Compensation Philosophy Paper
Name
________
Professor ______

Introduction Compensation is viewed differently, depending on the individual persons perspective (e.g. employee, manager, stockholders, etc.). An employee may view compensation as what is owed to him or her for work performed, while a manager may view pay as an expense. In order for an organization to have an effective compensation strategy, it must consider the various perspectives when creating the organizations compensation strategy. Milkovich, Newman, and Gerhart, authors of Compensation, define Compensation as, “All forms of financial returns and tangible services and benefits employees receive as part of an employment relationship,” (2011, p. 10). In other words, salary is not the only consideration when determining compensation. The cost of such benefits as: employee healthcare, dental, life insurance, retirement plans, etc., must be considered when creating a compensation system. There are many factors an organization must consider when developing a compensation strategy; however, for a compensation strategy to be effective it must; align with organizational goals, reward employee performance, and consider fairness in pay.
Analysis
When developing a compensation strategy, an organization needs to ensure that its compensation strategy aligns with organizational goals. For instance, if an organizational goal is to increase sales of a particular product in the upcoming year (as compared to the previous year) its compensation strategy should be structured to drive its employees towards that goal. One type of cash compensation that would focus employee efforts towards organizational goals would be cash compensation incentives (also known as variable pay). Incentive based compensation strategies influence future performance, aligning employee goals with organizational goals. Many organizations within the financial and auto industries utilize incentive based compensation strategies in order to achieve organizational goals. Incentives for reaching set goals would normally be in the form of cash bonuses, stock ownership, or stock ownership at a decreased price. Another type of compensation used to increase employee performance towards organizational goals would be merit pay. While incentives are used to influence future performance, merit pay recognizes employee past performance. According to Milkovich et al., “Outstanding performers could receive a 6 to 8 percent merit increase 8 months after their last increase, whereas an average performer may receive, say, a 3 to 4 percent increase after 12 to 15 months,” (2011, p. 12). In 2009, the Contemporary Accounting Research Journal published an article outlining a study analyzing employee performance under performance based compensation systems as compared to non-performance based. Researchers, Joanna L.Y. Ho (University of California, Ivrine), Ling-Chu Lee (National Pingtun Institute of Commerce), and Anne Wu (National Chengchi University), analyzed data collected over a six-year period, from the largest car dealership in Taiwan. According to the study, “Our findings suggest that while lower commission rates reduce the incentive for employees to work hard after meeting the minimum requirement, the hurdle rate motivates some employees to exert more effort to avoid losing their jobs,” (Ho, Lee, & Wu, 2009, p. 192). The study also showed that a compensation strategy that was less performance based attracted lower performing employees and less higher-performing employees. As suggested by Ho, Lee, and Wu’s study, cash incentives and merit pay have a significant impact on employee performance and an impact on the organization’s bottom line. Comparing Costco’s success to Sam’s Club (owned and operated by Wal-Mart) is a great way to see the impact of organizations compensation strategy. According to a 2006 article in the Harvard Business Review, Sam’s Club pays its average employee $10 an hour, as compared to Costco’s $17 an hour. Along with its higher average pay, Costco offers better benefits overall, as far as: retirement plans, medical insurance, and dental insurance. “As a result, Costco generated $21,805 in the U.S. operating profit per hourly employee, compared with $11,615 at Sam’s Club,” (Cascio, 2006). Fairness can have a direct relationship to internal alignment and external competiveness. Internal alignment refers to pay within an organization: * How pay is determined and pay differentials are determined for individuals performing the same job within the organization.
And
* How pay differentials are determined for individuals performing dissimilar jobs within the organization (i.e. an analyst as compared to a computer programmer). External competiveness refers to individual pay within an organization as compared to individuals pay, performing similar work at a competing organization. Just as what is considered compensation varies by an individual’s perspective, so does fairness in compensation. According to Milkovich:
One group argues that if fair (i.e., sizable) differentials among jobs are not paid, individuals may harbor ill will toward the employer, resist change, change employment if possible, become depressed, and ‘lack that zest and enthusiasm which makes for high efficiency and personal satisfaction in work,’ (2011, p. 87).
On the other side of that argument, Unions would argue that differentials in pay should be smaller, with individuals receiving equal pay for equal work. Individuals or groups that argue for smaller pay differentials believe it supports cooperation and commitment from employees, while at the same time improves performance. This argument was supported by a study conducted on compensation policies within the hotel industry in China. According to the article, titled: The Motivational Effects of Pay Fairness: A Longitudinal Study in Chinese Star-Level Hotels, there was a direct correlation between employee perception of fairness in pay and employee performance. Researchers, Wu, Sturman, and Wang state, “When the employees think they are paid fairly, they will make efforts to do a good job,” (Wu et al., 2013, p. 194). Results of the study showed that work performance increased an average of twenty percent with increased perception of fairness in pay. Wal-Mart is a great example of an organization that has a poor reputation for employee compensation. According to a Business Week article titled, Stop the Bullying: Wal-Mart, “Wal-Mart employees earn 20% less than an average U.S. retail worker, and some $10,000 less than what the average two-person family requires to meet its basic needs, “(The Debate Room, n.d.). Having a reputation for low compensation, as compared to other organizations within the same industry, could lead to low retention rates and an inability to attract quality employees.
Conclusion
There are many factors an organization must consider when developing a compensation strategy. Directing employee efforts by building a compensation strategy that leads to organizational goal obtainment is essential in a compensation system. The most effective pay systems are tied to performance and performance can be influenced through cash incentives and merit based pay. Performance can also be influenced through a pay system that is considered fair through both, internal alignment and external competitiveness. For a compensation strategy to be effective it must; align with organizational goals, reward employee performance, and consider fairness in pay.

References:
Cascio, W. F. (2006, December). The high cost of low wages. Harvard Business Review. Retrieved June 29, 2013, from http://hbr.org/2006/12/the-high-cost-of-low-wages/ar/1
Ho, J. L., Lee, L., & Wu, A. (2009). How Changes in Compensation Plans Affect Employee Performance, Recruitment, and Retention: An Empirical Study of a Car Dealership. Contemporary Accounting Research, 26(1), (spring 2009), 167-199. doi: 10.1506/car.26.1.6
Milkovich, G. T., Newman, J. M., & Gerhart, B. A. (2011). Compensation (10th ed.). New York, NY: McGraw-Hill Irwin.
The Debate Room. (n.d.). Stop the Bullying, Wal-Mart: The retailer needs a new business model. It should stop squeezing employees and suppliers, and charge customers a little more. Pro or con? Bloomsburg Business Week. Retrieved June 29, 2013, from http://www.businessweek.com/debateroom/archives/2007/04/stop_the_bullying_wal-mart.html
Wu, X., Sturman, M. C., & Wang, C. (2013). The Motivational Effects of Pay Fairness: A Longitudinal Study in Chinese Star-Level Hotels. Cornell Hospitality Quarterly, 54(2), 185-198. doi: 10.1177/1938965512471891