Lesson 1, Topic 1
In Progress

Factors in determining pay rates

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Basic Factors in Determining Pay Rates. Employee compensation includes all forms of pay going to employees and arising from their employment. It has two main components, direct financial payments (wages, salaries, incentives, commissions, and bonuses) and indirect financial payments (financial benefits like employer-paid insurance and vacations).

In turn, employers can make direct financial payments to employees based on increments of time or based on performance. Time-based pay still predominates. Blue-collar and clerical workers receive hourly or daily wages, for instance.

Others, like managers or Web designers, tend to be salaried and paid weekly, monthly, or yearly. The second direct payment option is to pay for performance. For example, piecework ties compensation to the amount of production (or number of “pieces”) the worker turns out. Sales commissions tie pay to sales. Many employers’ pay plans combine time-based pay and incentives.


Employee compensation all forms of pay or rewards going to employees and arising from their employment.
Direct financial payments pay in the form of wages, salaries, incentives, commissions, and bonuses. Indirect financial payments pay in the form of financial benefits such as insurance.

Aligning Total Rewards with Strategy

The compensation plan should first advance the firm’s strategic aims—management should produce an aligned reward strategy. This means creating a compensation package that produces the employee behaviors the firm need human resources, s to achieve its competitive strategy. Put another way, the rewards should provide a clear pathway between each reward and specific business goals.

We will see that many employers formulate a total rewards strategy to support their strategic aims. Total rewards encompass traditional pay, incentives, and benefits, but also “rewards” such as more challenging jobs (job design), career development, and recognition.

Equity and Its Impact on Pay Rates

In studies at Emory University, researchers investigated how Capuchin monkeys reacted to inequitable pay. Some monkeys got sweet grapes in return for trading pebbles; others got cucumber slices. If a monkey receiving a cucumber slice saw a neighbor get grapes, it slammed down the pebble or refused to eat. It seems even lower primates may demand fair treatment in pay. Among humans, too, the equity theory of motivation postulates that people are motivated to maintain a balance between what they perceive as their contributions and their rewards. Equity theory states that if a person perceives an inequity, a tension or drive will develop that motivates him or her to reduce the tension and perceived inequity.

Research tends to support equity theory, particularly as it applies to those underpaid. For example, in one study turnover of retail buyers was significantly lower when the buyers perceived fair treatment in rewards and in how employers allocated rewards. Overpaying can sometimes backfire, too, perhaps “due to feelings of guilt or discomfort.

In compensation, one can address external, internal, individual, and procedural equity:
●● External equity refers to how a job’s pay rate in one company compares to the job’s pay rate
in other companies.
●● Internal equity refers to how fair the job’s pay rate is when compared to other jobs within the same company (for instance, is the sales manager’s pay fair, when compared to what the
production manager earns?).
●● Individual equity refers to the fairness of an individual’s pay as compared with what his or her coworkers are earning for the same or very similar jobs within the company, based on
each person’s performance.
●● Procedural equity refers to the “perceived fairness of the processes and procedures used to
make decisions regarding the allocation of pay.”

Managers use various means to address such equity issues. For example, they use salary surveys (surveys of what other employers are paying) to monitor and maintain external equity. They use job analysis and comparisons of each job (“job evaluation”) to maintain internal equity. They use performance appraisal and incentive pay to maintain individual equity. And they use communications, grievance mechanisms, and employees’ participation to help ensure that employees view the pay process as procedural fair. Some firms administer attitude surveys to monitor employees’ pay satisfaction.

Questions typically include, “How satisfied are you with your pay?” and “What factors do you believe are used when your pay is determined?”

To head off discussions that might prompt feelings of internal inequity, some firms maintain strict secrecy over pay rates, while others publicize them. However, “open pay” policies can backfire. In one firm, employees vigorously opposed paying a high salary to a great candidate unless everyone else’s pay went up, too, for instance. As of now, the research concerning pay secrecy is inconclusive, and most employers don’t have open pay policies. For external equity, online pay sites like Salary.com make it easy to see what one could earn elsewhere.

Union Influences on Compensation Decisions

Unions and labor relations laws also influence pay plan design. Historically, the wage rate has been the main issue in collective bargaining. However, unions also negotiate other pay-related issues, including time off with pay, income security (for those in industries with periodic layoffs), cost-of-living adjustments, and health care benefits.

Pay Policies

The employer’s compensation strategy will manifest itself in pay policies. For example, a top hospital like Johns Hopkins might have a policy of paying nurses 20% above the prevailing market wage. Pay policies can influence the employer’s performance and profitability, as the accompanying feature on Wegmans Food Markets illustrates.

Managers need pay policies on a range of issues. One is whether to emphasize seniority or performance. For example, it takes 18 years for a U.S. federal employee to progress from step 1 to step 9 of the government’s pay scale. Such seniority-based pay may be advantageous to the extent that seniority is an objective standard.

One disadvantage is that top performers may get the same raises as poor ones. Seniority-based pay might seem to be a relic reserved for some government agencies and unionized firms. However, one survey found that 60% of employees responding thought high-seniority employees got the most pay. Only about 35% said their companies paid high performers more.

How to distinguish between high and low performers is another policy issue. For example, for many years Payless Shoe Source gave everyone the same raise. However, after seeing its market share drop over several years, management decided on a turnaround strategy.

This necessitated revising the firm’s compensation policies, to differentiate more aggressively between top performers and others.46 Other pay policies cover how to award salary increases and promotions, overtime pay, probationary pay, leaves for military service, jury duty, and holidays.

Activity 9.2

  1. Explain the basic factors of determining pay rates?
  2. Discuss Equity and its impact on pay rates.
  3. Describe Pay Policies.