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Compensation
Twelfth Edition
Jerry M. Newman
State University of New York–Buffalo
Barry Gerhart
University of Wisconsin–Madison
George T. Milkovich
Cornell University
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COMPENSATION, TWELFTH EDITION
Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2017 by McGrawHill Education. All rights reserved. Printed in the United States of America. Previous editions © 2014,
2011, and 2008. No part of this publication may be reproduced or distributed in any form or by any means,
or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education,
including, but not limited to, in any network or other electronic storage or transmission, or broadcast for
distance learning.
Some ancillaries, including electronic and print components, may not be available to customers outside the
United States.
This book is printed on acid-free paper.
1 2 3 4 5 6 7 8 9 0 DOC/DOC 1 0 9 8 7 6
ISBN
MHID
978-1-259-53272-6
1-259-53272-0
Senior Vice President, Products & Markets: Kurt L. Strand
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Printer: R. R. Donnelley
All credits appearing on page or at the end of the book are considered to be an extension of the copyright
page.
Library of Congress Cataloging-in-Publication Data
Milkovich, George T., | Newman, Jerry M., | Gerhart, Barry A., author.
Compensation / George T. Milkovich, Cornell University, Jerry M. Newman, State University of New
York/Buffalo, Barry Gerhart, University of Wisconsin/Madison.
Twelfth ed. | New York, NY: McGraw-Hill Education, [2017]
LCCN 2015041046 | ISBN 9781259532726 (alk. paper)
LCSH: Compensation management.
LCC HF5549.5.C67 M54 2017 | DDC 658.3/2—dc23
LC record available at http://lccn.loc.gov/2015041046
The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a website
does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw-Hill Education
does not guarantee the accuracy of the information presented at these sites.
www.mhhe.com
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Table of Contents
Preface
xiii
2. Does the Study Separate Correlation from
Causation? 26
3. Are There Alternative Explanations? 27
PART ONE
Your Turn: The Role of Labor Costs in Retail
Electronics 27
INTRODUCING THE PAY MODEL
AND PAY STRATEGY
Chapter One
The Pay Model
Chapter Two
Strategy: The Totality of Decisions
3
Compensation: Does It Matter? (or, “So What?”) 3
Compensation: Definition, Please 5
Society 5
Stockholders 7
Managers 9
Employees 11
Incentive and Sorting Effects of Pay on Employee
Behaviors 11
Global Views—Vive la Différence 12
Forms of Pay
13
Cash Compensation: Base 14
Cash Compensation: Merit Increases/Merit
Bonuses/COLAs 14
Cash Compensation: Incentives 15
Long-Term Incentives 16
Benefits: Income Protection 16
Benefits: Work/Life Balance 16
Benefits: Allowances 17
Total Earnings Opportunities: Present Value of a
Stream of Earnings 17
Relational Returns from Work 17
A Pay Model
18
Compensation Objectives
Four Policy Choices 22
Pay Techniques 24
18
Book Plan 25
Caveat Emptor—Be an Informed Consumer
1. Is the Research Useful?
26
25
Similarities and Differences in Strategies
40
40
Different Strategies within the Same Industry 43
Different Strategies within the Same Company 43
Strategic Choices 44
Support Business Strategy 45
Support HR Strategy 47
The Pay Model Guides Strategic Pay
Decisions 48
Stated versus Unstated Strategies
49
Developing A Total Compensation Strategy:
Four Steps 50
Step 1: Assess Total Compensation
Implications 51
HR Strategy: Pay as a Supporting Player or
Catalyst for Change? 51
Step 2: Map a Total Compensation Strategy 54
Steps 3 and 4: Implement and Reassess 57
Source of Competitive Advantage:
Three Tests 57
Align 57
Differentiate 57
Add Value 58
“Best Practices” versus “Best Fit”? 59
Guidance from the Evidence 59
Virtuous and Vicious Circles 60
Your Turn: Merrill Lynch 61
Still Your Turn: Mapping Compensation
Strategies 63
iii
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iv
Table of Contents
PART TWO
INTERNAL ALIGNMENT:
DETERMINING THE STRUCTURE
Chapter Three
Defining Internal Alignment
73
Jobs and Compensation 74
Compensation Strategy: Internal Alignment
Supports Organization Strategy
Supports Work Flow 75
Motivates Behavior 76
Structures Vary among Organizations
Number of Levels 77
Differentials 77
Criteria: Content and Value
74
75
76
77
What Shapes Internal Structures?
