Employee remuneration and compensation policies

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Employee remuneration and compensation policies

 

1.        Problem definition

 

The topic that we will be focusing on in the following is the employee remuneration related issues. Remuneration is the compensation that employees receive for the work they have done. Employees need to believe that they are receiving fair remuneration for their efforts; if not they will probably seek other employment because no worker will work for nothing or less than what they perceive they deserve (Bronwynne 2007, p. 65). Remuneration can be paid to employees in various ways. We can differentiate between direct and indirect remuneration. Direct remuneration is the salary or wage an employee receives. Salaries are usually paid monthly and wages weekly or daily. And every business has its own particular kinds of indirect remuneration, or fringe benefits. Over the above the employees’ salary, the business may pay the following: pension, insurance, housing, transport, leave, profit sharing (Nieuwenhuizen 2007, p. 194). The remuneration issues are often the core reasons why employees are not motivated to work to their potential and even leave the employers to see better jobs in other positions. And in this case it is regarding the remuneration design of the marketing managers of the company, Waterway Industries, who has been the best performer and the marketing manager of the company ever and led the company to the success and fast growth in the kayaking product lines which the company is currently enjoying right now. And the problems will be the choose of remuneration setting to control the cost and at the same time retaining the best talent for the company for a continual success that is desired by the management and the shareholders.

 

2.        Theoretical support

 

There are three major pay rate setting: seniority based pay, performance based pay and skill based pay. By definition, organizations that utilize seniority-based compensation systems make pay decisions based on the length of time the staffs have been in a position and on years of related experience (Bogardus 2009, p.295). It is believed that the seniority-based pay is the representative of an entitlement compensation philosophy. And it is applicable in the management positions because of the requirements of the related long time working experience in the management of the specific area, but it would discourage the entry of the new fresh employees. Pay for performance refers to any compensation system that links pay and performance. The concept of basing pay on performance is not new. The two most common general categories of pay for performance are merit pay and variable pay. Merit pay links pay to individual performance that is consistent with the mission of the organization. The type of performance evaluation most often associated with merit pay plans are appraisals that focus on individual performance. Variable pay is usually a lump-sum payment, contingent on results. Variable pay is usually dependent on employee or organizational performance, or both (opm.gov 2010). Skill‐based pay (SBP) is a compensation system that rewards employees with additional pay in exchange for formal certification of the employee’s mastery of skills, knowledge, and/or competencies. Skill is acquired and observable expertise in performing tasks. Knowledge is acquired information used in performing tasks. Competencies are more general skills or traits needed to perform tasks, often in multiple jobs or roles (siop.org).

According to the Agency Theory, utility functions of the principal and agent are divergent and sometimes contradicting and that for the agent to behave in the interests of the principal, the principal has to work out a compatible remuneration contract and for the agent to serve the principal’s utility function (Preker 2007, p.151), and the theory requests that effective remuneration contract should be either effort-based if the effort could be observed or estimated, or outcome-based if the outcome is observable. Therefore, a major goal and also the ultimate goal of any compensation program should be to motivate employees to perform their best.

When the remuneration comes to the management, it is also known as executive pay which is the financial compensation received by an officer of a firm, often as a mixture of salary, bonuses, shares of and/or call options on the company stock. According to Jay A. Conger (2009), there are five principles when considering the management of the executive pay: (a) independence among the directorship; (b) fair internal and external standard for any decisions; (c) alignment to value producing performance; (d) an emphasis on long term value for shareholders by achieving key metrics and (e) full and clear disclosure of compensation arrangements. Below we will talk about some problems in the remuneration policies in the position of marketing manager and look into the possible alternatives before the final recommendation could be made.

In of the role of stock option in the executive compensation pay, according to Eugene F. Brigham, Joel F. Houston (2009, p. 11) is once a relatively small part of total compensation but now accounts for roughly 80 per cent of a typical CEO’s compensation, and similar high percentage could also be found in other senior management positions. And the stock options provide the senior management with an incentive to raise their companies’ stock prices. In addition, it is said that researchers believe that there is a strong casual relationship between the compensation procedures and the stock price performance. But there are factors to be taken into account, on one hand stock options will lead to a stock dilution which refers to a general term that results from the issue of additional common shares by a company (White 2003, p. 55) and also based on the view of Fred K. Foulkes (1991, p. 178) by providing the incentive stock options to employees, in particular the executives, shareholders will lose their entire tax deduction while the executives receive tax deduction. Therefore while designing the executive pay for the senior management, accounting and taxation do play a role but the author also suggests that such role should be limited and subordinate to the greater role of motivation.

