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CHAPTER 1: ROADMAP TO EFFECTIVE COMPENSATION

1. Profit-Sharing

What it is: A way for a company to share its profits with employees.

Example:

●​ Imagine you work for a company, and at the end of the year, they make a profit of $1
million.​

●​ The company decides to share 10% of that profit with employees through a profit-sharing
plan.​

●​ If there are 100 employees, each employee might get $1,000 as a bonus (10% of $1
million divided by 100 employees).​

Why it’s good: If the company does well, you get a share of the profits. This motivates
employees to work harder since they benefit when the company does well.

2. Employee Share Purchase Plan (ESPP)

What it is: A program that lets employees buy the company’s stock at a discounted price.

Example:

●​ Let’s say you work for a tech company. The current price of the company’s stock is $100
per share.​

●​ Your company offers an ESPP that allows employees to buy the stock for only $85 per
share (a 15% discount).​

●​ You decide to buy 10 shares for $85 each, instead of paying $100 each in the open
market.​

●​ Later, if the stock price goes up to $120 per share, you could sell your shares and make
a profit of $35 per share.

Why it’s good: You can buy the company’s stock at a discount, and if the stock price goes up,
you can make money by selling it later. It also makes you feel more connected to the company
since you own a part of it.

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3. Gain Sharing Programs

Gain-sharing programs typically set up a baseline level of performance, and when employees
help the company exceed this baseline, they receive a share of the "gains" (the improvements
or savings). The gains could come from reduced costs, faster work processes, or higher
productivity.

Example:

Imagine a factory that makes furniture. The company sets a target to reduce production costs by
$100,000 in a year through better efficiency.

●​ If the employees work together and find ways to reduce costs—such as optimizing their
production methods, using fewer materials, or speeding up the process—and they save
$120,000 instead of just $100,000, the extra $20,000 is considered the "gain."​

●​ The company would then share a portion of that $20,000 gain with the employees, as a
reward for their efforts.​

Why it’s good:

●​ Incentivizes Teamwork: Employees work together to improve processes.​

●​ Focuses on Efficiency: Unlike profit-sharing, which depends on overall profits,

gain-sharing focuses specifically on improving efficiency or cutting costs, making it a
direct and measurable way to reward employees.​

●​ Motivates Employees to Innovate: Employees are encouraged to find new and better
ways to do things that benefit the company.

Your Compensation System: Asset or Liability?

Canadian firms typically spend 40 - 70 percent of their operating budgets to compensate their
employees. For many firms, compensation is the single largest operating expenditure.
According to Statistics Canada, employers in Canada are now spending nearly a trillion dollars
on wages, salaries, and benefits. A compensation system that has worked well in the past can
become a serious liability when circumstances change.

At its most basic, the purpose of a compensation system is to help create a willingness among
qualified persons to join the organization and to perform the tasks the organization needs. What
this generally means is that employees must perceive that accepting a job with a given
employer will help them satisfy some of their own important needs. These include economic

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needs for the basic necessities of life but may also include needs for security, social interaction,
status, achievement, recognition, and growth and development

Extrinsic vs. Intrinsic Rewards

Abraham Maslow contended that humans have a hierarchy of 5 needs, and that each level of
need is satisfied through different behaviours:

1.​ Physiological needs- need for food and shelter

2.​ Safety and security - protection from physical and emotional harm
3.​ Social needs - affection, belongingness, respect
4.​ Self- esteem - status and recognition
5.​ Self- actualization - growth and self- fulfillment

The theory posits that humans tend to first satisfy their basic needs (such as physiological and
safety) before the higher order needs such as self- actualization. Each level in the hierarchy
must be fairly well satisfied before the next level motivates human behaviour; that is, once a
lower order need is satisfied, then the next level takes precedence and dominates human
behaviour.

