing jobs to Mexico, China, and other nations. (Increasingly, white collar work in areas like finance, computer programming, and legal services is also being sent overseas.) Exhibit 1.1 reveals that the hourly compensation (wages plus benefits) for Mexican manufacturing work ($6.82) are about 19 percent of those paid in the United States ($36.34). China’s estimated $3.38 per hour is about 9 percent of the U.S. rate. However, the value of what is produced also needs to be considered. Productivity in China is about 22 percent of that of U.S. workers, whereas Mexican worker productivity is 30 percent of the U.S. level.16 Finally, if low wages are the goal, there always seems to be somewhere that is lower. Some companies (e.g., Coach) are now moving work from China because its hourly wage, especially after recent increases, is not as low as in countries like Vietnam, India, and the Philippines. However, for other companies such as Foxconn, which builds iPhones and iPads for Apple, even with rapid increases in wages in China, labor costs remain very low in China compared to those in the United States and other advanced economies and Foxconn appears to be poised to continue having a larger presence in China.17 (We return to the topic of international comparisons in Chapter 7 and Chapter 16.) Some consumers know that pay increases often lead to price increases. They do not believe that higher labor costs benefit them. But other consumers lobby for higher wages. While partying revelers were collecting plastic beads at New Orleans’ Mardi Gras, filmmakers were showing video clips of the Chinese factory that makes the beads. In the video, the plant manager describes the punishment (5 percent reduction in already low pay) that he metes out to the young workers for workplace infractions. After viewing the video, one reveler complained, “It kinda takes the fun out of it.”18 Stockholders Stockholders are also interested in how employees are paid. Some believe that using stock to pay employees creates a sense of ownership that will improve performance, which will, in turn, increase stockholder wealth. But others argue that granting employees too much ownership dilutes stockholder wealth. Google’s stock plan cost the company $600 million in its first year of operation. So people who buy Google stock are betting that this $600 million will motivate employees to generate more than $600 million in extra revenue. Stockholders have a particular interest in executive pay.19 (Executive pay will be discussed further in Chapter 14.)20 To the degree that the interests of executives are aligned with those of shareholders (e.g., by paying executives on the basis of company performance measures such as shareholder return), the hope is that company performance will be higher. There is debate, however, about whether executive pay and company performance are strongly linked in the typical U.S. company.21 In the absence of such a linkage, concerns arise that executives can somehow use their influence to obtain high pay without necessarily performing well. Exhibit 1.2 provides descriptive data on chief executive officer (CEO) compensation. Note the large numbers (total annual compensation of about $10 million to $11 million, depending on whether one uses the median or mean) and also that the bulk of compensation (stock-related) is connected to shareholder return or other performance measures (bonus). As such, one would expect changes in CEO wealth and shareholder wealth to be, generally speaking, aligned. To be sure, there are overpaid executives who earn a lot and produce little in return for shareholders (or other stakeholders such as employees). However, the assessment of whether an executive is being paid appropriately for performance is not as simple as it may seem: As the example indicates, the answer to how strongly CEO pay and shareholder return are related depends to some degree on how carefully the timing and measurement of performance are addressed. One study, which sought to address this issue found a strong relationship (ΔR2 = .35, ΔR = .59) over time between total shareholder return and a new, corresponding concept, CEO return (i.e., change in CEO wealth). Exhibit 1.3 shows how CEO wealth changes in response to changes in shareholder wealth. Although CEO and shareholder interests appear to be significantly aligned on average, there are important exceptions and it is certainly an ongoing challenge to ensure that executives act in the best interest of shareholders. For example, during the meltdown in the financial services industry, top executives at Bear Stearns and Lehman Brothers regularly exercised stock options and sold stock during the 2000 to 2008 period prior to the meltdown. One estimate is that these stock-related gains plus bonus payments generated $1.4 billion for the top five executives at Bear Stearns and $1 billion for those at Lehman Brothers during the 2000–2008 period. “Thus, while the long-term shareholders in their firms were largely decimated, the executives’ performance-based compensation kept them in positive territory.” The problem here is that shareholders paid a huge penalty for what appears to have been overly aggressive risk-taking by executives, but the executives, in contrast, did quite well because of “their ability to claim large amounts of compensation based on short-term