3.        Case study

As mentioned in the case study, Lee Carter as the manager of the marketing department, is given 51,000 dollar plus yearly bonus of between 15,000 dollar and 19,000 dollar to make up for not paying a commission on her sale, referring back to our above literature review, such pay rate setting could be categorized into the variable pay for performance which as mentioned above  is usually a lump-sum payment, contingent on results and it is usually dependent on employee or organizational performance, or both (opm.gov 2010). Therefore, the determination of the bonus becomes the only variable of the pay received by Lee Carter which means that in the common years, she will receive 51,000 dollar plus yearly bonus of 15,000 dollar and receive  51,000 dollar plus yearly bonus of 19,000 dollar in the good years. The target of remuneration setting for the marketing manager now is how to set the pay rate in such a way that it retain and motivate the marketing manager which is critical to the success of the company. Below let us analyze the advantage and disadvantage of the current performance based variable pay from the perspective of the company.

 

3.1    Advantage of the current performance based variable pay

 

3.1.1            Cost saving

First of all, the current performance based variable pay help save cost because if the marketing manager is paid according to her sale that she has managed to push for, she will receive a lot more than the current total paid because as mentioned in the case she is personally in charge around 40 per cent of the company sale. As seen from the case, though the company is growing and also because of the fast growth, the company is running out of cash flow because of the increased account receivable, therefore cost saving would be necessary for the future growth of the business and also the new product development which is important for the long term success of the company.

 

3.1.2            Avoidance of equity (stock) dilution

Secondly, by not offering the stock option and other equity option to the marketing manager, the company manages not to dilute the ownership and control of the company. If Lee Carter is provided a sound stock option, then as mentioned above there will be a stock dilution which refers to a general term that results from the issue of additional common shares by a company (White 2003, p. 55). If Lee Carter chooses to exercise the stock option which is very possible because the company is on the raise under her lead and there is no way she would not exercise the stock option if she would continue to stay in the company. Hence additional stocks would be issued to her as a kind of compensation to her effort to bring the company’s sale to the current rapid growth track. The stock option’s direct victims are the shareholder as dilution means that a shareholder will experience a reduction of his or her share of the stock value and profits as additional shares are issued to new shareholders though the new shareholder is the company’s marketing managers (Beyster & Economy 2007, p. 56).

 

3.2    Disadvantage of the current performance based variable pay

If the company continues to usage the current performance based variable pay to provide only 51,000 dollar plus yearly bonus of 15,000 dollar in the common years and   51,000 dollar plus yearly bonus of 19,000 dollar in the good years to Lee Carter, there will be two major possible consequences that the company has to be prepared.

 

 

3.2.1            Loss of the 40 per cent of the total orders

 

One immediate effect is the possible loss of the sale orders, as mentioned in the case study, Lee Carter is personally in charge around 40 per cent of the company sale and also because there is no time to formalized the order taking and distributing channel building, many orders are negotiated by Lee Carter personally, and therefore there could be high possibility that the big customers will only recognize Lee Carter rather than the company, Waterway Industries, in another word, Lee Carter could leave with the 40 per cent of the company’s sale which is not an expected result for the company or its shareholders.

 

3.2.2            Cost of substitution of the marketing manager

Because as mentioned in the case study, if the company does not choose to act proactively to bring changes to the current performance based variable pay which ranges from 66,000 dollar to 70,000 dollars to the market manager, then Lee Carter would probably leave the company because she has already been offered better compensation package by other companies which had been overheard by the CEO Cyrus Maher, therefore, it is very possible that Lee Carter would leave the company which means that the company would have to replace the marketing manager position with another person. And the substitution of a marketing manager would link with personnel costs that include recruiting, training and compensation costs and also the cost of generating performance (Green & Mavor 2003, p. 129). And in the case of Waterway Industries, even though the company could find another suitable candidate to take over the marketing manager position, even the training cost could be overlooked, the cost of smooth take over of the jobs that Lee Carter is doing currently would take a certain period of time which is harmful to the fast growing business of the company. Therefore, time seem to be the most important and critical loss that will be incurred if a substitution of marketing manager is a must.