Rewards are linked to this theory. Anything provided by the organization that satisfies one or
more of an employee’s needs can be considered a reward

Extrinsic rewards: satisfy basic needs for survival and security, as well as social needs and
needs for recognition. They derive from factors surrounding the job such as pay, supervisory
behaviour, coworkers, and general working conditions.

Intrinsic rewards: satisfy higher level needs for self- esteem, achievement, growth, and
development. They derive from factors inherent in the work itself - the job content - such as the
amount of challenge or interest the job provides, the degree of variety in the job, and the extent
to which it provides feedback and allows autonomy, as well as the meaning or significance of
the work.

Rewards vs Incentives
Although the terms “rewards” and “incentives” are often used interchangeably in common
parlance, it is important to understand that they are not in fact synonymous.

Rewards are the positive consequences of performing behaviours desired by the organization,
and employees normally receive these rewards either subsequent to performing the behaviour
(in the case of extrinsic rewards) or during performance of the behaviour (in the case of intrinsic
rewards).

Incentive is a promise that a specified reward will be provided if the employee performs a
specified behaviour. Incentives are offered to induce employees to perform behaviours that
they might not otherwise perform, or to perform these behaviours at a higher level than they

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otherwise would. Incentives are intended to induce valued behaviour, while rewards serve to
recognize valued behaviour.

However, at a given organization, the two concepts can merge over time; this is because
rewards, when used consistently to recognize a desired behaviour, often come to be seen as an
implied promise for performing that behaviour in the future, in other words, as an incentive.

Reward vs. Compensation Strategy

Both extrinsic and intrinsic rewards are important to people and, if utilized effectively, each can
produce important benefits for the organization. The mix of these rewards provided by an
organization is termed its reward system. The compensation system deals only with the
economic or monetary part of the reward system. But since behaviour is affected by the total
spectrum of rewards provided by the organization and not just by compensation, the
compensation system can never be regarded in isolation from the overall reward system. This
practice of looking at the total spectrum of rewards which include career advancement
opportunities, the intrinsic characteristics of the job, work/life balance, employee recognition
programs, and a positive workplace culture, as well as compensation is known as the total
rewards approach to compensation. This approach is becoming increasingly common in
Canada

Under the total rewards approach, before a company starts developing its compensation
system, it needs to establish a reward strategy. The reward strategy is the plan for the mix of
rewards, both extrinsic and intrinsic, that the organization intends to provide to its members
along with the means through which they will be provided in order to elicit the behaviours
necessary for the organization’s success. The reward strategy is the blueprint for creating the
reward system.

The compensation strategy is one part of the reward strategy the plan for creating the
compensation system. The compensation system has three main components:
(1) base pay: foundation pay component for most employees and is generally based on some
unit of time an hour, a week, a month, or a year.
(2) performance pay: relates employee monetary rewards to some measure of individual, group,
or organizational performance.
(3) indirect pay: employee benefits,” consists of noncash items or services that satisfy a variety
of specific employee needs, such as health protection (e.g., extended medical and dental plans)
or retirement security (e.g., pension plans).

There are two key aspects of a compensation strategy.

One aspect is the mix across the three compensation components, and whether and how this
mix will vary for different employee groups. The other is the total amount of compensation to be
provided to individuals and groups. In short, “ How
should compensation be paid?” and “How much compensation should be paid?” are the two key
questions for compensation strategy.

The first step in formulating a compensation strategy is to determine the role that

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compensation will play in the reward system. Assuming that organizations wish to minimize
compensation costs whenever possible, we must first identify what other rewards are being
provided by the organization and determine whether these alone are sufficient to elicit the
necessary behaviour from organization members. For example, some voluntary organizations
receive thousands of hours of labour from their members for no pay whatsoever; intrinsic
rewards alone are sufficient to motivate the needed behaviour.

Unpaid Interns

The use of unpaid interns has led to much debate in Canada and was, in fact, a contested issue
in the last national elections. It was seen a hot issue for youths.