80
Economic Pressures 80
Government Policies, Laws, and Regulations 81
External Stakeholders 81
Cultures and Customs 82
Organization Strategy 82
Organization Human Capital 83
Organization Work Design 83
Overall HR Policies 83
Internal Labor Markets: Combining External and
Organization Factors 84
Employee Acceptance: A Key Factor 84
Pay Structures Change 85
Strategic Choices in Designing Internal
Structures 86
Tailored versus Loosely Coupled 86
Hierarchical versus Egalitarian and Layered versus
Delayered Structures 86
Guidance from the Evidence
88
Equity Theory: Fairness 89
Tournament Theory (and Pay Dispersion):
Motivation and Performance 90
Institutional Theory: Copy Others and
Conform 92
(More) Guidance from the Evidence 92
Consequences of Structures
Efficiency 94
Fairness 94
Compliance 94
mil32720_fm_i-xviii.indd 4
94
Your Turn: So You Want to Lead an
Orchestra! 95
Still Your Turn: (If You Don’t Want to Lead the
Orchestra…) 96
Still (yes, still) Your Turn: (NCAA) 99
Chapter Four
Job Analysis 106
Structures Based on Jobs, People,
or Both 107
Job-Based Approach: Most Common
Why Perform Job Analysis?
109
109
Job Analysis Procedures 110
What Information Should Be Collected?
111
Job Data: Identification 111
Job Data: Content 111
Employee Data 113
“Essential Elements” and the Americans With
Disabilities Act 116
Level of Analysis 117
How Can the Information Be Collected?
118
Conventional Methods 118
Quantitative Methods 118
Who Collects the Information? 120
Who Provides the Information? 120
What about Discrepancies? 121
Job Descriptions Summarize the Data
122
Using Generic Job Descriptions 122
Describing Managerial/Professional Jobs
Verify the Description 123
Job Analysis: Bedrock or Bureaucracy?
Job Analysis and Globalization 126
122
125
Job Analysis and Susceptibility to
Offshoring 126
Job Analysis Information and Comparability
across Borders 128
Judging Job Analysis
128
Reliability 128
Validity 129
Acceptability 129
Currency 129
Usefulness 129
A Judgment Call 130
Your Turn: The Customer-Service Agent
131
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Table of Contents
Chapter Five
Job-Based Structures and Job
Evaluation 140
Competencies and Employee Selection and
Training/Development 192
Guidance (and Caution) from the Research
on Competencies 192
Job-Based Structures: Job Evaluation 141
Defining Job Evaluation: Content, Value,
and External Market Links 142
Content and Value 142
Linking Content with the External Market
Technical and Process Dimensions 143
“How-To”: Major Decisions
One More Time: Internal Alignment Reflected in
Structures (Person-Based or Job-Based) 194
Administering and Evaluating the Plan 194
142
143
Wages Criteria Bias
198
201
147
PART THREE
Who Should Be Involved?
EXTERNAL COMPETITIVENESS:
DETERMINING THE PAY LEVEL
161
The Design Process Matters
161
The Final Result: Structure 163
Balancing Chaos and Control 164
Your Turn: Job Evaluation at Whole Foods
Chapter Six
Person-Based Structures
Chapter Seven
Defining Competitiveness
165
Types of Skill Plans 174
Purpose of the Skill-Based Structure
How Labor Markets Work
Labor Demand 224
Marginal Product 224
Marginal Revenue 224
Labor Supply 226
177
178
Person-Based Structures: Competencies
188
186
221
221
Modifications to the Demand Side
183
Defining Competencies 186
Purpose of the Competency-Based Structure
Objective 188
What Information to Collect? 188
Whom to Involve? 190
Establish Certification Methods 190
Resulting Structure 190
Compensation Strategy: External
Competitiveness 214
What Shapes External Competitiveness?