 

 

4.        The business objectives, HRM objectives and compensation policies

Because compensation policy is part of the HR planning, and the HR planning is the process that involves the determination of the true course of action which takes place at two levels: strategic level and action level (Deb 2006, p.76), in the strategic level, planning entails the setting of mission, goals and objectives which draw the outline and broad direction of the business activities in the long term; and in contrast in the action level, planning involves the setting of the short term based objectives which need to be specific, achievable and measurable for the companies, therefore we should examine look into the real business objectives and the strategies that the company is implementing before we can decide a compensation policy system is necessary or not. Based on the description in the case study, we assume that the company currently has the following business objectives:

 

4.1    Rapid business expansion in kayaking products

As cash cow of the Waterway Industries, the avenue brought by the selling of the kayaking series products accounts for a large proportion of the company’s income, and in addition the good news is that the order is increasing rapidly and Lee Carter as the marketing managers has contributed largely to such marketing and customer base expansion. And obviously, it is the key stakeholders (shareholders and management)’s interest to keep such business and sale expansion how it is doing right now.

 

4.2    Formalize the sale and distribution channels

Another business target is to formalize the sale and distribution channels, as mentioned in the case Lee Carter is personally in charge of around 40 per cent of the company sale, and supposedly some other key employees also have the similar large customer base, it is necessary for the company to formalize the sale and distribution channels which will enhance the monitoring of the marketing cost as well as reducing the reliance to the specific employees.

 

4.3    Maintain health financial situation with sufficient cash

Because of the increasing amount in the account receivable, the company is running out of cash in flow and that is why the CEO met with the the head of the commercial lending department at Centre Trust, and hence another goal would be to maintain the health financial situation with sufficient cash to avoid dry up of cash flow which could lead to the forced bankruptcy of the company.

 

4.4    New product and market development

Another strategic business goal is to engage in the new product and market development, as mentioned in the case, the company right now does not make clear which product and market segment should be focused, and because if the kayaking product lines become less profitable it would be critical that the company finds another cash cow to support the continual business development. And it seems that Cyrus Maher, the CEO of Waterway Industries, still has no idea about how the net product to be developed can be identified.

 

5.        Alternatives

 

5.1    Basic salary or bonus increase

The first alternative is to increase the basic salary or the bonus pay to reflect the important role of Lee Carter. The company could either increase the basic salary to a fixed level, let’s say 80,000 dollar, or the company could pay her with a basic salary and pay the bonus based on the sale that she manages to make. But such increase will incur spending of a lot of money because of the large sale that Lee Carter is capable of making. And but the increase of the bonus based on the performance will largely motivate Lee Carter to further expand the business in a good direction and also it is very possible that she would stay down and decline other competitors’ offer. But one more disadvantage of the pay increase and bonus increase is that it not only will increase the financial difficulties faced by the company but also there is chance that Lee Carter still considers other offers are more attractive that include equity options and other compensation schemes.

 

5.2    Provide stock option

The second alternatives would be to provide stock options to Lee Carter as part of the compensation to compliment her excellent performance and contribution to the company’s business growth. The CEO should help get the approval from the board of directors to provide Lee Carter with sufficient stock options to buying the stocks with relatively low price. Such equity option offering though would dilute the shareholders’ stocks, but it has three major benefits to the company: first of all, stock option express the company sincerity to salvage Lee Carter and treat her as a precious talent to the company, and hopefully this will increase the employee loyalty to the company; secondly, the offering of the stock options will increase the cash flow volume because the company would not have to increase the salary expense to cover Lee Carter’s basic salary increase or bonus increase to retain her in the above method. And as mentioned above under the current conditions, cash would be critical for the rapid expansion of the company’s business success because after Lee Carter’s exercising the stock option, there is only an issuing of new stocks and also this would not incur direct expenditure; thirdly, by providing stock options, Lee Carter will be much motivated to expand the business as an direct linkage has been established between her performance and the her compensation because the stocks that she holds account for a large proportion of her incomes, therefore Lee Carter would work not only for the best of the company but also the best of her personal interest.