While some regard unpaid internships as a good opportunity for training and “on
The job” experience, others view it as exploitation. As stipulated by labour and employment
standards legislation across Canada, unpaid internships are legally allowed only under certain
conditions: the placement must be educational (done for credits through a formal program); it
must be of benefit to the intern; the internship must not replace a paid position; and the intern
must not be promised the job at the end of the placement.

There are, however, many organizations, some well known, where interns work for no pay but
these conditions are not met. This has led to a crackdown on employers in Canada. One
investigation by the government revealed that of 123 workplaces that used interns in Ontario,
one quarter did not meet the requirements under the employment standards legislation. As a
result of the investigation, many interns received pay owning to them.

For example, if a firm is experiencing high employee turnover because employees find their jobs
mind numbingly dull, one solution might be to increase pay to make employees more reluctant
to quit. Another approach might be to try to enrich the jobs to make them more interesting,
thereby increasing intrinsic rewards. Of course, it may even be possible to dispense with these
jobs by automating them, which eliminates the reward issue entirely.

The best choice depends on the relative costs and benefits of each approach. It is possible that
the most cost effective approach is to do nothing, that is, if the cost of turnover is less than the
cost of increasing extrinsic or intrinsic rewards or of automating the jobs. However, other factors
come into play in this decision making process.

For example, job enrichment may not only reduce turnover but may also increase work quality.
This may tip the scales toward job enrichment or a combination approach, rather than simply
increased pay. The philosophy of the organization’s leadership is also important.

Criteria for Success: Goals for the Compensation System

1.​ Promote achievement of the organization’s goals.

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 2.​ Fit with and support the organization’s strategy and structure.
3.​ Attract and retain qualified individuals.
4.​ Promote desired employee behaviour.
5.​ Be seen as equitable.
6.​ Comply with the law.
7.​ Be within the financial means of the organization.
8.​ Achieve the above goals in the most cost effective manner.

In general, the optimal reward system will be the one that adds the most value to the
organization, after considering all its costs. However, this does not necessarily mean that the
optimal compensation system is the cheapest one. For example, for some firms, a high wage
compensation strategy may well be the one that maximizes overall company effectiveness.
Resource constraints may prevent a company from adopting what would otherwise be the
optimal reward strategy. But in general, an effective reward system maximizes the value added
relative to the resources devoted to the reward system

Roadmap for Effective Compensation

Step I: Understand Your Organization and Your People

The first step in creating an effective compensation system is to understand the organizational
context within which it will operate. The reward system is just one part of the total organizational
system, and each part must fit with and support the other parts.

There are three viable patterns into which these parts can be arranged, and each pattern
constitutes one type of managerial strategy. For success, each managerial strategy relies on a
different reward and compensation strategy.

The most appropriate managerial strategy is in turn determined by a number of key contextual
factors, such as the firm’s environment; its corporate strategy; its technology; its size; and, of
course, its people. A key implication of this set of factors is that they are all related whenever
one factor changes, it can create a need for many other organizational changes, including
changes to the reward and compensation system.

Three main behaviours are desirable to an organization — membership behaviour, task

behaviour, and citizenship behaviour — but the importance of each of these can vary
dramatically for different organizations. It is crucial to understand what specific attitudes and
behaviours are needed by your organization and the role the reward system can play in eliciting
these behaviours. Besides understanding how reward systems can promote desired
behaviours, it is also important to understand how reward systems can unintentionally generate
undesirable attitudes and behaviours.

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Step II: Formulate Your Reward and Compensation Strategy

The next step in creating an effective compensation system is to formulate your reward and
compensation strategy to determine the mix of compensation components to include in your
system and the total level of compensation to provide, relative to other employers.

To determine the compensation mix, you must understand what compensation options are
available, their advantages and disadvantages, and the consequences each produces. There
are three main compensation components — base pay, performance pay, and indirect pay.