Labor Market Factors 221
174
What Information to Collect? 179
Whom to Involve? 179
Establish Certification Methods 181
Outcomes of Skill-Based Pay Plans: Guidance
from Research and Experience 181
“How-To”: Competency Analysis
213
Control Costs and Increase Revenues 215
Attract and Retain the Right Employees 219
173
Person-Based Structures: Skill Plans
mil32720_fm_i-xviii.indd 5
195
198
The Perfect Structure 199
Your Turn: Climb the Legal Ladder
146
Ranking 147
Classification 148
Point Method 149
“How To”: Skill Analysis
Reliability of Job Evaluation Techniques
Validity 197
Acceptability 198
Bias in Internal Structures
Establish the Purpose 144
Single versus Multiple Plans 144
Choose among Job Evaluation Methods
Job Evaluation Methods
v
226
Compensating Differentials 226
Efficiency Wage 227
Sorting and Signaling 229
Modifications to the Supply Side (Only
Two More Theories to Go) 230
Reservation Wage 230
Human Capital 230
Product Market Factors and Ability to Pay
Product Demand 231
Degree of Competition 231
A Different View: What Managers Say
231
232
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vi Table of Contents
Segmented Supplies of Labor and (Different)
Going Rates 232
Organization Factors
234
Industry and Technology 234
Employer Size 234
People’s Preferences 234
Organization Strategy 235
Relevant Markets
Interpret Survey Results and Construct a
Market Line 278
236
Defining the Relevant Market 236
Globalization of Relevant Labor Markets:
Offshoring and Outsourcing 237
Competitive Pay Policy Alternatives
240
What Difference Does the Pay-Level Policy Make? 240
Pay with Competition (Match) 240
Lead Pay-Level Policy 242
Lag Pay-Level Policy 242
Different Policies for Different Employee
Groups 243
Not by Pay Level Alone: Pay-Mix Strategies 243
Consequences of Pay-Level and Pay-Mix
Decisions: Guidance from the Research 248
Efficiency 248
Fairness 249
Compliance 249
Your Turn: Two-Tier Wages
250
Verify Data 279
Statistical Analysis 284
Update the Survey Data 286
Construct a Market Pay Line 286
Setting Pay for Benchmark and Non-benchmark
Jobs 288
Combine Internal Structure and External
Market Rates 290
From Policy to Practice: The Pay-Policy
Line 291
Choice of Measure 291
Updating 291
Policy Line as Percent of Market Line
Why Bother with Grades and Ranges? 292
Develop Grades 293
Establish Range Midpoints, Minimums,
and Maximums 293
Overlap 294
Flexibility-Control
7-A: Utility Analysis 252
Reconciling Differences
Chapter Eight
Designing Pay Levels, Mix, and Pay
Structures 262
Major Decisions 263
Specify Competitive Pay Policy
The Purpose of a Survey 264
263
Adjust Pay Level—How Much to Pay? 264
Adjust Pay Mix—What Forms? 264
Adjust Pay Structure? 264
Study Special Situations 265
Estimate Competitors’ Labor Costs 265
Select Relevant Market Competitors
Design the Survey
mil32720_fm_i-xviii.indd 6
269
270
295
298
Balancing Internal and External Pressures:
Adjusting The Pay Structure 298
255
Fuzzy Markets
292
From Policy to Practice: Grades and Ranges 292
From Policy to Practice: Broad Banding
Appendix
Your Turn
Who Should Be Involved? 270
How Many Employers? 270
Which Jobs to Include? 273
What Information to Collect? 275
265
Market Pricing
298
299
Business Strategy (More Than “Follow
the Leader”) 299
Review 300
Your Turn: Google’s Evolving Pay
Strategy 301
Still Your Turn: Word-of-Mouse: Dot-Com
Comparisons 302
PART FOUR
EMPLOYEE CONTRIBUTIONS:
DETERMINING INDIVIDUAL PAY
Chapter Nine
Pay-for-Performance: The Evidence 312
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vii
Table of Contents
What Behaviors Do Employers Care About?
Linking Organization Strategy to Compensation
and Performance Management 314
What Does It Take to Get These Behaviors? What
Theory Says 319
What Does It Take To Get These Behaviors?