 

5.3    Talk with Lee Carter

One more alternative will be to consult with Lee Carter before any final decision is made. Though before negotiating with the marketing manager, the company’s management has to identify how much it could pay to Lee Carter and what is the maximum that the company could afford based on its conditions, it is a good way that the company could negotiate with Lee Carter to see what is her expectation and what the company could do such as changing the pay setting to make her feel that the compensation scheme reflects well her value contributed to the company. There are advantages and disadvantages of using direct consulting with Lee Carter. In term of disadvantages, on one hand, Lee Carter may request much more than anticipated by the management if the deal is negotiable because the compensation policy could be changed because of her, she would be likely to think that she is very very important to the company which enables her enjoy more bargaining power while negotiating the compensation package; on the other hand, direct talking may lead to the outbreak of the disagreements between the management and Lee Carter in the compensation package design. And in term of advantages, direct talking not only could avoid the generation of misunderstanding between the management and Lee Carter because of some possible rumors and direct also negotiation could help the management and the human resource management department to understand the need of Lee Carter.

 

6.        Conclusion

From the above discussion and analysis we can draw some conclusions about the executive compensation policy redesign for the marketing manager, Lee Carter, first of all, Lee Carter is the core of the marketing department as well as the source of business and the largest motivator for the current business growth that the company could not afford to lose; secondly, the company could not provide a compensation package that contains a high salary increase or bonus increase because of the limitation of cash flow in the company’s financial conditions; thirdly, the company need to expand and formalize its marketing department and marketing channels in order to gear up for an expanded business scale and this would requires the cooperation from the marketing manager to allocate the jobs to the subordinates rather than doing the majority of orders herself.

 

7.        Recommendation

The final decision and recommendation for the CEO to handle the redesign of the executive pay for the marketing manager Lee Carter is an integrated solution base on the needs of the strategic business goals and human resource management:

Firstly, the management of the company needs to access its financial conditions and see whether the company could afford an increase of Lee Carter’s compensation of any form.

Secondly, the management (CEO and the HR head) could negotiate with Lee Carter to see what is her thinking about the redesign of her compensation package.

Thirdly, a stock option would be recommended for the management to retain Lee Carter and link key performance to her own income and personal interest. And also it shows the company sincerity to salvage Lee Carter and also the company’s confident that Lee Carter would continue to contribute to a rapid business growth in the near future. And because of the limitation of the limited cash flow, a stock option would occupy the majority of the increase of the compensation in the new package while the salary and bound pay increase would not be obvious. Other kinds of compensations such as retirement scheme could also be negotiated accordingly. And the answer to retain Lee Carter or not is a definite yes even the cost could be high. But for so far, the company can’t work without her, but after the expansion and formalization of the marketing department, the company could regain more bargaining power and dedicate whether to retain her in the future or not based on the cost spent.

 

 

Reference

 

Beyster, J. R. & Economy, P. 2007, The SAIC solution: how we built an $8 billion employee-owned technology company. New Jersey: John Wiley & Sons, Inc. p. 56

Bogardus, A. 2009, PHR / SPHR Professional in Human Resources Certification Study Guide. Indiana: Wiley Publishing, Inc. p.295

Brigham, E. F. & Houston, J. F. 2009, Fundamentals of financial management. Natorp Boulevard Mason: South Western Cengage Learning. p. 11

Bronwynne, B. 2007, Fresh Perspectives: Managing People. Cape Town: Pearson Education South Africa (Pty) Ltd. p. 65

Conger, J. A. 2009. Boardroom Realities: Building Leaders Across Your Board. New Jersey: John Wiley & Sons.

Deb, T. 2006. Strategic Approach to Human Resource Management, New Delhi: Atlantic Publishers and Distributors, p.76

Foulkes, F. K. 1991, Executive compensation: a strategic guide for the 1990s. United States: Harvard Business Press. p. 178

Green, B. F. & Mavor, A. S. 2003, Modeling cost and performance for military enlistment: report of a workshop. Washington, D. C.: National Academy Press. p. 129

Nieuwenhuizen, C. 2007, Business Management for Entrepreneurs. Cape Town: Juta and Co Ltd. p. 194

opm.gov 2010. Pay for Performance: Your Performance Management Program Is the Foundation. visited on 26 Feb 2012. [online] link: http://www.opm.gov/perform/pay_for_performance.asp

Preker, A. S. 2007, Public ends, private means: strategic purchasing of health services. Winshington, DC: The International Bank for Reconstruction and Development. p.151

siop.org. What is skill based pay? visited on 26 Feb 2012. [online] link: http://www.siop.org/userfiles/image/SIOP_SHRM_Skill_Based_Pay.pdf

White, J. 2003, Investing in Stocks and Shares: A Step-by-step Guide to Making Money on the stock market. Oxford: How To Books Ltd. p. 55

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