Employers see compensation (pay, incentives, and benefits) as powerful tools for furthering
the company’s strategic goals. The textbook identifies the following reasons for this view:
 pay has a large impact on employees’ attitudes and behaviour
 compensation packages influence the kind of employees who are attracted to (and
remain with) an organisation
 pay, incentives, and benefits can help to align employees’ interests with those of the
broader organisation
 compensation is typically a significant organisational cost and this requires close
scrutiny.

In considering a compensation approach (pay and benefits), an employer needs to ask the following questions:
 How does the compensation approach fit with the organisation’s HR strategy and its overall business strategy?
 What are the costs of the approach?
 What is the expected return (in terms of desired behaviour and organisational
outcomes) from such an investment?
 How does the organisation communicate the compensation system to their managers and other employees?
 What level of participation in decision-making will be given to employees?

Communication is critical so that employees understand the compensation system—pay, recognition processes, and benefits—if they are to be motivated by the compensation offered, and if the company is to receive a return on investment from its efforts.

Another aspect of compensation system development highlighted in the textbook is that of employee participation in decision making. Participation encourages acceptance and makes implementation easier.

The medium through which these policies operate is the pay structure which involves the relative pay of different jobs (job structure) and how much they are paid (pay level).
Equity theory and fairness are particularly relevant to decisions about pay levels. Employees are typically concerned about two forms of equity:

1. External equity – focuses on what people in other organisations are paid for doing the same job (usually assessed by market pay survey).
2. Internal equity – focuses on what people in the same organisation, but in different jobs, are being paid.

In determining pay levels, organisations are faced with a trade-off between two pressures that influence the upper and lower limits of the amount that they can pay employees.

1. Upper limit constraint – to compete effectively in the product market, organisations must contain their labour costs or they will have to price their products at a level that is non-competitive.
2. Lower limit constraint – to attract good employees in the labour market, organisations need to be able to match the compensation offered by their competitors.

Benchmarking is usually undertaken through market pay surveys.

Compensable characteristics can include working conditions, job complexity, level of decision-making, required education, responsibility (e.g. for staff), and required experience. The most widely used system of job evaluation is the point-factor system which uses points for each compensable factor.

While most organisations adopt job-based pay structures, this approach has some inherent problems. The core problem is the tendency to become bureaucratic. The textbook argues that this occurs because:
 The detailed specification of jobs and duties can discourage flexibility.
 The hierarchical nature reinforces top-down decision-making and status differentials.
 The administrative effort required to update job descriptions and job evaluations can
be a deterrent to changing even when required.
 Job-based pay structures may not reward the desired behaviours because of rapid
changes in the environment.
 They encourage promotion-seeking behaviour and discourage lateral moves that may
be necessary for employee development and building organisational capacity.

Delayering and banding – involves the removal of some job levels and creating broader pay bands. This provides flexibility in job assignments and assigning merit increases and enables the rewarding of high performers. Disadvantages include: reduced opportunities for promotion, possibility of entrenching new status levels, and the danger of loss of budgetary control because of the greater spread between minimum and maximum levels.

Paying the person – here the emphasis is developing pay structures based on the knowledge, skills or competency of individual employees. Competency-based systems are typically reserved for managers.

 Reinforcement theory–high performance followed by a monetary reward (reinforcement) will make future high performance more likely.

 Expectancy theory–focuses on the power of incentives, i.e. the link between expected rewards and behaviour. This theory suggests that there are three primary determinants of whether the desired behaviour will be repeated–(1) the strength of the link between performance and reward, (2) the employee’s perception of how strong this link is, and (3) the value that the employee ascribes to the reward (pay or benefit).

 Equity theory–employees compare their own pay with that of others, particularly at their own level. If they perceive an inequity in their own pay, they will either reduce their input (effort or cooperation), or quit the organisation.

Thus, an outcome based pay contract increases the risk for the manager or employee who is being paid, whereas a behaviourally based pay contract reduces the risk for the manager or employee being paid, but increases the risk for the company.