What Practitioners Say 323
Does Compensation Motivate Behavior? 328
Do People Join a Firm Because of Pay? 328
Do People Stay in a Firm (or Leave) Because
of Pay? 329
Do Employees More Readily Agree to Develop
Job Skills Because of Pay? 330
Do Employees Perform Better on Their Jobs
Because of Pay? 330
Designing a Pay-for-Performance Plan
334
Efficiency 334
Equity/Fairness 336
Compliance 337
Your Turn: Burger Boy
Employee Stock Ownership Plans (ESOPs) 375
Performance Plans (Performance Share and
Performance Unit) 375
Broad-Based Option Plans (BBOPs) 376
Combination Plans: Mixing Individual and
Group 376
Your Turn
377
Appendix
10-A: Profit-Sharing (401K) at
Walgreens 378
Chapter Eleven
Performance Appraisals
The Role of Performance Appraisals in
Compensation Decisions 386
Performance Metrics
337
348
What is a Pay-for-Performance Plan? 348
Does Variable Pay Improve Performance
Results? The General Evidence 350
Specific Pay-for-Performance Plans: Short Term 350
Merit Pay 350
Merit Bonuses Aka Lump-Sum Bonuses 352
Individual Spot Awards 352
Individual Incentive Plans 353
Individual Incentive Plans: Advantages and
Disadvantages 356
Individual Incentive Plans: Examples 357
Team Incentive Plans: Types
384
387
Strategies for Better Understanding and
Measuring Job Performance 388
Chapter Ten
Pay-for-Performance Plans
358
Comparing Group and Individual Incentive
Plans 364
Large Group Incentive Plans 365
Gain-Sharing Plans 365
Profit-Sharing Plans 370
Earnings-at-Risk Plans 371
Group Incentive Plans: Advantages and
Disadvantages 372
Group Incentive Plans: Examples 373
mil32720_fm_i-xviii.indd 7
Explosive Interest in Long-Term Incentive Plans 373
The Balanced Scorecard Approach 388
Strategy 1: Improve Appraisal Formats 389
Strategy 2: Select the Right Raters 398
Strategy 3: Understand How Raters Process
Information 400
Strategy 4: Training Raters to Rate More
Accurately 404
Putting It All Together: The Performance
Evaluation Process 405
Equal Employment Opportunity and
Performance Evaluation 407
Tying Pay to Subjectively Appraised
Performance 408
Competency: Customer Care 409
Performance- and Position-Based
Guidelines 410
Designing Merit Guidelines 411
Your Turn: Performance Appraisal at American
Energy Development 413
Appendix
11-A: Balanced Scorecard Example:
Department of Energy (Federal
Personal Property Management
Program) 417
04/12/15 3:08 pm
viii Table of Contents
11-B: Sample Appraisal Form for
Leadership Dimension: Pfizer
Pharmaceutical 420
Defined Contribution Plans 481
Individual Retirement Accounts (IRAs) 483
Employee Retirement Income Security Act
(ERISA) 483
How Much Retirement Income to Provide? 485
PART FIVE
Life Insurance 486
Medical and Medically Related Payments
EMPLOYEE BENEFITS
Chapter Twelve
The Benefit Determination
Process 442
Why the Growth in Employee Benefits?