results.”23 Shareholders can influence executive compensation decisions in a variety of ways (e.g., through shareholder proposals and election of directors in proxy votes). In addition, the Dodd–Frank Wall Street Reform and Consumer Protection Act was signed into law in 2010. Among its provisions is “say on pay,” which requires public companies to submit their executive compensation plan to a vote by shareholders. The vote is not binding. However, companies seem to be intent on designing compensation plans that do not result in negative votes. In addition, clawback provisions (designed to allow companies to reclaim compensation from executives in some situations) are available under Dodd-Frank and have also been adopted in stronger form by some companies.24 Employees The pay individuals receive in return for the work they perform and the value they create is usually the major source of their financial security. Hence, pay plays a vital role in a person’s economic and social well-being. Employees may see compensation as a return in an exchange between their employer and themselves, as an entitlement for being an employee of the company, as an incentive to decide to take/stay in a job and invest in performing well in that job, or as a reward for having done so. Compensation can be all of these things.29 The importance of pay is apparent in many ways. Wages and benefits are a major focus of labor unions efforts to serve their members’ interests. (See Chapter 14.) The extensive legal framework governing pay, including minimum wage, living wage, overtime, and nondiscrimination regulations, also points to the central importance of pay to employees in the employment relationship. (See Chapter 17.) Next, we turn to how pay influences employee behaviors. Incentive and Sorting Effects of Pay on Employee Behaviors Pay can influence employee motivation and behavior in two ways. First, and perhaps most obvious, pay can affect the motivational intensity, direction, and persistence of current employees. Motivation, together with employee ability and work/organizational design (which can help or hinder employee performance), determines employee behaviors such as performance. We will refer to this effect of pay as an incentive effect, the degree to which pay influences individual and aggregate motivation among the employees we have at any point in time. However, pay can also have an indirect, but important, influence via a sorting effect on the composition of the workforce.30 That is, different types of pay strategies may cause different types of people to apply to and stay with (i.e., self-select into) an organization. In the case of pay structure/level, it may be that higher pay levels help organizations to attract more high-quality applicants, allowing them to be more selective in their hiring. Similarly, higher pay levels may improve employee retention. (In Chapter 7, we will talk about when paying more is most likely to be worth the higher costs.) Less obvious perhaps, it is not only how much, but how an organization pays that can result in sorting effects.31 Ask yourself: Would people who are highly capable and have a strong work ethic and interest in earning a lot of money prefer to work in an organization that pays employees doing the same job more or less the same amount, regardless of their performance? Or, would they prefer to work in an organization where their pay can be much higher (or lower) depending on how they perform? If you chose the latter answer, then you believe that sorting effects matter. People differ regarding which type of pay arrangement they prefer. The question for organizations is simply this: Are you using the pay policy that will attract and retain the types of employees you want? Keep in mind that high performers have more alternative job opportunities and that more opportunities, all else equal (e.g., if they are not paid more for their higher performance), translate into higher turnover, a likely significant problem to the degree it is the high performers leaving, especially to the degree that high performers in particular roles create a disproportionately high amount of value for organizations.32 This also raises the issue of dealing with outside offers that employees receive. We know that a substantial share of employee turnover results from receiving unsolicited outside offers. (In other words, turnover is not always in response to dissatisfaction. Sometimes, it is driven by opportunity.) These are likely to be some of the most valuable employees and thus policy and practice on dealing with outside offers (hopefully informed by research) is important.33 Let’s take a look at one especially informative study conducted by Edward Lazear regarding incentive and sorting effects.34 Individual worker productivity was measured before and after a glass installation company switched one of its plants from a salary-only (no pay for performance) system to an individual incentive plan under which each employee’s pay depended on his/her own performance. An overall increase in plant productivity of 44 percent was observed comparing before and after. Roughly one-half of this increase was due to individual employees becoming more productive. However, the remaining one-half of the productivity gain was not explained by this fact. So ... Purchase answer to see full attachment