You can then formulate a compensation strategy that defines the mix of compensation
components (along with the specific elements of these components) and the compensation level
strategy that best fits your organization. But to do this effectively, you must first understand the
constraints on your organization that define the parameters within which choices can be made.
These include legal constraints, labour market constraints, product/service market constraints,
and constraints on the financial resources available to the organization.

Step III: Determine Your Compensation Values

By this point, you will have developed a compensation strategy, but you don’t yet have a
compensation system.

Once you have formulated the compensation strategy, you must next establish the processes
for determining actual dollar values for jobs and for individual employees. The dollar value of
compensation to be provided to a specific employee is typically determined by a combination of
three factors:

1.​ The value of the employee’s assigned job relative to other jobs in the firm, usually
determined by a process called job evaluation.
2.​ The value of the employee’s job relative to what other firms are paying for this job,
usually determined through a process known as labour market surveys.
3.​ The value of the employee’s job performance relative to other employees performing the
same job, usually determined by a process called performance appraisal.

The first and third of these factors deal with achieving internal pay equity (equity of pay among
employees within the firm), while the second factor deals with achieving external pay equity
(equity with what comparable employees are being paid in other firms). Note that equity is not
the same as equality; giving equal pay to employees who make a lesser contribution to the firm
than other employees is in fact very inequitable. When developing a pay system, pay equity
(fairness) is our goal, not pay equality.

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Step IV: Design Your Performance Pay and Indirect Pay Plans

Step V: Implement, Manage, Evaluate, and Adapt the

Compensation System

Once developed, the compensation system needs to be implemented and then managed on an
ongoing basis. Key issues here include procedures for implementing the system,
communicating information about the system, dealing with compensation problems, budgeting,
and controlling compensation costs. In addition, after implementation, the compensation system
needs to be continually evaluated to determine whether it is accomplishing the company’s
objectives and whether it is doing so in the most cost- effective manner possible.
If not, then some of the technical aspects of the compensation system may need to be changed,
or the compensation and rewards strategy may need to be reworked entirely, as the feedback
loops in.
Furthermore, if the circumstances facing the organization change, or if the technology, strategy,
or structure of the organization changes, these changes may trigger a need for changes to the
compensation strategy or system. In addition, the organization must have a way of detecting
unintended negative consequences generated by the compensation system.

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 CHAPTER 2: STRATEGIC FRAMEWORK FOR COMPENSATION

Strategy and the Concept of Fit

An organization’s mission, vision and/or values provide the basis for its strategies.

The Vision of an organization refers to the long term, optimal desired state; it’s like “what you
want to be when you grow up” or your aspirational goal. Its mission is more
immediate; that is,
the present state or purpose of the organization, or “who you are today.” It gives the reason
for the organization’s existence. Organizational
values
refer to its underlying guiding
principles, beliefs, and attitudes that guide behavio
ur; for instance, “teamwork” and
“integrity” can be organizational values.
Fit is an important concept in strategic management.
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It refers to the
alignment of strategies at
various levels in an organization. There are two related concepts: vertical and horizontal fit, or
vertical and horizontal integration.
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Vertical fit
refers to the alignment between an
organization’s mission, vision and/or values, and the various supportive strategies that
cascade down an organization. A tight fit means that human resource management (HRM)
strategies, for
instance, are closely aligned with the strategic thrust of the organization; that is,
the HRM strategies support the organizational strategy. For instance, 3M and Apple are widely
known for their innovative organizational strategies. Compensation strategie
s that support
innovation imply that there is some level of vertical fit.
Horizontal fit
refers to the alignment
between and among strategies at the same level; for instance, HRM strategies such as
performance management and compensation are aligned or sup
port each other.
The organization’s strategy helps it to achieve its mission, vision, values, and goals.
The
business strategy
(sometimes known as the “competitive strategy” or “corporate
strategy”) is the organization’s plan for how it will achieve its go
als. The
organization