444
Wage and Price Controls 444
Unions 444
Employer Impetus 444
Cost Effectiveness of Benefits 445
Government Impetus 445
The Value of Employee Benefits 445
Key Issues in Benefit Planning, Design, and
Administration 446
Benefits Planning and Design Issues
Benefit Administration Issues 448
Components of a Benefit Plan
446
450
Employee Benefit Communication
Claims Processing 459
Cost Containment 460
Your Turn: World Measurement
457
474
Retirement and Savings Plan Payments
mil32720_fm_i-xviii.indd 8
481
491
Benefits for Contingent Workers 493
Your Turn: Adapting Benefits to a Changing
Strategy 493
EXTENDING THE SYSTEM
501
Who Are Special Groups? 502
Compensation Strategy for Special
Groups 502
461
Workers’ Compensation 474
Social Security 476
Unemployment Insurance 478
Family and Medical Leave Act (FMLA) 480
Consolidated Omnibus Budget Reconciliation
Act (COBRA) 480
Health Insurance Portability and Accountability Act
(HIPAA) 480
Defined Benefit Plans
491
Paid Time Off During Working Hours
Payment for Time Not Worked 491
Child Care 492
Elder Care 492
Domestic Partner Benefits 493
Legal Insurance 493
Chapter Fourteen
Compensation of Special Groups
458
Chapter Thirteen
Benefit Options 470
Legally Required Benefits
Miscellaneous Benefits
PART SIX
Employer Factors 451
Employee Factors 455
Administering The Benefit Program
486
General Health Care 486
Health Care: Cost Control Strategies 489
Short- and Long-Term Disability 490
Dental Insurance 491
Vision Care 491
480
Supervisors 502
Corporate Directors 503
Executives 504
What’s All the Furor over Executive
Compensation? What the Critics and Press
Say 510
What’s All the Furor over Executive Compensation?
What Academics Say 514
Scientists and Engineers in High-Technology
Industries 516
Sales Forces 520
Contingent Workers 524
Your Turn: A Sports Sales Plan
526
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Table of Contents
Chapter Fifteen
Union Role in Wage and Salary
Administration 534
Localizer: “Think Global, Act Local” 582
Exporter: “Headquarters Knows Best” 582
Globalizer: “Think and Act Globally and Locally” 582
Expatriate Pay
The Impact of Unions in Wage
Determination 536
Unions and Alternative Reward Systems
543
Lump-Sum Awards 544
Employee Stock Ownership Plans (ESOPs)
Pay-for-Knowledge Plans 544
Gain-Sharing Plans 545
Profit-Sharing Plans 545
544
546
550
555
MANAGING THE SYSTEM
560
569
571
The Total Pay Model: Strategic Choices
572
National Systems: Comparative Mind-Set
572
Japanese Traditional National System 572
German Traditional National System 576
Strategic Comparisons: Traditional Systems in
Japan, Germany, United States 577
Evolution and Change in the Traditional Japanese
and German Models 580
582
614
Minimum Wage 618
Overtime and Hours of Work
Child Labor 627
Trade Unions and Employee Involvement 564
Ownership and Financial Markets 564
Managerial Autonomy 565
Comparing Costs (and Productivity) 566
Labor Costs and Productivity 566
Cost of Living and Purchasing Power
Overview
Fair Labor Standards Act Of 1938
Is National Culture a Major Constraint on
Compensation? 562
mil32720_fm_i-xviii.indd 9
Borderless World Borderless Pay?
Globalists 591
Your Turn: IBM’s Worldwide Business and
Employment Strategies and Compensation 592
Still Your Turn: Globalization of the Labor
Market: The English Premier League 596
Government as Part of the Employment
Relationship 614
Centralized or Decentralized Pay-Setting
Regulation 557
Strategic Market Mind-Set
Objectives? Quel
Chapter Seventeen
Government and Legal Issues in
Compensation 611
The Global Context 552
The Social Contract 554
Comparing Systems
Expatriate Systems
dommage! 590
584
PART SEVEN
Your Turn: Predicting a Contract’s Clauses
Culture
583
Elements of Expatriate Compensation
The Balance Sheet Approach 586
Union Impact on General Wage Levels 536
The Structure of Wage Packages 538
Union Impact: The Spillover Effect 539
Role of Unions in Wage and Salary Policies and
Practices 539
Chapter Sixteen
International Pay Systems
ix
618
620
Living Wage 627
Employee or Independent Contractor?
Prevailing Wage Laws 631
Antitrust Issues 631
Pay Discrimination: What is it? 632
The Equal Pay Act 634
628
Definition of Equal 634
Definitions of Skill, Effort, Responsibility,
Working Conditions 635
Factors Other Than Sex 635
“Reverse” Discrimination 636
Title VII of the Civil Rights Act of 1964 and
Related Laws 636
Disparate Treatment 638
Disparate Impact 639
Executive Order 11246
639
04/12/15 3:08 pm
x
Table of Contents
Pay Discrimination And Dissimilar Jobs
642
Evidence of Discrimi …
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